The computation of income taxes poses problems in financial reporting. The major problems arise because current period taxable income is measured using different rules than those used in accounting for pretax income.
Taxes are paid based on tax reporting, but from a financial reporting standpoint, the tax expense in the income statement (IS) is based on the matching principle and is computed on pretax accounting income. In order to achieve matching between taxes based on taxable income and taxes based on pretax income for accounting purposes, deferred tax entries are put through the accounting books.
The differences between the tax expense for tax and the accounting tax expense create deferred tax liabilities (credits) and deferred tax assets (debits or prepaid taxes).
Here are key terms based on tax return:
Here are key terms based on financial reporting:
| CHADZAMIRA: The difference between timing differences and temorary differences is not very clear. I may need more clarity.|
Tax expense is therefore the product of tax rate and pretax income.
| mywirelesskit: Timing difference happens when a certain tax amount is shown in different time intervals for the Income Tax returns and the Financial statements. Depriciation is a good example. If one buys a machine for $100,000 whose life is 5 years with zero salvage value . One uses the double-declining method of depriciation in their tax returns and straight line method in their Financial statements. The depriciation expense each year will differ between the Tax returns and the financial statements. But the total depriciation expense will be same for both the methods if we add all the five years.|
A permenant difference happens when a certain type of income is exempt from the Income Tax return but is present in Financial statements. The interest on Tax free municipal bonds is a good example.
|StanleyMo: thanks wirelessguy :)|
|kasthala: Good explanation. Thanks a lot mywirelesskit.|
|kenn0244: self explanatory|
| MrDeVillie: i guess the difference asked was between 'timing' and 'temporary' ... not 'timing' and 'permanent' |
What is the difference between 'timing' and temporary differences?
|soorajiyer: could somebody please explain difference between timing and temporary? thank you!|
|mcbreatz: The timing difference creates the temporary difference. They are closely related. accounting statements vs tax statements may have timing differences on reporting. Over time if the difference will correct itself or balance out then it is only a temporary difference.|