税効果会計とは？計算方法と仕訳、財務諸表への影響を解説

When a company reports its financial results, a difference often arises between the profit calculated under accounting rules (book income) and the income calculated under tax law (taxable income). Tax effect accounting is the procedure used to adjust for this difference. The process ensures that the profit shown on financial statements and the corresponding tax expense are logically matched over time. This accounting treatment aims to present a company’s financial position and performance more accurately to stakeholders like investors and creditors.

Applying tax effect accounting creates consistency between the pre-tax net income on the income statement and the related corporate tax expenses. This allows for a more precise calculation of net income, which reflects the company’s true earning power. The procedure is particularly important for publicly traded companies and others with a wide range of stakeholders, as it helps ensure the reliability of financial reporting.

The Need for Tax Effect Accounting

The two primary measures of corporate performance, accounting profit and taxable income, are calculated for fundamentally different reasons. Accounting aims to fairly report a company’s performance and financial position to stakeholders. In contrast, tax law is designed to collect taxes fairly based on rules set by government policy. This difference in purpose creates discrepancies in the timing and scope of how revenue and expenses are recognized.

These discrepancies are broadly divided into “temporary differences” and “permanent differences.” Tax effect accounting is only concerned with adjusting for temporary differences. If these differences are ignored, the accounting profit and its corresponding tax expense will not align, and the resulting net income may not accurately reflect the company’s performance for that period.

Temporary Differences

A temporary difference is a discrepancy between the book value of an asset or liability and its value for tax purposes, which is expected to reverse in the future. This occurs because accounting and tax rules recognize revenues and expenses at different times. For example, an allowance for bad debt may be recorded as an expense for accounting, but it is not deductible for tax purposes until the debt is actually written off.

This difference will be resolved in the future when the bad debt occurs. A temporary difference is any discrepancy between book and tax values that will reverse over time. Tax effect accounting is the procedure for reflecting the impact of these timing differences on future tax payments in the current financial statements.

Permanent Differences

A permanent difference is a discrepancy between accounting and tax rules that will never reverse. These arise from fundamental differences in what is considered a valid expense or income. For example, entertainment expenses that exceed the limit stipulated by tax law or certain dividend income that is not considered taxable revenue fall into this category.

Even if entertainment expenses are fully recorded for accounting purposes, the amount that can be deducted for tax purposes has a limit, and the excess amount will never become deductible. Similarly, some dividend income recorded as revenue in accounting is not included in taxable income to prevent double taxation. These are called permanent differences because they do not resolve over time and are not subject to adjustment under tax effect accounting.

Main Components of Tax Effect Accounting

The core of tax effect accounting involves two accounts: “Deferred Tax Asset” and “Deferred Tax Liability.” These accounts are used to record the effect of temporary differences on future tax payments. If a temporary difference will reduce future taxes, it creates a deferred tax asset. If it will increase future taxes, it creates a deferred tax liability.

By recording these items on the balance sheet, companies incorporate expected changes in their future tax burden into their current financial position. This process is an important part of adjusting the gap between book income and taxable income to provide more accurate financial reporting.

Deferred Tax Asset

A deferred tax asset represents a future reduction in tax payments and is effectively a prepayment of taxes. It is recognized when a “deductible temporary difference” exists, which is a difference that will decrease taxable income in the future. This includes items that have been recorded as an expense for accounting purposes but are not yet deductible for tax purposes.

Specific examples that create deferred tax assets include:
An allowance for bad debts that exceeds the tax-deductible limit.
Provisions for unpaid employee bonuses.
Depreciation expense that is higher for book purposes than what is allowed for tax purposes in a given period.
Inventory write-downs that are not yet recognized as a tax-deductible expense.

These items increase taxable income now but will become tax-deductible when the difference reverses, such as when a bad debt is written off or a bonus is paid. This results in a lower corporate tax burden in the future.

Deferred Tax Liability

A deferred tax liability represents a future increase in tax payments and can be considered a postponement of taxes. It is recorded when a “taxable temporary difference” exists, which is a difference that will increase taxable income in the future. This can occur with items that have not yet been recognized as profit for accounting but have already been included in taxable income.

