Introduction
Today, most accountants are unanimous in defining income taxes as expenses, and a few arguments prove this statement. On the one hand, the United States Generally Accepted Accounting Principles (GAAP) stipulate that this approach should be followed (Schroeder et al., 2019). On the other hand, this treatment is aligned with the general accounting theory. The latter indicates that the earnings that individuals and organizations obtain should be reduced by their obligations to the government. That is why many people rely on this superficial attitude and believe that taxes accounting is a simple and straightforward issue. However, some controversies arise when income accrual and appropriate taxation cover two or more time periods. When such temporary differences exist, deferred income tax assets and liabilities emerge.
One can state that deferred tax is a sum of money that should be paid as taxes in the future. In more scientific terms, the concept under analysis is found in the company’s income statements, and it represents the difference between the income tax expense reported and the income tax payable. The amount and payment requirements of deferred taxes depend on how tax authorities and organizations define the income of the latter. In addition to that, it is reasonable to explain the difference between deferred tax assets and liabilities. According to Schroeder et al. (2019), these assets account for future tax benefits, while liabilities refer to payables. In any case, deferred taxes are associated with a significant issue because organizations can follow different guidelines regarding how they should report taxes in the future period. Since GAAP and the International Financial Reporting Standards (IFRS) focus on the issue, the current individual learning project analyzes this aspect and demonstrates that deferred tax discounting and a specific recognition approach should be implemented.
Historical Development of Financial Accounting Theory
A typical theory is a set of beliefs and assumptions that are used to predict and explain various events, objects, or phenomena. As Schroeder et al. (2019) stipulate, an accounting theory exists “to provide a set of principles and relationships that explains observed practices and predicts unobserved practices” (p. 1). In other words, this theoretical framework is used to explain why organizations rely on particular accounting methods and foresee what consequences will emerge when different methods are selected. One should separately admit that the accounting theory relies on credible and reliable data that is tested and proved by accounting research. It is challenging to overestimate the significance of this theoretical framework because it contributes to the overall economic well-being of society and its individual representatives. That is why many experts invest in enriching the theory to make it more effective and beneficial for the world.
The accounting theory is multi-faceted because it offers explanations and predictions regarding individual concepts, and deferred taxes are no exception. The first income tax law appeared in 1913 and was in use by the early 1940s (Schroeder et al., 2019). According to this approach, income tax expense was considered totally equal to income taxes payable, and since taxes were relatively low, their accounting was easy and straightforward. However, the situation changed during World War II when the Internal Revenue Code (IRC) was amended, which allowed organizations to depreciate the cost of their emergency facilities over 60 months (Schroeder et al., 2019). As a result, companies obtained an opportunity to reduce their taxable income because tax depreciation was accelerated. That is why there emerged room for inconsistency because accelerated tax depreciation and normal depreciation for financial accounting purposes were significantly different, which resulted in various pretax accounting and taxable income amounts (Schroeder et al., 2019). Consequently, the opportunity to pay taxes in the future essentially affected accounting procedures.
The information above denotes that some actions were required to address the inconsistency. The first step was to clarify whether taxes were expenses or the distribution of the organization’s profits to the government. The Committee on Accounting Procedure addressed the problem and issued ARB No. 23, stating that income taxes should have been equaled to companies’ other expenses (Schroeder et al., 2019). This suggestion denotes that income statements have tax consequences, and the latter are considered expenses that should be recognized in the period incurred. This information denotes that income statement items should be matched with their respective tax consequences, and this matching is called interperiod tax allocation (Schroeder et al., 2019). An issue emerges because it is challenging to settle temporary differences between taxable income and tax payments.
One should highlight that ARB No. 23 did not comment on cases when tax returns and income statements cover a long period of time. Since the stipulated regulation failed to explain how to calculate tax consequences, it often happened that future tax rates would be significantly different from the current ones. That is why APB Opinion No. 11 was issued to introduce the deferred method implying that the future tax consequences could be calculated using today’s tax rates (Schroeder et al., 2019). That approach was criticized because when the future consequence occurred, tax rates were different, which resulted in balance sheet inconsistencies. That is why the Financial Accounting Standards Board (FASB) issued appropriate regulations, but they also faced criticism because the issue of deferred taxes raises intense discussion.
