Accounting income Versus taxable income

The nine key points of difference between accounting income

and taxable income are detailed below:

1. Meaning: Accounting income is the difference between the

revenue earned and expenses incurred by an entity, as
computed from its books of accounts.
- Taxable income is the resultant income computed after
making allowances and disallowances to accounting income in
line with tax laws.

LO 1
Cont.....ed
2. Basis of calculation
 The basis of calculation of accounting income is the
books of accounts prepared by the entity.

 The basis of calculation of taxable income is the

accounting income and the provisions contained in the
tax laws.

LO 1
 Cont....ed
3. Hierarchy
 Accounting income is calculated first.

 Taxable income is calculated subsequently after adjusting

the accounting income for tax allowances and
disallowances.

4. Statutory compliance
 Accounting income must comply with the jurisdictional
accounting standards and rules. For example, US GAAP in
the USA, Ind-AS in India etc.

LO 1
 Cont....ed
Taxable income must comply with jurisdictional
tax laws. For example, IRC in the USA, Income-tax
Act in India etc.
5. Accrual or cash basis
Accounting income is generally prepared on
mercantile or accrual basis.
Tax laws however generally result in a combination
of accrual and cash basis being followed

LO 1
 Cont....ed
6. Subject to audit
Calculation of accounting income is subject to statutory audit.
The calculation of taxable income is subject to tax audit.
7. Reporting : Accounting income is reported in the financial
statements of the entity. It is reported in the profit and loss
account or income statement.
Taxable income is reported in the tax return of the entity.

8. Assessment : Calculation of accounting income is not subject

to any external assessment.
 Cont....ed
Taxable income is assessed by tax authorities of the IRS. They
may make adjustments to the taxable income if they find any
non-compliance with tax laws.

9. Purpose of calculation: Accounting income is calculated

primarily for reporting to various stakeholders. It forms the
basis of evaluation of the entity’s performance on the basis of
which stakeholders take various decisions.
 Example:

Chelsea, Inc. reported revenues of $130,000 and

expenses of $60,000 in each of its first three years of
operations. For tax purposes, Chelsea reported the
same expenses to the IRS in each of the years.
Chelsea reported taxable revenues of $100,000 in
2015, $150,000 in 2016, and $140,000 in 2017. What
is the effect on the accounts of reporting different
amounts of revenue for IFRS versus tax?

LO 1
 Cont.....ed
Book vs. Tax Differences
IFRS Reporting 2015 2016 2017 Total

Revenues $130,000 $130,000 $130,000 $390,000

Expenses 60,000 60,000 60,000 180,000
Pretax financial income $70,000 $70,000 $70,000 $210,000

Income tax expense (40%) $28,000 $28,000 $28,000 $84,000

ILLUSTRATION 19-3
Tax Reporting 2015 2016 2017 Total

Revenues $100,000 $150,000 $140,000 $390,000

Expenses 60,000 60,000 60,000 180,000
Taxable income $40,000 $90,000 $80,000 $210,000

Income taxes payable (40%) $16,000 $36,000 $32,000 $84,000

LO 1
 Book vs. Tax Differences

Comparison 2015 2016 2017 Total

Income tax expense (IFRS) $28,000 $28,000 $28,000 $84,000

Income tax payable (TA) 16,000 36,000 32,000 84,000
Difference $12,000 $(8,000) $(4,000) $0

Income tax expense (40%) $28,000 $28,000 $28,000 $84,000

Are the differences accounted for in the financial statements? Yes

Year Reporting Requirement

2015 Deferred tax liability account increased to $12,000
2016 Deferred tax liability account reduced by $8,000
2017 Deferred tax liability account reduced by $4,000

LO 1
 Recap of temporary versus permanent differences

-Temporary differences are between the carrying amount of an

asset or liability in the Statement of Financial Position and its tax
base. Temporary Differences may be either:

- Taxable Temporary Differences: Which are temporary

differences that will result in taxable amounts in determining
taxable profit (tax loss) of future periods when the carrying amount
of the asset or liability is recovered or settled.

