Question

Listed below are items that are treated differently for accounting purposes than they are for tax purposes.

(i) Explain the difference between a temporary difference and a permanent difference.

(ii) Indicate whether the items are permanent differences or temporary differences. For
temporary differences, indicate whether they will create deferred tax assets or deferred
tax liabilities.

1. An accelerated depreciation system is used for tax purposes, and the straight-line depreciation method is used for financial reporting purposes for some plant assets.
2. A landlord collects some rents in advance. Rents received are taxable in the period when they are received.
3. Expenses are incurred in obtaining tax-exempt income.
4. Costs of guarantees and warranties are estimated and accrued for financial reporting purposes.
5. Installment sales of investments are accounted for by the accrual method for financial reporting purposes and the installment method for tax purposes.
6. Interest is received on an investment in tax-exempt governmental obligations.
7. For some assets, straight-line depreciation is used for both financial reporting purposes and tax purposes, but the assets’ lives are shorter for tax purposes.
8. The tax return reports a deduction for 80% of the dividends received from various corporations. The cost method is used in accounting for the related investments for financial reporting purposes.

Answer 1

(I) temporary difference is the tax difference that arises for a shorter period of time and will be reversible at a later stage. it gives rise to deferred tax asset and deferred tax liability.

permanent difference is the opposite. it is never recovered and does not give rise deferred tax asset and deferred tax liability. it changes the tax statue of the company and the rise and fall in tax liability is permanent.

(II)

1- different depreciation is an example of temporary difference-

the difference in both the figures is for a time period only and will be recovered as soon as the depreciation ends.

2- rent in advance- temporary difference

it will recover in the month rent was supposed to be collected.

taxes are paid in advance therefore it will create deferred tax asset

3- expenses incurred for tax exempt income are permanent transfer

and will not be recovered.

4 estimations-are temporary difference

it will recover when the costs are actually incurred. therefore, arise deferred tax asset.