Difference between GAAP Accounting and Tax Accounting

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All accounting reports are not equal as illustrated by different methods of accounting applied in the United States. Business accounting shows financial transactions recording of a business’ financial transactions. For public companies, the required accounting method is the Generally Accepted Accounting Principles (GAAP). On the other hand, Tax Accounting is not any different although there are other options for tax payers.

History

The basis of formation of the GAAP is as a result of accounting practice standardization. In the United States, the Financial Accounting Standards Board (FASB) is the highest authority which maintains and develops the accounting framework. The foundation of tax accounting was laid by the U.S constitution when the 16th Amendment was ratified giving birth to a revenue collection agency whose history dates back to 1894. After a number of reorganizations, there were several names and alteration changes hence giving birth to today’s Internal Revenue Service.

Purpose

The main purpose of GAAP is to offer uniformity in accounting principles, practices and standards which result to financial statements that can be compared across the board.

The purpose of IRS is in developing and maintaining the framework of tax accounting whose intention is levying tax against taxable income and net earnings. From the definition of GAAP, revenue is different from taxable income as tax is collected at the earlier of cash receipt or earning.

Depreciation

This refers to cost allocation over an asset’s estimated useful life. Under the GAAP, the common methods of depreciation include the straight line method, reducing balance method and sum of digits method.

On the other hand, Tax Accounting often uses the system of Modified Accelerated Cost Recovery that defines declined percentages. Moreover, IRS under section 179 allows the tax payers to expense a fixed asset during the year of purchase.

Basis

The accounting basis used in producing financial statements normally determines how transactions are reported and eventually the informational reports on the financial statements.

GAAP only allows the option of accrual basis of accounting. Tax accounting may use the accrual, cash basis or modified basis of accounting. For small businesses, the cost of using and developing GAAP can be very high. As such, IRS allows smaller companies to use alternative methods to account for their business transactions.

Accruals

Under the GAAP accounting system, expenses which are due for payment but are not yet paid for usually accrue on the balance sheet. This results to expenses accrual which is a liability that should be paid at a later date. It is at the time of accrual that the expense is taken. On the other hand, Tax Accounting does not factor in the accrual basis unless the tax return of your business is reported on the basis of accrual. IRS imposes cash limitations and modified accounting basis which factors in revenue limitations and also limitations of expenses and income reporting.

Inventory

For tax and book purposes, there are two principle methods used in inventory accounting. Last-In-Last-Out (LIFO) is the first. In this method, the cost of purchased inputs used in production in a given time period is matched with the generated revenue of items sold in the same period of time. The method is applied whether or not the inputs have been physically used in producing anything in that period of time. IRS stipulates that those businesses that use LIFO in inventory accounting on their tax returns should also use LIFO when reporting taxable income in the financial statements.

In the GAAP system, businesses are allowed to claim income using the FIFO or LIFO method. In contrast to LIFO, the cost of the oldest inputs is matched with revenue realized from sale of those goods.

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