GAAP

• GAAP is followed by publicly traded companies, and is established from various sources. The Securities and Exchange Commission, the Financial Accounting Standards Board, the American Institute of Certified Public Accountants, Congress and industry practice all help shape what constitutes GAAP. As a general rule, companies that are traded on U.S. stock exchanges are required to follow GAAP. Many small businesses that are not publicly traded do not follow GAAP unless required to by investors or creditors such as banks.
  
  

Tax

• Tax is often meant to signify the accounting rules proscribed by the Internal Revenue Code. The Internal Revenue Code is a set of tax laws passed by and amended by Congress. The Internal Revenue Service and Department of the Treasury are allowed to create regulations and other authoritative guidance that may explain or add requirements to the Internal Revenue Code. Businesses such as partnerships, limited liability companies and corporations must follow tax accounting rules when filing their tax returns.
  
  

GAAP vs. Tax Income

• GAAP and tax accounting may provide for different amounts of income. GAAP often requires certain advance cash payments such as prepaid rent or subscription revenue to be deferred as income until a later year when it is actually earned so that investors can get a true picture of the profitability of a company. Tax rules might require the revenue to be included as income during the current year, because the focus of tax accounting is to collect tax revenue. In addition, deductions might be recognized in different years under GAAP as compared to tax. For example, GAAP may require a company to estimate and record warranty expenses during the current year even though no cash payments under the warranty program have been made. However, tax rules will not allow a company to record a warranty expense until the company actually makes a cash payment under the warranty program.
  
  

GAAP vs. Tax Basis

• Accountants often discuss the difference in the GAAP basis and tax basis of assets, and the difference in the gain or loss associated with a sale of these assets. The adjusted basis of an asset is generally calculated as its historical cost plus improvements or additions and less certain deductions such as depreciation. GAAP and tax accounting rules often provide for differences in the additions and deductions used to arrive at adjusted basis. For example, Bootsma Incorporated purchases a delivery van for $28,000. Assume tax accounting rules allow Bootsma Incorporated to expense the entire cost of the delivery van in year 1 as depreciation. Bootsma Incorporated's adjusted basis in the van would be $0, calculated as $28,000 historical cost minus accumulated depreciation of $28,000. However, assume for GAAP purposes that Bootsma Incorporated can only deduct depreciation of $4,000 in year 1. Bootsma Incorporated's adjusted basis for GAAP purposes would be $24,000, calculated as the $28,000 historical cost minus accumulated depreciation of $4,000.