What is an Interperiod Tax Allocation?
An interperiod tax allocation is the temporary difference between the effects of tax policy on the financial reporting of a business and its normal financial reporting as mandated by an accounting framework, such as GAAP or IFRS. For example, the Internal Revenue Service may mandate that a specific depreciation period be used for a fixed asset, while the internal accounting policies of a business dictate the use of a different number of periods. The resulting difference is a temporary one, in that the asset will eventually be fully depreciated for both tax and accounting purposes. During the periods when there is a temporary difference, there is said to be an interperiod tax allocation.
There are four types of transactions that can cause a temporary difference, which are as follows:
Delayed recognition of taxable income
Accelerated recognition of taxable income
Delayed recognition of expenses for tax purposes
Accelerated recognition of expenses for tax purposes
Most businesses will have an ongoing series of temporary differences that will eventually be resolved, which means that there will always be some sort of interperiod tax allocation. The tax accountant should maintain records of the amounts of these reconciling items as part of the ongoing effort to construct tax returns.
There are different views on the amount of interperiod tax allocation to recognize. At one extreme, the amount of income tax expense recognized exactly matches the current amount of income tax, which means that there is no allocation. The opposite view is to allocate the tax effects of all temporary differences, with no consideration of the likelihood of their reversal. A midway view is to allocate only those differences that are likely to reverse in the near term.
Related AccountingTools Courses
Example of an Interperiod Tax Allocation
Fireball Flight Services operates a high-altitude solar telescope from a small business jet. It recently acquired a replacement solar telescope for $300,000. For its own financial reporting, Fireball’s accountant always uses the straight-line method of depreciation for the company’s assets. In this case, the useful life that the accountant assigns to the telescope is 15 years, with no expected salvage value. This will result in a $20,000 annual depreciation charge over the life of the telescope, after which its carrying amount will be zero.
The accountant uses a different depreciation approach when developing financial statements for tax purposes. The accelerated method that she chooses results in a $35,000 depreciation charge in the first full year of the asset, after which the depreciation charge declines rapidly.
In the first full year of depreciating the telescope, the firm’s book depreciation for the asset is $20,000, while its tax depreciation is $35,000, resulting in a $15,000 temporary difference. At the company’s 21% tax rate, the accountant records a deferred tax liability of $3,150 (calculated as the 21% tax rate x $15,000 temporary difference). This entry reflects the fact that Fireball has saved $3,150 in income taxes in the current year, because of the accelerated depreciation method that was applied to the telescope asset. This amount is an interperiod tax allocation. The firm will eventually pay down this liability, when the tax depreciation on the telescope gradually falls below the straight-line depreciation on its books.
By the end of the 15-year life of the telescope, both depreciation methods will have resulted in the same depreciation expense being charged, resulting in no interperiod tax allocation.
