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Unformatted text preview: A CRITICAL ANALYSIS OF INTERPERIOD TAX ALLOCATION Kenneth E. Stone Central Missouri State University Dennis Nicoll Central Missouri State Univesity ( Published in The National Accounting Journal, Vol.1, No. 1, Winter 1999) I. Introduction Generally Accepted Accounting Principles (GAAP) for publicly held corporations has required interperiod tax allocation (ITA) since the issuance of Accounting Principles Board Opinion No. 11 in 1967. Currently, ITA is required by Statement of Financial Accounting Standards (SFAS) No. 109. SFAS No. 109 requires the "Liability" method as opposed to the previously used "Deferred" method. While there are differences between the two promulgations, about the same ITA has been required for thirty years. One justification of ITA is the matching concept. The proponents of this concept think the income tax provision on the income statement should be matched with the tax items on the income statement regardless of which fiscal period these items are reported for tax purposes. The difference between the tax provision and the current-year tax liability is recognized as Deferred Income Tax. This approach is supposed to better match revenues and expenses (income and Tax) and be a better indicator of earnings for a particular period. The Deferred tax on the balance sheet is also supposed to indicate the existence of a future tax liability or future tax reduction. The SFAS No. 109 requires the "Liability" or "Asset-Liability" method. The primary emphasis of this method is on properly stating the Deferred Tax on the Balance Sheet. Therefore, the primary concept followed in SFAS No. 109 is the asset and liability recognition principle. Matching is achieved for the most part, but is sacrificed to some extent in order to properly state assets and liabilities. Any necessary adjustment of the deferred tax account results in an adjustment of the income tax expense or other tax effect of the current year. Some critics of interperiod tax allocation argue that at least a portion of the deferred tax is likely to be permanent because reversing differences are likely to be offset by new temporary differences. Financial analysts often ignore reported deferred tax [White et al. 1994] because they are uncertain about its informational content. Analysis of the tax notes accompanying financial statements requires a high degree of technical understanding, and sufficient information may not be available for complete analysis. Does the cost of interperiod tax allocation exceed the benefits to investors? If the answer is yes, why do we continue to practice it? In this paper, the authors take a critical look at the practice of ITA and draw some conclusions about continuing ITA as a requirement of GAAP....
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