Definition
The financial accounting term interperiod income tax allocation refers to the distribution of income tax expense between accounting periods. This occurs due to a timing difference between taxable income and the accounting income appearing in the company's financial statements.
Explanation
Also referred to as a comprehensive tax allocation, an interperiod tax allocation is required to ensure alignment between the income tax expense appearing in financial statements and the obligation determined when calculating accounting income. The interperiod allocation aligns Generally Accepted Accounting Principles with federal and state income tax rules.
While it might seem logical to align the company's financial statements with the tax guidelines outlined by the IRS, doing so can actually distort the true financial performance of the business. The use of accelerated depreciation for tax purposes versus straight line for book purposes is a good example of how this distortion can occur.
An interperiod allocation is achieved by accruing income taxes to align with accounting income whenever there is a timing difference that impacts taxable income or expenses.
Example
Company A purchases a new machine for $100,000 in Year 1. Tax laws allow Company A to depreciate the asset over 5 years at $20,000 per year. Company A will use 10 years for book purposes; thereby incurring an expense of $10,000 per year. The table below demonstrates how the interperiod tax allocation aligns what is shown on Company A's financial statements (Income Tax Expense) and its tax records (Tax Depreciation).
Tax Expense | Tax Depreciation | Deferred Income Taxes | |
Year 1 | $10,000 | $20,000 | $10,000 |
Year 2 | $10,000 | $20,000 | $20,000 |
Year 3 | $10,000 | $20,000 | $30,000 |
Year 4 | $10,000 | $20,000 | $40,000 |
Year 5 | $10,000 | $20,000 | $50,000 |
Year 6 | $10,000 | $40,000 | |
Year 7 | $10,000 | $30,000 | |
Year 8 | $10,000 | $20,000 | |
Year 9 | $10,000 | $10,000 | |
Year 10 | $10,000 | $0 |
Related Terms
The income statement is a financial accounting report that demonstrates how net income, or profit, is derived from revenues. The main categories appearing on an income statement include revenues, cost of goods sold, operating expenses, non-recurring items and net income.
Moneyzine EditorNovember 6th, 2024
The term Generally Accepted Accounting Principles, or GAAP, is used to describe a set of guidelines, accounting rules, techniques and frameworks utilized in the preparation of a company's financial statements.Moneyzine EditorJanuary 19th, 2024
The term income tax is used to describe federal and state tax obligations payable on individual or business income. Income taxes are computed by completing tax forms available from the Internal Revenue Service.Moneyzine EditorNovember 6th, 2024
The financial accounting term depreciation is sometimes defined as a decline in tangible plant's service potential. Depreciation is a method of allocating the cost of a tangible asset in a systematic manner to those time periods that benefit from the use of the asset.Moneyzine EditorJanuary 16th, 2024
Deferred income tax is the accounting term used to describe situations where the income tax expense and the income tax payable are not the same. Deferred income taxes are listed on the balance sheet as a liability.Moneyzine EditorNovember 6th, 2024
