Chapter 5.3® - Conceptual Issues in Interperiod Tax Allocation - Comprehensive & Partial Tax Allocation Methods (theory only)

• Part 5.1 - Accounting for Corporate Income Taxes & Intra-period Tax Allocations
• Part 5.2 - Income Tax Provision or Expense? Differences between Taxable & Accounting Income (Permanent & Temporary Differences)
• Part 5.3 - Conceptual Issues in Interperiod Tax Allocation - Comprehensive & Partial Tax Allocation Methods (theory only)
• Part 5.4 - Future Tax Calculations using the Deferral or Liability (Accrual) Methods, Basic Illustration of Interperiod tax Allocation
• Part 5.5 - Changes in Income Tax Rate, Recording Future Tax Liability
• Part 5.6 - Difference between Carrying Value and Tax Basis
• Part 5.7 - Reconciliation of Effective Tax Rates & Differential Reporting & Accounting Treatment of the Investment Tax Credit

Interperiod income tax allocation has long been very contentious. Conceptually, there are three basic underlying issues:

Extent of Allocation:

It refers to the range of temporary differences to which Interperiod tax allocation is applied. The three basic options are:

The taxes payable method recognizes the amount of taxes assessed in each year as the income tax expense for that year: income tax expense = current income tax. This is also known as flow-through method.

The comprehensive allocation method is the opposite extreme: the tax effects of all temporary differences are allocated, regardless of the timing or likelihood of their reversal.

Partial allocation falls between no allocation and full allocation. Under partial allocation, Interperiod income tax allocation is applied to some types of temporary differences but not to all. There are several different ways of classifying those temporary differences that should be allocated and those that should not, and therefore this is not really just one alternative.

Taxes Payable Method:

The experts of the taxes payable method argue that income tax is an aggregate measure, applied to the overall operations of the company as a whole, and that is artificial to disaggregate the income tax amount as though each item of revenue and expense were taxed individually. The taxes payable method corresponds with the actual cash outflow for income taxes. It can be argued that earnings measured on the basis of the taxes payable method are superior to earnings measured by using full allocation if cash flow prediction is a primary objective of financial reporting.

Comprehensive Allocation:

In this allocation, a future cash flow impact arises from all temporary differences, no matter how far in the future that impact occurs. Taxes saves in the current year via an early tax deduction will have to be paid in a future year when the expense is recognized. The deduction is only available for accounting and not for the tax. It is a violation against the matching of cost and revenue principle.

Partial Allocation:

The experts of partial allocation attempt to take a middle ground by arguing that some temporary differences merit allocation while others do not. The general idea is that material non-recurring temporary differences that likely to reverse in the near future should be accorded tax allocation. For example, when a company decides to shut down a division, the full costs of discontinuing the operation must be estimated and included in accounting income in the year that the decision is taken. For tax purposes, the costs are deductible only when actually incurred.

Measurement Method

When the effects of temporary differences are measured, should the tax rate be:

This is the measurement method issue.