Accounting vs Taxable Profit: Difference and Comparison

Accounting profit is the financial profit reported by a company in its financial statements, calculated by subtracting expenses from revenues, and it may differ from taxable profit due to variations in tax laws, deductions, credits, and timing differences related to income recognition and expense deductions, leading to variations in the amount of income subject to taxation.

Taxable profit, on the other hand, represents the income on which an entity is legally required to pay taxes to the government, and it is calculated in accordance with the tax laws and regulations applicable in a specific jurisdiction.

Key Takeaways

1. Accounting profit is the net income reported on financial statements, calculated by subtracting total expenses from total revenues.
2. Taxable profit is the income a business must pay taxes, determined by applying tax regulations and adjustments to the accounting profit.
3. Differences between the two arise from variations in accounting methods, allowable deductions, and tax regulations that impact income calculations.

Accounting Profit vs Taxable Profit

Accounting profit is the profit of the Company, whereas Taxable Profit is profit which is taxable. Accounting profit is known after conducting a financial audit, while taxable profit is known after a tax audit. The former is for the current financial year, while the latter for the following year.

Accounting profit includes every explicit cost that is involved in doing the business. The difference between sales and the cost of production of goods sold is called Gross profit.

All other expenses are subtracted from the gross profits to derive the Accounting profit.

Explicit operating expenses are utilities, rent paid, depreciation, interest, salaries, amortization and other day-to-day operational costs of running the business.

Taxable profit is derived after considering the tax liabilities. It considers or includes the accounting profit and certain expenses, and then calculated & updated in profit & loss account.

Accounting profit is sometimes higher than taxable profit as organizations want to reduce the tax liabilities defined within the acceptable tax guidelines.

Comparison Table

Feature	Accounting Profit	Taxable Profit
Definition	Net income after all expenses, including taxes, have been accounted for	Portion of the accounting profit that is subject to income taxes
Calculation	Revenue – Expenses – Taxes	Accounting profit adjusted for tax-deductible and non-deductible expenses, tax credits, and other tax-related items
Purpose	Measure of a company’s financial performance	Determine the amount of income tax a company owes
Relevance	Used by investors, analysts, and creditors to assess a company’s financial health	Used by governments to collect revenue
Timing	Reported on the income statement	Reported on the tax return
Frequency	Annually	Annually
Accounting principles	Follows Generally Accepted Accounting Principles (GAAP)	Follows tax laws and regulations
Adjustments	Includes non-cash expenses and other adjustments that may not be tax-deductible	Includes adjustments for tax-deductible expenses, tax credits, and other tax-related items
Impact on taxes	Used to calculate the amount of taxes owed	Directly determines the amount of income tax a company pays
Relationship	Taxable profit is lower than accounting profit	Accounting profit provides a more comprehensive picture of a company’s financial performance, while taxable profit is specific to tax purposes

What is Accounting Profit?

Accounting profit, also known as net income or profit before taxes, is the measure of a company’s financial performance after subtracting all expenses from its total revenue. It is calculated according to Generally Accepted Accounting Principles (GAAP) and reported on the income statement, providing valuable insights for various stakeholders.

Here’s a breakdown of its key characteristics:

Calculation:

• Accounting profit = Revenue – Expenses

Components:

• Revenue: Includes all income earned by the company through its operations, such as sales of goods and services, interest income, and rental income.
• Expenses: Encompasses all costs incurred by the company in generating its revenue, including operating expenses (e.g., salaries, rent, utilities), cost of goods sold, and depreciation and amortization.

Purpose:

• Offers a comprehensive measure of a company’s financial health and profitability.
• Provides valuable information for investors, analysts, and creditors to assess the company’s performance and make informed investment decisions.
• Helps management track the company’s financial progress and make informed business decisions.

Significance:

• Accounting profit is crucial for determining the company’s ability to generate profits and grow its business.
• It impacts various financial ratios, such as return on equity and profit margin, which are used to benchmark the company’s performance against competitors and industry standards.
• It contributes to the calculation of other financial statements, such as the balance sheet and cash flow statement, providing a complete picture of the company’s financial position.

