CP 10-2 Financial vs. tax depreciation
The following is an excerpt from a conversation between two employees of Omni Technologies, Jay Bach and Cora Hardaway. Jay is the accounts payable clerk, and Cora is the cashier. Jay: Cora, could I get your opinion on something?
Cora: Sure, Jay.
Jay: Do you know Jo, the fi xed assets clerk?
Cora: I know who she is, but I don’t know her real well. Why?
Jay: Well, I was talking to her at lunch last Monday about how she liked her job, etc. You know, the usual . . . and she mentioned something about having to keep two sets of books . . . one for taxes and one for the fi nancial statements. That can’t be good accounting, can it? What do you think?
Cora: Two sets of books? It doesn’t sound right.
Jay: It doesn’t seem right to me either. I was always taught that you had to use generally accepted accounting principles. How can there be two sets of books? What can be the diff erence between the two? How would you respond to Jay and Cora if you were Jo?
Answer:
You should explain to Jay and Cora that it is acceptable to maintain two sets of records for tax and financial reporting purposes. This can happen when a company uses one method for financial statement purposes, such as straight-line depreciation, and another method for tax purposes, such as MACRS depreciation. This should not be surprising, since the methods for taxes and financial statements are established by two different groups with different objectives. That is, tax laws and related accounting methods are established by Congress. The Internal Revenue Service then applies the laws and, in some cases, issues interpretations of the law and congressional intent. The primary objective of the tax laws is to generate revenue in an equitable manner for government use. Generally accepted accounting principles, on the other hand, are established primarily by the Financial Accounting Standards Board. The objective of generally accepted accounting principles is the preparation and reporting of true economic conditions and results of operations of business entities. You might note, however, that companies are required in their tax returns to reconcile differences in accounting methods. For example, income reported on the company’s financial statements must be reconciled with taxable income. Finally, you might also indicate to Jay and Cora that even generally accepted accounting principles allow for alternative methods of accounting for the same transactions or economic events. For example, a company could use straight-line depreciation for some assets and double-declining-balance depreciation for other assets.
Cora: Sure, Jay.
Jay: Do you know Jo, the fi xed assets clerk?
Cora: I know who she is, but I don’t know her real well. Why?
Jay: Well, I was talking to her at lunch last Monday about how she liked her job, etc. You know, the usual . . . and she mentioned something about having to keep two sets of books . . . one for taxes and one for the fi nancial statements. That can’t be good accounting, can it? What do you think?
Cora: Two sets of books? It doesn’t sound right.
Jay: It doesn’t seem right to me either. I was always taught that you had to use generally accepted accounting principles. How can there be two sets of books? What can be the diff erence between the two? How would you respond to Jay and Cora if you were Jo?
Answer:
You should explain to Jay and Cora that it is acceptable to maintain two sets of records for tax and financial reporting purposes. This can happen when a company uses one method for financial statement purposes, such as straight-line depreciation, and another method for tax purposes, such as MACRS depreciation. This should not be surprising, since the methods for taxes and financial statements are established by two different groups with different objectives. That is, tax laws and related accounting methods are established by Congress. The Internal Revenue Service then applies the laws and, in some cases, issues interpretations of the law and congressional intent. The primary objective of the tax laws is to generate revenue in an equitable manner for government use. Generally accepted accounting principles, on the other hand, are established primarily by the Financial Accounting Standards Board. The objective of generally accepted accounting principles is the preparation and reporting of true economic conditions and results of operations of business entities. You might note, however, that companies are required in their tax returns to reconcile differences in accounting methods. For example, income reported on the company’s financial statements must be reconciled with taxable income. Finally, you might also indicate to Jay and Cora that even generally accepted accounting principles allow for alternative methods of accounting for the same transactions or economic events. For example, a company could use straight-line depreciation for some assets and double-declining-balance depreciation for other assets.
