Entrepreneurship and Small Business (ESB) V2 Certification Practice Exam

How is income tax expense calculated?

1. Gross profit * tax rate

2. Net income * tax rate

3. Revenue * tax rate

4. Equity * tax rate

The correct answer is: Gross profit * tax rate

Income tax expense is primarily calculated based on a company's taxable income. Taxable income is derived from net income after adjustments for various accounting principles and taxable items. The correct approach for calculating income tax expense involves using net income, as it reflects the company's overall performance after all expenses have been accounted for. The option indicating that income tax expense is calculated as gross profit multiplied by the tax rate is not accurate. Gross profit is the revenue remaining after deducting the cost of goods sold, but it does not consider all operating expenses, interest, or taxes. Therefore, using gross profit does not provide a realistic or comprehensive measure of what the taxable income is, leading to incorrect calculations of the income tax expense. The correct calculation involves multiplying the net income by the tax rate, as net income provides a more accurate representation of the profits available for taxation after all deductions. This clearly reflects how tax is applied to the earnings of the company, ensuring that tax expenses are calculated appropriately based on overall profitability rather than just income levels or revenue figures.