in this video we're going to discuss the difference between book and tax income so when we say book income what we really mean is pre-tax Financial income so that's the income that is required to be computed by Gap by generally accepted accounting principles in the United States so that's going to end up on the income statement and then the financial statements that are prepared by The Firm that are used by investors and creditors at the end of the fiscal year so this is Gap pre-tax income right now taxable income tax income is that which is computed for purposes of your tax return for the corporation that's submitted to the IRS so there's this Form 1120 that a corporation must file and so to to pay the corporate uh income taxes and so the taxable income is what is reported to the IRS whereas the pre-tax Financial income is reported to investors and creditors uh in the financial statements so there are going to be large differences in some cases there are going to be differences between book and tax income and the reason is is that these different types of income are computed for different purposes they have different objectives and so they're going to be computed in slightly different manner so Brook book income so this is Gap income for the financial statements is going to be uh reported on a cruel basis right remember we talked about a cruel accounting accounting for events in the period in which they happen to occur rather than in the period which they happen to be settled in cash so that's a cruel accounting and so book income on a cruel basis is going to be intended to track changes in the firm's wealth did the firm's wealth increase or decrease During the period and and investors and creditors are going to be the ones using this information and they're going to be trying to predict the future they're trying to make predictions about the timing and the certainty of the firm's cash flows all right so that's the objective of book income is so that investors and creditors can use the financial statements to see what is going to happen with this firm in the future taxable income on the other hand it's it's used by the IRS to to raise money for the United States government right so it's a completely different objective it's not investors and creditors and matter of fact investors and creditors aren't even going to see the firm's tax return right so it's based that this taxable income is based on this this Doctrine called ability to pay so I just want to give you an example so let let's say that you're a landlord and your tenant pays you they pay you $800 rent but they pay you on day one before you've actually before they've even lived in the apartment or anything so they they prepay the rent $800 now for for book purposes for book purposes we're using a cruel accounting and we say hey this hasn't been earned yet we don't recognize that $800 as revenue and thus it wouldn't end up in pre-tax Financial income because it hasn't been earned however however with taxable income the US government doesn't care whether it's been earned or not right this isn't information for investors and creditors what they care about is the ability to pay and when you receive that prepaid rent as the landlord they say aha you just got $800 you are in a position to pay if they wait till next year next quarter or whatever and say hey we'll wait till it's been quote unquote earned well then they might not be able to get their tax from you right so you've got the money and now they're ready to tax you so there's different objectives and different ways of accounting for it now tax income some things are are reported on a cruel basis for taxes but usually what we call as a modified Cash basis is how tax income is disc cribe now these differences between a a cruel accounting and this modified Cash basis that's used for taxes so if we're if we're accounting for book income differently than tax income it's like we're keeping two sets of books and so we're going to have these differences the natural question is about these differences do they reverse at some point and the answer is yes in some cases if it is a temporary difference that just means that okay book and tax income are different this period but over time that that that it will reverse and and the the one is requiring deductions or expenses be taken earlier and then it'll make up later and we we'll talk about that with like depreciation for example but in some cases it's a permanent difference for example life insurance income so if the firm has in life insurance proceeds that they receive from the the know CEO passing away that is not going to be taxed however it is going to end up in pre-tax Financial income and thus in book income and so that's never going to be reversed and so we're going to call it a permanent difference between tax and book income and we're going to talk about temporary and permanent differences in the videos to come