Difference Between Accounting Profit and Taxable Profit

Edited by Diffzy | Updated on: April 30, 2023

       

Difference Between Accounting Profit and Taxable Profit

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Introduction

The term "profit" might have different interpretations as we move from one profession to the other. A businessman's perspective may differ from that of an accountant's. In accounts, profit is defined as an additional net gain over and above the total expenditures required running a business. This profit is called "accounting profit." Taxable profit also includes considering the liability of its figures calculated. The latter adheres to the working principles outlined in the Income Tax Act and is calculated using formulas developed by the Income Tax Department itself. When accounting for profit involves financial accounting and reporting, taxable income includes tax reporting and accounting. Proper knowledge of these financial statements enables the business to flourish and make continuous developmental progress while also reducing any liabilities. These values evaluate a company’s performance as a whole, helping them to raise its profit and margins and reduce any unwanted losses. 

Accounting Profit Vs. Taxable Profit 

Accounting Profit

Accounting profit denotes the additional or surplus net gain after the total expenditures spent on a business. It is calculated by deducting the expenditure from the net revenue received. A relatively well profit reflects a company’s performance, progress, and sustainability as it records both revenues and expenses at the same time. It is the only record that investors consult to review the business standards that the company has acquired. This knowledge can help a company to understand its liquidity and work on it to create larger profit margins. Also, enabling an early establishment in the field of business is the goal. Also, these are used as highly reliable indicators for investors to know about the developmental progress and establishment of a business.

Taxable Profit

The amount taxable is calculated using the principles and guidelines established by the Income Tax Act and Department. The peculiar difference between accounting profits and taxable income is that the former is calculated on a continuous and regular basis, whereas the latter is usually a one-time procedure that also includes the liabilities from the previous years. The difference between accounting and taxable profits is described in detail in the following table given below.

Difference Between Accounting Profit and Taxable Profit in Tabular Form

Main Parameters of  Comparison Accounting Profit Taxable Profit
Profit Type It is the additional gain that a company or person receives after all costs and expenditures. Taxable profits are usually consider also the company liability  which is not included while calculating the accounting profits.
Functions Accounting profit involves financial operations. It enables businessmen to know about the possible profitability of a business. This is a reliable indicator of an established business that investors look upon. Taxable profit involves tax operations and uses tax reporting instead of financial reporting. In addition, tax liabilities are typically included in taxable profit.
Working Principle The principles of operations are based on the generally accepted accounting principles or GAAP (General accepted accounting principles). On the other hand, Taxable profits follow the guidelines laid down by the income tax department to calculate the taxable income figures of a company. The rules are set by a governmental organization.
Activities The operation is usually continuous in the case of accounting profit. This is used as a continuous and reliable marker of progress and performance made by a company over a timeline. On the other hand, the taxable profit is considered a one-time event. Not all companies may be entitled to pay imposed tax. This is solely based on the operative earnings of the company and may vary from one to another company depending on their profitable or non-profitable status.
Recording Timeline Accounting profits are usually done on a monthly basis. This allows for a continuous evaluation of overall developmental progress and economy standards of an establishing company. On the other hand, taxable profit also considers any previous debts, income, and other details. A lower tax liability indicates a greater profit margin for a company.
Accounting System A company reports accrued revenues and expenses to derive accounting profit figures, whereas cash-based accounting, or cash revenues and expenses, is used in tax reporting to obtain taxable income. Taxable profit uses only cash based exchange, and occurs even when there no clients or customers for a business.

What is Accounting Profit? 

The primary motive of any business is to maximize its profit margin. Accounting profit provides businessmen with a clear understanding of all expenditures spent on selling, marketing, and administrative services and the net gain after all these expenses are covered. This is a reliable indicator of a company’s overall performance, which makes it highly essential for investors to review them. More than gross profit and other figures used, they show the profitability of a running business. The most essential fact that makes it so important is that it includes all related costs of doing business without any exemptions.

How do you calculate accounting profit?

Accounting profit is usually calculated using GAAP's standard rules for accurate figures. While calculating the accounting profit, there are multiple components that must be kept in mind.

  1. Sales expenditures involve the cost of goods sold and the total cost of production.
  2. Operating expenses include additional utilities on rent, interest paid, depreciation, amortization values, employee salaries, and other daily costs required to run the business.
  3.  Non-operating expenses 
  4. Taxes

All these component values are deducted from the net revenue gained by the company to determine the accounting profit or accounting loss.

So the formula will be:

Total net gain-(Sales expenditures + Operative +Non Operative Expenses + Taxes) = Account profit or loss

However, it is important to note that the concept of opportunity cost has no relevance in accounting profit, which can also be used as an additional indicator of a company's potential profitability.

Hence, if the net revenue gained by the company exceeds the net expenditures, then the remainder is an accounting profit. On the other hand, if the net expenditures exceed the net revenue gained by a company, then it is said to have an accounting loss for the firm.

The calculation is usually done by accrual based computing techniques that are much faster in evaluation and also in processing terms.

