<< If Deferred Tax Liabilities (DTL) are not expected to reverse in the future, they are best classified as Equity (DTL decreased and Equity increased by the same amount) >> When we do this, what is the impact on income statement? Is there any line item in income statement to reduce the NI? I believe that we cannot simply reduce liability and increase equity.
“I believe that we cannot simply reduce liability and increase equity.” You can, in fact. Recall the accounting equation AED=LRC. As long as the equation balances, any combination is possible. As for your question, I believe theres no impact on IS.
May be I am missing something here… Say, company A and company B both are in same financial position(including DTL), except future performance(profit). company A has so much DTL and not going to make any profit in foreseeable future. company B has same amount of DTL and going to make profit just close enough to payoff DTL. company A can write off DTL and increase Equity company B can pay off DTL and that would result in increased Equity. Are we sayting that both company A and B are indifferent at the end of the day.
For company B, paying off DTL would not increase Equity. It would reduce assets (probably cash) by the amount of the payoff. Thus liabilities and assets will decrease by an equal amount, and equity will stay the same.
This question is outside the scope of CFA textbook, i think. When you are certain that the DTL will not be reversed in the future. Because DTL arose in the past period so you should make a prior period adjustment which is reported below the line, net of tax in the IS. However, the reasons for irreversible DTL might be due to change in account principle or estimates. Those changes are treated differently. Overall, they all go to equity.
The irreversibility of the DTL happens in the case of growing companies. When the assets of the company are growing every year and the differnce b/w pretax income and taxable income keeps on growing (majorily due to the depreciation). in this case there is no need of passing any accounting entry. the adjustment is only for analysis purpose. Bcoz once the company enters in to a stagnation phase after the growth phase, DTL will start reversing. secondly, the future profitablity of the company impacts the Deffered Tax Asset not deffered tax liability. bcoz even the company is incurring losses the DTL when reverses will reduce your losses (lower charge for depreciation for example) in the tax return and consequently the DTA. Hope this will answer your question.