Question

Why are the financial statements submitted to the government for tax purposes not always the same as the financial statements sent to investors?

I understand that businesses want to make their numbers look good to investors, while also paying as few taxes as possible to maximize profits. However, the IRS and the GAAP both have different rules when it comes to recording financial information. This results in businesses having two different sets of accounting records; duplicating work in this way seems inefficient and potentially unethical. Why are the IRS and GAAP holding accountants to different reporting rules?

Answer 1

The financial statement submitted to government for tax purpose are not same as financial statements as per GAAP. The reason being the taxable income is prepared on the tax laws which need adjustments for few items. For example: Certain expenses like warranty and provision for liability are disallowed which are allowed on payment basis. But theses expense is accrued in books based on accrual concept. Similarly incomes which are received in advance are taxable in tax laws based on cash receipt basis whereas per GAAP these are accounted as unearned revenue.

The government has framed tax laws rules keeping the mind the way revenue is generated and the way expenses are paid so that taxes are paid based on actual receipts and payments rather than on accrual basis. The government does not want to postpone the income and expenses in the name of accrual concept. The taxability is mainly driven by actual receipt or payment basis so that business pays the tax on the income at the earliest. The Financial statements as per GAAP are driven by fundamental accounting concepts and the main concept is the Accrual concept. As per Accrual concept the income and expenses are accounted based on when they are earned or incurred respectively.

Hence there arises the need to keep two books of accounts one as per GAAP for external reporting purpose and another one as per tax laws for government reporting purpose.