Interperiod Tax Allocation
A business's usual financial reporting as required by an accounting framework, such as GAAP or IFRS, and the temporary divergence caused by the effects of tax policy on that financial reporting is known as an interperiod tax allocation. For instance, internal accounting procedures of a company may require the use of a different number of periods for fixed assets than those required by the Internal Revenue Service.
This transitory discrepancy is caused by the fact that the asset will eventually be fully depreciated for both tax and accounting reasons. An interperiod tax allocation is stated to exist during the times when there is a transient difference.
The following four sorts of transactions, which can result in a momentary discrepancy, are:
- Delayed recognition of taxable income
- Accelerated recognition of taxable income
- Delayed recognition of expenses for tax purposes
- Accelerated recognition of expenses for tax purposes
Advantage Of Interperiod Tax Allocation
In order to use the interperiod tax allocation, there are two main advantages. Standardization and comparability are two of them. This approach makes sure that every business computes its deferred tax credit or liability balances in accordance with the same rules. The Financial Statements of various companies can now be more easily compared by analysts, investors, creditors, and other interested parties.
Disadvantage Of Interperiod Tax Allocation
This method's primary drawback is that it necessitates a corporation to make precise predictions regarding the future (specifically, expected future income taxes). These projections may differ from actual outcomes and result in a discrepancy between the financial statements and real future income tax obligations.
Example of Interperiod Tax Allocation
For various objectives, businesses frequently apply accelerated depreciation and straight-line depreciation to the same piece of equipment. Typically, a company uses accelerated depreciation rules for tax purposes while using straight-line depreciation for accounting.
Take the purchase of a $200,000 crane by Acme Construction Company as an illustration. According to IRS regulations, equipment can be depreciated from the time it is put into use until the business recovers its cost basis.
This gives Acme a five-year, $40,000 depreciation allowance. However, Acme's accounting department utilizes a 10-year straight-line accounting system, which shows a $20,000 annual spend for the first 10 years. These approaches ultimately result in a complete asset depreciation. Using a thorough tax allocation, the transitory discrepancy over the crane's financial life is settled.
- Companies utilize comprehensive tax allocation analysis to find inconsistencies between their accounting for tax purposes and their accounting for commercial purposes.
- Differences between the periods used for financial reporting and tax filing account for the majority of the variances.
- Comprehensive tax allocation revealed disparities that were caused by accelerating or postponing deductions and/or taxable income.