In: Accounting
Explain the difference between permanent and timing difference. (Accounting)
Please answer in essay form.
Timing differences occur whenever there is a difference between the tax base and the carrying amount of assets and liabilities on the balance sheet.
Permanent differences are differences between the tax and financial reporting of revenue or expense items which will not be reversed in the future.
A permanent difference is a difference between the tax expense and tax payable caused by an item that does not reverse over time. In other words, it is the difference between financial accounting and tax accounting that is never eliminated. An example of a permanent difference is a company incurring a fine. Tax codes rarely ever allow a deduction in the event of a fine, but fines are often deducted from income in book accounting.
A permanent difference will cause a difference between the statutory tax rate and the effective tax rate. Also, because the permanent difference will never be eliminated, this tax difference does not generate deferred taxes, as in the case with timing differences.
Timing differences are differences between pretax book income and taxable income that will eventually reverse itself or be eliminated. To put this another way, transactions that create temporary differences are recognized by both financial accounting and accounting for tax purposes, but are recognized at different times. This is why temporary differences are also known as timing differences.
An example of a timing difference is rent income. Accrual accounting will only allow revenue to be recorded when it is earned, but if a company receives an advance payment of rental income, it must report this under taxable income on its tax return. As such, this revenue will be recorded on the tax return but not the book income. This creates a timing difference in this period. At a future period when the rental revenue is finally earned, the company will record that revenue under book income but not on its tax return, thereby reversing and eliminating the initial difference.