Question

Why is it important to understand the difference between an originating temporary difference and permanent difference in a company as related to deferred taxes? Explain if this concept is relevant for personal finance

Answer 1

Permanent Difference

The differences in taxable income and accounting income for the items which originate in one period but do not reverse in subsequent periods are called as permanent differences.
Example- Interest on Municipal bonds, penalties paid, etc.

Temporary Differences

The differences in taxable income and accounting income for the items which originate in one period and reverse in subsequent periods are called as temporary differences.
Example- Depreciation, Warranty expenses, etc.

It is important to know the catagory of each difference since, only the temporary differences are considered for the deferred tax computations. Permanent differences does not feature in the deferred tax computations.

This concept of permanent difference and temporary difference does not feature in personal finances.