Reconciliation of Financial and Tax Accounting

Parallel existence of financial and tax accounting

Domination of tax accounting

Lack of external incentives for maintaining high quality financial accounting records and, as a consequence,

Poor quality of financial accounting records and preparation of financial statements. Lack of quality accounting records creates problems:

At the microeconomic level

• Lack of a reliable information data base for making sound management decisions

At the macroeconomic level

• There is no reliable view of the state of the economy
• There is no reliable data base for the nation-wide panning purposes

The conclusions of the regulators about economic processes should be based on reliable information from financial statements that present a view of financial position of an enterprise, its performance, and information on changes of the financial position of this enterprise.

Adequate supply of information can be guaranteed only if financial statements are in high demand. How can this be achieved?

Establish direct link between the data from financial statements and a taxable profit under tax legislation.

Even now, the law of Ukraine "On Accounting and Financial Reporting in Ukraine", Ukrainian Accounting Standards (UAS), current chart of accounts allow to maintain high quality financial accounting records and prepare reliable financial statements that can meet the information needs of the widest possible groups of internal and external users.

This is what the Law "On Accounting and Financial Reporting in Ukraine" states:

"Financial Accounting is a mandatory type of accounting maintained by an enterprise. Financial, tax, statistical and other types of reporting that use money measure are based on financial accounting data". Requirements of the legislation for the taxable profit will never be completely the same as requirements of the standards concerning the recognition of revenues and expenses and determination of the financial result.

Accounting standards make up a stable basis of maintaining financial accounting records and preparing financial statements. The government tax policy may be sufficiently flexible and may change, depending on the nature of economic processes.

UAS 17, Income Tax, recognizes that in order to calculate the tax expense, other than taxable profit can be used, i.e. in the financial accounting itself there are mechanisms to reconcile financial accounting and tax reporting. These are deferred tax assets and tax liabilities that must be calculated based on taxable or deductible temporary differences.

To achieve the full reconciliation of financial accounting and tax reporting, it is proposed to reform the corporate profit taxation law in two areas:

First area
Fundamental change of the concept of the income tax object! The taxable object should be the financial result of an enterprise's ordinary activities before taxes according to the income statement showing the financial results as corrected for permanent and temporary differences.

The practical application of this approach should be the development and implementation of the income tax return form that begins with a profit (loss) before taxes from the income statement with further adjustments for permanent and temporary differences between taxable and balance sheet bases of relevant assets and liabilities.
Given below is an outline of the tax return:



Advantages of the use of such an approach are evident:

• Requirements of the Law "On Accounting and Financial Reporting in Ukraine" concerning the primary nature of financial accounting are enforced
• There are additional incentives for establishing and maintaining financial accounting records in companies
• Company management understand the link and difference between accounting profit and taxable profit
• The information data base for making sound decisions is growing, there are new favorable conditions for implementing management accounting and budgeting systems leading to the improvement of the company management
• The income tax administering procedures are improved.

The tasks in the first area can be accomplished even without additional adjustments in the current Law "On Corporate Profit Taxation".

In fact, the project's consultants have already developed a form of such a tax return. The project may test this tax return at three or more pilot enterprises to prove the viability of this approach.

Second area
The second area proposed by the project envisages a more substantial revision of the company profit taxation law for the purpose of bringing tax accounting closer to financial accounting. However, we believe that, in any case, these two types of accounting will never be identical and there will always be a need to reconcile financial accounting and tax accounting data. It can be done, in any case, through the tax return form proposed by us. Undoubtedly, the content of the tax return will be changed to comply with changes in the corporate profit taxation law, but the approach should remain the same: from the financial result to taxable profit.

This area of activities was discussed at the meeting of the working group under the Ministry of Finance, but, to our deepest regret, the work of this group was suspended in 2005.