Accounting For Deferred Taxes: Time For A Change

Abstract

<p>This study examines the theory underlying the current accounting and reporting standards for deferred taxes. Given the goal of global accounting convergence and under the proposed condorsement approach, the FASB and the IASB have a historic opportunity to revise the existing deferred tax accounting standards. Thus, it is warranted to illustrate the financial consequences of using the proposed flow-through (where tax expense is equal to the statutory tax liability) approach versus the asset-liability method of accounting for deferred taxes. We achieve this objective by computing the change in the debt-to-equity (DTE) ratios for the 2004-2010 period when net deferred tax balances are eliminated and corresponding adjustments are made in the total liability and stockholders equity balances. Based on our observations, we propose that the underlying issue in accounting for deferred taxes is the unit problem and argue that deferred taxes do not represent assets and liabilities as defined by accounting standards.<strong></strong></p>

A historical review of the rise of tax effect accounting as a financial reporting norm

“…Acheampong et al, 2013; Chang et al, 2009; Herbohn et al, 2010). More generally, the inclusion of deferrals may lead to deterioration in reported financial position, affecting ratios such as debt to equity as well as impacting on borrowing constraints and reputation (Colley et al, 2012; Wong, 2005).…”