Question

How is the definition of Income for tax purposes different from Generally accepted accounting principles? Be brief and to the point with respect to when earned and when recognized in the books of accounting.

Answer 1

Income for tax purposes is recognized when earned or received, whereas under GAAP, it's recognized when earned and matched with expenses in the same period. Taxable income considers deductions and exemptions from adjusted gross income, while accounting profit involves total revenue minus explicit costs.

Step-by-step explanation:

The definition of income for tax purposes often differs from the Generally Accepted Accounting Principles (GAAP) primarily in the timing of recognition. For tax purposes, income is recognized when it is earned or received, whereas GAAP focuses on the matching principle, recognizing income when it is earned and matching the income with related expenses in the period incurred, regardless of when actual payment occurs. This discrepancy arises due to the aim of tax income, which is to determine the ability to pay taxes, while GAAP aims to provide a fair and consistent representation of financial performance.

Taxable income is calculated by subtracting deductions and exemptions from adjusted gross income. Different tax rates apply to various income levels, and individuals may also be eligible for tax credits or be subject to the alternative minimum tax. Accounting profit, on the other hand, is considered a cash concept and includes total revenue minus explicit costs, representing the actual cash inflow and outflow. Economic profit includes both explicit and implicit costs, providing a more comprehensive view of a business's financial health.