Income taxes and financial accounting
Abstract: The paper discusses the basic elements of tax allocation, analyzes extensively the principal timing difference: accelerated depreciation for tax purposes and straight-line depreciation for published financial reporting, looks into the major aspects of SFAS No. 109, and explores the difference of GAAP and IFRS on tax allocation.
1. Income tax allocation
In order to comply with IRS tax code and make sense of the tax expands for income statement analysis, income tax allocation involves with high level of complexity for financial statement. This paper tries to explain how income tax allocation works by comparing of accelerated tax ...view middle of the document...
In 1992, SFAS No.109 came out to solve the problem of conservatism by SFAS No.96. Basically, for recognizing deferred tax assets, SFAS No. 109 is much more flexible and liberal than SFAS No. 96. SFAS No. 109 only required sensible assurance of recognition of deferred tax assets, while SFAS No. 96 need much more specificity. Moreover, SFAS No. 109, instead of SFAS No. 96, recognized tax loss carry-forwards as deferred tax assets. In addition, difference could be found in the classification of current and noncurrent deferred assets and liabilities between SFAS No. 96 and 109. There are reverses from current and noncurrent deferred assets and liabilities by SFAS No. 96, which recognizes reversal from noncurrent to current within a year or the operating period. SFAS No. 109 specifies the current or noncurrent differences by the time when deferred assets or liabilities occur. Hence, noncurrent are the deferrals by tax and book depreciation differences, while current are differences between accrual methods of bad debt and actual write-offs of uncollectibles.
1.2 The rationale of income tax allocation
Thomas (1974, 146) stated that tax allocation embodies the allocation problem in one of its most pathological forms…tax allocation may be perceived as an attempt to make allocation consistent, and its allocation problems are the consequences of other allocations. The basis rationale of income tax allocation is the proper and consistent allocation of income tax in the suitable place in financial reporting for users to interpret and analyze. The rationale is based on matching concept. Not as usual usage of matching in other cases, (e.g. gains are matched against losses), the matching concept applied by the tax allocation dedicates to match income tax expense with pre-tax accounting income in a standardized way. Because pre-tax income tax is highly related to the after-tax income, the matching concept results in the placement of tax allocation in the last place of the income statement. Within the framework of historical cost approach, using asset values based on the actual amount on money paid for assets with no inflation adjustment, also support the rationale of income tax allocation.
Even though income tax allocation could be a smoothing tool to balance the timing difference between timing difference between time of the tax return and the time of the publication of the financial statement, it would be rather to be a system outcome, which is demand by the IRS and SFAS No.109. In this way, rigid uniformity comprehensive allocation is in favor for use with an income statement focus on the asset-liability approach.
1.3 Tax allocation and accelerated depreciation
In the widely use viewpoint, the most significant applications of income tax allocation is accelerated depreciation for tax purposes and straight-line depreciation for financial reporting. Straight-line depreciation method is the easiest and most widely used method of depreciation. The...