Question

Countries themselves are separated in terms of how accounting systems developed legally. On the one hand, you have micro-based, common law countries like the U.S., who have adopted fair presentation standards.

From an accounting perspective, should tax accounting and financial accounting be uniform?

Answer 1

Tax accounting and financial accounting

While large corporations and publicly traded companies must follow the financial accounting, small businesses have the choice of using either the financial accounting method or the tax accounting method. The difference between the two accounting methods is in the timing of when sales and purchases are recorded based on either accrual or cash. Most small businesses prefer to use the cash-based tax accounting. Choosing different accounting methods can have different impacts on business and tax returns

Financial Accounting

Financial accounting is mostly known as accrual-based accounting. Under the accrual method, companies record sales revenues and purchase expenses when they are earned and incurred, regardless of whether cash from sales has been collected and cash for purchases has been paid. To determine a sale or purchase transaction date for recording, companies need to ascertain the completeness of a sale or purchase. Unfinished delivery of goods or services and partially receiving from a purchase don't account for an earned revenue and incurred expense. Recording doesn't take place until the completion of the sale or purchase orders.

Tax Accounting

Tax accounting often is referred to as cash-based accounting, and thus focuses primarily on actual cash receipts and cash payments, rather than their related sale or purchase transactions. Companies don't record a sale or purchase transaction at the time of the transaction until cash is received or paid later. Small businesses with annual sales of $5 million or less may elect to use the tax accounting to help them better manage their cash positions, which hold more significance to a small business's survival than a larger company.

                                                      Business impact is the accrual-based financial accounting and the cash-based tax accounting can impact a small business differently. While financial accounting can accurately track business transactions as they are taking place, it doesn't show a business's actual cash reserve situations. A small business using the accrual method may report a good level of income in its accounting books but may be low on cash at its bank account if customers haven't paid yet. The cash-based tax accounting allows a small business to follow its cash situations more closely. But on the other hand, the cash-based method may mislead on a business's profitability if customers all pay their bills in a single period, causing a jump in cash receipts.

                                         Tax Impact is the election of an accounting method for business recording and financial reporting will have a tax impact on a small business because the same accounting method often is also used for preparing tax returns. Depending on the time of the year when a business transaction occurs and when the monetary settlement takes place, a small business may pay more or less on taxes for its current tax year. For example, using cash accounting, if a small business didn't make cash payment for a current-year purchase until next year, it could not declare a tax deduction on the purchase expense and thus would pay more taxes for the current tax year.