Current GAAP
The current GAAP are a leading resource that governs accounting issues in the United States. These recommendations establish accounting principles and rules, while accountants should abide by GAAP when their task is to create financial statements. Public companies are additionally expected to follow the GAAP rules, and this standardized approach is necessary to achieve clarity and consistency in financial statements offered by organizations and individuals. In general, the US GAAP stipulate that income tax is an expense, which denotes that organizations and individuals should appropriately treat it on their financial statements.
GAAP additionally offer valuable insight into the concept of deferred taxes, which makes it impossible to ignore the principles in this assignment. According to Oxner et al. (2018), “GAAP require comprehensive accounting for income tax effects in the financial statements, including recognition of deferred income tax assets and liabilities when appropriate” (p. 12). The amounts of these tax-related liabilities and assets are primarily determined by legislated tax rates. In other words, this information denotes that organizations should follow the GAAP recommendations to identify these amounts and time regulations.
When the GAAP guidelines are considered, it is necessary to draw attention to available depreciation methods. For example, an organization can simultaneously rely on the straight-line depreciation type for financial reporting and use the Modified Accelerated Cost Recovery System for tax purposes (Oxner et al., 2018). This information demonstrates that a company can depreciate the asset more rapidly for tax purposes than for financial reporting ones (Oxner et al., 2018). These different depreciation amounts are introduced in the books and, according to GAAP ASC 740, they result in a temporary difference (Oxner et al., 2018). This information denotes that the overall sum of depreciation of the asset is identical according to the two methods, but year-to-year figures will be different. That is why it is essential to acknowledge that the GAAP rules provide organizations with an opportunity to choose among various depreciation approaches depending on the company’s purposes.
Since the differences in the amounts can be either positive or negative, taxable or deductible amounts can arise in the future. On the one hand, the temporary difference can result in the necessity to reduce future taxable income, which is known as a future deductible amount. This scenario leads to the emergence of a deferred income tax asset (Oxner et al., 2018). On the other hand, the temporary difference can lead to a future taxable amount that will bring the need to increase future tax payments. These circumstances will result in a deferred income tax liability (Oxner et al., 2018). These findings demonstrate that the GAAP guidelines allow companies to determine and define their deferred taxes.
In other words, deferred tax assets or liabilities emerge because of the difference between accounting approaches for an asset or liability for financial or tax purposes. According to ASC 740, organizations can use a 5-step model to identify and calculate deferred taxes. Firstly, it is necessary to find a temporary difference that has occurred after applying different appreciation methods (Schroeder et al., 2019). Secondly, it is necessary to categorize the temporary difference by determining whether it will result in a taxable or deductible amount. Thirdly, one should find an appropriate tax rate, and Oxner et al. (2018) explain that it is enacted by appropriate legislation pieces. Fourthly, a calculation process should take place to record deferred tax liabilities or assets. Finally, an organization or an individual should determine the need for valuation allowance that is found when it is more likely than not that “some portion or the entire deferred tax asset will not be realized” (Schroeder et al., p. 431). This information demonstrates that GAAP offer specific recommendations on how to deal with deferred taxes.
Comparing and Contrasting US GAAP and IFRS
The previous section has presented exhaustive comments regarding how the GAAP guidelines define and approach deferred taxes. These regulations offer multiple depreciation methods, which results in the emergence of temporary differences because assets can be treated for general accounting purposes and tax purposes. Furthermore, it has been explained how deferred taxes can be calculated according to the rules of ASC 740. Now, it is reasonable to determine how IFRS that are used in many countries outside the United States approach the accounting concept under consideration.
A traditional approach stipulates that it is possible to categorize deferred taxes as assets or liabilities. However, Flagmeier (2022) stipulates that not all deferred taxes result in future tax payments, which denotes that it is impossible to mention that these taxes may not be value relevant. According to Mear et al. (2020), the “value-relevance of deferred tax is predominantly US-based” (p. 21). This finding denotes that other countries rely on a different approach to categorize and treat this accounting concept.
Under IFRS, International Accounting Standard (IAS) 12 exists to provide regulations on income taxes. According to Brouwer and Naarding (2018), this financial guideline has faced much criticism because it relies on the comprehensive balance sheet model that provides insufficient information for investors. In particular, this approach only reveals a superficial connection between deferred taxes and future cash flows (Brouwer & Naarding, 2018). Since these details present generalized information regarding deferred taxes, the following paragraphs will highlight similarities and differences in how GAAP and IFRS treat this phenomenon.