For example, if a company sells a fixed asset and recognizes a gain for accounting purposes but uses a special tax provision to defer the tax on that gain, a taxable temporary difference is created. This difference will increase taxable income in the future as the tax deferral reverses. Therefore, a deferred tax liability must be recorded on the balance sheet to represent this future tax obligation.

Calculation and Journal Entry Process

The practice of tax effect accounting involves identifying temporary differences, calculating their impact on future taxes, and recording the result with journal entries. This process is necessary for a company’s financial statements to properly match accounting profit with its corresponding tax expense.

Calculation Steps

The first step is to identify and sum up all temporary differences by comparing the book value of assets and liabilities with their tax basis. This requires listing all items treated differently for book and tax purposes, such as depreciation and bad debt allowances. These are separated into deductible temporary differences, which reduce future taxes, and taxable temporary differences, which increase them.

Next, the total amount of temporary differences is multiplied by the “statutory effective tax rate.” This rate represents the company’s total expected tax burden, combining federal, state, and local corporate income tax rates. This calculation (Temporary Difference × Statutory Effective Tax Rate) determines the specific amount of the deferred tax asset or liability.

Recoverability of a Deferred Tax Asset

When recording a deferred tax asset, its “recoverability” must be carefully evaluated. Recoverability is the likelihood that the company will actually realize the future tax reduction. If a company is not expected to generate sufficient taxable income in the future, there will be no tax liability to reduce, and the deferred tax asset has no value.

Companies must consider past performance and future earnings forecasts based on business plans to determine if a deferred tax asset can be recorded. If future profits are highly probable, the full amount of the calculated deferred tax asset can be recorded. However, if future profitability is uncertain or the company has a history of losses, it may be required to reduce the value of the asset or not record it at all.

Journal Entries

Once the amount of the deferred tax asset or liability is determined, a journal entry is made to record it. The offsetting account used in this entry is “Provision for Income Taxes – Adjustment,” which appears on the income statement. This account adjusts the current tax expense to align with the book profit for the period.

To record a deferred tax asset, the entry is a debit to “Deferred Tax Asset” and a credit to “Provision for Income Taxes – Adjustment.” This reflects an increase in assets and a decrease in the total tax expense. To record a deferred tax liability, the entry is a debit to “Provision for Income Taxes – Adjustment” and a credit to “Deferred Tax Liability,” reflecting an increase in liabilities and an increase in the total tax expense.

Presentation and Disclosure in Financial Statements

The deferred tax assets and liabilities calculated through tax effect accounting are presented on the balance sheet and the income statement. Understanding where these items are recorded helps in analyzing a company’s financial condition.

Balance Sheet

On the balance sheet, deferred tax assets are typically presented in the non-current “other assets” section. Deferred tax liabilities are presented in the “non-current liabilities” section. Classifying them as non-current shows that their impact on future taxes is incorporated into the company’s long-term financial position.

If both deferred tax assets and deferred tax liabilities exist, they are generally offset, and the net amount is presented. For example, if a company has a $5 million deferred tax asset and a $2 million deferred tax liability, the balance sheet will show a net deferred tax asset of $3 million. This netting simplifies the financial statements.

Income Statement

On the income statement, the adjustment from tax effect accounting is displayed in an account often titled “Provision for Income Taxes – Adjustment” or “Deferred Income Tax Expense.” This line item is located within the income tax expense section, following the current tax expense. The current tax expense is adjusted by this amount to arrive at the total income tax expense for the period.

For example, in a period when deferred tax assets increase, the adjustment will be a credit, reducing the total tax expense. Conversely, if deferred tax liabilities increase, the adjustment will be a debit, increasing the total tax expense. This adjustment helps the total tax expense shown on the income statement more closely reflect the company’s pre-tax income.

Notes

Companies are required to provide additional details about tax effect accounting in the notes to the financial statements. This includes a breakdown of the major causes of deferred tax assets and liabilities. For instance, the notes will show how much of the total deferred tax amount is attributable to items like depreciation, bad debt allowances, or employee benefit provisions. This information helps investors and analysts understand the specific factors driving a company’s future tax obligations or benefits.