- Deductible Temporary Differences: Which are temporary

differences that will result in amounts that are deductible in taxable
profit (tax loss) of future periods when the carrying a mount of the
asset or liability is recovered or settled.
LO 1
Temporary Differences

Revenues or gains are taxable after they are recognized in financial income.

An asset (e.g., accounts receivable or investment) may be recognized for revenues or

gains that will result in taxable amounts in future years when the asset is recovered.
Examples:
1. Sales accounted for on the accrual basis for financial reporting purposes and on the
installment (cash) basis for tax purposes.
2. Contracts accounted for under the percentage-of-completion method for financial
reporting purposes and the cost-recovery method (zero-profit method) for tax
purposes.
3. Investments accounted for under the equity method for financial reporting purposes
and under the cost method for tax purposes.
4. Gain on involuntary conversion of non-monetary asset which is recognized for
financial reporting purposes but deferred for tax purposes.
5. Unrealized holding gains for financial reporting purposes (including use of the fair
value option) but deferred for tax purposes.
LO 6
Temporary Differences

Expenses or losses are deductible after they are recognized in financial income.

A liability (or contra asset) may be recognized for expenses or losses that will result in
deductible amounts in future years when the liability is settled. Examples:
1. Product warranty liabilities.
2. Estimated liabilities related to discontinued operations or restructurings.
3. Litigation accruals.
4. Bad debt expense recognized using the allowance method for financial reporting
purposes; direct write-off method used for tax purposes.
5. Share-based compensation expense.
6. Unrealized holding losses for financial reporting purposes (including use of the fair
value option), but deferred for tax purposes.

LO 6
Temporary Differences

Revenues or gains are taxable before they are recognized in financial income.

A liability may be recognized for an advance payment for goods or services to be

provided in future years. For tax purposes, the advance payment is included in taxable
income upon the receipt of cash. Future sacrifices to provide goods or services (or
future refunds to those who cancel their orders) that settle the liability will result in
deductible amounts in future years. Examples:
1. Subscriptions received in advance.
2. Advance rental receipts.
3. Sales and leasebacks for financial reporting purposes (income deferral) but reported
as sales for tax purposes.
4. Prepaid contracts and royalties received in advance.

LO 6
 Temporary Differences

Expenses or losses are deductible before they are recognized in financial income.

The cost of an asset may have been deducted for tax purposes faster than it was expensed
for financial reporting purposes. Amounts received upon future recovery of the amount of
the asset for financial reporting (through use or sale) will exceed the remaining tax basis of
the asset and thereby result in taxable amounts in future years. Examples:
1. Depreciable property, depletable resources, and intangibles.
2. Deductible pension funding exceeding expense.
3. Prepaid expenses that are deducted on the tax return in the period paid.
4. Development costs that are deducted on the tax return in the period paid.
 Permanent Differences

Permanent differences result from items that (1) enter into

pretax financial income but never into taxable income or (2)
enter into taxable income but never into pretax financial income.

Permanent differences affect only the period in which they

occur. They do not give rise to future taxable or deductible
amounts. There are no deferred tax consequences to be
recognized.

LO 6
Permanent Differences

Items are recognized for financial reporting purposes but not for tax purposes.

Examples:
1. Interest received on certain types of government obligations.
2. Expenses incurred in obtaining tax-exempt income.
3. Fines and expenses resulting from a violation of law.
4. Charitable donations recognized as expense but sometimes not deductible for tax
purposes.

Items are recognized for tax purposes but not for financial reporting purposes.

Examples:
1. “Percentage depletion” of natural resources in excess of their cost.
2. The deduction for dividends received from other corporations, sometimes considered
tax-exempt.

LO 6
Deferred tax liabilities versus deferred tax assets

Deferred Tax Liabilities are the amounts of income taxes

payable in future periods in respect of taxable temporary
differences. Deferred Tax = Taxable Temporary Differences *
tax rate (future)

A deferred tax liability should be recognised for all taxable

temporary differences, unless the deferred tax liability arises
from the initial recognition of goodwill or the initial recognition of
an asset or liability in a transaction which:

- Is not a business combination and

- At the time of transaction, affect neither accounting profit nor

taxable profit (or tax loss) LO 1
 Cont...ed

Recognition of Deferred Tax Assets

- Deferred Tax assets are the amounts of income taxes

recoverable in future period in respect of:

- Deductible temporary differences.

