A Note on the Financial Reporting of Depreciation and Income Taxes

Abstract

The financial reporting of income taxes becomes more complicated whenever depreciation is recognized faster or slower for tax purposes than for financial reporting purposes.' Under the flow-through method of tax accounting, the financial reporting of income taxes is not adjusted for the tax effects of depreciation timing differences. Hence, the tax expense in the income statement equals the tax assessable for the year. However, under interperiod income tax allocation, either tax or depreciation expense is adjusted to remove the effect of timing differences on net income after tax. If depreciation for tax purposes is greater than the amount recognized in the financial report, an adjustment increasing tax or depreciation expense can be made with the offsetting entry to a current tax liability, a noncurrent tax liability, or an addition to the allowance for depreciation. Analogously, decreases in tax or depreciation expense arising from a slower recognition of depreciation for tax purposes are reported in the balance sheet as a current tax asset, a noncurrent tax asset, or a reduction of the allowance for depreciation.2