What is Taxable Profit? 

It is not uncommon for a company's accounting profit to be greater than its taxable profit. A greater profit means a higher tax imposed. So, taxable profit means nothing other than the profits on which tax is imposed by the government. This is solely based on the operative earnings of a company’s business gain. The figures vary from one to another based on their net earnings. It follows the rules and a guideline set by the income tax act of 1961 and is regulated by the income tax department. Also, not all businesses are subjected to a tax. If a person or business is entitled to have non-profit status, then they are not obligated to pay any taxes. Also, different tax rates apply to various firms based on their accounting frame. However, an important idea that must be remembered here is that reduced accounting profit comes with reduced tax income. It is the only income that every company reports to the Internal Revenue Service and its government to know about the net gain and economy of a business.

Taxable income knowledge helps the company to adjust its accounting profit so that it has a reduced tax liability to report to the government while also achieving continuous progress and economic development.

How do you calculate your taxable income?

It usually follows the guidelines and rules set by the income tax department to perform various calculations. Several components included in its calculation are:

  1. Accounting profit.
  2. Non-allowable expenses (added).
  3. Allowable expenses (subtracted).

So the formula would be:

Accounting profit + taxable profit = taxable profit Allowable expenses vs. non-allowable expenses 

Hence, a key point to remember is that the accounting profit figure is also a component used in calculating the taxable profit.

The reporting system is here in the income tax department instead of the financial accounting and reporting system in which accounting profits are calculated for a company. Also, the tax profits follow a cash-based exchange between the government and companies to regulate the taxes paid, whereas the accounting profits use a computed accrual system to report their profits.

Main Difference Between Accounting Profit and Taxable Profit in Points

  • Type of profit. It is the additional gain that a company or person receives after all costs and expenditures. Taxable profits are usually considered a liability.
  • Functions: This involves financial operations. It enables businessmen to know about the possible profitability of a business. It involves tax operations. Tax liabilities are also taken into account when calculating taxable profit.
  • Operational principle - The principle of operation is based on generally accepted accounting principles. Being guided by the income tax department, the rules are set by governmental organization itself.
  • Activities - The operation is usually continuous in the case of accounting profit. On the other hand, the taxable profit is considered a one-time event.
  • Accounting Timeline - Accounting for profits is usually done on a monthly basis. On the other hand, taxable profit also considers any previous debts, income, and other details.
  • Cash-Based vs. Accrual-Based Reporting System

Also, the taxable income could be differentiated from the accounting profit based on the accounting method. The cash method used in taxable profits only records cash exchanged between clients, sponsors, employees, and companies in a business. It also identifies the exchange when a company pays cash for its products and services. On the other hand, accrual-based accounting is used by the accounting profits figures. They even records sales at all-time even when the company might not necessarily receive money from a customer.

Depreciation and inventory valuation also has an essential role to play in differentiating between accounting profit and taxable income. Depreciation refers to a non-expense that a company reports accounting for the wear and tear of infrastructure, property, equipment, and other physical assets utilized by the company to run the business. It shows us the lifetime or the timeline of each acquired item.

Conclusion 

A company’s accounting profit and taxable income can be different based on the time of filing or recording the values. Also, the calculating methods vary based on the principles they use. The former follows the reporting periods because it adheres to GAAP, or generally accepted accounting principles, whereas the latter adheres to tax rules. While accounting profit is computed using the accrual method of accounting, taxable profits use cash-based accounting principles. On the other hand, if the net revenue gained by the company exceeds the net expenditures, then the remainder is an accounting profit. On the other hand, if the net expenditures exceed the net revenue gained by the company, then it is said to have an accounting loss for the form. 

Accounting profit and taxable profit figures are calculated after certain timelines only. This makes it easy to watch their natural progress over the timeline and evaluate themselves. Accounting profit is calculated by different accounting frameworks or by the government itself. For example, the calculation principles for evaluating accounting profits are set by the GAAP system, whereas the taxable profit calculations are based on guidelines laid down by the income tax department, which is a governmental organization itself. Accounting profit must have a greater value than taxable profit, which indicates an established business that is running at a profit.

These financial statements describe a company’s performance as a whole and review its standards of profitability and establishment. These could be used as reliable indicators by investors and sponsors to decide on taking up different projects or not. More than just figures and other indicators like gross profit, all expenses spent to run a business are included in the accounting profit. These values evaluate a company’s working principles and standards and provide them with an idea of the possible alterations they could make to increase their profit margin and avoid unnecessary losses.

References 

  • https://www.tutorialspoint.com/differentiate-between-accounting-profit-and-taxable-profit
  • https://smallbusiness.chron.com/difference-between-accounting-profit-taxable-income-22470.html
  • https://yourbusiness.azcentral.com/difference-between-accounting-profit-taxable-income-2650.html

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"Difference Between Accounting Profit and Taxable Profit." Diffzy.com, 2024. Sat. 18 May. 2024. <https://www.diffzy.com/article/difference-between-accounting-profit-and-taxable-profit-1116>.



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