Accounting profit (also called pretax income) is its income before taxes calculated in line with accounting standards. Taxable income is the income calculated in accordance with tax laws.

Since accounting standards and tax laws may treat transactions differently, accounting profit is typically different than taxable income. Such differences may arise when:

  • Revenues and expense may be recognized in one period for accounting purposes and a different period for tax purposes;
  • Some revenue and expense items may be recognized under accounting standards but might be disallowed under tax laws, and vice versa.
  • Tax laws might allow carry forward of prior-year tax losses, etc.

Taxable income

Income tax payable is based on taxable income. Income tax paid may be lower or higher than income tax payable due to the existence of advance payments or refunds. Since taxable income differs from accounting profit, income tax payable differs from the amount that would be due in taxes had the company applied the tax rate to its accounting profit.

As the matching concept requires companies to recognize expenses in the period in which the associated revenue is recognized, companies must recognize a deferred tax asset or liability to the extent of any difference between income tax payable and accrual-equivalent tax due on accounting profit.

Tax base

Income tax expense during a period is the sum of any income tax payable and any change in deferred tax assets and liabilities. The tax base of an asset or liability is the amount at which it is value for tax purposes, and the carrying amount is its financing-accounting equivalent book value. Differences between the tax base and carrying amount also result in differences between taxable income and accounting profit.

Current tax assets and liabilities

A company’s current tax liability is the amount payable in taxes with respect to current year taxable income. Any refund of taxes paid in a prior period is recognized as a current tax asset. A current tax liability (or asset) is different from what becomes due in accordance with accounting standards.

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