In financial accounting, the depreciation mechanism spreads the cost of a long-lived asset over its entire service life. Tax accounting takes a different approach, the Modified Accelerated Cost Recovery System (ACRS). Modified ACRS recovers the cost of the asset faster than the financial accounting method. Since the result is a higher depreciation deduction in the early years and a lower taxable income in those years, you probably will use the method for income tax purposes. In some unusual situations, accounting depreciation does result in lower taxable income.
Do not use modified ACRS in your accounting records. If you do, you may understate your financial accounting income, which would result in misleading figures on the profitability of your business.
In applying the techniques mentioned above, as well as other aspects of income taxation, most businesses call on an income tax expert for help. The rules of income tax accounting are much more complicated than those of financial accounting. If you fail to take full advantage of these rules, you pay more income taxes than necessary. Or, if you do not follow the rules, you could pay a sizable penalty.
Nonprofit organizations do not pay income taxes unless they also engage in profit-making activities. However, many of them must file financial statements with the state or federal government or with agencies such as United Way. In general, these financial statements are prepared in accordance with the financial accounting rules described in this overview, but the details vary according to the requirements of the individual agencies.