Change in Deferred Taxes Statement of Cash Flows Impact

ijraklr's picture
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Im using the indirect method to calculate the cash flow statement. should i subtract increase in deferred tax asset and add back increase in deferred tax liability?

What is a Deferred Tax Asset (DTA)?

A Deferred Tax Asset is an asset on a company's balance sheet that reduces taxable income for a business. This represents a temporary difference between the cash taxes that are paid and the taxes that are reported under GAAP accounting. The DTA is found under current assets on the balance sheet. The concept is explained further in the video below.

Increase in Deferred Tax Assets Impact on Statement of Cash Flow (SOCF)

In the operations section of the statement of cash flow, we record the cash expenses and income.

When a deferred tax asset increases, a company has paid out more taxes now and they do not need to pay out later - therefore this is a current cash expense.

  • Increase in a DTA - decrease in cash balance
  • Decrease in a DTA - increase in cash balance

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Comments (17)

Feb 16, 2013

Yes. Your intuition is correct. It is an increase in an asset (i.e. a use of cash), so you would subtract it from the operating activities section on the CF statement.

If you think about it, a DTA represents taxes that a company has paid, but that haven't been reflected on the income statement (due to differences in GAAP and tax accounting). As such, the tax expense on the IC is actually understating the actual cash the company paid to satisfy its tax obligations.

Or in accounting (and as an example), you would:

cr. 100 cash used to pay taxes
dr. 60 tax expense
dr. 40 DFA

Feb 17, 2013
CountryUnderdog:

Yes. Your intuition is correct. It is an increase in an asset (i.e. a use of cash), so you would subtract it from the operating activities section on the CF statement.

If you think about it, a DTA represents taxes that a company has paid, but that haven't been reflected on the income statement (due to differences in GAAP and tax accounting). As such, the tax expense on the IC is actually understating the actual cash the company paid to satisfy its tax obligations.

Or in accounting (and as an example), you would:

cr. 100 cash used to pay taxes
dr. 60 tax expense
dr. 40 DFA

thanks! that's really helpful! Do you know if the increase in Noncontrolling interests should be adjusted using the indirect approach for cash flow statement? i started with net income (minority interest subtracted already)..

Feb 17, 2013

Sorry to intrude on your post but what is an nol? excuse my ignorance.

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Feb 17, 2013

net operating losses

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Feb 17, 2013

If you're asking what's the transaction to use NOLs it's debit cash & credit deferred tax asset for the amount of nol used

Feb 17, 2013

no, question is how is deferred tax asset treated? Is it a non-cash reduction from net income so added back on cash flow statement? And if deferred tax assets are credited what is the balancing entry? Finally, is the change in deferred tax asset reversed on cash flow statement? thx

Feb 17, 2013

yes, you add it back on CF statement. Deferred tax is debit to create it, credited to reverse it.

entry
dr. income tax expense
dr. deferred tax
cr. income tax payable

Feb 17, 2013

I always set up my dcf models for companies with NOLs with another tab for the nol. The NOL tab should calculate based on the taxable income, how much if the NOL will be used, and how much is left for future periods. You can then set up the DCF to pull from this tab.

Feb 17, 2013
valuationGURU:

I always set up my dcf models for companies with NOLs with another tab for the nol. The NOL tab should calculate based on the taxable income, how much if the NOL will be used, and how much is left for future periods. You can then set up the DCF to pull from this tab.

Ok, cool -- dpes the DTL arising from temporary differences not affect cash taxes?

Feb 17, 2013

I am not sure. I am not a CPA but I imagine this method is accurate enough given all the other assumptions in a dcf model

Feb 17, 2013

In PH's cashflow statement the deferred tax line is the amount of taxes from the income statement that were non-cash (i.e. deferred). Similar to the adjustment for depreciation and amortization, they just added the non-cash effect in there directly. In their case, cash taxes paid during the year were higher than the tax provision on the income statement, which is why the CFS adjustment is negative.

Note 4 reconciles the DTA change year over year on the balance sheet, and you'll see that there's a big effect from other comprehensive income. Since OCI is not contained in net income, just deducting the balance sheet change from net income wouldn't fully reflect the cash impact that deferred taxes had on the company over the year.

On a separate note, if what you're really after is trying to learn how to build a 3 statement model, you would probably be better served trying to build up a model of future years rather than reconcile historicals. There is always noise and special adjustments in the historical periods, but as long as you know how the normal items are supposed to work and can get a future BS, CF and IS to tie out - that's what really matters.

Feb 17, 2013

Downtown,
If I understand you correctly than the OCF deferred tax line item is the combination of the change in Net Deferred Taxes on the Balance Sheet Plus the Change in Net Deferred Taxes in the OCI section?

In a related question in calculating Enterprise Value and Invested Capital how do you handle the Net Deferred Taxes as of the valuation date or TTM?

Feb 17, 2013

Downtown,
If I understand you correctly than the OCF deferred tax line item is the combination of the change in Net Deferred Taxes on the Balance Sheet Plus the Change in Net Deferred Taxes in the OCI section?

In a related question in calculating Enterprise Value and Invested Capital how do you handle the Net Deferred Taxes as of the valuation date or TTM?

Feb 17, 2013
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