The Most Taxing Questions – Cash Flows and Tax Books © 2004 Dr. B. C. Paul

Income Tax  Income Tax is a government take of a businesses (or your) intake of new wealth  To calculate the tax your must determine the income  In simplest terms  Gross Earnings – Business Expenses

Net Income May Not Be So Easy  We’ll ignore what's wrong with Gross Revenue right now  Business Expenses  Could just tax the cash flow  Problem is that projects produce large negative cash flows during set up  Assets last for years  General feeling that a producing asset that would serve years of production could not be written off in one year  There was also an accounting tradition of writing long lived assets off over time.  Would Make Revenue swing wildly

A Split in Conventions  Taxes and Accountants spread the cost of long lived assets over time  Cash Flows put expenses where they physically occur  Result – Multiple Sets of Books  Cash Flow book is based on when real money moves  Tax and Accounting Books are based on conventions spreading costs for long lived assets over time

The Pain  Your Cash Flow has to show when real money moves  Taxes going out represent real money moving  Therefore you have to keep a set of funny money books to keep track of taxes so you can decide when real money moves

Asset Categories  Split into Expensed or Depreciated  An asset that is depreciated  Is used for business purpose to produce income  Have an identifiable useful life of more than 1 year  Must decay, be used up, wear out, or loose value to the owner

Expensed Items  Calculating Taxable Income  Gross Receipts  Minus Expenses  Expensed Items are taken off “Income” in the year they occur  Expensed items  Have useful life of less than a year  Or have a specific allowance in the tax code for them to be written off  Example – Small businesses can write-off about 20K per year of office equipment even though it satisfies definition of depreciable asset

Examples of Expensed Items  Labor Expenses  Utilities  Office consumables  Raw material inputs to your process  (Warning the list is not exhaustive)

Examples of Depreciable Items  Manufacturing tools  Handling devices for food and beverage manufacture  Autos and Aircraft  Computers and Office Equipment  Buildings or mine structures  Utility distribution or sewage treatment facilities

Cash Flow Items Neither Expensed or Depreciated  Land (considered to be an asset that retains and holds value – money spent is just converted into a different form)  Individual Personal Home  Rental houses are depreciated  They produce income – personal homes don’t – they are personal consumption