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Chapter 12 - Solution Manual

The tax effect of a temporary difference is measured

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The tax effect of a temporary difference is measured as the difference between income taxes computed with and without the inclusion of the temporary difference. The resulting difference between income tax expense and income taxes currently payable is a debit or credit to the deferred income tax account. The deferred method is based on the matching concept. The tax effects of temporary differences are matched with the temporary differences when they originate and reverse. The matching concept is
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270 important to income reporting because of the going concern assumption. Since business entities are presumed to be going concerns, enterprise performance must be assessed at intervals. That is, accountants must report periodically to investors, creditors and other users. Periodic reporting requires that accountants report on the performance of the entity during an accounting period so that users can assess enterprise how well the enterprise is utilizing resources to generate future cash flows for operations, reinvestment in operations, and dividends for investors. Some contend that the deferred tax balances resulting from application of the deferred method are meaningless because they result from the calculation of tax expense, i.e., they do not meet the definition of assets or liabilities. However, the income statement is the most important financial statement, and matching is a critical aspect of the accounting process. Thus, it is of little consequence whether deferred tax debits or credits meet the definition of assets or liabilities in the conceptual sense. Because the deferred method matches tax expense with all items reported in the income statement regardless of when they appear in the tax return, the resulting deferred taxes are the result of historical transactions or events that created the temporary differences. Since accounting reports most economic events on historical cost basis, deferred taxes should be reported in a similar manner. Historical cost is objective, verifiable, and neutral. It fulfills the stewardship function of accounting and is the cornerstone of the traditional accounting model. Accounting numbers should be reliable. The historical tax rates used to compute income tax expense and thus the deferred tax balances are historical rates and as such are objective, verifiable, and neutral. As a result their use increases the reliability of accounting information. Team 2 Defend the asset/liability method of accounting for income tax expense The asset/liability method of accounting for income tax expense is balance sheet oriented. Under the asset/liability method, the tax benefits or liabilities that will be realized or assessed on temporary differences when they reverse. The result is the reporting of the future tax consequences of prior and present temporary differences between pretax financial accounting income and taxable income.
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