SFAS No. 109, “Accounting for Income Taxes,” requires inter-period tax allocation for temporary differences. Required:
a. Define the term temporary difference.
b. List the examples of temporary differences contained in SFAS No. 109. c. Defend inter-period income tax allocation.
a. Temporary Difference – Definition
An assumption inherent in an enterprise's statement of financial position prepared in accordance with generally accepted accounting principles is that the reported amounts of assets and liabilities will be recovered and settled, respectively. Based on that assumption, a difference between the tax basis of an asset or a liability and its reported amount in the statement of financial position will result in taxable or deductible amounts in some future year(s) when the reported amounts of assets are recovered and the reported amounts of liabilities are settled (SFAC No. 109, par. 11).
Income tax liabilities (or assets) can arise when the amount of pretax income reported on a company’s income statement is not the same as what is reported on the company’s income tax return. These differences arise since the income tax laws measure income differently than GAAP: tax accounting is performed on a cash basis, whereas GAAP uses the accrual basis. Therefore, temporary differences will arise when a company’s tax return and income statement report revenues and expenses in different years. When these temporary differences exist, companies determine income tax expense based on the income reported on the income statement, which is often different from the amount of taxes payable to the government. Although the temporary difference originates in one period, it reverses in subsequent periods and the tax laws permit companies to delay reporting their income as part of taxable income, therefore the company also delays paying taxes on that income. The temporary differences are due primarily to timing differences, since the timing of revenues, gains, expenses or losses in income often occurs in a different period from taxable income (Schroeder et al., 2011). It is also important to note that temporary differences affect multiple accounting periods and therefore income taxes are allocated between these accounting periods. Deferred tax assets are recognized as deductible temporary differences, whereas deferred tax liabilities are recognized as taxable temporary differences (Leahey, 1993). b. Temprary Differences – SFAS 109
Examples of temporary differences from paragraph 11 of SFAC No. 109 are listed below: a. Revenues or gains which are taxable after they are recognized in financial income. An asset (e.g. a receivable) may be recognized for revenues or gains that will result in future taxable amounts when the asset is recovered.
b.Expenses or losses which are deductible after they are recognized in financial income. A liability (e.g. a product warranty) may be recognized for expenses or losses that will result in future tax deductible amounts when the liability is settled.
c.Revenues or gains which are taxable before they are recognized in financial income. A liability (for example, subscriptions received in advance) may be recognized for an advance payment for goods or services to be provided in future years.
d. Expenses or losses that are deductible before they are recognized in financial income. The cost of an asset such as depreciable personal property may have been deducted for tax purposes faster than it was depreciated for financial reporting.
e.A reduction in the tax basis of depreciable assets because of tax credits.
f.An increase in the tax basis of assets because of indexing whenever the local currency is the functional currency.
g.An increase in the tax basis of assets because of indexing whenever the local currency is the functional currency. The tax law for a particular tax jurisdiction might require adjustment of the...