- [Instructor] Now here's a question you may not
have thought of before.
How many sets of accounting books does a large company keep?
And the answer is not one.
A large company keeps three sets of books.
First there are the records that are used to prepare
the summary reports for outsiders: the financial reports.
Second are the detailed internal information sources
that are used to make detailed decisions.
These internal books are not revealed to outsiders.
That's the second set of books.
The third set of books are prepared based
based on a different set of rules.
on a different set of rules.
These are the tax books.
For tax reporting to governments.
So three sets of books.
In fact, it's a sign of a sophisticated economy
or a sophisticated company that they have three
that they have three sets of books.
sets of books.
A simple company often only has one set of books.
The books they use to report their income taxes.
The books they use toreport their income taxes.
But as a company gets more sophisticated.
It develops these three different sets of records.
The summary financial reports are given to outsiders.
The managerial accounting reports are used internally.
And the tax accounting records are used in reporting
in reporting to the government.
to the government.
And because these three sets of books are used for
are used for three different purposes,
three different purposes they do not necessarily include
they do not necessarilyinclude the same numbers.
the same numbers.
The amount of income reported and computed can be different
can be different in each of these
in each of these three different sets of books.
three different sets of books.
So let's talk about the general concept of income taxes.
So on this continuum here you see at one end,
you see at one end economic income,
economic income and at the other end cash flow.
and at the other end, cash flow.
Economic income is a subjective number
based on value changes.
And financial reporting income tends to try to reflect
to try to reflect economic income.
economic income.
As a result, financial reporting income is a subtle
is a subtle and sophisticated number.
and sophisticated number.
At the other end of the continuum cash flows
cash flows are very objective.
are very objective.
It's quite easy for a business to tell exactly
when it collects and when it received cash.
In general, income tax rules and income tax reporting
tend to be more objective.
More like cash flows.
Now there are many reasons for this tendency
towards objectivity in the income tax rules.
First of all because income tax rules are the law
they need to be clear.
They need to be objective.
There can't be too much uncertainty.
Therefore, cash flow works better for income tax rules.
In addition there's the issue of ability to pay.
In addition, there's theissue of the ability to pay.
Assume that I have income that I've earned this year but
but I don't collect thecash until next year.
I don't collect the cash until next year.
Well if you tax me this year, before I receive the cash
I don't have the cash to pay the tax.
So it's often the case that income tax rules
are more cash based.
So you are taxed when you have the cash to pay the tax.
A third aspect of the income tax accounting is
is the aspect that makes incometaxes kind of complicated.
the aspect that makes income taxes kind of complicated.
You see lawmakers around the world have used income tax
have used income tax rulesfor social tinkering purposes
rules for social tinkering purposes to encourage or
discourage certain kinds of behaviors.
This is where a lot of the complexity
in the tax code comes from.
We'll talk about these tax breaks later in the course.
Now income taxes are not the most important thing
the most important thing in the world,
in the world.
but they are a pervasive aspect
But they are pervasive aspect of business and personal life.
of business and personal life.
We don't need to become tax experts but we need to become
but we need to become familiarwith income tax issues
familiar with income tax issues and become confident
and become confident aswe face income tax issues
as we face income tax issues in our business
in our business and personal lives.
and personal lives.