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Accounting for income taxes.

Deferred taxes arise when the accountant uses an accounting method for financial statement reporting different from income tax reporting. This usually creates a difference between net income per financial statements and net income per the tax return. Sometimes these differences are immaterial and other times the difference is significant. There are times when accountants must use generally accepted accounting principles (GAAP) for financial statement reporting. Generally, financial statements prepared in accordance with GAAP will have some reported income or expenses that will not have tax consequences in the current year. This difference is what is known as a timing difference.

In December 1987, FASB issued statement #96, Accounting for Income Taxes, which supersedes APB opinion #11 and is effective for fiscal years beginning after December 15, 1988. The objective of the statement is to account for current and deferred taxes payable because of temporary differences arising between financial statement reporting and tax reporting. A deferred tax liability or asset represents the amount of taxes payable or refundable in future years as a result of temporary differences at the end of the current year. Permanent differences such as interest on bonds exempted by tax law are not included in financial statement tax computations.

The basic principles of accounting for income taxes include:
 1. A current or deferred tax liability
 is recognized for tax consequences
 of all events recognized
 in the financial
 2. Current or deferred tax consequences
 are measured by applying
 current tax laws to determine
 the current or deferred
 3. Future enactments of a change
 in tax laws or rates are not anticipated
 for income or expenses
 for future periods.

"Tax is not recognized on financial statement income or expenses for future years. "

The term "timing difference" was used in APB opinion # 11 for differences between periods in which transactions affect taxable income and periods in which they entered into the determination of pretax financial income. Timing differences also created differences between the tax basis of an asset or liability and its financial basis. Statement #96 changes the terminology from timing differences to temporary differences.

One of the major problems with APB opinion #11 was the accumulation of deferred taxes without specific identification of the asset or liability that gave rise to the deferred tax. The temporary differences under statement #96 become taxable or deductible when the asset is recovered or the liability is settled.

Tax is not recognized on financial statement income or expenses for future years. In other words, assets or liabilities must be reported on the financial statements to be used in tax calculations.

The tax consequences of the temporary difference between the financial statement income and the tax return income become a liability.

Presentation of deferred tax liability on the balance sheet arises because of the assumption that the financial statement and tax differences will eventually be reconciled and settled.

An example of deferred tax liability may be on an installment sale. At the time of the sale, the transaction is reported for financial statement presentation as a debit to accounts receivable and a credit to sales. For tax reporting, the income is not recognized until received. Other examples may be estimated liabilities such as product warranties and lawsuit settlement, unearned revenues such as subscriptions paid in advance, depreciation (ACRS and MACRS are not recognized under GAAP), difference in basis of assets (tax basis in prior years being reduced for ITC), and foreign currency transactions. To record the difference between income taxes payable and the income tax liability on financial statement income, the accountant must first compute the financial statement taxes. Once this is computed, the accountant must then recompute the net income using the current tax laws. The difference becomes either a liability or an asset. Each liability or asset which gives rise to deferred tax consequences must be identified. Using current tax laws, determine an estimate of future years in which temporary difference will result in taxable or deductible amounts and the net taxable or deductible amount in each future year. The deferred tax liability or asset is classified on the balance sheet as to current or non-Current.

For more information on this important statement, contact NSPA's Education Department.
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Article Details
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Author:Born, Bernice Drewyor
Publication:The National Public Accountant
Article Type:column
Date:Feb 1, 1990
Next Article:Get in step with AICPA - or else!

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