Key Takeaways
- A deferred tax asset is recognised only to the extent that future taxable profit will be available to absorb the deductible temporary differences or losses.
- IAS 12 requires reassessment at every reporting date, with previously unrecognised deferred tax assets recognised if recoverability becomes probable.
- Entities with a recent history of losses face a higher evidence bar: IAS 12.35 requires convincing evidence beyond the losses themselves.
- Getting the recoverability assessment wrong overstates net assets and understates the effective tax rate, both of which hit the audit opinion.
What is Deferred Tax Asset?
IAS 12.24 requires an entity to recognise a deferred tax asset for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the temporary difference can be used. The same principle applies to unused tax losses and unused tax credits under IAS 12.34. "Probable" here carries its IFRS meaning (more likely than not), but the standard layers on additional conditions. Where an entity has a history of recent losses, IAS 12.35 limits recognition to the amount supported by sufficient taxable temporary differences reversing in the same period, or by convincing other evidence that enough taxable profit will arise.
The measurement rule at IAS 12.47 requires deferred tax assets to be measured at the tax rates expected to apply when the asset is realised, based on rates enacted or substantively enacted at the reporting date. The auditor's focus under ISA 540.13(a) lands on management's profit forecasts: the projections that support recoverability are accounting estimates with embedded assumptions about revenue growth, margin recovery, and the timing of temporary difference reversals. IAS 12.82 also requires disclosure of the amount and expiry dates of unused losses for which no deferred tax asset is recognised, a line item that inspection teams review closely.
Worked example: Bergstrom Skog AB
Client: Swedish forestry and paper company, FY2025, revenue EUR 75M, IFRS reporter. Bergstrom has an unused tax loss carryforward of EUR 4.8M from FY2023, when a downturn in pulp prices produced a pre-tax loss. The Swedish corporate tax rate is 20.6%. In FY2024 the company returned to profitability (EUR 2.1M taxable profit), and FY2025 taxable profit is EUR 3.4M. Management forecasts taxable profit of EUR 3.0M annually for FY2026 and FY2027.
Step 1 — Identify the deductible item
The EUR 4.8M tax loss carryforward is the source of the potential deferred tax asset. Sweden does not impose an expiry on tax loss carryforwards, though an annual limitation restricts use to 50% of taxable profit exceeding SEK 5M (approximately EUR 440,000) in any single year.
Documentation note: record the loss carryforward amount, the jurisdiction's carryforward rules, and confirm no change of ownership restriction applies under Swedish law. Reference IAS 12.34.
Step 2 — Assess recoverability
Bergstrom has a recent loss history (FY2023). IAS 12.35 requires evidence beyond the existence of the loss itself. The entity returned to profit in FY2024 and FY2025. Management's board-approved forecasts project EUR 3.0M annual taxable profit for the next two years. After applying the Swedish limitation rule, approximately EUR 1.3M of the loss can be used per year against profit above the threshold, plus unrestricted use against the first SEK 5M. The team estimates full utilisation within four years.
Documentation note: record the profit forecasts, the board approval date, the loss utilisation schedule year by year, and the basis for concluding that taxable profit is probable per IAS 12.35–36. Cross-reference to the FY2024 actual results as corroborative evidence of the forecast trend.
Step 3 — Measure the deferred tax asset
EUR 4.8M multiplied by the enacted rate of 20.6% produces a gross deferred tax asset of EUR 989,000. Because the full loss is expected to be utilised (supported by forecasts and the absence of an expiry date), the entire EUR 989,000 is recognised.
Documentation note: record the tax rate source (Swedish Income Tax Act, substantively enacted at the reporting date), the calculation, and the sensitivity analysis showing the effect on the deferred tax asset if taxable profit falls 25% below forecast. Per IAS 12.47, confirm the rate reflects the manner in which the asset is expected to be realised.
