It's the job of an accountant to create accurate financial statements, which means that assets, liabilities, sales and expenses should be recorded in the period in which they were incurred. However, the Internal Revenue Service may offer conflicting guidance for paying taxes,
It's the job of an accountant to create accurate financial statements, which means that assets, liabilities, sales and expenses should be recorded in the period in which they were incurred. However, the Internal Revenue Service may offer conflicting guidance for paying taxes, which creates timing differences between taxes owed and taxes paid. In response to these timing differences, the Financial Accounting Standards Board, or FASB, created Statement 109 to advise accountants how to treat and recognize income taxes in the current period and in the future.
Principle 1: Estimated Taxes in the Current Year
Unfortunately, the IRS, doesn't have the same accounting principles as the FASB. According to FASB Opinion 109, the first principle to be employed in the treatment of income taxes deals with the estimation of current year taxes. This principle states that a current tax liability or asset should be recognized using taxes payable -- a balance sheet account -- in the year the liability is created, which may create a temporary difference in the amount of taxes paid to the IRS and the amount of taxes shown on the income statement.
Principle 2: Deferred Taxes and Future Payments
Due to the temporary differences created from the first principle, a deferred tax liability or asset is created to estimate future tax payments and carry-forwards. A deferred tax liability or asset estimates the increase or decrease in taxes that must be paid or carried forward in future periods.
Principle 3: Future Changes in Tax Laws Are Not Considered
A deferred tax liability is used to account for temporary differences in the current year and future years, but tax rules often change. For example, a company may choose to recognize all of an installment sale in the current year, due to revenue recognition policies, but the IRS does not recognize the full sale until the year the revenue is actually received, which may be the following year. The third principle used to account for income taxes states that any changes in future tax laws or rates should not be taken into consideration within the deferred tax liability. Only the current laws and rates are used to calculate the amount of the deferred tax liability.
Principle 4: Deferred Tax Assets May Be Offset By Tax Benefits
The final principle used in the determination of income taxes deals with the measurement of deferred tax assets. Deferred tax assets re