One of the longest debates in accounting history is the issue of deferred taxes.
ID: 2461596 • Letter: O
Question
One of the longest debates in accounting history is the issue of deferred taxes. The controversy began in the 1940s and has continued, even after the FASB issued Statement of Financial Accounting Standards No. 109 in 1992. At issue is the appropriate treatment of tax consequences of economic events that occur in years other than that of the events themselves.
Required:
1. Distinguish between temporary differences and permanent differences. Provide an example of each.
2. Distinguish between intraperiod tax allocation and interperiod tax allocation (deferred tax accounting). Provide an example of each.
3. How are deferred tax assets and deferred tax liabilities classified and reported in the financial statements?
Explanation / Answer
Solution.
1.
Deferred Tax Liabilities – Deferred tax liabilities are anticipated future tax liabilities derived from situations where future taxable income will be greater than future financial accounting income due to temporary differences. All deferred tax liabilities are recognized on the balance sheet.
Deferred Tax Assets – Deferred tax assets arise when the amount of taxes paid in the current period exceeds the amount of income tax expense in the current period. They are anticipated future benefits derived from situations where future taxable income will be less than future financial accounting income due to temporary differences
The revenue and expenses we show in our balance sheet and income statement don’t always translate into income and deductions for tax purposes. Tax accounting and financial accounting have slightly different rules, which is why your business's taxable income isn’t always the same as the net income on your financial statements.
Some of these instances result in permanent tax differences. For example, interest income from municipal bonds is excluded from taxable income, and half of meals and entertainment expense is always disallowed. Other differences are temporary. These differences have to do with timing. You’ll end up recognizing the income and expenses eventually, but you just may recognize them sooner under one system than you do under the other.
A classic example of a temporary difference is financial and tax depreciation. Both systems allow depreciation, but tax laws allow you to accelerate your depreciation faster than you can under financial accounting. That means that, in early years, you may be able to claim a $5,000 depreciation expense on your taxes even though you’ve only listed $4,000 on your income statement. Conversely, in later years, you may only be able to claim $3,000 in depreciation for tax purposes while you have $4,000 listed on your books.
Temporary timing differences create deferred tax assets and liabilities. Deferred tax assets indicate that you’ve accumulated future deductions -- in other words, a positive cash flow -- while deferred tax liabilities indicate future cash outflows. For corporations, deferred tax liabilities are netted against deferred tax assets and reported on the balance sheet. For pass-through entities like S corporations, partnerships, and LLCs, they appear on a supporting schedule on your business tax return.
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