One business, two rulebooks

Two rulebooks, one ledger

It is March, and Morrow Bikes' accountant sends the owner two numbers for last year. The Scorecard (income statement) shows a profit of $200. The tax return shows taxable income of $180. The owner wants to know which one is wrong. Neither is.

Book accounting and tax accounting are two rulebooks applied to the same transactions. The book rulebook (US GAAP here, IFRS elsewhere) exists to tell owners and lenders whether the loop created value. The tax rulebook exists to tell the tax authority what the law says Morrow owes. Same repairs, same invoices, same bank account, different rules, so the two answers differ without anyone lying.

People call this "two sets of books". It is shorthand for two reconciled bases, not permission to hide records. Morrow keeps one ledger. Schedules and adjustments turn that one ledger into a set of financial statements and, separately, a tax return. The audited statements and the return need not share the same depreciation, the same recognition timing or the same list of deductible expenses.

One machine, two schedules

Morrow bought a wheel-truing machine for $100. The books depreciate it $20 this year. A hypothetical tax rule lets Morrow deduct $40 this year. Book profit carries a $20 expense; taxable income carries a $40 deduction. So taxable income is 40 − 20 = $20 lower than book income from this one item.

This is the course's second question, which clock, and the tax rulebook keeps its own clock. The return took a bigger deduction early, so it has less left to deduct later. When the two schedules catch up with each other, the difference reverses. The next unit turns that future into a number.

Four amounts that people merge

Keep four amounts apart: book pretax income, taxable income, current tax expense and cash tax paid. The first is a Scorecard number. The second comes from the return. The third is the tax the return says Morrow owes for the year, which sits in tax payable until it is settled. The fourth is what left the bank.

Morrow's current tax for the year is $45. During the year it paid $40 in installments and settled a $12 balance still owed from last year's return. Cash tax paid is 40 + 12 = $52, and $5 of this year's tax is still payable at year-end. Installments, prior-year balances and refunds all move cash on their own timetable.