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Dot Corporation uses accelerated depreciation for tax purposes and straight-line depreciation for financial reporting. The company has a large cash position which is invested in tax-free municipal bonds. With regard to Dot's financial statements and tax reporting:

A the depreciation expense causes a temporary difference between income tax expense and taxes payable, and the interest income creates a permanent difference.

The interest income from municipal bonds is a permanent difference; thus, no deferred taxes are created and the difference is reflected in the company's effective tax rate. The different depreciation methods result in temporary differences that are expected to reverse. In the case of depreciation, a deferred tax liability is created. Valuation allowance accounts only apply to deferred tax assets and are created when it becomes probable that the company will not have enough future income to realize the full value of the deferred tax assets.

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