To begin with, one should state that the two guidelines offer a few similar features. Both GAAP and IFRS rely on balance sheet temporary differences while dealing with deferred taxes, which denotes that measurement focuses on the tax rates that are expected to be present when the difference reverse (Schroeder et al., 2019). Secondly, these two regulation sets do not imply any discounting of deferred taxes. According to Brouwer and Naarding (2018), IAS 12 stipulates that “deferred taxes should be measured on a nominal base and that time value should not be considered” (p. 211). This information demonstrates that discounting is not available because it would need detailed scheduling of temporary differences. The experts also mention that some local GAAP standards can permit discounting, but this fact is rather an exception (Brouwer & Naarding, 2018). These examples demonstrate that significant similarities exist between the selected frameworks.
Simultaneously, it is reasonable to acknowledge the differences found in GAAP and IFRS. The first aspect refers to the recognition of deferred tax assets. The US GAAP guidelines recognize them in full, but a valuation allowance can be introduced under particular conditions. It has already been discussed what this term denotes and when it is applied. Simultaneously, the IFRS recommendations denote that the deferred tax assets are initially recognized to a particular extent. In this case, it is necessary to determine whether it is more likely than not that sufficient taxable profits will occur in the future (Mear et al., 2021). In addition to that, one should state that IFRS provide organizations with an opportunity to choose between the enacted or substantially enacted rate (Brouwer & Naarding, 2018). The latter refers to the rate that is approved but not required. These findings reveal that GAAP and IFRS treat deferred taxes with essential differences, which should be reflected by appropriate accounting procedures and approaches.
Suggested Problem Areas
The information above demonstrates that the GAAP and IFRS regulations offer different interpretations of the same aspects, which denotes that one option can be better than the other. Furthermore, one should not ignore the fact that the discussed guidelines can have particular weaknesses. For example, Brouwer and Naarding (2018) mention that IFRS IAS 12 has been widely criticized for vague and inconsistent interpretations of accounting aspects. That is why the following paragraphs are going to highlight two areas that require attention. The discussion below is based on the analyzed and synthesized information from the selected scholarly and peer-reviewed sources.
On the one hand, one should draw attention to discounting of deferred taxes. As Brouwer and Naarding (2018) state, discounting is not available because it would require detailed scheduling of temporary differences. That is why both GAAP and IFRS do not typically permit discounting. However, US GAAP only allow for discounting when an organization sees the timing and amount of associated cash flows, which is typically true for bonds and notes payable (Schroeder et al., 2019). When income taxes are under consideration, a plethora of events and phenomena can impact the time and amount of future cash flows (Schroeder et al., 2019). That is why discounting is not available, and the IFRS regulations are criticized for their absence. Nevertheless, some scientific evidence indicates that this state of affairs is not beneficial for organizations. Discounting deferred taxes can allow companies and individuals to reduce or postpone their tax payments, which can evidently lead to improved economic conditions.
On the other hand, it has been identified that US GAAP and IFRS offer various guidelines regarding the recognition of deferred taxes. At the same time, the GAAP guidelines imply the use of valuation allowance if there is a strong possibility that the entire deferred tax asset or its portion is not going to be implemented (Schroeder et al., p. 431). If this criterion is absent, deferred taxes are recognized in their entirety. However, the IFRS guidelines follow the opposite approach to recognizing deferred taxes. By default, the deferred tax assets are initially recognized to a particular extent. The latter is defined by the more-likely-than-not criterion, which implies that it is believed that sufficient taxable profits will be recorded in the future (Mear et al., 2021). That is why it is reasonable to determine which approach to deferred taxes recognition is more convenient and better for organizations and individuals as well as their accounting activities.
The information above has presented two significant problem areas that have been identified as a result of literature analysis and synthesis. That is why these issues are essential for accountants, entrepreneurs, and organizations, which denotes that it is necessary to offer or highlight the approaches that are more effective than their counterparts. Thus, one of the following sections will comment on the suggested course of action and explain how it is possible to improve deferred tax accounting for businesses that represent international contexts. This information would be a significant step toward the unification of accounting procedures and standards in various countries worldwide.
