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A temporary difference is defined in ASC 740-10-20.

ASC 740-10-20

Temporary Difference - A difference between the tax basis of an asset or liability computed pursuant to the requirements in Subtopic 740-10 for tax positions, and its reported amount in the financial statements that will result in taxable or deductible amounts in future years when the reported amount of the asset or liability is recovered or settled, respectively. Paragraph 740-10-25-20 cites eight examples of temporary differences. Some temporary differences cannot be identified with a particular asset or liability for financial reporting (see ASC 740-10-05-10 and ASC 740-10-25-24 through 25-25), but those temporary differences do meet both of the following conditions:
  1. Result from events that have been recognized in the financial statements.
  2. Will result in taxable or deductible amounts in future years based on provisions of the tax law.

As noted in the definition, ASC 740-10-25-20 cites eight examples of temporary differences. Importantly, those examples are not intended to be all inclusive.

ASC 740-10-25-20

An assumption inherent in an entity’s statement of financial position prepared in accordance with generally accepted accounting principles (GAAP) is that the reported amounts of assets and liabilities will be recovered and settled, respectively. Based on that assumption, a difference between the tax basis of an asset or a liability and its reported amount in the statement of financial position will result in taxable or deductible amounts in some future year(s) when the reported amounts of assets are recovered and the reported amounts of liabilities are settled. Examples include the following:
  1. Revenues or gains that are taxable after they are recognized in financial income. An asset (for example, a receivable from an installment sale) may be recognized for revenues or gains that will result in future taxable amounts when the asset is recovered.
  2. Expenses or losses that are deductible after they are recognized in financial income. A liability (for example, a product warranty liability) may be recognized for expenses or losses that will result in future tax deductible amounts when the liability is settled.
  3. Revenues or gains that are taxable before they are recognized in financial income. A liability (for example, subscriptions received in advance) may be recognized for an advance payment for goods or services to be provided in future years. For tax purposes, the advance payment is included in taxable income upon the receipt of cash. Future sacrifices to provide goods or services (or future refunds to those who cancel their orders) will result in future tax deductible amounts when the liability is settled.
  4. Expenses or losses that are deductible before they are recognized in financial income. The cost of an asset (for example, depreciable personal property) may have been deducted for tax purposes faster than it was depreciated for financial reporting. Amounts received upon future recovery of the amount of the asset for financial reporting will exceed the remaining tax basis of the asset, and the excess will be taxable when the asset is recovered.
  5. A reduction in the tax basis of depreciable assets because of tax credits. Amounts received upon future recovery of the amount of the asset for financial reporting will exceed the remaining tax basis of the asset, and the excess will be taxable when the asset is recovered. For example, a tax law may provide taxpayers with the choice of either taking the full amount of depreciation deductions and reduced tax credit (that is, investment tax credit and certain other tax credits) or taking the full tax credit and reduced amount of depreciation deductions.
  6. Investment tax credits accounted for by the deferral method. Under the deferral method as established in paragraph 740-10-25-46, investment tax credits are viewed and accounted for as a reduction of the cost of the related asset (even though, for financial statement presentation, deferred investment tax credits may be reported as deferred income). Amounts received upon future recovery of the reduced cost of the asset for financial reporting will be less than the tax basis of the asset, and the difference will be tax deductible when the asset is recovered.
  7. An increase in the tax basis of assets because of indexing whenever the local currency is the functional currency. The tax law for a particular tax jurisdiction might require adjustment of the tax basis of a depreciable (or other) asset for the effects of inflation. The inflation-adjusted tax basis of the asset would be used to compute future tax deductions for depreciation or to compute gain or loss on sale of the asset. Amounts received upon future recovery of the local currency historical cost of the asset will be less than the remaining tax basis of the asset, and the difference will be tax deductible when the asset is recovered.
  8. Business combinations and combinations accounted for by not-for-profit entities (NFPs). There may be differences between the tax bases and the recognized values of assets acquired and liabilities assumed in a business combination. There also may be differences between the tax bases and the recognized values of assets acquired and liabilities assumed in an acquisition by a not-for-profit entity or between the tax bases and the recognized values of the assets and liabilities carried over to the records of a new entity formed by a merger of not-for-profit entities. Those differences will result in taxable or deductible amounts when the reported amounts of the assets or liabilities are recovered or settled, respectively.

Other events not described in ASC 740-10-25-20 may give rise to temporary differences. Whatever the event or circumstance, a temporary difference will arise when a basis difference is expected to result in a taxable or deductible amount when the reported amount of an asset or liability is recovered or settled, respectively. ASC 740-10-25-23 describes taxable and deductible differences.

ASC 740-10-25-23

Temporary differences that will result in taxable amounts in future years when the related asset or liability is recovered or settled are often referred to as taxable temporary differences (the examples in paragraph 740-10-25-20(a); (d); and (e) are taxable temporary differences). Likewise, temporary differences that will result in deductible amounts in future years are often referred to as deductible temporary differences (the examples in paragraph 740-10-25-20(b); (c); (f); and (g) are deductible temporary differences). Business combinations (the example in paragraph 740-10-25-20(h)) may give rise to both taxable and deductible temporary differences.

The financial statement reported amount of an asset or liability and its settlement or recovery is based on US GAAP. The tax basis of an asset or liability and the timing of its inclusion in taxable income is based on the laws and regulations of the relevant tax jurisdiction of each respective taxpaying component of the consolidated reporting entity (e.g., US federal, US state, non-US jurisdictions). For financial accounting purposes, the tax bases of assets and liabilities are based on amounts that meet the more-likely-than-not recognition threshold under ASC 740-10-25-5 and are measured pursuant to the measurement requirements of ASC 740-10-30-7. A tax basis computed pursuant to that recognition and measurement model may be different from a tax basis computed for and reported on a filed or expected-to-be-filed tax return. Therefore, adjustments from “as filed” amounts may be necessary in order to properly determine deferred taxes.
There are also certain circumstances when the deferred taxes recognized for US GAAP differ from those recognized for statutory reporting purposes. Question TX 3-1 addresses valuation allowance considerations when there is a difference in deferred taxes recorded between US GAAP and statutory financial statements.
Question TX 3-1
A reporting entity has a deferred tax liability for US GAAP that represents a source of taxable income that could be used to realize existing deferred tax assets. However, for its statutory financial statements, the deferred tax liability does not exist. For purposes of assessing whether a valuation allowance is necessary for its deferred tax assets, should the absence of the deferred tax liability on the statutory financial statements be considered?
PwC response
No. If the financial statements being presented are US GAAP financial statements, the reporting entity should assess the need for a valuation allowance based on the US GAAP deferred taxes. As such, the deferred tax liability that exists for US GAAP should be considered as a potential source of taxable income that could realize existing deferred tax assets.
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