There are many old jokes about the businessman who keeps two sets of books – one correct set, and the other for taxes. The old joke is – in fact – true. This is how we accountants do it.
Congress designed tax rules to compute your tax bills. They contain many special rules designed to encourage you to do certain things (like invest in solar energy), and to discourage you from doing other things (earning illegal income). However, they are not designed for you – the owner – to measure your business’s performance.
On the other hand, a separate set of rules, called Generally Accepted Accounting Principles (“GAAP,” for short) were designed to help you measure the profitability and financial position of your business.
What’s the difference? Suppose your business takes advantage of many helpful tax-saving strategies (like Section 179 write-offs). These will lower your taxable income and cut your tax bill. However, such strategies should improve your real profits and cash flows. GAAP financial statements were designed to give you a more realistic measure of your performance.
In practice, companies usually keep one set of records. However, they typically present two different sets of financial statements – one for the tax authorities, and another for you – the owner.