Profit can have a different meaning depending on the purpose and whom it is directed to. The most commonly used is accounting profit and taxable profit. One uses the accounting standards to calculate revenue and expenses, whilst the other uses concepts applicable to the Income Tax Act. Both serve different purposes, so it is important to note that the accounting profit a business makes in a year is not the same as what is considered taxable. The table below outlines a brief outline of the differences.
Key Differences between Accounting Profit and Taxable Profit
Example 1: Accounting and tax difference for depreciation of an asset
Company A purchased an equipment for @2,000. For accounting purposes, the assets effective life is 4 years ($500 per year) while the tax depreciation estimated by the commissioner is 2 years ($1,000 per year). The following outlines the difference in the depreciation / deduction each year.
Accounting Treatment
Tax Treatment
As seen above, for Year 1 an expense of $500 was recognized in the profit and loss but for tax purposes, a deduction of $1,000 was recognized when calculating the taxable income.
Note that over time, there will be no differences as both treatments will eventually recognized the cost of the asset ($2,000) as an expense / deduction. These timing differences are called temporary differences.
Example 2: Accounting and tax difference for a profit / loss
The below example shows how the accounting and tax profit can differ due to the different treatment of specific items.
There are many points which differentiate the two methods. It is important to note that they both serve different purposes so what a business displays as accounting profit is different to what is considered taxable. A business needs to have an understanding of both to ensure compliance with both accounting standards and the Income Tax Act.
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