How to Account for Taxation Under GAAP
Under United States' generally accepted accounting principles (GAAP), the accounting for income taxes is governed by Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 740, Accounting for Income Taxes. ASC 740 is based on the premise that there often are differences between the amount of income a company or reporting entity may recognize for income tax reporting purposes and the amount of pretax income the same company or reporting entity may recognize for financial reporting purposes under GAAP.
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Instructions
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Compute the company's pretax income for the reporting period using Internal Revenue Service guidelines. If the reporting period is the same as the company's tax year, this will be the taxable income reported on the company's income tax return.
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Compute the company's pretax income for the reporting period under U.S. GAAP.
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Identify differences between the amount of a company's pretax income under U.S. GAAP and the amount of taxable income as reported on the company's income tax return. Identify the causes for those differences. A difference, for example, may be accounts receivable that may be written off as uncollectible under U.S. GAAP but may not be written off for federal taxation purposes.
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Split the causes between permanent differences and non-permanent differences. Non-permanent differences are those that will reverse in future income tax periods. They are, in effect, timing differences. Permanent differences are those that will not reverse in future income tax periods. Permanent differences are often caused by the Internal Revenue Service disallowance of certain deductions that are allowed under GAAP -- such as officer life insurance.
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Total the amount of net non-permanent differences.
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Add or subtract the net non-permanent differences to the net income or loss of the company under U.S. GAAP.
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Multiply the net income or loss after adjustment by the company's effective marginal tax rate. This is the amount of income tax expense or, in the case of a net loss, the amount of income tax benefit.
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If the amount of income tax expense computed above is greater than the amount of cash-basis income tax paid, debit income tax expense on the income statement for the difference and credit deferred income taxes on the balance sheet. If the amount of income tax expense computed above is less than the amount of cash-basis income tax paid (or there is an income tax benefit), credit income tax expense on the income statement for the difference and debit deferred income taxes on the balance sheet.
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