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Chapter 5.6® - Difference between Carrying Value and Tax Basis

As we have discussed about the temporary differences in our above illustrations which is impacting the taxable income versus accounting income; this is the income statement approach to income tax allocation. Section 3465, generally uses the balance sheet approach for identifying and accounting for the temporary differences. The balance sheet approach identifies a temporary difference as any asset or liability that has a tax basis that is different from its carrying value for accounting purposes. The carrying value is simply the amount at which an item is reported on the corporation’s balance sheet. The tax basis is the amount relating to that asset or liability that would appear on a balance sheet if one were prepared for tax purposes.

Now, to determine the carrying value and the tax basis of the $600,000 gain in our example, we need to look at the different accounting policies that being used for accounting and tax purposes. For accounting, the gain is recognized as income in 2006, which leaves a carrying value of zero: there is no deferred gain shown on the corporation’s balance sheet. For tax purposes, however, the corporation has deferred tax recognition of the gain until 2008 – the $600,000 is treated as a deferred gain. The tax basis therefore is $600,000.

Using the balance sheet approach, it is the difference between the balance sheet carrying value of zero and the tax basis (i.e. deferred revenue) of $600,000 that gives rise to the temporary difference. Each year that the temporary difference is outstanding, the balance in the future income tax liability account should equal the difference between the tax basis and the carrying value multiplied by the enacted income tax rate. At the end of each year:

2006: ($600,000 cr. - $0) X 40% = $240,000 Credit

2007: ($600,000 cr. - $0) X 30% = $180,000 Credit

2008: ($0 - $0) X 30% = $0

The tax basis of the deferred revenue drops to zero at the end of 2008 because the gain enters taxable income in 2008; it is also no longer deferred and has no tax basis. The temporary difference therefore reverses in 2008.

Future Income Tax Assets:

There are some other events that give rise to the future income tax assets. The reason they arise when the expense is recognized first for the accounting and deducted later for the tax. For example:

• Deferred executive compensation that is treated as an expense for accounting purposes but that is deductible for tax only when paid. The tax basis of the liability for deferred compensation is zero.

• Warranty costs that are estimated and charged to income in the year of the sale; for tax purposes, warranty costs can be deducted only when paid. The tax basis of the warranty liability is zero.

• Write-downs of inventory or other assets for accounting purposes; the tax effect is recognized only when realized at the time of sale. The carrying value has been reduced to market, while the tax basis remains at historical cost.

Balance Sheet Presentation:

When future income tax assets or liabilities are reported on a balance sheet in which current and long-term assets and liabilities are segregated, they must be classified as either current or long-term. The classification is current if the temporary differences that gave rise to the future income taxes are current assets or current liabilities. Following assets and liabilities will be classified as current future tax amounts:

• Instalemnt notes receivables

• Allowance for doubtful accounts

• Inventories

• Accrued receivables

• Warranty liabilities

• Notes payable

• Accrued liabilities


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