Introduction
In accounting, Book Profit is a frequently used term, and it is essential to understand the meaning of Book Profit to excel at accounting. It tends to put up the profits earned by a company using a straightforward formula, which is a significant step in accounting.
This article highlights the concept of book profit and explains the procedure to compute the same.
Defining Book profit
It is evident that profit is the sum of the Market Price removed from the Sale Price. The term “book profit” describes a profit that has been recorded in the business’s accounting records but has not yet been realized.
Since the profit is still recorded in the company’s books of accounts, it is known as Book Profit. When the company realizes the earnings, it becomes realized profits and is included in net profits.
Calculating book profit is crucial for figuring out the business’s tax obligations. According to the Income Tax Act and share market jargon, book profit is defined differently.
In simple terms, book profit can also be defined as what you get as a result when you deduct all expenses from a business’s revenue. Therefore, it is the financial income of any company before taking the taxes into account.
Explaining Book Profit?
Most of the book profit calculation is influenced by GAAP (Generally Accepted Accounting Principles). It indicates that the accrual method of accounting is used. Cash receipts and payments are not taken into account while recording revenue or expenses.
Instead, income is reported as it is earned and costs as they are incurred. Thus, monetary sales are not the only source of revenue. Similarly, expenses are not limited to ones paid in cash. When correctly accounted for, book profit is a good indicator of a company’s profitability.
In general, the business benefits more from more significant book profits. It evaluates a company’s financial performance over a specific time frame. Since it is determined using accepted accounting principles, book profit can be used to compare a company to others. It also complies with the requirements of certain government agencies. By complying with the GAAP, book profit provides an organization’s stakeholders with clear information about its profitability.
Understanding Book Profit and Taxable Income
A company’s taxable profit might not necessarily match book profit (or taxable income). This is because the two have conflicting interpretations of particular revenue and spending elements.
For instance, the only permitted method of depreciation for taxation purposes is MACRS (Modified Accelerated Cost Recovery System). If the company uses a depreciation method different from MACRS for financial accounting, this leads to a difference in the depreciation amount.
Additionally, some expenses are not tax-deductible for income-related reasons. For instance, entertainment and representation costs are not tax deductible. Typically, book profit does not match taxable profit due to the variations in interpretation.
So, accountants make specific reconciling entries to transform book profit into taxable profit. The basis for calculating a business’s income tax obligation is its taxable earnings.
On a company’s tax return, you will notice the net profit or income amount. The tax code serves as the foundation for calculating both income tax and taxable profit.
Any modifications to GAAP have no impact on taxable earnings because it is determined by a different standard (IRS regulations). Instead, it is impacted by any changes to tax legislation. As a result, even if a company consistently performs at a high level throughout time, changes in tax laws may cause its taxable income to alter. Therefore, an expense previously non-deductible, for instance, might now be deductible
How to calculate Book Profit?
It is easy to learn the calculation of Book Profit once we understand it comprehensively. The formula for calculating the book profit is:
Book Profit= Revenue- Expenses
It is easier to understand through examples, so here is one which shows the calculation of the Book Profit:
John and Sons Company has the following mentioned revenue and expense figures (in Rupees)-
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|---|---|
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Total cash sales
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350000
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Total credit sales
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700000
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Total cost of sales
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660700
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Total operating expenses
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275550
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Other income
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184200
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Other expenses
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66308
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Now, with these figures, we can easily calculate the book profit for John and Sons Company. The same formula mentioned above shall be used to calculate book profit. So, in order to calculate the final revenue figure, we need to add the total cash sales, credit sales, and other income.
REVENUE- 350000+700000+184200=1234200
Also, to find the final expenses figure, we need to add the total cost of sales, operating expenses, and other expenses.
EXPENSES= 660700+275550+66308= 1002558
Finally, book profit will equal to REVENUE- EXPENSES, which is 1234200-1002558=231642
Book Profit and Net Profit
As both of these terms are so commonly used in accounting terminology, it is crucial to understand them properly.
- Book profit means the profit calculated in accordance with the applicable provisions of the Income Tax Act.
- Whereas, Net profit is the profit calculated in line with the company’s Book of Accounts and the applicable provisions of the Companies Act.
- In the event of business formation, book profit is not taken into account when calculating tax. Meanwhile, net profit is calculated after accounting for the corporation’s tax liability.
- Analysts and stakeholders do not monitor it; instead, it is used chiefly for taxation. Net profit is a crucial metric used for many financial ratios and is actively watched by analysts and stakeholders.
Conclusion
The calculation of the tax liability for every organization requires the determination of book profit. That is the reason it holds importance in accounting. Book Profit also brings with it the understanding of taxes and net profit, thus helping you make better action plans for your business.
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