What it means
Accounts are prepared to show shareholders a fair picture of performance, while tax rules are written to raise revenue and encourage particular behaviour. Because the two have different purposes, the profit in the annual report and the profit the tax authority taxes are almost never the same number.
The bridge between them is a set of adjustments. Some expenses are recorded in the accounts but not allowed for tax, some income is taxable in a different period, and some reliefs exist for tax that have no accounting equivalent.
The most common adjustment is depreciation. Accounting depreciation is added back to profit and replaced with capital allowances, the tax system's own schedule of relief on qualifying assets, which often gives faster relief in the early years.
Other frequent adjustments include disallowed entertainment costs, fines and penalties, general provisions that are not yet specific, and income such as certain dividends that has already been taxed elsewhere. Each is either added back to or deducted from accounting profit to reach the assessable figure.
The term is used most in tax systems following the British tradition, including the UK, Nigeria, Hong Kong and much of the Commonwealth, while US practice usually speaks of taxable income. The concept is the same even where the vocabulary differs, and non-finance managers meet it whenever they ask why the tax charge does not look like the profit multiplied by the tax rate.
In practice
Real-world examples.
Example
A haulage company invests $1.8 million in new vehicles and claims accelerated capital allowances in the first year. Its accounting profit is unchanged, but assessable profit falls sharply and the cash tax payment drops by several hundred thousand dollars in that year.
Example
A hospitality group charges $180,000 of client entertainment through the profit and loss account. None of it is deductible for tax, so the full amount is added back and the group pays tax on profit it never really had available.
Example
A software business books a $250,000 general provision against slow-paying customers at year end. The tax computation adds it back because the provision is not specific, and only releases relief in a later year when particular invoices are written off as bad.
Formula
Calculation
Assessable profit = accounting profit + disallowed expenses and add-backs - allowable deductions and exempt income.
A distribution business reports an accounting profit before tax of $2,400,000. The tax computation adds back depreciation charged in the accounts of $300,000, disallowed client entertainment of $40,000 and a general provision for doubtful debts of $60,000, which is $400,000 of add-backs in total.
It then deducts capital allowances of $420,000 granted on qualifying plant and vehicles, and exempt dividend income of $80,000 already taxed at source, which is $500,000 of deductions.
Assessable profit = $2,400,000 + $400,000 - $500,000 = $2,300,000. At a corporate tax rate of 25%, the tax payable is $2,300,000 x 25% = $575,000. Note that applying 25% to the accounting profit of $2,400,000 would have suggested $600,000, so the adjustments are worth $25,000 of real cash in this year alone.Case study
Seen in the real world.
Brackenmoor Foods is an invented company used here as an illustrative example. Its managing director could not understand why the tax bill kept exceeding what he calculated by multiplying profit by the tax rate, and suspected the accountants had made an error.
A walkthrough of the tax computation showed the arithmetic was correct and the pattern was structural. The business spent heavily on staff entertainment and client hospitality, carried large general provisions, and owned mostly leased premises that generated very little in capital allowances, so add-backs consistently exceeded deductions.
In this fictional account the finance team began producing a reconciliation from accounting profit to assessable profit alongside every quarterly report. The visibility changed behaviour: entertainment spend was reclassified and controlled, provisions were made specific where evidence allowed, and the illustrative effective tax rate fell by nearly two percentage points within a year.
Watch out
Common mistakes.
- Assuming the tax charge equals accounting profit multiplied by the tax rate. Adjustments for disallowed costs, capital allowances and exempt income move the taxable base in both directions.
- Treating every add-back as a permanent extra cost. Many differences are timing differences that reverse in later periods rather than genuine additional tax.
- Leaving the tax computation until after the year has closed. Most planning opportunities, particularly around capital spending timing, only exist before the year end.
Questions
People also ask.
Is assessable profit the same as taxable income?
Broadly yes, with assessable profit being the term used in the UK and many Commonwealth systems and taxable income the usual US term.
Why is depreciation added back?
Because tax systems replace the company's own depreciation policy with standardised capital allowances so that all businesses receive relief on the same basis.
Can assessable profit be negative?
Yes, and a negative figure is a tax loss that can usually be carried forward against future profits or, in some systems, carried back.
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