Step 4 — Reassess at year-end
At 31 December 2025, EUR 3.4M of taxable profit has absorbed a portion of the carryforward. The remaining loss is EUR 1.4M (EUR 4.8M less EUR 3.4M absorbed in FY2025, after applying limitation rules across FY2024 and FY2025). The deferred tax asset reduces to EUR 288,000. The EUR 701,000 reduction flows through tax expense in the income statement.
Documentation note: record the revised loss carryforward schedule, the journal entry reducing the deferred tax asset, and the reconciliation of the effective tax rate per IAS 12.81(c). Confirm the remaining EUR 288,000 is still recoverable based on the FY2026 forecast.
Conclusion: the deferred tax asset of EUR 288,000 at year-end is defensible because the recoverability assessment rests on two years of actual profits corroborating the forecast, the tax rate is enacted, and the utilisation schedule accounts for Sweden's annual limitation rule.
Why it matters in practice
- Teams recognise deferred tax assets on loss carryforwards without documenting why future taxable profit is probable. IAS 12.82 requires disclosure of the amount of deductible temporary differences and unused tax losses for which no deferred tax asset is recognised. ISA 540.18 requires the auditor to evaluate whether the point estimate is reasonable. Accepting management's forecast at face value, without testing the assumptions or comparing to historical accuracy of prior forecasts, leaves the recoverability conclusion unsupported.
- Deferred tax assets and liabilities are frequently netted without verifying the conditions in IAS 12.74. Netting is permitted only when the entity has a legally enforceable right to set off current tax assets against current tax liabilities and the deferred amounts relate to the same taxable entity and the same taxation authority. Netting across jurisdictions or across entities that file separate returns violates the standard and misstates both the asset and liability lines.
Deferred tax asset vs. deferred tax liability
| Dimension | Deferred tax asset | Deferred tax liability |
|---|---|---|
| Source | Deductible temporary differences, unused tax losses, unused tax credits (IAS 12.24, 12.34) | Taxable temporary differences where the carrying amount exceeds the tax base (IAS 12.15) |
| Balance sheet effect | Increases net assets; represents future tax savings | Increases liabilities; represents future tax payments |
| Recognition test | Recognised only when future taxable profit is probable (IAS 12.24) | Recognised for all taxable temporary differences unless a specific exemption applies (IAS 12.15) |
| Reassessment direction | Previously unrecognised assets may be recognised when prospects improve (IAS 12.37) | Existing liabilities may be reduced when the temporary difference reverses or the tax rate changes |
| Common audit risk | Overstated: recoverability not supported by evidence | Understated: taxable temporary differences omitted or misclassified |
The practical difference matters because the recognition threshold is asymmetric. A deferred tax liability is recognised for nearly every taxable temporary difference. A deferred tax asset requires a probability assessment that depends on forward-looking profit projections. This asymmetry means the audit effort on deferred tax assets is heavier, and the documentation requirement (forecasts, utilisation schedules, sensitivity analysis) is correspondingly greater.
Related terms
Frequently asked questions
How do I audit the recoverability of a deferred tax asset?
Obtain management's taxable profit forecasts and compare them to historical results over at least three prior periods. Test the key assumptions (revenue growth, margin projections, timing of temporary difference reversals) against external evidence where available. ISA 540.13(b) requires the auditor to evaluate whether the data and significant assumptions are appropriate. If the entity has a loss history, verify that the evidence meets the higher bar in IAS 12.35.
Does a deferred tax asset expire?
It depends on the jurisdiction. Some countries impose time limits on loss carryforwards (Germany caps utilisation rather than imposing expiry; the Netherlands limits carryforward to nine years as of 2022). IAS 12.34 requires assessment of whether the losses will be used before any statutory expiry. The auditor should confirm the applicable local law and reflect any expiry constraint in the utilisation schedule.
When do I reassess a previously unrecognised deferred tax asset?
At every reporting date. IAS 12.37 requires the entity to reassess unrecognised deferred tax assets and recognise them to the extent that it has become probable that future taxable profit will allow recovery. A change in circumstances (return to profitability, a new contract, or a restructuring that improves the profit outlook) can trigger recognition that was not justified in the prior period.