Question

Explain why a business taxpayer that uses GAAP for financial reporting would end up with “book-tax differences” relating to the depreciation of balance-sheet assets. In other words, how do GAAP and tax depreciation differ? Identify and briefly explain at least two major differences.

Answer 1

The depreciation as per GAAP for financial reporting and tax depreciation differs due the following reason

· Depreciation is accounted in GAAP based on appropriate method for class of asset. For example Building is depreciated based on straight line method, Machinery is depreciated as per doubt declining balance method, delivery vehicle is depreciated as per units-of-activity method etc. But as per tax laws the method of depreciation allowed can be different. For example: MACRS depreciation method.

· Depreciation calculation as per GAAP books has flexibility since assets can be depreciated as per accounting policy of the firm. For example: Machinery can be depreciated based on 150% of straight line method. But in tax depreciation – depreciation expense is strictly accounted as per tax laws and accounting policy of the firm has no relevance in computation of taxable income.