NCPA - National Center for Policy Analysis

Three Differences between Tax and Book Accounting

August 9, 2011

For all practical purposes, U.S. corporations must keep two sets of books: one set to comply with Generally Accepted Accounting Practices (GAAP) and the other to comply with the Internal Revenue Code.  GAAP rules are intended to promote uniform statements that accurately convey the financial history, health and prospects of a business, while the tax code is intended to generate revenues for the government but also achieve certain public policy goals, says David S. Logan, an economist with the Tax Foundation.

The following are just three of the most common textbook differences between book and tax accounting:

Cash-Based vs. Accrual-Based Accounting.

  • Most activities accounted for in a corporation's financial statements are done so using what is known as the accrual method -- when a company receives payment, it is immediately taxable income in the view of the IRS (unless it is deferred income).
  • However, on a financial statement, the matching principle must be used under U.S. GAAP rules, which ensures that the income generated by an output and the expense incurred for that output are recognized in the same period.

Treatment of Depreciation.

  • Companies generally use two main types of depreciation: straight line and accelerated.
  • With straight-line depreciation, an identical percentage of the difference between initial and salvage value is depreciated every year, resulting in a book value equal to salvage value at the end of the asset's useful period.
  • Accelerated depreciation leads to higher depreciation (which is tax-deductible) during the initial years of the asset's life than in the final years.

Treatment of Inventory.

  • Two principal methods are used when accounting for inventory for book and tax purposes.
  • The first is the last-in, first-out method -- the cost of inputs purchased for production in a given period is matched with the revenues generated by items sold in the same period.
  • The second is the first-in, first-out system, which matches the cost of the oldest inputs with the revenue of goods sold in a given period.

Source: David S. Logan, "Three Differences between Tax and Book Accounting that Legislators Need to Know," Tax Foundation, July 27, 2011.

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