Question

A friend of yours is working toward a master of business administration (MBA) degree. He e-mails you the following note:

"Hey! How are things going? I need your help! We are studying income taxes in my Financial Accounting class and just finished talking about deferred taxes. I think the professor said something about adjusting the value of deferred taxes when it's an asset but not when it's a liability. When I looked at my homework problem, the balance sheet shows both a deferred tax asset and a deferred tax liability. Shouldn't it be one or the other? And why would one need the value adjusted for one, but not the other? Help!"

You want to help your friend, but you remember having some questions yourself:

• Analyze why FASB requires companies to report both deferred tax assets and deferred tax liabilities instead of netting them.
• Examine why the FASB requires valuation adjustments for deferred tax assets but does not for deferred tax liabilities.

Answer 1

1 ) Analyze why FASB requires companies to report both deferred tax assets and deferred tax liabilities instead of netting them.

The existing standard on deferred taxes [Statement of Financial Accounting Standards (SFAS) 109, Accounting for Income Taxes] states that deferred taxes should be separated between their current and noncurrent portions because classifying them all as noncurrent would be confusing and lead to inappropriate current ratios. FASB changed this stance in the new standard because of its belief that the cost of separating deferred taxes between their current and noncurrent portions outweighs any benefits to financial statement users.

2 ) Examine why the FASB requires valuation adjustments for deferred tax assets but does not for deferred tax liabilities.

Balance of Deferred tax asset and deferred tax liability should be netted off i.e. either DTA or DTL should be disclosed in the balance sheet and both should not be disclosed simultaneously for the same period.

Enterprise should offset DTA and DTL if :

1) The enterprise has a legally enforceable right to set off e.g. Amount representing DTA, DTL falls under the purview of same governing taxation laws such as income tax act, 1961 and the laws permit to make a single net payment.

2) The enterprise intends to settle the asset and liability on a net basis.

DTA, DTL should be disclosed under a separate heading in the balance sheet separately from current assets and current liabilities.