Accounting for Income Taxes
I. Overview – Accounting for income taxes involves both intraperiod and interperiod tax allocation. Intraperiod allocation matches a portion of the provision for income tax to the applicable components of net income and retained earnings. Income for federal tax purposes and financial accounting income frequently differ. Income for federal tax purposes is computed in accordance with the prevailing tax laws, whereas financial accounting income is determined in accordance with GAAP. Therefore, a company’s income tax expense and income taxes payable may differ. The incongruity is caused by temporary differences in taxable and/or deductible amounts and ...view middle of the document...
Tax laws or rates,
vii. Expected realization of a deferred tax asset, and the
viii. Tax status of the entity.
III. Comprehensive Interperiod Tax Allocation – Income Tax Return vs. Financial Statements
h. Objective – the objective of interperiod tax allocation is to recognize the amount of current and future tax related to events that have been recognized in financial accounting income.
ix. Current Year Taxes:
1. Payable (liability) or
2. Refundable (asset)
x. Future Year Taxes:
3. Deferred tax liability, or
4. Deferred tax asset (benefit)
i. Differences – There are two types of differences between pretax GAAP financial income and taxable income. All differences are either permanent differences or temporary differences.
xi. Permanent Differences
5. Permanent differences do not affect the deferred tax computation. They only affect the current tax computation. These differences affect only the period in which they occur. They do not affect future financial or taxable income.
6. Permanent differences are items of revenue and expense that either:
a. Enter into pretax GAAP financial income, but never enter into taxable income (interest income on state or municipal obligations) or
b. Enter into taxable income, but never enter into pretax GAAP financial income (dividends received deduction).
xii. Temporary Differences
7. Temporary differences affect the deferred tax computation.
8. Temporary differences are items of revenue and expense that may:
c. Enter into pretax GAAP financial income in a period before they enter into taxable income.
d. Enter into pretax GAAP financial income in a period after they enter into taxable income.
j. Comprehensive Allocation – The asset and liability (sometimes referred to as the Balance Sheet Approach) method is required by GAAP for comprehensive allocation. Under comprehensive allocation, interperiod tax allocation is applied to all temporary differences. The liability method requires that either income taxes payable or a deferred tax liability (asset) be recorded for all tax consequences of the current period.
xiii. Temporary differences are recognized for GAAP purposes before or after they are recognized for tax purposes; the related income tax effect will be recognized for GAAP purposes before or after it is recognized for tax purposes.
9. Items that are first recognized for tax purpose will eventually be recognized for GAAP purposes (or vice versa), therefore, the differences are temporary and will eventually “turn around”
10. These temporary differences affect future periods and require that:
e. A liability (for future taxable amounts), or
f. A benefit (for future deductible amounts)