Tax vs. book depreciation
The game of accounting uses a very thick rule book. In fact, sometimes it uses two. Tax laws often differ from the generally accepted accounting principles that govern the preparation of financial statements. Why is this?
The purpose of financial accounting is to provide accurate financial data on which to base business decisions. Income tax laws serve a different purpose: they provide revenue for governmental goods and services. Some deductions that are allowable to arrive at taxable income are not allowed under generally accepted accounting principles (GAAP). Because the goals of financial accounting and income tax accounting differ, sometimes their rules differ, too.
This tool focuses on book depreciation for several reasons:
GAAP helps you generate accurate data for better business decision making.
Lenders, investors, and other third parties often prefer or even require financial statements based on GAAP.
Tax laws are amended yearly, whereas accounting principles remain constant.
Book depreciation methods are acceptable for tax use, but tax methods are not accepted under GAAP.
Under the rules of financial accounting, fixed asset costs are allocated to the time periods that they benefit. Your financial statements should reflect how your assets contribute to the generation of revenue over time. The depreciation methods presented here allocate a portion of an asset's cost to each year that the asset helps produce income.
Many small businesses enter depreciation expenses only once a year, at tax time. If depreciation figures are off throughout the year, your business planning and decision-making may be adversely affected. This calculator provides the information you need to record depreciation expenses on a monthly, quarterly, or annual basis, giving you a better picture of your financial position throughout the year.
At this point, you might rightly be wondering how to adjust for the variance between tax and book depreciation. The answer depends on your form of organization. For sole proprietorships, partnerships, and S corporations, the adjustment is already included on ordinary tax forms. C corporations must report the difference on their financial statements in a liability account called Deferred Taxes. For more information about making these adjustments, consult your accountant.
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