Tax Law And Accounting
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Income tax is a part of the fiscal policy of our economy. The first federal income tax was imposed by Congress in 1862, to finance the waging of the Civil War. The Civil War income tax was repealed in 1872, but a new income tax was enacted as part of the 1894 Tariff Act. However, the Supreme Court struck down the income tax in 1895. It ruled that the portion of the income tax that applied to income on property was a direct tax that, under the United States Constitution, could not be levied without apportioning the tax by population. In 1913, the states ratified the Sixteenth Amendment to the United States Constitution, which made possible modern income taxes (Taxation).
The sources of the modern income tax statutes are court decisions, case law, legislation, constitutional provisions, and international taxation laws. Objectives of the income tax statutes are to raise resources for the government, to reduce the inequalities of income in the economy, to promote the balanced development, and to give thrust to the strategic sectors of the economy for economic development (Pope, Anderson, and Kramer).
If the economy is in recession, then the tax credit and tax cuts will increase the disposable income and thus increase the overall production of the economy. It will help in recovery of the economy. But one has to take care that increase in the disposable income should not be wasted on the conspicuous expenditure but utilized for the essential consumption expenditure. Then only it can lead to increase in the employment, which will lead to increase in real growth in national income. If the economy is overheated then the reverse strategy can be employed.
Other changes to fiscal policy should be simultaneously pursued, that would have been more successful. Public spending, it is the most potent weapon to raise the consumption and to increase the economic growth. Increased government expenditure will open new job opportunities in the economy, which means creation of demand for goods and services. It can lead to pump priming, which means increase in private expenditure through an injection of fresh purchasing power in the form of an increase in public expenditure. Such expenditure should be progressively raised in the depression.
Public Debt policy is that the government can reduce the public borrowing so that there are more resources with the public to increase the consumption. Efficient Administrative machinery is also needed to effectively implement the fiscal policy.
Accounting is the means by which information about an enterprise is communicated and thus, is sometimes called the language of business. Many different users have need for accounting information in order to make important decisions. These users include investors, creditors, management, governmental agencies, labor unions, and others. Investors and other stakeholders in the firm need regular financial information to help them monitor the firm's progress. Thus, the financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and other financial decisions. The information should be helpful to present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts. The information should also provide information about economic resources, the claims to those resources, and the changes in them. SFAC No. 2 notes that useful information must have the characteristics of relevance, reliability, and comparability or consistency. Relevancy means that information should be timely and bear on the decision-making process by possessing feedback and/or predictive value. Reliability means that information must be faithful in representation; free from bias, neutral, and verifiable. Comparability is even though different companies may use different accounting methods, there is still sufficient basis for valid comparison. Consistency is that deviations in measured outcomes from period to period should be the result of deviations in underlying performance (Framework).
According to the Investopedia.com "GAAP are the common set of accounting principles, standards and procedures that companies use to compile their financial statements. GAAP are a combination of authoritative standards (set by policy boards) and simply the commonly accepted ways of recording and reporting accounting information." Thus GAAP, (Generally accepted accounting principles), which help in achieving the above objectives whilst preparing financial statements, including the company's balance sheet, income statement and cash flow statement. Moreover principals are necessary to allow the economy to function efficiently, because decisions about the distribution of resources rely heavily on credible, concise, and understandable financial information. Financial information about the operations and financial position of individual companies is also used by the public in making various kinds of decisions.
GAAP is based on prevalent industry practice; Accounting Principles Board (APB) statements and opinions; Financial Accounting Standards Board (FASB) statements, concepts, technical bulletins and interpretations; American Institute of Certified Public Accountants (AICPA) statements, issue papers, bulletins, interpretations and concepts; as well as various other professional announcements, textbooks and articles.
On the other hand, income taxes are based upon the Internal Revenue Code or the income tax department of the local or state government. It is guided by the regulations issued by them to achieve the objectives laid down by the government.
A first objective is to understand the difference between tax accounting and financial accounting. The major differences can be timing and recognition differences. The timing difference involves revenue such as prepaid rent for GAAP and tax return purpose. In addition, timing differences can be due to different methods of valuing assets like different depreciation rates under GAAP and tax accounting rules. Additionally there is difference in how are taxes reported in GAAP and Tax accounting. GAAP reporting does not accurately present taxes paid. Tax reporting does not accurately reflect the useful life of the equipment. Another can be recognition of the liabilities or income or expenses. When rental fees are collected in advance the GAAP, applied rent revenue recognized when earned. The tax code applied the rent collection considered as taxable income (New York Life).
The recognition differences can be the permanent differences where some income and expense items being recognized under GAAP but not for tax purposes, or vice versa. For example, certain incomes which are tax exempted will not be considered in tax accounting. Similarly some expenses can be non deductible under tax accounting. Another difference can be revenue municipal bonds. In GAAP, the revenue recognized as interest is earned. According to the Tax Code, the interest revenue is exempt from federal taxes.
Accounting for SERP-PLUS Program. http://www.newyorklife.com/cda/0,3254,13315,00.html as retrieved on February 15, 2007.
Investopedia. http://www.investopedia.com as retrieved on February 15, 2007.
Pope, Thomas A., Anderson, Kenneth E., and Kramer, John L. Prentice Hall's Federal Taxation 2007: Individuals, Twentieth Edition, by Published by Prentice Hall. Copyright © 2007
Seago, W. Eugene. Income difference caused by interest capitalization. The CPA Journal On-line. November 1989. http://www.nysscpa.org/cpajournal/old/07950780.htm as retrieved on February 14, 2007.
Taxation in the United States. http://www.answers.com/topic/taxation-in-the-united-states as retrieved on February 17, 2007.
The Conceptual Framework. http://www.csun.edu/~hfact004/Ch2-concept.html as retrieved on February 16, 2007.