Question

how do you prepare a reconciliation statement to determine taxable income?

Answer 1

Permanent Book-Return Differences:

Some types of income and expenses never affect a company’s taxes. income taxes, for example, is treated as an expense on a company’s books when calculating net income. Tax law does not allow businesses to deduct their tax bill as an expense. At no point can a business deduct income tax paid, which creates a permanent book-return difference. Other common permanent differences include disallowed travel and entertainment expenses and tax-exempt interest income.

Temporary Book-Return Differences:

Businesses might recognize some types of income or expenses at different times for accounting and tax purposes. GAAP allows companies several options for calculating depreciation expense, for example, which often recover the cost of capital purchases slower than the Internal Revenue Service-prescribed systems. The different systems lead to larger depreciation deductions on the company's tax return than on its books during the first few years, and larger book expenses for depreciation than tax deductions in later years. Over time, both methods provide the same total deduction, resolving the temporary difference in income

Tax Return Reconciliation:

The Internal Revenue Service provides schedules on which businesses can reconcile their accounting income to their taxable income. Many businesses can use the simpler Schedules M-1 and M-2, but companies with assets of more than $10 million are required to complete the more detailed Schedule M-3 instead. The schedules start with accounting income, increase it with expenses that aren’t tax-deductible and income that is taxable but not yet reported on the books, then decreases it for book income that’s not taxed and tax deductions that exceed book expenses.

Balance Sheet Reconciliation:

Accounting rules also require businesses report the differences in book-tax income that will eventually resolve. Temporary book-tax differences only change the timing, not the amount, of taxes that a company will pay. When a temporary difference results in taxable income being lower than accounting income, the company reports a deferred tax liability to reflect the taxes owed when the difference resolves. When the company pays more in taxes because of a temporary difference, it can report a deferred tax asset if it’s likely to owe enough taxes when the difference resolves