When a change in tax law is enacted on a date that is not close to an enterprise’s year-end, a question arises as to how temporary differences should be computed as of an interim date. We have identified three potential approaches:
a) Assume that the entity files a short-period tax return as of the date of the law’s enactment. The tax laws govern how annual deductions such as depreciation are allowed in a short-period return. The existing book bases of the assets and liabilities would be compared with these “pro forma” tax bases to determine the temporary differences.
b) Assume that net temporary differences arise and reverse evenly throughout the year. For example, if the beginning net temporary difference is $100 and the projected ending net temporary difference is $220, the temporary difference increases by $10 a month as the year progresses.
c) Assume that net temporary differences arise in the same pattern that pretax accounting income is earned. That is, if pretax income is earned 10%, 20%, 30%, and 40% in the first through fourth quarters, respectively, then temporary differences would increase or decrease on that basis as well.
In terms of the asset-and-liability approach underlying ASC 740
, the first alternative might be viewed as the most intuitive, but it is inconsistent with the principles of interim reporting, which treat an interim period as an integral component of the annual period, not as a discrete period. The second alternative would be practical; however, like the first alternative, it is inconsistent with how an entity estimates its quarterly tax provision and, thus, its deferred tax accounts. The third alternative avoids both of those inconsistencies and would be relatively easy to compute. Whichever method is chosen, it should be applied consistently.