Introduction
Financial accounting rules have tended to differ regarding the linking of tax liabilities and payments to reported earnings (Diehl, 2010). Recently, the differences between book and tax earnings have drawn a lot of attention on accounting issues. The deferred tax positions have tended to increase with the increase in the reliance of fair-value accounting over transaction-driven cash basis accounting (Diehl, 2010). This paper seeks to examine whether deferred tax assets (DTAs) and deferred tax liabilities (DTLs) satisfy the definition and recognition criteria for assets and liabilities according to the AASB framework for the preparation and presentation of Financial Statements. The paper will also determine if the answer will change if the asset and liability definitions in the IASB/FASB proposed Conceptual Framework were to be applied.
Definitions and recognition of assets and liabilities according to the AASB Framework for the preparation and presentation of Financial Statements
The AASB framework defines “Assets” as future economic benefits controlled by an entity as a result of past transactions or other past events (AASB, 2008, p. 13 ). The criteria for recognition of assets states that: “an asset is recognized in a financial statement when it’s probable that the future economic benefit embodied in the asset will eventuate, and that the asset has a cost or other value that can be determined reliably” (AASB, 2008, p 22).
The AASB framework defines “liabilities” as future sacrifices of economic benefits that the entity is presently obliged to make to other entities as a result of past transactions or events. A liability is “recognized in the statement of financial position when it’s probable that the future sacrifice economic benefits will be required, and when its amount can be measured reliably” (AASB, 2008, p. 25).
How deferred tax liabilities (DTLs) and deferred tax assets (DTAs) arise and whether they fit the definition and recognition of assets and liabilities by the AASB
The total tax expense accrued by a company is equal to its statutory corporate tax multiplied by its taxable book income (Diehl, 2010). The taxable book income, “which often matches with the income earned today, but which is to be taxed at some point in the future, is equal to the pre-tax book income minus the permanent disparities between book and tax income” (Diehl, 2010, p. 15). Permanent differences occur when tax rules and accounting rules differ on constituents of income or expenses. For instance, the reporting of fines and penalties is usually not taxed but is deducted in the computation of book earnings. The permanent book-tax differences do not result in deferred tax assets or deferred tax liabilities because their effects on a company’s accounting earnings are seen.
On the other hand, “the temporary book and tax differences occur when the accounting rules and tax rules do not agree on the time of recognizing a component of income” (Diehl, 2010, p. 16). For instance, the recognition of expenses accrued due to compensation such as bonuses. Various accounting standards often attempt to reconcile efforts and accomplishments and thus factor in expenses incurred even if they are yet to be paid (IASB, 2006).
The tax code often tries to limit the number of assumptions in the computation of taxable income and therefore it more readily adopts cash-based accounting for different expenses. A current tax expense can be defined as a firm’s estimate of the taxes that will be reported on its current year’s tax returns (Diehl, 2010). The differences between a firm’s current tax expenses and its total tax expense usually generate the disparities between book and tax. These disparities are identified as deferred tax expenses.
Temporary differences can occur as a result of many diverse circumstances, for instance, the differences between accounting and tax rules. The “deferred tax assets and liabilities are described as the current statutory corporate tax rate times the historical sum of the firm’s temporary differences” (Diehl, 2010, p. 25). If the temporary differences are positive for a given firm, i.e., the cumulative total tax expense exceeds the cumulative current tax expenses. A firm in such a situation has a deferred tax liability (DTL) (Diehl, 2010). DTL means that a company has future taxes to pay on income that has already been booked for accounting.
On the other hand, a company or firm whose taxable income is higher than its book income has a deferred tax asset (DTA) which implies that the company is owed future tax relief (Diehl, 2010). According to the FASB/IASB conceptual framework, the recovery of deferred tax liability is more direct as it is better captured in the tax code. However, the recovery of deferred tax assets is a bit complicated and depends on whether they are previously planned to be reflected in the future financial statements when payment is to be done.
The above description shows how DTA and DTL develop, implying that they can be evaluated and determined. This finding is consistent with the AASB definition and criteria for recognizing Assets and Liabilities in the statement of financial position. The AASB’s definition and recognition criteria for assets and liabilities defer in wording from that of both IASB and FASB but mean the same thing. However, the proposed IASB/FASB definition emphasizes the present rather than the past and future in the definition of assets and liabilities.
Proposed IASB/FASB framework scenario
The working definition of an asset proposed by the IASB/FASB refers to an asset as a “present right or another present privilege, of the entity to a resource that is capable of generating economic benefits to the entity either directly or indirectly” (IASB, 2006, p. 3). The proposed IASB/FASB “definition of liabilities is present obligations to other entities that compel potential outflows or other sacrifices of economic benefits” (IASB, 2006, p. 7).
The newly proposed definitions outlined above do not alter the idea of liabilities and assets in a major way. They only provide a more disciplined way of determining if particular items fit in the definitions (Diehl, 2010). Thus, deferred tax assets (DTAs) and deferred tax liabilities (DTLs) still satisfy the definition and recognition criteria for assets and liabilities even when the proposed IASB/FASB Conceptual Framework (IASB, 2006).
Conclusion
This paper sought to examine whether deferred tax assets (DTAs) and deferred tax liabilities (DTLs) satisfy the definition and recognition criteria for assets and liabilities according to the AASB framework for the preparation and presentation of Financial Statements. It also sought to determine whether that would change with the change in assets and liability definitions in the IASB/FASB proposed Conceptual Framework. The paper has established that both DTAs and DTLs satisfy the definition and recognition criteria for assets and liabilities according to AASB Framework. It has also established that nothing will change if definitions in the proposed IASB/FASB are adopted.
References
AASB. (2008). Definition and Recognition of the Elements of Financial Statements. Victoria: Australian Accounting Research Foundation.
Diehl, K. (2010). How deferred tax assets and liabilities influence US stock prices. Illinois: Western Illinois University.
IASB. (2006). Conceptual Framework: Liability and asset definition. London: IASB.