Focusing on the Conceptual Framework
It is an expected and justified requirement to unify and explain resolving accounting issues. That is why the Financial Accounting Standards Board (FASB) has developed specific recommendations on how to cope with such tasks. These guidelines are known as the Conceptual Framework Project that establishes standards in the accounting sphere (Schroeder et al., 2019). Additionally, the Conceptual Framework is essential because it establishes the purposes of financial reporting so that the accounting process aims at achieving specific standards. The Conceptual Framework Project consists of a few levels, and qualitative characteristics are among them, and these features make accounting information valuable and useful (Schroeder et al., 2019). Thus, it is reasonable to consider how and whether the information presented in the two previous chapters, “Current GAAP” and “Comparing and Contrasting US GAAP and IFRS,” is aligned with these qualitative characteristics.
Relevance and faithful representation are the fundamental qualities of the Conceptual Framework. On the one hand, financial information is relevant if it can make a difference in decision-making (Schroeder et al., 2019). This condition is achieved when details have a predictive value, which means that this information piece can be used to foresee future events (Schroeder et al., 2019). The confirmatory value should be additionally present since this characteristic demonstrates whether information responds to previous evaluations. It is possible that the details from the selected chapters are aligned with these characteristics. The two recommendation sets under analysis, GAAP and IFRS, were created some time ago, which denotes that they are based on expert opinion and subject to regular reviews. Furthermore, Brouwer and Naarding (2018) stipulate that the “general approach of IAS 12 is consistent with the Conceptual Framework” (p. 206). This information demonstrates that the qualitative characteristic of relevance is present in the identified chapters.
On the other hand, financial information should be faithfully represented. This characteristic implies that the stated details are accurate, which is possible when completeness, neutrality, and freedom of error are preserved (Schroeder et al., 2019). Everyone understands that it can be challenging or even impossible to achieve perfection, and this characteristic feature promotes approaching these standards to the closest possible extent. One can state that these qualitative characteristics are mainly present within the GAAP and IFRS guidelines. This conclusion relies on the idea that the information from the chapters offers a complete description, it is presented without any bias, and no errors are presented (Schroeder et al., 2019). This discussion demonstrates that the identified qualitative characteristics have been included.
In addition to that, a few more qualitative characteristics enhance the usefulness of financial information. They are verifiability, comparability, understandability, and timeliness, and they are found in the previous chapters (Schroeder et al., 2019). Firstly, verifiability is preserved since the presented details allow knowledgeable and independent experts to reach a consensus regarding accounting concepts. Secondly, comparability is evident because the US GAAP and IFRS recommendations are contrasted and compared. Thirdly, understandability is relevant because the guidelines rely on specialized vocabulary to discuss these concepts. This statement denotes that the content is clear for accountants and other knowledgeable people, while individuals without specific knowledge cannot understand the meaning precisely. Finally, it is impossible to state that the presented details lack timeliness. The rationale behind this suggestion is that accountants and other experts are free to access the stipulated guidelines at any time to support their decision-making. Consequently, the information from the “Current GAAP” and “Comparing and Contrasting US GAAP and IFRS” chapters is perfectly aligned with the Conceptual Framework and its qualitative characteristics.
Suggested Course of Actions
The information above has demonstrated that it is possible to locate a few problem areas associated with deferred taxes accounting. On the one hand, both the GAAP and IFRS guidelines argue against discounting deferred taxes, but some experts stipulate that this feature can lead to positive outcomes. On the other hand, it has been found that the two regulation sets recognize the concept under analysis differently. This approach is subject to inconsistency as well as hurts comparability and understandability of the concept. That is why the following paragraphs will explain how it is possible to address these issues and achieve positive outcomes.
Many specific arguments can demonstrate why it is reasonable to allow discounting of deferred taxes. Firstly, this accounting approach is believed to be economically better for organizations because discounting allows such companies to postpone or reduce their tax payments (Schroeder et al., 2019). This state of affairs denotes that organizations face weaker accounting obligations, which can improve their financial health. Secondly, a failure to discount deferred taxes deprives companies of the opportunity to improve their financial statements (Mear et al., 2020). This suggestion indicates that discounting ensures that organizations can identify and demonstrate their operational advantage. Thirdly, a powerful argument for discounting deferred taxes is that this approach is aligned with general accounting principles for pension costs, leases, and notes receivable and payable (Schroeder et al., 2019). The successful implementation of the principle to other accounting items allows for expecting the same outcomes for deferred taxes. Finally, Schroeder et al. (2019) explain that discounting is justified because it is one of the adequate indicators of future cash flows. That is why sufficient evidence demonstrates that it could be useful to allow discounting deferred taxes.
