Question

Question: Interest on municipal bonds is referred to as a permanent difference when determining the proper amount to report for deferred taxes. Explain the meaning of permanent differences, and give two other examples.

Short answer

Answer

The permanent difference arises when the unevenness between taxable and accounting income will never reverse. Example: fine, penalties, Tax-exempt interest, etc.

Step-by-step solution

Step 1:Meaning of Bonds

Bonds are the security issued by the company to raise funds. It contains a fixed rate of interest payable by the company to the bondholders.

Permanent difference

Permanent difference means the difference between the taxable income and the accounting income which can not be reversed in future. Hence, it does not results in deferred tax asset or liability.

The two examples of the permanent difference

1. Items recognized for accounting purpose but not for income tax purposes

Example: Interest income on municipal bonds, fines, and penalties

1. Items are recognized for tax purposes but not for accounting purposes.

Example: Dividend exclusion, statutory depletion.