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Accounting for Income Taxes 1920-1984
Another point of controversy has been whether or not the deferred tax account fits the definition
of a liability. This was argued in the early litera ture and remains a point of disagreement. Smith
(1984) pointed out that deferred taxes barely even fit the criteria of FAS No. 5 for a conting ency,
yet it was being accrued as a full-fledge d liability. Recall that before a loss contingency could be
recorded it m ust be: 1) probable and 2) reasonably estim ated. Sm ith (1985) argued th at the
comprehensive tax allocation ap proach is neither and suggested that, at best, retained earnings
might be appropriate.
Other authors used the Conceptual Fra mework to argue the deferred tax issue; Rosenfield and
Dent (1983) argued against it, Defliese (Defliese, Rosenfield and Dent, 1983) and Wyatt, Dieter
and Stewart (1984) sup ported the opinion. Wy att, Dieter and Stewart (1984) first discussed the
need for comprehensive allocation based on Concept Statement No. 1.
The FASB has concluded in SFAC No. 1 that the primary focus of financial reporting is
information about earnin gs and its com ponents; and that inf ormation abou t earnings
based on accrual accounti ng generally provid es a better indicat ion of an enterprise’ s
present and c ontinuing ability to generate favorable cash flows than information lim ited
to the financial effects of cash receipts and payments. We believe the “no allocation” and
partial tax allocation approaches are not b ased on sound prem ises, often produce results
that are not meaningful, and result in mis matching of benefits and costs (Wyatt, Dieter
and Stewart, 1984, p. 1).
They also us ed SFAC No . 3’s definiti on of liab ilities to justify recording deferred taxes as a
liability.
Deferred taxes payable for this type of timing difference meet the definition of a liability.
Their extinction will i nvolve a future s acrifice of econom ic benefits as a result of past
transactions or events. T he past trans actions or ev ents are those that gener ated pre-tax
accounting income (Wyatt, Dieter and Stewart, 1984, p. 16).
Rosenfield and Dent (Def liese, Rosenfi eld and De nt, 1983) took issue with whether or not the
obligation ha s already be en incurred. The y re iterated the FASB’s definition of a liabili ty as
“probable future sacrifices of econom ic benefits arising from present obligations of a particular
entity to transfer assets or provide services to other entities in the future as a result of past
transactions or events” (SFAC No. 3 , par. 28, in Rosenfield and Dent, 1983, p. 4 7). This
definition basically stipulates three criteria for a liability:
1.) Probable future sacrifice;
2.) Obligation to another entity;
3.) Obligation has already been incurred.
Rosenfield and Dent (19 83) concurred that the firs t two have been satisfied, but argued tha t the
last criterion had not been fulfilled. The third cr iterion results from the stat ements that it is a
“present obligation” that is “a result of past trans actions or events.” The authors stated tha t this
requires “the obligation to be a result so lely of past events and not to be a r esult of future events,
alone or in conjunction with past events,” (Rosenfield and Dent, 1983, p. 47). The reasoning they
gave for deferred taxes not to fit this criterion was as follows:
Taxable revenue would h ave to be earned in the f uture for the en terprise to have an
obligation for income taxes that would appear in its future income tax returns. Earning
the future revenue wouldn’t be m erely ancillary to the obligation. The obligation for all
ASBBS E-Journal, Volume 4, No.1, 2008 167