Ask Me Help Desk - Two Sets of Books: Tax and Financial Purposes

What is the purpose of using two set of books in your business? Is it necessary? If so, why?

You don't necessarily have to literally have two sets of books. But you do have to make certain adjustments to the books for tax purposes. Is it necessary? Yes and no.

Since GAAP rules do not always agree with tax rules, then what's on your books may not be correct for what you need to do for taxes. This is pretty common. Publicly traded companies must follow GAAP. But let's say you have a small business you run out of your home. You don't have to follow GAAP and you do not have to have your books audited, unless there's a special requirement for a bank loan or something. Although it's a good idea to follow the basic accounting rules for your books, even if doing a cash basis. (You just don't need to get as picky.)

But let's use some examples and you'll more see what I mean. Depreciation is a great example. GAAP has its own methods to do depreciation, such as straight-line and declining balance. So the company uses one of these on their books. But these don't work for the IRS. They have their own methods. So this will affect a) the amount of depreciation expense on the income statement, and b) the amount of accumulated depreciation (and book value) on the balance sheet. You don't need to keep a second set of books just to adjust this. Though a spreadsheet would help to keep track of it. This is such a common difference that it's right on the tax form for a corporation. There's a place to record differences between taxable income and book income, and depreciation is a line that's already there.

Even a small company could have a difference like that. However, a small private company can easily get away with just doing the tax method on their books and saying the heck with it. :-) A company which is required to follow GAAP can't do that, so they have to make the adjustment.

There are other differences, like things the IRS might consider deferred income, but GAAP says must be recognized this year as income, or vice versa. Another common one could be inventory costing. I am not a tax person, so I can't tell you all these differences. Like I think installment sales may be one but not sure.

I've always worked at small companies and the adjustments have been easy and straight forward, but if it got complicated, I guess I could see the point of keeping two sets of books. That would depend on how long it takes to make the adjustments at year-end versus having to duplicate everything into another set of books. Having always done smaller companies, big giant companies are just things I can't really even fathom.

Quote:

Originally Posted by morgaine300

You don't necessarily have to literally have two sets of books. But you do have to make certain adjustments to the books for tax purposes. Is it necessary? Yes and no.

Since GAAP rules do not always agree with tax rules, then what's on your books may not be correct for what you need to do for taxes. This is pretty common. Publically traded companies must follow GAAP. But let's say you have a small business you run out of your home. You don't have to follow GAAP and you do not have to have your books audited, unless there's a special requirement for a bank loan or something. Although it's a good idea to follow the basic accounting rules for your books, even if doing a cash basis. (You just don't need to get as picky.)

But let's use some examples and you'll more see what I mean. Depreciation is a great example. GAAP has its own methods to do depreciation, such as straight-line and declining balance. So the company uses one of these on their books. But these don't work for the IRS. They have their own methods. So this will affect a) the amount of depreciation expense on the income statement, and b) the amount of accumulated depreciation (and book value) on the balance sheet. You don't need to keep a second set of books just to adjust this. Though a spreadsheet would help to keep track of it. This is such a common difference that it's right on the tax form for a corporation. There's a place to record differences between taxable income and book income, and depreciation is a line that's already there.

Even a small company could have a difference like that. However, a small private company can easily get away with just doing the tax method on their books and saying the heck with it. :-) A company which is required to follow GAAP can't do that, so they have to make the adjustment.

There are other differences, like things the IRS might consider deferred income, but GAAP says must be recognized this year as income, or vice versa. Another common one could be inventory costing. I am not a tax person, so I can't tell you all these differences. Like I think installment sales may be one but not sure.

I've always worked at small companies and the adjustments have been easy and straight forward, but if it got complicated, I guess I could see the point of keeping two sets of books. That would depend on how long it takes to make the adjustments at year-end versus having to duplicate everything into another set of books. Having always done smaller companies, big giant companies are just things I can't really even fathom.

Great Answer, this was a HUGE help to me for understtanding the use of two sets and rules, etc. I feel more confident preparing my accounting paper and including my new found understanding.