I don’t really get why a loss carryforward would result in a DTA, instead of a DTL.
My basic understanding of the DTA, DTL criteria is that if you paid less this time, you pay more in the future(if tax payable
If the taxable income is -$10000, then don’t you NOT pay tax for this period?
So, if you didn’t pay this time, you pay next time; which means DTL occurs - was my understanding.
The question was
In its first year of operations, a firm produces taxable income of -$10000. The tax rate is 40%. The firm’s BS will report a deferred tax:
A. asset of $4000
B. asset of $10000
C. liability of $4000
and I chose C…
I think I’m messed up here… Some help would be very nice.
If an entity has the loss carried forward that exactly means that its future tax liabilities will be reduced. Anyway reduction can only be realized in a case of determined tax liability in the further periods (this means that an entity should turn on positive results in the future).
If an entity will continue to realize losses in the future periods, it is likely that it will not realize the prior accumulated tax losses to reduce current tax liabilities. For this reason, according to IFRS, an entitiy can recognize loss carried forward as a DTA only if it is certain that it will achieve a reduction of future tax liabilities, while under USGAAP, the loss carried forward should be recognised as DTA but simultaneously on the allowance account entity should offset amount that is assumed there will not be realized. Therefore, loss carried forward is a DTA if it can be realized. In event of aquisition, if losses of targeted company can be realized as tax deduction, this fact would increase a value of target company because merger company can use those merged losses to deduct its own tax liabilities.
Flashback is absolutely correct… Breaking it down further…
In the current year, the company in your example made a loss of -10,000 and the tax rate is 40%.
40% of -10,000 is -4,000.
Since you can only make tax payment on Positive Cash flow, in the even that you have a negative cash flow, it becomes an asset for the firm which they can use to reduce their tax expense (liability) in the future.
Like Flashback rightly said, this will be recognised as an asset only if it is probable that it will be recovered, i.e., the firm will make positive profit in subsequent years which it will now use the -4,000 to reduce its tax expense for that year.
I hope this helps.
Exactly, maybe helps in better understanding DTA one of IFRS conditions met by item that can be recognized as an asset in BS, if it supposed that will bring future economic benefit to the owner. Benefits are not only received cash inflows than reduced future cash outflows as well. In the case of using DTA, reduced outflows are future tax payments (more cash remain to the shareholders).