Orange Incorporated uses the accrual method of accounting. Here is a reconciliation of Orange's allowance for bad debts for the current year.

Beginning allowance for bad debts $60,000
Actual write-offs of accounts receivable during the year (80,000)
Addition to allowance 90,000
Ending allowance for bad debts $70,000

Because of the difference between the GAAP and the IRC tax rules for accounting for bad debts, Orange Incorporated has an:

Question

Orange Incorporated uses the accrual method of accounting. Here is a reconciliation of Orange's allowance for bad debts for the current year.

Beginning allowance for bad debts	$60,000
Actual write-offs of accounts receivable during the year	 (80,000)
Addition to allowance	  90,000
Ending allowance for bad debts	$70,000

Because of the difference between the GAAP and the IRC tax rules for accounting for bad debts, Orange Incorporated has an:

BlackTom AI · Accepted Answer

First, restating the scenario helps set the stage: Orange Incorporated uses GAAP accrual accounting for its financial statements, while the IRC tax rules for bad debt deductions differ from GAAP. The provided reconciliation shows the movements in the allowance for bad debts during the year and yields an ending balance of $70,000.

Option 1: "$10,000 permanent excess of book income over taxable income." Under a permanent difference, there would be a difference that never reverses in future periods (e.g., due to fines or 50% meals, depending on the rule). Here, the difference arises from how GAAP and tax treat bad debt deductions, which reverses in future periods as write-offs occur or as allowances are established. Thus this is not a permanent difference but a temporary timing difference.

Option 2: "$10,000 permanent excess of taxable income over book income." This would imply a non-reversing difference that causes taxable income to consistently exceed book income by $10,000 each year. The bad debt treatment in tax versus GAAP is typically a timing difference that reverses, not a permanent one, so this choice mischaracterizes the nature of the discrepancy.

Option 3: "$10,000 temporary excess of taxable income over book income." Here, we analyze the math: the year’s bad debt expense under GAAP (the allowance method) is calculated as write-offs plus ending allowance minus beginning allowance, i.e., 80,000 + 70,000 − 60,000 = 90,000. For tax purposes, the deduction is generally limited to actual write-offs (80,000). Therefore, book income is reduced by 90,000, while taxable income is reduced by only 80,000. This creates a timing difference of 10,000, with taxable income being higher than book income by 10,000 in the current year. Since this reverses in future periods when the difference unwinds, it is temporary.

Option 4: "$10,000 temporary excess of book income over taxable income." This would imply that book income is higher than taxable income by $10,000 in the current year, reversing later. That is the opposite of what the calculations show: book income is lower (more deductions) than taxable income due to the larger GAAP deduction, not higher. Therefore, this choice incorrectly states the direction of the difference.

In summary, the mechanism here is a timing difference caused by GAAP allowing a larger bad debt expense (90,000) than the tax deduction (80,000), which makes book income lower than taxable income by 10,000 in the current year. This temporary difference will reverse when future years’ deductions align, producing or resolving the timing difference as appropriate.

SP25-BL-BUS-A327-1377 Quiz 9

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