What are deferred taxes?

The need for deferred tax accounting arises because companies often postpone or pre-pays taxes on profits pertaining to a particular period.

Deferred tax liability

There may be a difference in the way certain items of expense are allowed to be treated for tax purposes and how a company actually treats them. Tax laws allow full depreciation in the first year after a company acquires certain assets. However a company may actually write off the depreciation over several years on its financial statements. The company may charge depreciation at lower rates than allowed under tax laws. Or it may use a different method of charging depreciation. Example: Pre-issue expenses expenses on !"# or expenses incurred on mergers$ may be allowed to be written off over a fixed number of years. The company may stretch the write-off over a longer period. %n these cases$ a company ends up postponing part of its tax liability on this year&s profits to future years. This is because$ in the current year$ its profits for tax purposes would be lower than the profits computed for accounting purposes. 'ew accounting standards require that a company carve out a part of its current year&s profits (equal to the future tax liability on such transactions) as a deferred tax liability. The deferred tax liability serves the purpose of a reserve$ which will be drawn down in the future years to meet the company&s future tax liability.

Deferred tax asset

The tax laws may not recogni*e some of the expenses that a company has accounted for in its accounts. +or instance$ provisions made at the discretion of the management$ such as those for bad debts$ which are not fully recogni*ed by tax authorities. %n such cases$ a company is actually pre-paying taxes pertaining to future years. +or the year$ the profits that the taxman calculates would be higher than those computed by the company. Therefore a company would save on tax in the years when the expenses or provisions actually materiali*e.

Accounting for a deferred tax asset?

, company may recogni*e the excess tax paid over and above the tax liability as a -deferred tax asset-. However$ in the interests of conservative accounting$ companies should recogni*e such deferred tax assets only if they actually anticipate that their income in future will be enough to allow the company to set off the losses or the excess tax paid. %n other words if a company is

not profitable in the future there will be no tax savings to benefit from and therefore accounting for this asset is not .ustified. %f the analyst/s purpose is forecasting and he see0s to identify the persistent components of +1++$ then it is not appropriate to add bac0 deferred tax changes that are expected to reverse in the near future. %n some circumstances$ however$ a company may be able to consistently defer taxes until a much later date. %f a company is growing and has the ability to indefinitely defer tax liability$ an analyst ad.ustment to net income is warranted. 21onversely$ companies often record expenses for financial reporting purposes (e.g.$ restructuring charges) that are not deductible for tax purposes. %n this instance$ current tax payments are higher than reported on the income statement$ resulting in a deferred tax asset and a subtraction from net income to arrive at cash flow on the cash flow statement. %f the deferred tax assets is expected to reverse (e.g.$ through tax depreciation deductions) in the near future$ the analyst would not want to subtract the deferred tax asset in his cash flow forecast to avoid underestimating future cash flows. 3n the other hand$ if the company is expected to have these charges on a continual basis$ a subtraction is warranted to lower the forecast of future cash flows.4 5 If a company knows that it will have a tax benefit in the future they will recognize that benefit by accounting for a deferred tax asset. However, if the recognition of the ac uired deferred tax benefit results from an identifiable event after its occurrence it would be reported as a reduction of income tax expense for that period.

Adjusting for a deferred tax asset

There are two classifications for a deferred tax asset: 5. Expense: a. %s a bonifide 6,,P expense today b. %t is not a tax deduction today Is NOT subtracted from the cash flow calculation 7. !evenue a. 'ot a bonifide 6,,P expense today b. %t is however taxable income. ubtracted from the cash flow calculation
VIACOM INC 10-K 2003-12-31: Balance Sheet ASSETS 2003/12/31 2002/12/31 2001/12/31 2000/12/31 Deferred tax assets, net (Note 11) $69,000,000 $238,600,000 $359,700,000 $336,300,000 8y recogni*ing deferred tax liabilities in its boo0s$ a company ma0es sure that the tax liability Deferred tax assets, net (Note 11) $0 $289,000,000 for any particular year is reflected in that year&s financials and does not$359,700,000 carry over to future Total Deferred tax assets $69,000,000 $527,600,000 $336,300,000

Why account for deferred taxes?

profits for a period are from its LIABILITIES Deferred tax liabilities, net (Note 11)
Total Deferred taxes 5 +ree +low taxes 9aluation Changes in1ash Deferred

profits. %t brings investors one step closer to understanding exactly how much of a company&s operations (rather than from fiscal savings).
$297,200,000 $228,200,000 $755,800,000 $0 ($527,600,000) ($1,299,100,000) $1,131,200,000 $771,500,000 $176,300,000

$931,500,000 $595,200,000

VIACOM INC 10-K 2003-12-31: Cash Flow Increase in income taxes payable and net deferred tax liabilities 2003/12/31 $663,700,000 2002/12/31 $826,600,000 2001/12/31 $439,400,000 2000/12/31 $442,000,000

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