Definition
The financial accounting term gross change method refers to one of two approaches used to compute the tax effects of a number of timing differences. The gross change method is also known as the group-of-similar-items, gross change basis. With this method, the tax effects of originating timing differences use current rates, while the reversals use prior tax rates.
Explanation
Most companies have two sets of books: financial accounting and income tax. Timing differences can occur for a number of reasons, and most are temporary in nature. A timing difference will occur when the calculation of pretax net income for accounting purposes (book) is different than that determined for income tax purposes. When a timing difference is temporary in nature, companies will make both originating and reversing entries to smooth out those differences over time. These transactions typically involve journal entries to the deferred income tax account.
In practice, companies have a large number of these timing differences, making tracking the originating and reversing transactions on an individual item basis impractical. To simplify the computation of these tax effects, companies can use either the gross or net change methods.
With the gross change method, the originating journal entries to deferred income taxes are calculated using the tax rate that applies in the current period, while the reversing entries use the rates that applied at the time of the originating entry (historical rates). The typical steps a company goes through to compute these journal entries include:
Separating the timing differences into similar groups such as installment sales and depreciation.
Subdividing these groups of similar items into originating and reversing transactions.
Using the current tax rate to determine the aggregate originating difference for each group identified in step 1.
Using prior tax rates to determine the aggregate reversing difference for each group identified in step 1.
Calculating the difference between the aggregate originating and reversing differences (steps 3 and 4), and preparing the deferred income tax journal entry for each group identified in step 1.
Since each of the above groups will likely have different originating (historical) tax rates in step 4 above, companies will typically use a weighted average rate for each group. The weighted average is calculated by taking the aggregate deferred income taxes and dividing it by the aggregate timing difference in each period.
Related Terms
- The financial accounting term timing differences refers to variances between what a company reports in its financial statements and income tax returns. Timing differences can occur when revenues and expenses are included in the calculation of accounting income in one period, while their impact on taxable income is reported in a different period.
Moneyzine EditorSeptember 21st, 2023 - The financial accounting term permanent differences typically refers to transactions that are recognized for financial reporting purposes but not for income tax purposes. Although less common, permanent differences can also refer to transactions that are recognized for income tax purposes, but not for financial reporting purposes.Moneyzine EditorSeptember 20th, 2023
- The financial accounting terms originating and reversing differences refer to the initial timing variance between pretax accounting income and taxable income, and the elimination of those variances. Originating and reversing entries are needed due to timing differences, which occur when revenues and expenses are included in the calculation of accounting income in one period, while their impact to taxable income is reported in a different period.Moneyzine EditorSeptember 20th, 2023
- The financial accounting term net change method refers to one of two approaches used to compute the tax effects of a number of timing differences. The net change method is also known as the group-of-similar-items, net change basis. With this method, the tax effects of both originating and reversing timing differences use current rates.Moneyzine EditorSeptember 20th, 2023