Appropriate evidence demonstrates that the US GAAP approach to recognizing deferred taxes is better. According to the IFRS rules, deferred taxes are recognized to a specific extent that is determined by whether sufficient taxable profits are more likely than not to occur in the future (Mear et al., 2021). However, the GAAP guidelines offer to recognize deferred taxes in their entirety if there is no strong probability that the tax or its portion will not be implemented in the future (Schroeder et al., 2019). This condition is known as valuation allowance, and it implies that organizations are provided with flexibility in recognizing deferred taxes. Consequently, organizations can benefit from the approach suggested by US GAAP because it allows them to adjust their accounting to their needs and financial performance characteristics (Brouwer & Naarding, 2018). Consequently, it is evident that the presented way of recognizing deferred taxes is productive and provides companies with significant advantages.
The information above has demonstrated that the two suggested options are significant and justified. The rationale behind this statement is that scholarly evidence reveals that discounting deferred taxes and using the GAAP approach to recognizing deferred taxes provide organizations with essential benefits. They include better economic performance, weaker financial obligations, and increased flexibility in accounting. These positive features are considered sufficient to claim that the suggested courses of action should be implemented for organizations to improve their financial and accounting performance.
Biblical Application
The Bible does not say anything about deferred taxes because the concept was absent at the time when the Holy Scriptures appeared. However, the book offers numerous and explicit arguments in favor of taxation in general. The current assignment consulted the Bible (King James Version, 1769/2017) to provide specific details to prove the statement above. On the one hand, Jesus explicitly supported taxation and asked people to “render to Caesar the things that are Caesar’s” (Matthew 22:21). These words denote that individuals were encouraged to pay taxes to the ruler. On the other hand, the Bible stipulates that authorities are ministers of God, which denotes that paying money to them is a reasonable and justified activity (Romans 13:6-7). This evidence is sufficient to claim that the Holly Scripture strongly advocates for taxation. Even though deferred taxes are not directly rendered in the Bible, it is possible to make a grounded suggestion that they are not in conflict with the source. One should separately acknowledge that the suggested changes do not contradict the Holy Scriptures.
Conclusion
The Bible indicates that taxes are justified because authorities are considered ministers of God, which makes it reasonable for people to pay money to them. Thus, the individual learning project focuses on deferred taxes and analyzes this concept to identify weaknesses and offer ways to eliminate them. The historical overview demonstrates that deferred taxes are a relatively young concept that only emerged in the mid-20th century. Today, it is a widespread case when organizations’ income allocation and appropriate taxes cover different periods of time. In this case, effective accounting principles and standards are needed to regulate how this concept should be treated. Thus, the United States Generally Accepted Accounting Principles and the International Financial Reporting Standards meet these objectives because the guidelines explain how organizations should approach various accounting activities in different countries. The current project demonstrates that these regulation sets have similarities and differences in how they treat the concept under analysis.
The analysis of deferred taxes according to the two guidelines above and scientific literature reveals that some problem areas can be identified. They are whether it is necessary to discount deferred taxes and how it is more appropriate to recognize them. Thus, the analysis of credible and reliable sources indicates that differed tax discounting is a suitable approach because it provides organizations with economic benefits and improves their accounting performance. Simultaneously, it is more suitable to recognize deferred taxes according to the GAAP procedure. This approach is beneficial since it provides companies with accounting flexibility, which can result in better financial performance. In conclusion, this individual learning project has identified deferred tax issues and offered effective ways to address them.
References
Brouwer, A., & Naarding, E. (2018). Making deferred taxes relevant. Accounting in Europe, 15(2), 200-230. Web.
Flagmeier, V. (2022). The information content of deferred taxes under IFRS. The European Accounting Review, 31(2), 495-518. Web.
King James Bible. (2017). King James Bible Online. (Original work published 1769). Web.
Mear, K., Bradbury, M., & Hooks, J. (2020). Is the balance sheet method of deferred tax informative? Pacific Accounting Review, 32(1), 20-31. Web.
Mear, K., Bradbury, M., & Hooks, J. (2021). The ability of deferred tax to predict future tax. Accounting & Finance, 61(1), 241-264. Web.
Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2019). Financial accounting theory and analysis: Text and cases (13th ed.). Wiley.
Oxner, K. M., Oxner, T. H., & Phillips, A. D. (2018). Impact of the tax cuts and jobs act on accounting for deferred income taxes. The Journal of Corporate Accounting & Finance, 29(2), 12-21. Web.