Permanent and Temporary Differences
Response to the following problem:
To implement interperiod income tax allocation, an accountant must be able to distinguish between permanent and temporary differences. The following is a list of three differences between a corporation's pretax financial income and taxable income:
a. Estimated warranty costs (covering a three-year warranty) are expensed for financial reporting purposes at the time of sale but are deducted for tax purposes when incurred.
b. MACRS depreciation for income tax purposes exceeds straight-line depreciation for financial reporting purposes.
c. Percentage depletion for tax purposes exceeds cost depletion for financial reporting purposes.
Required:
1. Define (a) permanent difference and (b) temporary difference.
2. Define interperiod income tax allocation and briefly describe its application under generally accepted accounting principles.
3. Indicate and explain whether each of the three differences listed in this case should be treated as a temporary or permanent difference.