Hi, in the last post we covered deferred tax assets and liabilities. Today we will look into tax base and carrying value.
Temporary differences due to difference in the tax base and carrying amount of assets and liabilities lead to the creation of deferred tax assets and liabilities. Tax base is the amount attributed to an asset or liability for tax purposes, where as carrying amount is the value at which an asset or liability is carried on the financial statements.
Tax base of an asset
Tax base of an asset is the amount that will be deductible for tax purposes in future as the economic benefits of the asset are realized. Let’s understand tax base and carrying value and the deferred tax assets and liabilities that they lead to with the following examples.
The cost of equipment is $100000 and the depreciation expense recognized on the income statement is $10000. The depreciation expense on the tax return is $ 25000.
At the end of the first year, the tax base is $75000 ($100000-$25000) and the carrying value is $90000 ($100000 – $10000).
A deferred tax liability of $15000 * tax rate is created. This is because less depreciation expense has been recognized on the income statement, leading to higher net income and higher income tax expense on the income statement, while the taxes actually paid are lower due to the higher depreciation recognized on the tax return. These taxes will be payable in future.
Research and Development
Let us assume $50000 of R&D costs was fully expensed on the income statement during the year. On the tax return the R&D costs were capitalized and amortization expense of $25000 was recognized.
At the end of the year, the tax base is $50000 – $25000 = $25000. The asset has no carrying value on the balance sheet as it was completely expensed during the year.
In our example, this situation will lead to the creation of a deferred tax asset. This is because the net income before tax on the income statement is lower than taxable income as the entire R&D costs of $50000 was expensed, while on the tax return the depreciation expense was only $25000.
Let us assume gross outstanding receivables are $10000 and the company has recognized bad debt expense of $1000. Therefore the carrying value of the asset is $9000. Tax base of the asset will be $10000 as bad debt expense cannot be recognized on the tax return until the receivables are deemed totally unrecoverable.
This situation will lead to the creation of a deferred tax asset as the taxable income will be higher than net income before tax. This will lead to more actual taxed paid than income tax expense recognized on the income statement. Deferred tax asset will lead to less tax outflow in future periods.
Tax base of liabilities
Tax base of a liability is the carrying amount of the liability less any amounts that would be deductible for tax purposes in the future. Let’s understand tax base of liabilities with examples.
$1000 has been received from a customer during the year for goods to be shipped the next year. For tax purposes, unearned revenue is taxable when collected. For accounting purposes, unearned revenue is a liability which will be reduced as revenue is collected over future periods and recognized to the income statement.
Since the customer advance has already been taxed it will not be taxed in future, therefore the tax base is zero. Since $1000 has been taxed as revenue but not yet reported on the income statement a deferred tax asset is created.
The firm has a outstanding promissory note with principal of $10000 and interest accrues on it at 5% and is payable at the end of the quarter.
Promissory notes are treated the same way on financial statements and on tax returns. The carrying value and the tax base both are $10000. Interest paid is included both on the tax return as well as on the income statement. Therefore there is no deferred asset or liability created.
That’s all in this post guys….in the next post we will cover impact of tax rate changes ….stay posted.
For solved examples please refer to the CFA Institute books or CFA study materials. The problems can be easily solved using the CFA institute approved financial calculators. Please refer to the CFA exam policy and CFA calculator guide.
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