Definitions and explanations
GAAP accounting is accounting as per ‘Generally Accepted Accounting Principles’. GAAP accounting involves preparation of financial statements in accordance with the standardized accounting rules and principles laid out in the particular jurisdiction.
The main purpose of GAAP accounting is to ensure that financial statements prepared by different entities of a specific jurisdiction are comparable to one another. GAAP accounting is required to be followed by all public entities in the presentation of their financial statements.
GAAP accounting provides for an accrual basis of accounting wherein incomes and expenses are accounted for when they are actually incurred, irrespective of exchange of actual cash.
GAAP accounting is regulated by accounting and regulatory boards of the specific jurisdiction.
Tax accounting is a method of accounting that applies the same principles and methods as used to prepare a tax return of the entity. The purpose of tax accounting is to prepare financial statements in line with taxation principles so as to keep a track of the entity’s taxable income throughout the year.
Taxable income can differ from income arising on account of GAAP accounting. This difference may arise as tax rules can hasten income recognition or delay expense allowance that may otherwise be recorded on accrual as per GAAP accounting. Tax accounting seeks to bridge this gap and results in presentation of taxable income.
Tax accounting only records transactions which have an impact on the taxable income of the entity.
Tax accounting principles are prescribed by tax law and regulated by tax regulatory bodies of the specific jurisdiction.
Differences between GAAP accounting and Tax accounting:
The difference between GAAP accounting and tax accounting have been detailed below:
1. Principles applied
- GAAP accounting involves drawing up of financial statements while adhering to accounting standards and rules.
- Tax accounting involves accounting as per tax rules and principles.
- The purpose of GAAP accounting is to result in preparation of reliable and comparable financial statements for reporting purposes.
- The purpose of tax accounting is to arrive at taxable income for the specific period.
3. Accounting basis
- GAAP accounting provides for mercantile/accrual basis of accounting.
- Tax accounting allows for use of cash, accrual or modified basis of accounting.
4. Regulated by
- GAAP accounting is generally regulated by accounting and regulatory boards such as the Securities and Exchange Commission and Financial Accounting Standards Board in the USA.
- Tax accounting is regulated by the tax regulatory authorities of the jurisdiction such as the Internal Revenue Service in the USA.
5. Transactions recorded
- GAAP accounting seeks to record all transactions entered into by an entity. All expenses and incomes are recorded on accrual basis as and when they are incurred.
- Tax accounting seeks to record only those transactions which have an impact on the taxable income of an entity.
6. Reporting reliability
- GAAP accounting presents a complete picture of the financial position of the entity as it records all transactions entered into by the entity. It gives an accurate picture of assets and liabilities of the entity. GAAP accounting is used for generating financial reports.
- Tax accounting records only tax-impacting transactions and therefore gives a less reliable presentation of the overall financial position of the entity. It, however, provides a more reliable measure of the income of the entity which is subject to tax.
7. Used by
- GAAP accounting is used by entities that are required to report financial statements to their investors and other third parties. Entities that require detailed reports for financial analysis prefer the use of GAAP accounting.
- Tax accounting, on the other hand, is preferred by smaller entities that are not required to do any public reporting and are more interested to simply track their taxable income.
- GAAP accounting is more complex as it involves a plethora of accounting standards and principles to be applied to a wide variety of transactions. It requires technical knowledge of accounting principles to apply.
- Tax accounting is a simpler method of accounting as it applies tax principles to limited tax-impacting transactions. These principles tend to be more universal as they are drafted to be more easily understandable.
9. Time and money cost
- Application of GAAP accounting requires a more robust accounting system in place which is more time consuming and involves a higher cost.
- The application of tax accounting is less complex and less costly as compared to GAAP accounting.
GAAP accounting vs tax accounting – tabular comparison
A tabular comparison of GAAP accounting and tax accounting is given below:
|Standardized accounting rules and principles||Tax rules and principles|
|Preparation of reliable and comparable financial statements||Presentation of taxable income|
|Accrual basis||Accrual or cash or modified basis|
|Accounting and regulatory bodies||Tax regulatory bodies|
|All transactions||Transactions having impact on taxable income|
|More reliable presentation of assets and liabilities||Less reliable presentation of assets and liabilities|
|More by entities that require reporting of financial statements||Smaller entities not requiring public reporting|
|More complex||Less complex|
|Cost to implement|
|Higher cost||Lower cost|
Conclusion – GAAP accounting vs tax accounting:
Entities can choose which accounting model to follow based on their purpose for accounting. GAAP accounting gives a more accurate and reliable presentation of the financial position of the entity. While public entities are mandatorily required to follow GAAP accounting for reporting purposes, other entities can choose to follow simpler tax accounting system if they do not require complex financial analysis reports and are more concerned with the tracking of their taxable income. Many companies in USA adopt both the models (i.e., GAAP accounting to meet their legal financial reporting requirements and tax accounting to find out net tax obligations.)