Temporary and Permanent Differences

Introduction

Temporary differences occur whenever there is a difference between the tax base and the carrying amount of assets and liabilities on the balance sheet.

Permanent differences are differences between the tax and financial reporting of revenue or expense items which will not be reversed in the future.

Temporary differences vs. permanent differences

Temporary differences

The formation of deferred tax assets or liabilities from temporary differences can only occur if the differences reverse themselves at some future date and to such an extent that the balance sheet items are expected to create future economic benefits for the company.

Temporary differences are divided into (i) taxable temporary differences, and (ii) deductible temporary differences.

Taxable temporary differences are temporary differences which result in a taxable amount in the future when determining the taxable profit as the relevant balance sheet item is recovered or settled.

They result in a deferred tax liability when the carrying amount of an asset exceeds its tax base, or when the tax base of a liability exceeds its carrying amount.

Deductible temporary differences are temporary differences which result in a reduction or deduction of taxable income in the future when the relevant balance sheet item is recovered or settled. They result in a deferred tax asset when the tax base of an asset exceeds its carrying amount, or the carrying amount of a liability exceeds its tax base.

Permanent differences

Since they are not reversed, permanent differences do not give rise to deferred tax assets or liabilities. Examples of the items which give rise to permanent differences include:

  • Income or expense items that are not allowed by tax legislation, and
  • Tax credits for some expenditures which directly reduce taxes.

All permanent differences will result in a difference between a company’s effective tax rate and statutory tax rate.

The following examples will help to illustrate when temporary differences arise versus permanent differences.

  • Dividends receivable: Dividends receivable are not usually taxable, and therefore, the carrying amount will equal to the tax base. This gives rise to a permanent difference and will not result in the recognition of any deferred tax asset or liability. Unlike a temporary difference, a permanent difference will never be reversed. Taxable income and accounting profit will be permanently different with the amount of dividends receivable, even on future financial statements as an effect on the retained earnings reflected on the balance sheet.
  • Research and development costs: Any difference between the carrying amount and tax base is a temporary difference which will reverse in the future.
  • Accounts receivable: Like the case of research and development costs, any difference between the carrying amount and tax base is a temporary difference which will reverse in the future.
  • Donations: If tax legislation does not allow donations to be deducted for tax purposes, then no temporary difference will result, and therefore no deferred tax asset or liability will be recognized. This constitutes a permanent difference.
  • Interest received in advance: Any difference between the carrying amount and tax base is a temporary difference which will reverse in the future.
  • Rent received in advance: Any difference between the carrying amount and tax base is a temporary difference which will reverse in the future.
  • Loan: If no temporary difference results from the loan or interest paid, no deferred ta item will be recognized.

Question 1

Which one of the following statements is inaccurate?

A. Permanent differences are differences between the tax and financial reporting of revenue or expense items which will not be reversed in the future.

B. Temporary differences arise when there is a difference between the tax base and the carrying amount of assets and liabilities.

C. Permanent differences arise when there is a difference between the tax base and the carrying amount of assets and liabilities.

Solution

The correct answer is C.

Temporary differences, and not permanent differences, arise whenever there is a difference between the tax base and the carrying amount of assets and liabilities.

Question 2

Canadian Syrup Inc. received a government grant of $2,000 for buying a domestically manufactured machine. The governmental grant would result in:

A. A permanent tax difference.

B. A deductible temporary tax difference.

C. A taxable temporary tax difference.

Solution

The correct answer is A.

The grant would result in a permanent difference because the difference is not expected to reverse in the future.

 

Reading 30 LOS 30f:

Distinguish between temporary and permanent differences in pre-tax accounting income and taxable income

 

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