Question

Define the terms temporary difference and permanent difference as they pertain to the financial reporting of income tax expenses. Describe how these two book-tax differences affect the gap between book and taxable income. How are permanent and temporary differences alike? How are they different?

Answer 1

Temporary difference;

Temporary differences between book income and taxable income arise due to timing that is why after specific time these differences come to end. Temporary differences are arise due to revenue and expense items recognized in one period for taxe purpose but recognized in a different period for the books or vice versa.

For example; Depreciation expense can be calculated for book income by straight line method but may be calculated by accelerated method for taxable income.

Permanent difference;

Permanent differences are those type differences which remain intact for long time too because these differences never reversed even after passing long time. Permanent differences are due to items which are recognized for book but not recognized for tax or vice versa. In other words we can say some items of revenue or expense are recognized for book but not recognized for tax or vice versa.

For example; Some expenses are recognized for calculating book income but it may be that these expenses are not deductible for tax purpose.

How these two book-tax differences affect the gap between book and taxable income?

As we know that temporary differences reversed after some time because if some items of revenues are recognized for book then these items will be recognized in different period for tax, so for a particular period temporary differences will lead to gap between book income and taxable income although after that period due to reversal of temporary differences impact will be zero.

In same manner permanent differences remain intact due to some items of revenues & expenses which either recognized for book but not recognized for tax purpose that is why there will be permanent gap between book income and taxable income.

How are permanent and temporary differences alike?

As we are aware that due to permanent and temporary differences, book income and taxable income differs in a particular period hence both permanent & temporary differences lead to difference between book income and taxable income for a specific period. Thus both looks alike.

How are they different?

Temporary differences lead to gap between book income and taxable income in a particular period because after that period temporary differences are revesable hence after that period temporary differnces will show no impact but as we know that permanent differences are non-reversable in nature that is why permanent differences will lead to a permanent gap between book income and taxable income, That is why it proves that both are different.