Question

When accounting for income taxes, the differences between financial accounting and taxation accounting creates permanent and temporary differences between the expenses and liabilities reported under each regime.

Why do these differences exist?

What are the reasons that explain why we have one system of accounting for financial reporting, and a second for taxation?

Please give an in-depth explanation for the various reasons for why there are two systems for this, instead of one.

Answer 1

As we know that the profits as per financial accounting and taxation accounting differ. The reasons of difference between two profits are of two types:

Timing difference- These differences originate in one period and are capable of reversal in one or more subsequent years. For example

•Difference due to rate of depreciation.

• Difference due to method of depreciation.

• Expenses debited in the statement of profit and loss for accounting purpose but allowed for tax purpose in subsequent year and not in the same year.

Permanent difference- These differences originate in one period and are not capable of reversal in the subsequent years. Thus this difference is permanent in nature and the difference always remains. For example- amount given as donation, expenses of personal nature are considered as expenses in financial accounting but are disallowed in taxation accounting.

Thus these are the reasons why we have a different system of accounting for computing both financial and taxation profits.

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