Question

How does a change in tax rate affect existing deferred income tax accounts?

A.) It is considered, but it should only be recorded in the accounts if it reduces a deferred tax liability or increases a deferred tax asset.

B.) It is applied to all temporary or permanent differences that arise prior to the date of the enactment of the tax rate change, but not subsequent to the date of the change.

C.) It is reported as an adjustment to tax expense in the period of change.

D.) It is handled retroactively in accordance with the guidance related to changes in accounting principles.

Answer 1

Items on a balance sheet that will reduce taxable income in future are called deferred tax assets. For example, overpayment of taxes is shown as an asset to the company. Deferred tax liability is a tax that is due for the current period but is still unpaid.

Deferred tax assets and liabilities are determined on the basis of current tax rates. However, with change in tax rates, deferred tax assets and liabilities will be adjusted accordingly.

Option (c) is correct.

• If the tax rate increases, the deferred taxes will increase, i.e. deferred tax assets and liabilities will increase. Similarly, if the tax rate decreases, deferred taxes will decrease.
• The change in tax rates also affect the income tax expense, which is the tax recognized on income statement.

So, change in tax rate is reported as an adjustment to tax expense in the period of change.