Differences Between Accounting Profit and Taxable Income

Accounting profit also referred to as income before taxes is reported on a company’s income statement following the prevailing accounting standards.

Taxable income is the portion of a company’s income that is subject to income taxes following the tax laws of the jurisdiction within which a company operates.

Accounting profit and taxable income may differ due to different guidelines which relate to how income is reported on a company’s financial statements and how it is measured for income tax purposes.

Key Definitions

• Taxable income is the basis for a company’s income tax payable or recoverable. It is calculated based on a company’s tax rate and appears on the balance sheet.
• Tax expense (or tax benefit) is reported on the income statement and is an aggregate of a company’s income tax payable (or recoverable) and any changes in deferred tax assets and liabilities.
• Deferred tax assets arise when a company’s taxable income is greater than its accounting profit resulting in an excess amount being paid for income taxes, and the company expects to recover this difference in the course of future operations. Actual income taxes payable will therefore be greater than the financial accounting income tax expense.
• Deferred tax liabilities arise when a deficit amount is paid for income taxes and a company expects to eliminate this deficit during future operations.
• The valuation allowance is a reserve created against deferred tax assets and is based on the likelihood of the realization of deferred tax assets in future accounting periods.
• The tax base of an asset or liability is the amount at which it is valued for tax purposes, whereas the carrying amount is the amount at which it is valued according to accounting principles. Differences between the tax base and carrying amount result in differences between the accounting profit and taxable income.

Differences Between Accounting Profit and Taxable Income

Differences between accounting profit and taxable income can occur in several ways, inclusive of the following:

• revenues and expenses may be recognized in one reporting period for tax purposes and in another period for accounting purposes;
• specific revenue and expense items may not be recognized for accounting purposes but recognized for tax purposes. Alternatively, they may be recognized for accounting purposes but not recognized for tax purposes;
• the tax base and carrying amount of assets and/or liabilities may differ;
• the deductibility of gains and losses of assets and liabilities may vary for income tax and accounting purposes;
• the tax losses of previous years may be used to reduce the taxable income in later years, subject to tax rules. This will result in differences between the accounting and taxable income (tax loss carryforward); and
• the adjustments of reported financial data from previous years may not be recognized equally for accounting and tax purposes or may be recognized in different periods.

Question

Which of the following statements accurately describes an occurrence of a difference between accounting profit and taxable income?

1. The tax base and carrying amount of assets and/or liabilities is the same.
2. The tax losses of previous years cannot be used to reduce the taxable income in later years.
3. Revenues and expenses may be recognized in one reporting period for accounting purposes and in another period for tax purposes.

Solution

The correct answer is C.

The statement, “revenues and expenses may be recognized in one reporting period for accounting purposes and in another period for tax purposes,” provides an example of a difference between accounting profit and taxable income.