Book and Tax Differences – Current Liabilities

Because of these differing objectives, revenue and expense measurements that are used to determine taxable income may differ from those used in financial reporting. Accountants in these cases distinguish between book and tax measurements in that book measurements are used for financial reporting purposes, while tax measurements must comply with income tax laws.

In most cases, differences between book and tax measurements are temporary in nature. In order to stimulate purchases of property, plant, and equipment, for example, the U.S. government allows firms to depreciate such assets quickly for tax purposes. Firms can thereby reduce their income taxes in the earlier years after purchasing such assets. This accelerated depreciation usually exceeds the amount of depreciation expense that is used for financial accounting measurements of income. In later years, however, the situation is reversed. Financial statements continue to report depreciation expense, although the asset is already fully depreciated for tax purposes.

Accounting standards for reporting income tax expenses and liabilities reflect a basic premise: all events that affect the tax impact of temporary differences should be recognized currently in the financial statements. Broadly, two types of events can affect these expected tax impacts: (1) a change in the amount of temporary differences between the book and the tax bases of a firm’s assets (or liabilities) and (2) a change in tax rates that will apply to those temporary differences.

Historically, tax rates in the U.S. have been relatively stable. In the third quarter of 1993, however, a new deficit-reduction law raised the corporate tax rate from 34 to 35%. This apparently minor adjustment in tax rates required that firms revalue their deferred tax liabilities upward by about 2.9% (1% rate increase/34% old rate). Because accounting standards require this adjustment to be included in the calculation of tax expense for the quarter in which the new tax law is signed, many firms experienced a considerable drop in the forecast for third-quarter profits. As examples, International Paper’s profit forecast fell by 50.8%, and Georgia Pacific’s forecasted profits were revised to a forecasted loss.

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