Question

Books Dr C Drac SPOKI 100 SEIRO Depreciation expense Gain on fixed asset disposition Baddele expense Warranty expense Deferral compensation 195.000 (165,000) (580,000) 300.000) 1. What does a temporary difference mean, and how does it differ from a "permanent difference 2. For each of the differences listed explain the difference in plain English by making up an example. Also explain why it is temporary. See example below Depreciation Plain English description Why is this temporary Is this difference currently favorable to the taxpayer? The equipment is Although tax depreciation Yes. The annual depreciated straight-line is higher this year, in future depreciation for book purposes, but years book depreciation deduction is bigher under accelerated will be higher. By its than depreciation depreciation (MACRS) for nature, accelerated expense. This results tax purposes depreciation means that in lower laxable depreciation deductions go income and lower down each year taxes actually paid this year. Gaur Bad debt expense Warranty expense Deferred compensation Page 1 of 1

Answer 1

Answer-1:

(i) Temporary differences occurs whenever there is a difference between pretax book income and taxable income that will eventually reverse itself or be eliminated at some future date.

Where as permanent differences are differences between the tax and financial reporting of revenue or expense items which will not be reversed in the future.

(ii) The formation of deferred tax assets or liabilities from temporary differences can only occur if the differences reverse themselves at some future date and to such an extent that the balance sheet items are expected to create future economic benefits for the company.

On the other hand, permanent differences do not give rise to deferred tax assets or liabilities as they are not reversed.

(iii) Temporary differences are also known as timing differences because the differences are recognized by both financial accounting and accounting for tax purposes at different times. Hence does not cause a difference between the statutory tax rate and the effective tax rate.

Where as a permanent difference will cause a difference between the statutory tax rate and the effective tax rate.

Answer-2:

Gain Bad debt expense Plain English Why is this temporary Is this difference description currently favourable to the tax payer Gain is recognized for Certain revenue Yes taxpayer need not financial reporting accounted for by the to pay tax on this purposes before being installment method for currently. recognized for tax tax purposes, but purposes reflected in income currently This is an estimate. Tax accounting No, because it is not Bad debts is recognized bad debt deductible currently. recognized for financial expense only when it is reporting purposes written off. before being recognized for tax purposes This is an estimate. A company can't No, because it is not Warranty expense is deduct estimates as an deductible currently. recognized for financial expense on its tax reporting purposes return until it actually before being incurs the cost. recognized for tax purposes Deferred Tax accounting does No, because it is not compensation is not allow a deduction | deductible currently. recognized for financial for deferred reporting purposes compensation until the before being payments actually recognized for tax occur. purposes Warranty expense Deferred compensation