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Tax Calculation and Reporting – Story behind sample content – Part 1

Introduction to Taxes

Hello everyone,

I am far away from being tax expert, but I decided to write blog post on this topic. You must be asking why? Well, for almost one year I have been engaged in the Tax Calculation and Reporting sample content for SAP Profitability and Performance Management. I believe that I have picked up enough knowledge and tips to share with you all. Hope you will find it interesting and valuable.

As you are aware taxation is a major source of revenue for the government. For this reason, taxation is under supervision and process needs to be continuously monitored to be compliant with tax regulations.

This is especially noticeable in this period of global economic crisis, when each country faces the threat of budget deficit .In order to collect more taxes and to provide a stable budget, government officials have increased their audit activities and overall cooperation with taxpayers has become more rigorous. More and more penalties have been imposed to taxpayers, causing substantial financial costs and disputes.

Most of the penalties imposed are due to the deliberate tax evasion, but some of them are as well consequence of ignorance. Could those prosecutions be avoided by enhancing our tax knowledge and compliance awareness?
Let’s have an overview of direct taxes and learn the basics together.

Story Behind the Sample Content

Accounting Principles – Key Differences between US GAAP and IFRS


When talking about direct tax, we should have in mind that this tax is paid directly by an entity or organization and tax liability could not be transferred to a third party. Taxpayers pay taxes to government for different purposes, such as income tax, transfer taxes, property and capital gain. This use case is based on the income tax and that will be our focus.

Having in mind that there are two accounting concepts generally used, questions arise, what is the difference between them and how does it affect Direct taxes calculation?

International Financial Reporting Standards or IFRS, as a principles-based approach, better captures and represents the economics of a transaction, compared to the US Generally Accepted Accounting Principles or GAAP which is more rules-based. What does this mean in practice?

Well, in case we are using IFRS, then we have much more freedom in the reporting compared to the rules-based approach. Principles-based standard are just describing accounting principles; therefore, professionals have more flexibility in adjusting accounting principles to a company’s transactions rather than adjusting a company’s operations to accounting rules. As IFRS is the most popular accounting method around the world, it enables investors from different countries easily to compare financial statements of the companies.

Contrary to this flexibility, GAAP is far more rigid and allow less room for interpretation, meaning that companies and their accountants must adhere to the rules when they compile their financial statements. This decreases the risk for investors, because if there is no rules-based system, companies could report only the numbers that made them appear financially successful while avoiding reporting any negative news or losses. Rules-based gives opportunity to investors to compare the financial information of different companies but within United States.

There are many similarities with respect to income tax accounting under IFRS and US GAAP, but there are also many noticeable differences, especially in the methodology used. This is the reason why classification and recognition of certain items differ. Consequently, closing balance on GL account will differ, leading that overall calculation of the direct tax (tax base and amount payable) would be slightly different. Our sample content is based on the IFRS approach and in order to fulfill US GAAP requirement, it should be adjusted.

A number of observations related to the general consideration, measurement and presentation are summarized in the table below.

Differences Between Accounting Profit/Loss and Taxable Income

According to the IFRS, businesses have different accounting rules available. Therefore, company can choose to use one accounting rule for reporting to shareholders and the other for reporting to tax authorities. Those various approaches and guidelines could lead to the variations in the measurement and reporting of the income tax, consequently leading to the differences in accounting profit and taxable profit.

Prior to considering conditions under which those two are not equal, we need to differentiate between Accounting Profit/Loss and Taxable Income. Accounting profit is profit/loss for a period before deducting tax expense, whereas taxable income is the portion of the company’s income that is subject to the income taxes in accordance with the law and jurisdiction.

Deferred tax Assets / Liabilities

In case when we have differences between accounting and taxable profit, then we need to consider and include them in the calculation of deferred tax asset and deferred tax liabilities.

Deferred tax assets arise when a company’s taxable income is greater than its accounting profit resulting in an excess amount being paid for income taxes. Company expects to recover this difference during the course of future operations. This future asset will be used to lower our taxable income.

Deferred tax liabilities arise when a company’s taxable income is lesser than its accounting profit, resulting to a lesser amount of income tax paid and the company expects to eliminate this deficit during future operations.


Causes of difference between these two profits could be classified under following:
• different depreciation methods used for financial and tax reporting,
• revenue and expense recognition in different periods,
• tax base and carrying amount of assets and/or liabilities
• deductibility of gains and losses
• tax loss carry-forward.

Since one of the key differences is in the depreciation method, I will devote some time to discuss this in detail.

Imagine that a company is using the straight-line method of depreciation for financial reporting (reporting to the shareholders) and accelerated depreciation for income tax reporting (reporting to the tax authorities).

As we have two depreciation methods used, we will also have two different tax expenses.

Deferred tax liability has arisen because the tax expense reported in the financial statement is greater than the tax that we have actually paid.

The company is using the benefit of deferred tax liability today, but in accelerated depreciation methods, current high percentages will become lower in later years in the life of assets. The decision to use different methods will have consequences in the future. In our scenario, the company is currently enjoying the tax benefits, but will have to pay higher tax amounts in the later years.

Temporary and Permanent Differences


Differences that will be reversed in one or more future periods are temporary, and differences that will remain are called permanent.The accelerated depreciation case above is an example of a temporary difference. Aside from depreciation methods, a good example of temporary differences is timing of allowances.

For example, an expense is allowed for both accounting and tax purposes, but the timing of allowance differs. Those differences only give rise to deferred tax liabilities and assets.

Permanent differences arise in cases where differences will never be reversed. This occurs when income or expense items are not allowed for tax purposes, meaning they could be treated as tax deductible in the financial statements, whereas on tax return they will be added back. Therefore, they have no influence on the tax base or on the tax amount of the following assessment periods. For this reason, no deferred taxes should be recognized for permanent differences.

And we came to the end of the first part…

The second part will be even more interesting, as it will be following story in the sample content.

Meanwhile, stay informed and keep on asking questions.

Until next time,





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