Financial statements are prepared using Generally Accepted Accounting Principles – GAAP and tax returns are filed using the Internal Revenue Code. The financial statements prepared with GAAP present the income tax expense whereas the consequence of preparing tax returns with Internal Revenue code is income tax payable. The amount of income tax expense and income tax payable is usually different which is caused by various factors. These factors may be of temporary or permanent nature and include differences which relate to deferred tax liabilities, deferred tax assets, valuation allowance, tax rate changes and operating losses. The types and nature of these differences are discussed throughout this essay.
Causes of Deferred Tax Liabilities
Deferred tax liabilities are the amounts taxable in future and are caused by various temporary differences which include recognizing revenues earlier in the income statement than the tax returns and recognizing expenses at a later stage than the tax returns. The most common temporary difference that causes deferred tax liabilities is the calculation of depreciation by different methods. The straight line method is used in the GAAP financial statements whereas the depreciation on tax returns is usually accelerated depreciation. Another factor is the recording of prepaid expenses in the tax returns and presenting them as expenses in the GAAP income statement. The temporary difference due to recognition of revenues is caused by early recognition of total revenue from installment sales of assets and the company uses installment sales method for tax returns. Gain on assets based on fair value is also realized in the GAAP income statement while this gain is recognized on the tax returns when the asset is sold. This difference of recognizing gains also results in a deferred tax liability (Mulford & Comiskey, 2005). The amounts needed to record periodic income taxes include the income tax expense from the GAAP income statement, income tax payable amount from the tax returns and the difference as a deferred tax asset or liability. The deferred tax liabilities or assets are gradually decreased when the company starts paying off the tax liability or deducting the deferred tax asset amount.
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