- The carry forward of unused tax losses and

- The carry forward of unused tax credits.

- A deferred tax asset shall be recognised for all deductible

differences to the extent that it is probable that taxable profit will
be available against which the deductible temporary differences
can be utilized.
LO 1
 Future Taxable and Deductible Amounts

A temporary difference is the difference between the tax basis of an

asset or liability and its reported (carrying or book) amount in the
financial statements that will result in taxable amounts or deductible
amounts in future years.

Future Taxable Amounts Future Deductible Amounts

Deferred Tax Liability represents Deferred Tax Asset represents the
the increase in taxes payable in increase in taxes refundable (or
future years as a result of taxable saved) in future years as a result of
temporary differences existing at deductible temporary differences
the end of the current year. existing at the end of the current
year.

LO 2
FINANCIAL STATEMENT PRESENTATION
Statement of Financial Position

Deferred tax assets and deferred tax

liabilities are also separately recognized and
measured but may be offset in the statement
of financial position.

The net deferred tax asset or net deferred tax

liability is reported in the non-current section
of the statement of financial position.
LO 9
 Tax losses carried forward
A deferred tax asset shall be recognized for the
carry forward of unused tax losses if it is probable
(“more likely than not”) that future taxable profit
will be available against which the unused tax
losses can be utilized.

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Example :1
An entity has a tax loss of Br 8 million which can
be carried forward for 5 years. The estimated
cumulative taxable profits for the next five years
are Br 6 million. It is estimated that Br 2 million
of the tax loss will expire unused. The tax rate is
30%.
1. What is the deferred tax asset?
2. What is the journal entry?

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Example 1: Solution

The entity recognizes a deferred tax asset of Br

1.8 million (Br 6 million x 30%)

Deferred Tax Asset…………… 1,800,000

Deferred Tax Income…………………1,800,000

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Example: 2
An asset that costs Br 600,000 has a carrying
amount of Br 430,000. Cumulative depreciation for
tax purposes is Br 200,000 and the tax rate is 30%.
1. What is the tax base of the asset?
2. What is the temporary difference?
3. Is it taxable or deductible temporary difference?
4. What is the deferred tax?
5. Is it a deferred tax asset or liability?

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Example 2: Solution

1. TB= Br 600,000- Br 200,000=400,000

2. TD= Br 430,000- Br 400,000= 30,000
3. Taxable temporary difference
4. DT= Br 30,000 x 30%= 9,000
5. Deferred tax liability

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- Statement of Financial Position : for each type of temporary
difference. The amount of the deferred tax asset and liabilities
recognised in the Statement of Financial Position.
- Statement of Comprehensive Income: for each type of
temporary differences, the amount of the deferred tax income
or expense recognised in the Statement of Comprehensive
Income, if the information is not evident from the movement in
Statement of Financial Position amounts.
- Temporary Difference Reversals: the deferred tax expense
relating to the organization or reversal
of temporary differences and changes in tax rates or to the
importation of new taxes.
- Reduction of taxes : by using previously unrecognized tax loss,
tax credit or temporary difference
of a prior period.
-The written down of a deferred tax asset.

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 Cont.....ed
- Deductible Temporary Difference : the amount and expiry date
(if any) of deductible temporary differences, unused tax losses,
and unused tax credits for which no deferred tax asset is
recognised in the Statement of Financial Position.
- The aggregate amount of temporary differences related to
specific Investments.
- Deferred tax relating to items that are charged or credited to
equity.
- Future taxable profits : the amount of deferred tax asset and the
nature of the evidence supporting its recognition. When its
utilization depends on future taxable profits exceeding those
arising from the reversal of existing taxable temporary differences.
And the entity has made a taxable loss in either the current or
proceding period in the relevant tax jurisdiction (This Disclosure is
required when deferred tax assets are recognised in relevance
on future accounting profits. Despite the existence of recent
losses.
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