“Reversing entries” is an accounting principle that is used to simplify the accounting process when accounting for adjustments made for journal entries spanning more than one accounting period. This principle also applies to the accounting of differences between the net income listed in financial statements and taxable income reported on the tax return. These generally consist of temporary differences that will reverse themselves over time. However, the differences must be properly accounted for to avoid double entry and ensure the organization pays all required taxes.
Compute the amount of taxable income and income taxes payable for the tax year. For example, when preparing your 2011 taxes, you should calculate taxable income for 2011. You should determine your income tax liability using the rules of the Internal Revenue Code.
Identify any temporary year-end differences that will reverse, creating a taxable amount for the next year. For example, if the tax basis of an asset differs from the reported amount in the company’s financial statements, but will likely reverse itself in the foreseeable future, you will need to account for this temporary difference.
Record all applicable differences as deferred tax liabilities on the balance sheet. For example, assume one temporary difference at the end of 2011 will result in taxable amounts of $55,000 in 2012, $60,000 in 2013 and $65,000 in 2014. Each of these amounts results in a deferred tax liability that must be recorded on the balance sheets.
Create a journal entry to record the year’s income taxes payable, income tax expense and deferred income taxes. How you record your journal entry may vary depending on the type of accounting software or other accounting method used by the individual organization. For example, the specific steps taken to create a journal entry in Microsoft Office Accounting software may vary from those used in accounting software developed by another company.
Reverse deferred income tax entries in each applicable year. Following the previous example, the $55,000 deferred until 2012 should be converted to income taxes payable on the 2012 tax return. The $60,000 deferred until 2013 should be converted to income taxes payable on the 2013 tax return, and the $65,000 deferred until 2014 should be converted to income taxes payable on the 2014 tax return.
It is important to remember that, while income tax liability is governed by the rules of the Internal Revenue Code, tax expense is calculated under generally accepted accounting principles, or GAAP.
- Principles of Accounting: Chapter 4 – The Reporting Cycle
- University of California Department of Economics: Accounting for Income Taxes
- Financial Accounting Standards Board: Summary of Statement No. 109 - Accounting for Income Taxes (Issued 2/92)
- U.S. House of Representatives Downloadable U.S. Code: Title 26 – Internal Revenue Code.
- Microsoft Office: Make, edit, or void a journal entry
- Financial Accounting Standards Board. "Original Pronouncements," Page 3. Accessed June 20, 2020.
- Financial Accounting Standards Board. "Statement of Financial Accounting Standards No. 2," Page 12. Accessed June 20, 2020.
- Internal Revenue Service. "What is Taxable and Nontaxable Income?" Accessed June 20, 2020.
- Federal Register. "Reorganizations Under Section 368(a)(1)(F); Section 367(a) and Certain Reorganizations Under Section 368(a)(1)(F)." Accessed June 20, 2020.
- IRS. "Schedule M-1 Audit Techniques," Page 14. Accessed Jan. 14, 2020.
- Financial Accounting Standards Board. "Summary of Statement No. 109." Accessed June 20, 2020.
- Zacks. "Tax Payable vs. Deferred Income Tax Liability." Accessed June 20, 2020.
- It is important to remember that, while income tax liability is governed by the rules of the Internal Revenue Code, tax expense is calculated under generally accepted accounting principles, or GAAP.
Amanda L. Webster has a Master of Science in business management and a Master of Arts in English with a concentration in professional writing. She teaches a variety of business and communication courses within the Wisconsin Technical College System and works as a writer specializing in online business communications and social media marketing.