How Does Deferred Tax Impact Statement of Cash Flows?
What is Deferred Tax?
Deferred tax is the difference between a company’s tax liability and tax paid to the government. It happens due to the temporary difference between accounting and tax treatment. It can be separated into deferred tax asset and deferred tax liability.
Deferred tax asset: This happen when the company’s tax paid is more than the tax liability, it will great deferred tax asset to settle the future tax expense. It is due to the accounting profit is less than tax profit.
Deferred tax liability: happen when the tax paid is less than tax liability. Tax paid is based on the taxable profit while tax liability base on the accounting profit. The accounting profit is more than taxable profit so it will create a future obligation for the company to pay in the future.
Deferred Tax on Statement of Cash Flow
If we prepare a statement of cash flow using the direct method, the deferred tax will not show in operating activities as it is not a cash transaction.
However, under the indirect method, the deferred tax will be adjusted to profit in the operating activities as the following rule:
- Increase in deferred tax asset will result as cash outflow, so it will adjust as negative side.
- Decrease in deferred tax assets will result as cash inflow, so it will be adjusted as positive side.
- Increase in deferred tax liabilities will result as cash inflow, so it will be adjusted as positive side.
- Decrease in deferred tax liabilities will result in cash outflow, so it will be adjusted as negative side.
Example of Deferred Tax on Statement of Cash Flow
Based on the company ABC’s financial statement, we have the following information:
|Cost of goods sold||(100,000)|
|– Payroll Expense||(20,000)|
|– Depreciation Expense||(10,000)|
|– Admin Expense||(10,000)|
|– Income Tax Expense||(1,000)|
|Deferred Tax Asset||20,000||15,000||(5,000)|
|Total Lia & Equity||730,000||759,000|
|Cash flow from operating activities|
|Add back: depreciation expense||10,000|
|Change in Working Capital:|
|– Increase in Inventory||(35,000)|
|– Decrease in deferred tax asset||5,000|
|– Increase in A/P||10,000|
|– Increase in Accrued Payable||10,000|
|Total Cash Flow from Operating Activities||9,000|