Gross Change Method
The financial accounting term gross change method refers to one of two approaches used to compute the tax effects of a number of timing differences. The gross change method is also known as the group-of-similar-items, gross change basis. With this method, the tax effects of originating timing differences use current rates, while the reversals use prior tax rates.
Most companies have two sets of books: financial accounting and income tax. Timing differences can occur for a number of reasons, and most are temporary in nature. A timing difference will occur when the calculation of pretax net income for accounting purposes (book) is different than that determined for income tax purposes. When a timing difference is temporary in nature, companies will make both originating and reversing entries to smooth out those differences over time. These transactions typically involve journal entries to the deferred income tax account.
In practice, companies have a large number of these timing differences, making tracking the originating and reversing transactions on an individual item basis impractical. To simplify the computation of these tax effects, companies can use either the gross or net change methods.
With the gross change method, the originating journal entries to deferred income taxes are calculated using the tax rate that applies in the current period, while the reversing entries use the rates that applied at the time of the originating entry (historical rates). The typical steps a company goes through to compute these journal entries include:
- Separating the timing differences into similar groups such as installment sales and depreciation.
- Subdividing these groups of similar items into originating and reversing transactions.
- Using the current tax rate to determine the aggregate originating difference for each group identified in step 1.
- Using prior tax rates to determine the aggregate reversing difference for each group identified in step 1.
- Calculating the difference between the aggregate originating and reversing differences (steps 3 and 4), and preparing the deferred income tax journal entry for each group identified in step 1.
Since each of the above groups will likely have different originating (historical) tax rates in step 4 above, companies will typically use a weighted average rate for each group. The weighted average is calculated by taking the aggregate deferred income taxes and dividing it by the aggregate timing difference in each period.