Corporate Financial Reporting and Analysis, 3rd Edition

Chapter 15

Accounting for Income Tax

Introduction

In this chapter we explore how companies account for income tax under US GAAP and IFRS. Key concepts are illustrated using the financial statements and notes of Intel Corporation.

The single most important fact to know about the accounting for income tax is that the rules for calculating profits under GAAP or IFRS – known as “book income” – do not correspond to the rules for calculating profits under tax law (“tax income”). This divergence is seen in every rich country, and, increasingly, in the developing world. While some people may be disturbed by the idea that a company can report one profit number to its shareholders and a very different (often smaller) number on its tax returns, the practice is a logical outcome of the different objectives underlying book and tax accounting.

Financial accounting exists, first and foremost, to provide relevant financial information to lenders and equity investors. To advance this aim, GAAP and IFRS rely on the matching principle and accrual accounting. For example, if a company sells products under warranty, a provision is taken in the year of sale even if the cash costs of the warranty are not incurred until future periods. But while financial accounting principles require the recognition of such expenses, tax authorities will demand that cash actually be spent to service the warranty before a tax deduction is allowed. The result is a timing difference between the recognition of warranty expense ...