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What is the difference, if any between book tax vs GAAP tax?

Full Question: A company XYZ has a different book tax versus cash tax. How does that impact their FCF? And if they tell you that their book tax is 25% vs cash tax is 15%, how do you adjust for it in the FCF statements and analysis? Also, what is the difference, if any, between book tax vs GAAP tax?... Read More

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by Guest 1.

added 11 years ago

RE: What is the difference, if any between book tax vs GAAP tax?

GAAP requires the accrual method be used when companies create their financial statements. What you see on a company’s reported financial statement is commonly referred to as book. The pre-tax taxable income that a company reports to the IRS generally does not equate to pre-tax book (financial sta... GAAP requires the accrual method be used when companies create their financial statements. What you see on a company’s reported financial statement is commonly referred to as book. The pre-tax taxable income that a company reports to the IRS generally does not equate to pre-tax book (financial statement) income, due to both temporary differences and permanent differences. The IRS calculates taxable income on a cash basis.

The need for deferred tax accounting arises because companies often postpone (creating a deferred tax liability) or pre-pays taxes (creating a deferred tax asset) on profits pertaining to a particular period. The formal relationship (which may clarify the terms) is book income = taxable income plus/minus temporary differences ± permanent differences.

Temporary or timing differences between book vs. taxable income are due to items of revenue or expense that are recognized in one period for taxes, but in a different period for books (over the ""long run"", they cause no difference between the two incomes). The most common examples of temporary difference arise from depreciating an asset by the straight method for book (which creates lower expenses) and the accelerated method for taxes (which creates higher expenses and thus less of a tax burden). Permanent differences are differences that never reverse. An example of a permanent difference is (non- taxable) interest revenue on municipal bonds.

Temporary differences cause deferred taxes, while permanent differences cause a firm's effective income tax rate (book income tax expense ÷ pre-tax book income) to differ from the statutory tax rate.

What drives deferred tax accounting is (the changes in) the deferred tax asset and liability accounts. Deferred tax liabilities are liabilities for taxes due in the future (future cash outflow for taxes payable) on income that has already been recognized for books. In effect, although you have already recognized the income on your books, the IRS lets you pay the taxes later (due to the timing difference). Deferred tax assets are reductions in future taxes payable, because you have already paid the taxes on book income to be recognized in the future (like a prepaid tax).

Recognition of a deferred tax asset reduces future cash taxes payable and thus enhances FCF (although the asset has value only if the firm expects to pay taxes in the future).

The way it will impact your financial statements in your exaple is as follows: you should see a deferred tax asset on your balance sheet. The asset should slowly be reduced as the firm offsets cash taxes paid (book or reported taxes will be unaffected). Under cash flow from operating activities section of your cash flow statement you should see a line item called deferred income taxes. This will effectively increase you CFO and thus FCF if you are calculating FCF as FCF – CapEx by the amount of you tax savings.

The effect would be as you described - your tax cash rate (what you are actually paying) would be below your book rate (what you are reporting on your financial statments). Read More

by WST Expert 1.

added 11 years ago

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