Presentation of non-deductible expenses in financial statements depends on the basis of accounting on which the financial statements are prepared, rather than on whether or not they are audited financial statements. Financial statement presentation can be based on either Generally Accepted Accounting Principles, or GAAP, or on one of the Other Comprehensive Bases of Accounting, or OCBOA. Audited financial statement can also be either GAAP basis or OCBOA.
Non-deductible expenses in a business are legitimate expenses for accounting purposes, but they are not allowed as deductions from gross income on the business tax return. For example, expenses such as Internal Revenue Service or state government penalties and interest expense, certain premium payments for officers' life insurance, political contributions, certain fines, expenses related to tax exempt income or federal income tax expense reduce business net income, but do not reduce its taxable income.
In GAAP prepared financial statements, non-deductible expenses are not segregated from other business expenses on the Statement of Income and Expense. However, these non-deductible expenses must be added back to net income when calculating the income tax expense on taxable income. Accrued income -- earned, but not yet received -- and accrued expenses -- owed, but not paid -- are presented, including accrued non-deductible expenses. Accrued assets and liabilities are also present on the balance sheet, and any provision for a deferred income tax asset or liability must also take non-deductible expenses into account. An auditor may test these income tax calculations as part of his auditing procedures to determine whether the income tax provisions are fairly presented.
Cash Basis and Modified Cash Basis Presentation
Cash basis and modified cash basis financial statement presentation are two of the three most common forms of OCBOA financial statements. Cash basis financial statements present only cash coming in and cash going out during the period. Cash payments for non-deductible expenses are included with all other cash expenses and are not separate. Modified cash basis financial statements accrue long-term assets and liabilities; short-term assets and liabilities due during the current period are not presented. Because non-deductible accrued liabilities are short-term, they are not on the income statement or on the balance sheet. Non-deductible expenses are disclosed in the notes to these financial statements to explain why the company's accounting records differ from the OCBOA financial statements.
Tax Basis Presentation
Tax basis financial statements present only the income, expenses, assets and liabilities that appear on the business income tax return. Therefore, non-deductible expenses are not presented. They are disclosed in the notes to the financial statements along with all balance sheet accruals not included on the tax return to explain the differences between the company's accounting records and the tax basis financial statements. Tax preparers may include Form M-1 with the business tax return to reconcile the company's accounting records with the tax return. In an audited financial statement, the auditor may review Form M-1 and the disclosure notes to verify the OCBOA financial statements fairly present this information.
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