Updated July 18, 2023
Definition of Book Profit
Profit is the difference between Sale Price and Purchase Price. Book Profit refers to the profit which is shown in the books of accounts but not yet realized by the business. Since the profit is still in the Books of accounts of the business it is called Book Profit.
It is obvious for businesses to have book profits; however, these profits when realized by the business become realized profit and form part of Net Profit. Computation of Book Profit is important for determining the tax liability of the business. Book Profit is interpreted differently in Share Market parlance and as per the Income Tax Act which is discussed below under different subheads.
Explanation
Understanding Book profit requires basic knowledge that whatever purchased, if sold at higher price results in Profit and if sold at lower price results in a loss. However in cases where Market Price is higher than the price at which item is bought by the business (Book Price), but business continues to hold the same results in Book Profit. Let’s understand the same with the help of an example.
ABC Bank invested in the Bonds of Crayon International on 02 Jan 2020. The Bonds were bought at @1200 USD. On 31st March 2020, the Market price of Bonds stood @ 1240 USD. The number of Bonds purchased by ABC Bank is 20000 units. Based on the above:
|
Particulars |
Amount in USD |
| Purchase Price | 1200 |
| No of Bonds purchased | 20000 |
| Total Book Price | 24,000,000 |
| Market Price on 31st March 2020 | 1240 |
| Book Profit per unit of Bond | 40 |
| Total Book Profit as on 31st March 2020 | 800,000 |
Further Book Profit is not confined to just investments but also to normal business revenues as well however the methodology to compute Book Profit differs in the case of business form as per Income Tax rules prevalent in the country to which the business belongs.
Book Profit in Share Market
Book Profit in Share Market implies the timely booking of profits else it remains as Mark to Market (MTM) Notional profit. The value of securities in the share market keeps on fluctuating resulting in notional gains/losses on the securities held. When securities are held in the books of the business with gains it is called Book profits, however, this profit can’t be accounted for by the business as it is not realized.
Let’s understand this with the help of another example:
Ram bought the following shares on varying dates in the month of January 2020 namely;
|
Share Name |
Price ( in USD) | Quantity |
Total (in USD) |
| Reliance | 34 | 1000 | 34000 |
| HDFC | 20 | 400 | 8000 |
| 100 | 700 | 70000 | |
| Total | 112000 |
On 31st March it was informed that Ram has the following position:
|
Share Name |
Market Price ( in USD) | Quantity |
Total (in USD) |
| Reliance | 70 | 700* | 49000 |
| HDFC | 30 | 400 | 12000 |
| 400 | 700 | 280000 | |
| Total | 341000 |
*300 shares of Reliance sold @$70 per share.
Now we can see Ram will report a Net profit on the shares sold and a Book profit on the shares which are still held by him as under:
Realized Profit which will form part of Net Profit as it is realized:
(300 * {36}) =$10800
Book Profit for Ram as on 31st March 2020 will be as follows:
|
Share Name |
Market Price ( in USD) | Book Price ( in USD) | Quantity |
Book Profit (in USD) |
| Reliance | 70 | 34 | 700 | 25200 |
| HDFC | 30 | 20 | 400 | 4000 |
| 400 | 100 | 700 | 210000 | |
| Total | 239200 |
Book Profit as per Income Tax Act
As per Income Tax Act guidelines, it is derived from Net profit after adjusting for the following items:
- Addition of Income-tax payable/paid by the business which is included in the computation of Net Profit.
- Addition of amount transferred to any reserves and amount provision for contingent liabilities.
- Addition of provision for losses set aside for subsidiaries of the business and any dividend paid or proposed to be paid.
- Addition of certain expenses related to incomes that aren’t permission as per the provision of the Income Tax Act for the purpose of computation of Book Profit.
- Reduction by any amount added to derive Net Profit such as Long term capital gains, royalty, etc.
- Reduction of Non-cash expenses such as Depreciation if debited to P&L account for computation of Net Profit.
- Reduction of the amount of any brought forward unabsorbed depreciation use for computation of Net Profit.
Book Profit vs Net Profit
The two terms are used frequently in accounting parlance; however, differ a lot. Key differences are enumerated below:
|
Basis |
Book Profit |
Net Profit |
| Taxability | Book Profit is not used for determining tax in the case of Business forms such as Company etc. | Net profit is derived after adjusting for the tax liability of the business. |
| Meaning | Book Profit refers to the profit computed as per the Income Tax Act relevant to the business. | Net profit refers to the profit computed as per the Book of Accounts of the company in accordance with the Companies Act relevant to the business. |
| Analyst Focus | It is not tracked by the Analysts and stakeholders but is used more for taxation purposes only. | It is closely tracked by Analysts and stakeholders and is an important number used for various financial ratios purposes. |
Importance of Book Profit
Every legal entity is liable to pay income taxes in the country in which it operates and in order to pay its tax liability it is required to determine its tax liability which the first and foremost step in tax management. Determination of Book Profit is necessary for the purpose of calculating the Tax liability.
Conclusion
It is an accounting term which implies profits which are notional in nature and not realized by the business. Due to the notional nature, these profits are contingent and can change over time and maybe even wipe out completely as well in case of a drop in prices. In other words, we can say that Book Profits are paper profits and as such, they are not taxable in nature unlike Realized Net profits of the business.
Recommended Articles
This is a guide to Book Profit. Here we also discuss the definition and book profit in share marketing along with example and importance. You may also have a look at the following articles to learn more –
