ACCA Financial Reporting (F7) Practice Exam

What is the purpose of deferred tax assets?

1. To reduce tax rates

2. To recognize future tax benefits due to deductible temporary differences

3. To eliminate tax liabilities

4. To provide immediate cash flow

The correct answer is: To recognize future tax benefits due to deductible temporary differences

Deferred tax assets serve the purpose of recognizing future tax benefits that arise from deductible temporary differences. These differences occur when there is a discrepancy between the accounting income and taxable income. This can happen, for example, when expenses are recognized in the financial statements before they are deducted for tax purposes, creating a future benefit. When a business incurs expenses that are not yet deductible for tax purposes, it will eventually receive a tax deduction in the future, leading to a reduction in taxable income down the line. The deferred tax asset reflects this future benefit as it represents potential future tax savings that the entity can use to offset against taxable profits in future periods. This recognition aligns with the accrual basis of accounting, emphasizing the importance of matching income and expenses in appropriate periods, and underscores the principle of recognizing tax implications of transactions as they occur rather than solely when the cash is exchanged. By acknowledging these future benefits in the form of deferred tax assets, the financial statements provide a more accurate picture of the entity’s financial position and the expected tax effect of its future operations.