Importance of timing differences in accounting and businesses
In business, it is important to make an accurate tax return so as to avoid the costs associated with penalties that arise from filing wrong returns. An accountant needs to note down the differences in the timing of the amount of income to be taxed and accounting income. Proper identification of temporary differences helps an entity to accurately calculate deferred tax assets for a future deductible amount and deferred tax liability for a future taxable amount.
Temporary and permanent differences
For businesses, financial income is different from taxable income. Adjustments are always made on the financial income so as to get taxable income. Disparities in the timings of the identification of revenue and expenses in the books of account and tax reporting cause variations between financial income and taxable income. These differences in timings also cause a difference in income tax payable (when making tax returns) and income tax expense in the income statement. The differences between financial income and tax income give rise to either permanent or temporary differences. The temporary tax difference arises from the timing differences with regard to reporting of income or deducting of expenses that are the difference between the carrying amount of an asset and liability and its tax base. “The temporary differences create a deferred tax liability for future taxable amounts and deferred tax assets for future deductible amounts” (Financial Accounting Standards Board, 2012b). On the other hand, permanent differences arise from the inclusion of certain expenses or the exemption of certain types of revenues from taxation. These nontaxable revenues and nondeductible are used in the computation of financial income and not taxable income. The differences do not cause any accounting problems.
Current and deferred tax assets and liabilities
Deferred tax liability comprises temporary differences that will result in net taxable amounts in upcoming years. Deferred tax liability is recognized in the present year for the related taxes. This liability is payable in future years. Therefore, deferred tax liability matches with the meaning of a liability in the FASB concepts statement No. 6, Elements of Financial Statements (Financial Accounting Standards Board, 2012a). Therefore, “deferred tax liability represents a probable future sacrifice-taxable amount in future years will result from events whose occurrence is already assumed in an enterprise’s statement of financial position for the current year – recovery of the reported amount of receivable” (Financial Accounting Standards Board, 2012a). On the other hand, temporary differences give rise to deferred tax assets. These are benefits that give rise to deductible amounts in upcoming years. It is important to note that a deferred tax asset is recognized after reducing the amount of deferred tax liability. Secondly, deferred tax asset is recognized “to the extent that net deductible amounts in future years would be recoverable by a carryback refund of taxes paid in the current or prior years” (Financial Accounting Standards Board, 2012a). This shows the asymmetry of deferred tax liability. This statement is consistent with the FASB concepts Statement No. 2, Qualitative Characteristics of Accounting Information. Therefore, it is evident that the calculation of deferred tax assets and deferred tax liability is consistent with the accounting practice despite the fact that they are guided by tax laws. Since the two laws are consistent it gives people in businesses ease of preparing financial reports and tax returns.
References
Financial Accounting Standards Board. (2012a). Summary of Statement No. 96. Web.
Financial Accounting Standards Board. (2012b). Summary of Statement No. 109. Web.