Book income is the amount of income corporations publicly report on their financial statements to shareholders. This measure is useful for assessing the financial health of a business but often does not reflect economic reality and can result in a firm appearing profitable while paying little or no income tax.
Book Income vs. Taxable Income
Book income is used by companies to report their income and expenses to shareholders. Taxable income is used by businesses to report earnings and tax liability to tax authorities.
The two measures of income can differ dramatically and understanding that difference is key to understanding why some businesses may report profits on financial statements, but pay little or no federal income tax.
For example, firms may deduct from their gross income the cost of investment when determining taxable income, which reduces the firms’ tax liability. This is an important structural difference that helps make sure the tax code only targets net profits and not the cost of investment when levying income tax.
Similarly, net operating losses (NOLs) may be carried forward to future years if firms post losses in a given tax year beyond their tax liability. This ensures that the income tax is assessed on a firm’s average profitability and does not penalize firms with variable profits. In this case, creating a distinction between taxable income and book income is necessary for the proper tax treatment of firms with varying profitability across tax years.
Using book income, rather than taxable income, as a tax base raises the cost of investment and disproportionately penalizes firms with losses that don’t fit with the calendar year.
How Is Book Income Measured?
For tax purposes, business income is the money a business receives in exchange for providing labor, producing a good or service, or investing capital, minus expenses. However, different definitions of income can be used for different purposes.
Book income is defined using Generally Accepted Accounting Principles (GAAP) and is designed to report profits consistently in a way that reflects a business’ financial performance. GAAP requires accrual accounting, which has implications for measuring both costs and earnings.
If a construction firm purchases several new vehicles, the full cost of that purchase would not be reflected in a calculation of book income in the purchase year. Instead, the cost would be accounted for as the value of those vehicles depreciates. Even though the business expense (and the cash out the door) occurred in a single year, the business would account for that expense over multiple years.
Book income treats earnings in a similar way. If a client makes a purchase for a future delivery, but only pays the bill after the delivery is completed, the company making the sale will need to book the earnings even if the cash is not in the door (as an accounts receivable).
Combining both the accrued costs and earnings into book income allows for an overall financial picture of a firm that may not perfectly match economic reality. This mismatch could be something as simple as cash that has been spent for a purchase but only part of the cost is reflected in financial accounts because of depreciation.
Financial statements include taxes paid by firms. These tax numbers are sometimes used to measure tax as a share of book income. But because book income is calculated differently than taxable income, it is common for those income measures to diverge. Because of this, an effective tax rate calculated as taxes paid (as reported on financial statements) divided by book income may not match the effective tax rate if measured by dividing taxes paid by taxable income.
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FAQs
Book income is the amount of income corporations publicly report on their financial statements to shareholders. This measure is useful for assessing the financial health of a business but often does not reflect economic reality and can result in a firm appearing profitable while paying little or no income tax.
What is book income in trial balance? ›
The term “book income” generally means a company's financial income before its taxes are taken into account.
What is income answers? ›
Income is the money you receive in exchange for your labor or products. Income may have different definitions depending on the context—for example, taxation, financial accounting, or economic analysis.
What is the tax on book income? ›
The 2022 Inflation Reduction Act (IRA) introduced a new corporate minimum tax on book income that became effective January 1, 2023. The tax is calculated as 15 percent of adjusted financial statement income, which is different than taxable income.
How do you prove off the books income? ›
There are several types of proof of income, including tax returns, bank statements, court-ordered payments, social security benefits, W-2 or 1099-MISC forms, and a proof of income letter. Your proof of income should include your full name, the date, and other identifying information.
How do you reconcile book income to tax income? ›
Reconciliation Formula. In general, to reconcile book income to taxable income, we will add back expenses that are not tax deductible, add revenue that was not included in book income, subtract deductions not included in the calculation of book income, and subtract tax-exempt earnings.
Is book income the same as net income? ›
It's after the deductions of these that we have the net profit which you refer to as (taxable income). Book income is gross income. Taxable income is book income less deductible business expenses. The sum is net income before taxes.
What is an example of a book profit? ›
profit that has been made but that has not yet been taken, for example when shares have risen in value since they were bought but have not yet been sold: If the land was revalued and stated in the balance sheet at its current market price, this would result in the company making a book profit.
What is income in book keeping? ›
Accounting income is the profit a company retains after paying off all relevant expenses from sales revenue earned. It is synonymous with net income, which is most often found at the end of the income statement.
What is an income example? ›
Earned income includes wages, salary, tips and commissions. Passive or unearned income could come from rental properties, royalties and limited partnerships. Portfolio or investment income includes interest, dividends and capital gains on investments.
Multiply the hourly wage by the number of hours worked per week. Then, multiply that number by the total number of weeks in a year (52). For example, if an employee makes $25 per hour and works 40 hours per week, the annual salary is 25 x 40 x 52 = $52,000.
How do you answer an income statement? ›
Steps to Prepare an Income Statement
- Pick a Reporting Period. ...
- Generate a Trial Balance Report. ...
- Calculate Your Revenue. ...
- Determine the Cost of Goods Sold. ...
- Calculate the Gross Margin. ...
- Include Operating Expenses. ...
- Calculate Your Income. ...
- Include Income Taxes.
Book value is calculated by taking the aggregate value of all its assets and deducting all the liabilities from it. Assets include both current and fixed assets, and liabilities include both current liabilities and non-current liabilities.
What is pre-tax book income? ›
Pretax income, also known as earnings before tax or pretax earnings, is the net income earned by a business before taxes are subtracted/accounted for. Pretax income, however, accounts for deductions related to operating expenses, depreciation, and interest expenses.
What is the difference between book income and taxable income? ›
Book income vs.
It is the amount a corporation reports to its investors or shareholders and gives an idea of how well a company performed during a certain period of time. Tax income, on the other hand, is the amount of taxable income a company reports on its return.
What is a temporary difference between tax and book income? ›
If a temporary difference causes pretax book income to be higher than actual taxable income, then a deferred tax liability is created. This is because the company has now earned more revenue in its book than it has recorded on its tax returns.
What is the meaning of book money? ›
This means that the money is transferred from the payer's bank account to the receiver's bank account. The payer's credit balance decreases while the receiver's balance increases. The credit balance in a bank account is known as book money. The banks book their customers' payments to their bank accounts.
How do you calculate net book income? ›
The formula for calculating net income is:
- Revenue – Cost of Goods Sold – Expenses = Net Income. The first part of the formula, revenue minus cost of goods sold, is also the formula for gross income. ...
- Gross Income – Expenses = Net Income. ...
- Total Revenues – Total Expenses = Net Income.
