CFA Level I Exam · Analysis of Income Taxes

Accounting Profit vs Taxable Income for CFA Level I

Updated 7 October 2026 · Fact-checked

Accounting profit (pre-tax income) is income before tax measured under IFRS or US GAAP for investors. Taxable income is income measured under tax law for computing tax payable. They differ because the rules differ. Income tax expense = taxes payable + change in deferred tax liability − change in deferred tax asset.

Understand Accounting Profit vs Taxable Income

A company keeps two sets of numbers. One set follows financial reporting standards (IFRS or US GAAP). It is built to show investors a fair picture of performance. The other set follows the tax authority's rules. It decides how much tax the company must pay.

Accounting profit (also called pre-tax income or earnings before tax) is revenue minus expenses under the reporting standards. Taxable income is the income figure on the tax return. Income tax payable is taxable income × the tax rate. Income tax expense is the amount shown on the income statement.

The two profits differ because standards and tax law recognize revenue and expenses at different times or in different amounts. A common example is depreciation. A company may use straight-line depreciation in its books but an accelerated method for tax. Early on, tax deductions exceed book expense, so taxable income is lower than accounting profit. Tax payable is then lower than the tax a company would pay on its book profit.

Some differences reverse over time. These are temporary differences, and they create deferred tax assets or liabilities. Other differences never reverse. These are permanent differences, such as an expense that is never deductible or income that is never taxed. They affect the effective tax rate but create no deferred tax.

The income statement reports income tax expense, not tax payable. Tax expense equals tax payable plus or minus the change in deferred taxes. This is how the income statement matches tax to the period in which the related profit was reported.

Key formulas to remember

Income tax payable (current tax): Income tax payable = Taxable income × Tax rate; This is the cash tax owed to the authority for the period, based on the tax return.
Income tax expense: Income tax expense = Income tax payable + ΔDTL − ΔDTA; ΔDTL is the increase in deferred tax liability. ΔDTA is the increase in deferred tax asset. A decrease reverses the sign.
Income tax expense (alternative): Income tax expense = Current tax expense + Deferred tax expense; Deferred tax expense = ΔDTL − ΔDTA.
Tax on accounting profit: Pre-tax income × Tax rate; Equals income tax expense only when there are no deferred tax effects (no temporary differences, and no tax rate change).
Effective tax rate: Effective tax rate = Income tax expense ÷ Pre-tax income; Compare with the statutory rate to see the effect of permanent differences and other items.

How to solve Accounting Profit vs Taxable Income questions

Use this order for any question that links accounting profit, taxable income and tax expense.

1Identify what the question gives: pre-tax income, taxable income, tax rate, and deferred tax balances or changes.
2Compute income tax payable = taxable income × tax rate. If only the accounting side is given, adjust pre-tax income for the stated differences to reach taxable income.
3Decide whether each difference is temporary or permanent. Only temporary differences create deferred tax.
4Work out the direction. If taxable income is below pre-tax income because of a temporary difference, a deferred tax liability usually rises. If taxable income is above, a deferred tax asset usually rises.
5Apply: income tax expense = tax payable + ΔDTL − ΔDTA.
6If asked, compute the effective tax rate = tax expense ÷ pre-tax income.
7Check the sign: tax expense should be consistent with the direction of the deferred tax movement. Then match the answer to one of the three options.

Quickest way: Tax payable plus deferred movement

When to use it: Use when the question gives taxable income, a tax rate and changes in deferred tax balances, and asks for tax expense.

Multiply taxable income by the rate to get tax payable.
Add any increase in DTL. Subtract any increase in DTA.
If there are no temporary differences, simply use pre-tax income × rate.
Eliminate options that ignore deferred tax or use the wrong sign.

Common mistakes in Accounting Profit vs Taxable Income

Applying the tax rate to taxable income and calling it income tax expense.
Tax payable and tax expense sound alike, and the question may give only taxable income.
Fix: Taxable income × rate is tax payable. Add the change in DTL and subtract the change in DTA to get tax expense.
Getting the sign of the deferred tax adjustment wrong.
Students memorize the formula without thinking about direction.
Fix: A rising DTL means taxable income is lower than pre-tax income now, so tax payable is below the tax on book profit and the tax is deferred to later. Tax expense is therefore higher than tax payable. A rising DTA lowers expense below tax payable.
Treating permanent differences as creating deferred tax.
Any gap between book and tax income looks like a deferred item.
Fix: Only temporary differences reverse and create deferred tax. Permanent differences change the effective tax rate only.
Assuming taxable income is always lower than accounting profit.
Depreciation is the usual example, and it pushes taxable income down.
Fix: It can go either way. For example, warranty costs expensed in the books before they are deductible make taxable income higher at first.
Confusing the effective tax rate with the statutory rate.
Both are percentages related to tax.
Fix: The statutory rate is set by law. The effective rate is income tax expense ÷ pre-tax income and can differ because of permanent differences and rate changes.

Worked examples

Example 1

A company reports pre-tax income of $500,000 under IFRS. Taxable income is $420,000 because tax depreciation exceeds book depreciation by $80,000, which is a temporary difference. The tax rate is 30%. What is income tax expense?

Show the solution

Income tax payable = $420,000 × 30% = $126,000.
The temporary difference of $80,000 makes taxable income lower, so the DTL rises by $80,000 × 30% = $24,000.
Income tax expense = $126,000 + $24,000 = $150,000.
Check: pre-tax income × rate = $500,000 × 30% = $150,000. This matches because there are no other differences.

Answer: Income tax expense is $150,000.

Example 2

A company has income tax payable of $90,000. During the year its deferred tax liability increases by $12,000 and its deferred tax asset increases by $20,000. What is income tax expense, and how does it compare with tax payable?

Show the solution

Income tax expense = tax payable + ΔDTL − ΔDTA.
= $90,000 + $12,000 − $20,000.
= $82,000.
The deferred tax asset increase is larger than the DTL increase, so net deferred tax is a benefit of $8,000. Tax expense ($82,000) is below tax payable ($90,000) because of this net deferred tax benefit.

Answer: Income tax expense is $82,000, which is $8,000 less than tax payable.

Exam tips

Questions are standalone three-option MCQs. Compute tax payable first, then adjust for deferred taxes, and eliminate options that skip this step.
Read whether the question gives taxable income or pre-tax income. The rate is applied to taxable income for tax payable.
Watch for the words temporary and permanent. Permanent differences never create deferred tax.
Expect conceptual items too: why taxable income can be higher or lower than pre-tax income, and which direction the deferred item moves.

Practice questions from Analysis of Income Taxes

Accounting Profit vs Taxable Income in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Accounting Profit vs Taxable Income: frequently asked questions

What is the difference between accounting profit and taxable income?

Accounting profit is pre-tax income under IFRS or US GAAP, prepared for investors. Taxable income is the income figure under tax law, used to compute tax payable. The rules for timing and amounts of revenue and expense differ, so the figures differ.

What is the income tax expense formula in CFA Level I?

Income tax expense = income tax payable + change in deferred tax liability − change in deferred tax asset. Tax payable is taxable income × the tax rate. Equivalently, it is current tax plus deferred tax.

Why does taxable income differ from pre-tax income?

Tax law and accounting standards recognize some items at different times, such as depreciation, or treat them differently altogether, such as non-deductible expenses. Timing differences reverse and are called temporary. Others never reverse and are permanent.

Does a permanent difference create a deferred tax asset or liability?

No. Permanent differences do not reverse, so no deferred tax is recognized. They cause the effective tax rate to differ from the statutory rate.