As an accounting major in college, I quickly learned all of the complicated parts of the accounting cycle. I discovered how to input the details of business transactions into a computerized accounting system. At the end of an accounting cycle, such as a month, I became experienced with calculating the revenue for the period. If you’re starting a new business, determining an accurate amount of revenue for each accounting cycle is crucial. You must know how much profit you’re making each accounting period in order to be successful in the long-term. On this blog, you will discover how an experienced accountant can help you keep track of your revenue.
When you have a small business, you just write a check for income taxes and you don't have to worry too much about the accounting portion. However, as your business gets larger, the bookkeeping will get more complicated. When you use the accrual method of accounting, you need to account for income taxes in a specific way. Here is an overview of the process.
Why financial income and taxable income differ
The financial income shown in your accounting records will not necessarily match the taxable income that you report on your tax return. Why? Because different rules apply.
Your company will determine its pre-tax income using Generally Accepted Accounting Principles (GAAP). Taxable income, in contrast, will be based on income calculations determined by the Internal Revenue Code.
Examples of when financial and taxable income differ
For example, you might recognize revenue that you haven't received yet on your books, but you may not include that in the taxable income on your tax return. Or, you may depreciate an asset in different ways for bookkeeping and taxation purposes.
In other cases, you may recognize an expense on the books that your company pays because it affects your bottom line. But that expense may not be deductible for tax purposes. For instance, fines paid to regulatory agencies should be recorded in your books but not on your tax return.
Income tax expense versus income tax payable
The financial income on your books is used to calculate your income tax expense. That is the amount you'd spend on income tax if the tax rules matched your bookkeeping rules. You calculate your income tax payable based on your taxable income times the tax rate.
The difference between your income tax expense and your income tax payable is either a deferred tax asset or a deferred tax liability. You record all of these numbers in your records.
Understanding deferred tax assets and liabilities
When a difference between your books and the tax rules is going to save you money in the future, that is called a deferred tax asset. If the difference is going to lead to a tax bill in the future, that is called a deferred tax liability. You should also account for these on your books.
They should be netted out—that just means that you subtract the liabilities from the assets. Then, they should be presented as a long-term asset or liability on your balance sheet.
Turning financial statements into tax returns
If the information in your financial statements doesn't reflect the exact information you need to include on your tax return, how do you know what to put on your return? This is when it's time to outsource. Hire a tax preparer who knows all about financial accounting and tax prep. They can help with everything.
To learn more about tax preparation for your business, contact a tax prep service like Hough & Co CPA.Share