How to calculate Deferred Tax Assets, Calculation of Change in Trade Receivables & Payables in CFO

Modified on July 2, 2018

The current article in this series provides responses related to the following queries:

  • What is Deferred Tax Asset and how do we calculate it?
  • How to calculate changes in trade receivables/payables for the cash flow statement?
  • Resources to understand Deferred Tax Assets & Deferred Tax Liabilities?

 

What is Deferred Tax Assets and how do we calculate it?

Hi Dr. Vijay,

I attended your “Peaceful Investing” Workshop in Bangalore in July 2017 and was impressed by your clarity of thought and attention to detail. Thanks for teaching investors like me, the tricks of this trade.

I was doing the fund flow analysis for JHS Svendgaard and had a doubt with the deferred tax asset part of this company’s balance sheet. I have attached my fund flow analysis for this company, but I am not entirely clear as to why deferred tax assets are being added instead of being subtracted. If you shed some light on this aspect, it would be helpful.

 

How to calculate Deferred Tax Assets, Calculation of Change in Trade Receivables & Payables in CFO

Regards,

Author’s Response:

Hi,

Thanks for writing to us! It was great to have you at the workshop!

You would notice that the deferred tax assets have increased by ₹17 cr. In case of fund flow analysis, we treat all asset increases as outflow.

Deferred tax assets (DTA) are equivalent to excess tax paid to tax authorities, which would be adjusted against profits of future. Such assets are usually created under two circumstances:

1) Due to losses: E.g. in case of JHS, you would read at page 99 that the company sold a few fixed assets not in active use and Waves Hygiene Products in FY2016. It had sold them at a loss (about Rs. 17 cr.) and it would adjust this loss against profits of future years.

How to calculate Deferred Tax Assets, Calculation of Change in Trade Receivables & Payables in CFO

Further Advised Reading: Understanding the Annual Report of a Company

2) Due to different treatment of expenses by companies act and income tax act: E.g. when income tax act does not allow something to be deducted as an expense which is otherwise allowed by companies act as an expense. In these cases, the company will pay higher tax as per income tax act than as per companies act.

In case of JHS, the DTA is primarily due to the loss on sale of assets as per the disclosures in the annual report. However, we find uncertainty in a few things about the manner in which JHS has shown it in the annual report:

1) Usually, the deferred tax asset is created equal to the impact the loss/excess paid tax will have on the future tax payments. E.g. if the tax rate is 30% and the company books a loss of Rs. 100 cr., then in future it can adjust this loss of Rs. 100 cr. against a profit before tax up to Rs. 100 cr and in turn avoid paying an income tax of Rs. 30 cr. Therefore, the DTA should be Rs. 30 cr. and not the entire loss amount of Rs. 100 cr. Therefore, we are not able to understand the amount of DTA shown by JHS from the limited review of the annual report

2) Regarding the addition of an almost full amount of loss as DTA in the tax section in the P&L, it is again difficult to understand on the similar lines of argument in the point 1 above. It seems that this entry in the tax section of P&L, which increases PAT, is needed to show higher reserves/equity on the liability side of the balance sheet. Showing higher equity/liabilities is essential because on the asset side the company seems to have shown higher assets (entire loss e.g. Rs. 100 instead of only the amount of benefit/adjustment in future tax e.g. Rs. 30).

Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?

We believe that a CA can be a better person to comment whether JHS is right in handling the treatment of business losses in the manner that it did or it is an attempt to inflate profits. It might be that there is more information required from the company about any other key items, which have affected the treatment of business losses to make it treat the entire loss as DTA instead of only the amount of future tax benefits.

To get a brief overview of DTA, you may read the following article on Investopedia: https://www.investopedia.com/terms/d/deferredtaxasset.asp

All the best for your investing journey!

Regards,

Dr. Vijay Malik

 

 

How to calculate changes in trade receivables/payables for the cash flow statement?

Dear Doctor,

I have a doubt on Fund Flow Analysis. While analyzing the balance sheet with respect to cash flow statement, the amount seems to be a bit different. Could you please assist me?

The change in the trade receivables, as well as trade payables in the balance sheet, is many times different from the changes mentioned in the cash flow statement.

Regards,

Author’s Response:

Hi,

Thanks for writing to us!

In the cash flow statement, many times, companies club the trade receivables and trade payables with certain other items under current assets and current liabilities respectively. Therefore, many times, investors would notice that the figures of changes in only “Trade receivables” and “Trade Payables” are not matching with the figures in cash flow statement.

Further advised reading: Understanding Cash Flow from Operations (CFO)

Moreover, you would notice that in the cash flow statement, the companies have started labeling these items as “Trade and other receivables” and “Trade and other payables”.

In the “Trade and other receivables”, most of the times, the items under “Short-term loans & advances” (STLA) are clubbed. You may go through the details of the items under “Short-term loans & advances” (excluding the changes in the tax-related items under STLA) and try to club their changes with trade receivables and in most of the cases, you would be able to approximate/tally it with the figures in the cash flow statement.

Similarly, in case of “Trade and other payables”, many times, companies club other items under current liabilities, especially from section “Other current liabilities” and provisions along with trade payables. Therefore, there are differences in the changes in the “Trade payables” in the balance sheet and the cash flow statement. You may study the items under “Other current liabilities” and “provisions” and see their changes. They will provide you the explanation for the differences observed by you.

Hope it will resolve your queries.

All the best for your investing journey!

Regards,

Dr. Vijay Malik

 

 

Resources to understand Deferred Tax Assets & Deferred Tax Liabilities?

Dear Vijay,

Hope you are doing well.

I request your inputs on deferred tax implications.

Can you please guide me to understand the implications if a company posted quarterly results with an increase in deferred tax when comparing Q-o-Q results? This question came to me while going through recently declared results by Pennar Industries. There is a significant change in deferred taxes and current tax liability from Sep’ 2017 to Dec’ 2017.

In addition, if a company deferred taxes to a later period, where does it show in their balance sheet?

I appreciate your time and valuable inputs.

Regards,

Author’s Response:

Hi,

Thanks for writing to us!

We would request you to go through the following articles to understand more about deferred tax assets (DTA) and liabilities (DTL):

DTA: https://www.investopedia.com/terms/d/deferredtaxasset.asp

DTL; https://www.investopedia.com/terms/d/deferredtaxliability.asp

The above articles would give you a lot of understanding about deferred tax.

The deferred tax assets, as well as liability, are shown on the balance sheet. DTA under non-current assets and DTL under non-current liabilities. Many times, when companies have both DTA and DTL due to different factors, then they may adjust one with other and then the net DTA or net DTL on assets side or the liabilities side, as the case may be.

All the best for your investing journey!

Regards,

Dr. Vijay Malik

P.S.

 

DISCLAIMER

  • The above discussion is only for educational purpose to help the readers improve their stock analysis skills. It is not a buy/sell/hold recommendation for the discussed stocks.
  • I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013.
  • Currently, I do not own stocks of the companies mentioned above in my portfolio.

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