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Chapter 12 - Solution Manual

3 income taxes are levied on total taxable income not

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3. Income taxes are levied on total taxable income, not individual items of revenue or expense. Hence, there are no temporary differences between taxable income and accounting income. 4. Tax allocation hides economic differences between a company that employs tax savings strategies from one that does not. 5. Reporting tax expense equal to taxes paid provides a better predictor of future cash flows because many deferred taxes will never be paid. 6. Tax allocation presumes implicit forecasts of future profits, a practice which is inconsistent with conservatism. 7. Deferred tax liabilities do not meet the definition of a liability. There is no present obligation to the future taxes reported as deferred tax liabilities. There is no prior transaction because there is no legal liability until an actual tax return is filed. 8. The cost of doing interperiod tax allocation exceeds the benefits, if any, derived. b. Proponents of partial allocation of income taxes propose that interperiod tax allocation is appropriate for items that will reverse, but not for others. They cite the following arguments to defend their position. 1. Many temporary differences are not like items such as accounts payable. Accounts payable “roll over” as the result of individual transactions each of which is individually paid. Because income tax is based on total taxable income, consideration of the effects of groups of items is appropriate. 2. Comprehensive income tax allocation distorts economic reality. For many items there is no “roll over” because the tax rules persist, and the company continues to repeat the same economic transactions (e.g., purchase fixed assets). Thus, consideration should be give to the impact of the future, as well as to historical transactions. 3. Partial allocation enhances assessments of future cash flows. The deferred taxes reported would be more reflective of expected cash flow. 4. Comprehensive allocation is a rigid mechanical approach, which inherently results in the distortion of economic reality. c. Proponents of comprehensive allocation of income taxes argue that all temporary differences have future tax consequences and those tax consequences should be reported in the balance sheet as assets and liabilities. No allocation or partial allocation distorts the presenting of the economic facts because neither approach matches the items reported in the income statement with their tax cash flow effects. The following arguments support this position. 1. Individual temporary differences do reverse. They are temporary, not permanent. Thus, the focus should be on individual items not on groups of items. 2. Accounting is historical. It is inappropriate to offset the income tax effects of possible future transactions against the tax effects of transactions that have already occurred. 3.
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3 Income taxes are levied on total taxable income not...

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