Taxes are a significant component of cash outflow for both businesses and individuals. Because taxes are regulated independently of financial reporting requirements, they often result in reporting differences. In the United States, the federal tax authority is the Internal Revenue Service (IRS). However, the accounting standards, which play a significant part in determining taxable business income, are defined by generally accepted accounting principles (GAAP). When differences in timing occur as a result of inconsistencies between the federal tax and GAAP accounting systems, the result can lead to new taxable income or losses or create an asset or liability, which will reverse at a later time. These assets and liabilities will be reported on the financial statements and can change analytical ratios.

At A Glance

  • The terms revenue, income, and profit have distinct meanings within the accounting profession; calculating these figures is the basis for determining taxable income.
  • The tax base will define how much money a company will need to pay, and it is linked to the information found on the income statement.
  • Tax structure, residency status, and depreciation all determine what income is taxable; therefore, differences exist between tax returns and financial statements.
  • A company's or an investor's tax rate depends on the way an organization is structured.
  • Differences between tax rules and accounting rules can lead to deferred tax assets and deferred tax liabilities.
  • Deferred tax liabilities can have an unfavorable impact on a company's balance sheet.
  • Assets and liabilities can occur before the accounting period because of inaccurate estimates, insurance payments, and other situations.
  • Deferred tax assets can show an increase on current assets on a company's financial statements.