Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
According to Accounting Theory: Contemporary Accounting Issues by Evans, accountants
have developed two alternative approaches to accounting for income taxes, which are the
cash method and the allocation method. The cash method is described as a simple and
direct approach. The amount of income taxes actually paid for the year is reported on the
Income Statement. The amount comes from the firm income tax return and fit is not
adjusted in any way. Therefore, the firm actual transaction to record its income tax liability
is the basis for the amount of the income tax expense reported on the Income Statement.
The allocation method is a bit different. The actual amount of tax that is paid in the year is
ignored when it comes to reporting income tax expense on the Income Statement. The
amount of income tax expense reported on the Income Statement is based on the on the
income tax rate that the firm pays, which is applied to the amount of pretax income. This
makes the Income Statement perfectly consistent with the before-tax income. Using the
allocation method makes it look like all items on the Income Statement based on the same
method.
The development of accounting pronouncements for taxation reveals the difficulty that
standard-setter s had with this topic. Following are summaries of major pronouncements
dealing with accounting for income taxes.
APB OPINION #11
This pronouncement required the deferral method of accounting for income taxes. When
the accounting net income exceeded taxable net income, balancing credit should be
recognized, when the taxable net income exceeded the accounting, a balancing debit
should be recognized. This was considered a deferred credit and a deferred debit. Deferred
charges and credits were default classification and were placed on the Balance Sheet in
what was called no man land, or some undefined region, between liabilities and owner
equity for deferred credits and between assets and liabilities for deferred charges. Under
APB Opinion #11 it was believed that the balancing credits and debits would eventually
reverse and cancel out and therefore it was to be treated as a temporary measure.
From 1967 thru 1980, firms followed the comprehensive tax allocation procedures under
APB Opinion #11 and reported deferred charges and credits. However, some problems
arose from doing so. Because of the changes in tax rates and the nature of firm investment,
the balance of deferred tax credits on a firm balance sheet began togrow in size instead of
reversing and canceling out. Also, accountants were not sure that the balancing debits and