Limitations:

• Accounting profit can be affected by subjective accounting policies and estimates, leading to potential manipulation.
• It does not consider the impact of inflation, which can distort the true profitability of the company.
• It does not directly translate to the amount of income tax a company owes, as tax laws and regulations may allow adjustments for tax-deductible expenses and other tax-related items.

What is Taxable Profit?

Taxable profit, also known as taxable income, represents the portion of a company’s accounting profit that is subject to income taxes. It’s calculated by adjusting the accounting profit for tax-deductible and non-deductible expenses, tax credits, and other tax-related items.

Key characteristics:

• Definition: Portion of accounting profit subject to income taxes.
• Calculation: Accounting profit adjusted for tax-related items.
• Purpose: Determines income tax liability.
• Relevance: Used by governments to collect revenue.
• Timing: Reported on tax return.
• Frequency: Annually.
• Regulations: Follows tax laws and regulations.

Differences from Accounting Profit:

• Non-cash expenses: Accounting profit includes non-cash expenses like depreciation, which are added back to calculate taxable profit.
• Tax credits: Taxable profit is reduced by tax credits, which are government incentives that reduce tax liability.
• Tax deductions: Accounting profit is adjusted for tax-deductible and non-deductible expenses.
• Treatment of certain items: Certain items like meals, entertainment, and charitable donations may differ in accounting and tax treatment.

Significance:

• Determines the amount of income tax a company pays.
• Impacts financial ratios and investment decisions.
• Provides valuable information for tax authorities.

Factors affecting taxable profit:

• Tax code: Changes in tax laws and regulations can significantly impact taxable profit.
• Business decisions: Strategic choices regarding expenses, deductions, and tax planning can influence taxable profit.
• Accounting policies: The company’s accounting policies can affect the timing and recognition of certain expenses, impacting taxable profit.

Main Differences Between Accounting Profit and Taxable Profit

1. Calculation Basis:
   • Accounting Profit: Accounting profit is calculated based on accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS). It reflects a company’s financial performance according to accounting rules and principles, considering revenue recognition, expense matching, and accrual accounting.
   • Taxable Profit: Taxable profit is calculated based on a specific jurisdiction’s tax laws and regulations. It may differ from accounting profit due to differences in tax rules, deductions, and allowable expenses.
2. Timing of Recognition:
   • Accounting Profit: Accounting profit is recognized when revenues are earned, and expenses are incurred, following the accrual basis of accounting. This means that revenues and expenses are recorded when earned or incurred, regardless of when cash is exchanged.
   • Taxable Profit: Taxable profit is recognized based on the cash or modified accrual basis, depending on tax laws. On a cash basis, income is taxed when received, and expenses are deducted when paid. This can lead to timing differences between accounting and taxable profit.
3. Inclusions and Exclusions:
   • Accounting Profit: Accounting profit includes all revenues and expenses, regardless of whether they are taxable. It focuses on presenting an accurate financial picture of a company’s operations.
   • Taxable Profit: Taxable profit includes only those items subject to taxation according to tax laws. Some income and expenses may be excluded, while others may be subject to special tax rules or deductions.
4. Deductions and Credits:
   • Accounting Profit: Accounting profit does not consider tax deductions and credits. It reflects the financial performance of a business without regard to specific tax incentives or deductions.
   • Taxable Profit: Taxable profit considers tax deductions and credits allowed by tax laws. These deductions can significantly affect the amount of income subject to taxation.
5. Purpose:
   • Accounting Profit: Accounting profit is primarily used for internal financial reporting, decision-making, and providing information to stakeholders, including investors, creditors, and management.
   • Taxable Profit: Taxable profit is used for tax compliance purposes. It is the basis on which a company calculates its tax liability and pays income taxes to the government.
6. Variability:
   • Accounting Profit: Accounting profit tends to be more stable and consistent over time because it follows accounting principles and reflects economic events.
   • Taxable Profit: Taxable profit can vary significantly from year to year due to changes in tax laws, deductions, credits, and other tax-related factors.

References

1. https://bbronline.com.br/index.php/bbr/article/download/399/613
2. https://www.econstor.eu/handle/10419/109932