Hi guys. I have 2 questions regarding deferred tax.

1. To calculate the cumulative deferred tax asset or liability, we take the difference between the carrying amount and the tax base and then multiply by the tax rate. But how do you know if its Carrying amount - Tax base or Tax base - Carrying amount?

2. The next question is about the example on deferred tax assets in the Schweser notes, reading #31, pg 237. In the second paragraph, it is stated that at the end of year 1, the carrying value of the warranty liability is \$100. And the tax base of the liability is 0. How did they arrive at 0?

From what I read, tax liability is the carrying amount of the liability - any amounts that will be deductible on the tax return in the future.

So, why is my understanding (below) wrong? At the end of year 1, the carrying amt of the liability = \$100 Amount that will be deductible in the future = \$200 since the warranty work is only performed in year 2.

Howdy.

Personally, I wouldn’t advocate thinking about it as Carrying amount – Tax base or Tax base – Carrying amount. I prefer to think about it this way: will I have a potential benefit in the future (i.e., lower future taxes to pay), or a potential detriment in the future (i.e., higher future taxes to pay); the potential future benefit is an asset (DTA), whereas the potential future detriment is a liability (DTL).

For temporary differences that arise from depreciation, suppose that the carrying amount is greater than the tax base. That means that you’ve depreciated more for taxes to date, so you’ve _ paid lower_ taxes to date; therefore, you’ll be paying higher taxes in the future. That’s a detriment, so it’s a DTL: (carrying amount – tax base) × future tax rate. If the carrying amount is less than the tax base, then you’ve depreciated less for taxes to date, so you’ve _ paid higher_ taxes to date, which means you’ll have lower taxes in the future; that’s a benefit: DTA: (tax base – carrying amount) × future tax rate.

You are correct that the tax base of the liability is the carrying amount less the amount deductible in the future.

The carrying amount for this year’s warranty expense is \$100. The amount of this year’s warranty expense deductible in the future is \$100. (The \$200 figure is for this year’s _ and next year’s _ warranty expense. Next year’s expense hasn’t been incurred yet, so it doesn’t figure into the calculation.) Thus, it’s \$100 – \$100 = \$0.

However, as I wrote above, a better way to look at it is that in the future you will be able to deduct an additional \$100 on your taxes (more than on your income statement), so that’s a DTA: multiply \$100 by the tax rate.

You’re welcome.