IB Interview : Level 3 Accounting Questions - Part 2
Deferred Tax Assets and Liabilities
1. What gives rise to Deferred Taxes?
GAAP and IRS Tax accounting rules are often quite different from each other.
When there are disconnects between the two that will revert over time, those disconnects result in temporary differences which create Deferred Tax Assets and Liabilities.
If you owe more IRS tax now (relative to GAAP tax) it creates a Deferred Tax Asset.
If you owe less IRS tax now (relative to GAAP tax) it creates a Deferred Tax Liability.
2. What impact does a $10 increase in Deferred Tax Assets (or Liabilities) have on Cash Flow? Why?
This seems like a trick question, but Deferred Tax Assets and Liabilities follow the same rules for Sources and Uses of cash as traditional Working Capital items.
An Increase in an Asset is a Use of Cash, whereas a Decrease in an Asset is a Source of Cash.
An Increase in a Liability is a Source of Cash, whereas a Decrease in a Liability is a Use of Cash.
3. Bonus depreciation allows you to take 100% depreciation for tax purposes in year 1. Does this create a Deferred Tax Asset or Liability?
Bonus Depreciation creates a significant deduction today which lowers our tax bill now, but we have no future deductions so we pay more tax later.
Lower tax paid now, more tax paid later results in a Deferred Tax Liability.
4. If you run a subscription business where customers prepay for multiple years of service, does this create a Deferred Tax Asset or Liability?
If customers prepay for future years of service, the IRS is likely to require taxes to be paid before the Revenue is recognized.
This results in a higher tax bill in the early years and lower taxes in later years. More tax paid now and less tax paid in the future results in a Deferred Tax Asset.
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