INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) 51

SUGGESTED ANSWERS
Chapter 8: Deductions from Gross Income

CHAPTER 8
DEDUCTIONS FROM GROSS INCOME
Problem 8 – 1 DEDUCTIBLE OR NONDEDUCTIBLE FROM GROSS INCOME

1. Deductible 11. Nondeductible

2. Nondeductible 12. Deductible
3. Nondeductible 13. Deductible
4. Deductible, in lieu of tax credit (Sec. 34C3, NIRC) 14. Deductible
5. Deductible 15. Nondeductible
6. Nondeductible 16. Nondeductible
7. Nondeductible 17. Nondeductible
8. Deductible 18. Deductible
9. Deductible 19. Deductible
10. Nondeductible 20. Deductible

Problem 8 – 2 TRUE OR FALSE

1. True
2. True
3. False – Business expenses related to business income outside the Philippines is
deductible also.
4. False – Business expense is deductible from gross income.
5. True
6. True
7. True – Once OSD is opted, no capital loss could be deducted from capital gain.
8. False – Some business expenses are nondeductible or subject to limit.
9. False – Income outside the Philippines by a NRC is not taxable in the Philippines,
hence, no allowable deduction is allowed.
10. True
11. False – Compensation income is not subject to OSD.
12. False – NOLCO is not an itemized deduction.
13. True – Amortized over the term of the lease
14. False – ½ of 1%
15. False – 33%
16. False – Double –declining method
17. True
18. True

Problem 8 – 3 Problem 8 – 4 Problem 8 – 5 Problem 8 – 6

1. B 1. C 1. A 1. A
2. No choice, 2. A 2. A 2. C
OSD=40%
3. D 3. D 3. C 3. A
4. D 4. A 4. C 4. C
5. D 5. B 5. A 5. C
6. C 6. B 6. D 6. C
7. B 7. A 7. C 7. B
8. D 8. A 8. A 8. C
9. B 9. D 9. B 9. C
10. C 10. A 10. C 10. C
11. C 11. D
12. D 12. B
13. C
Problem 8 – 7 C
Expensed Capitalized
INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) 52
SUGGESTED ANSWERS
Chapter 8: Deductions from Gross Income

Change of motor of air condition P60,000

Repainting of building P10,000
Expansion of store 50,000
Cleaning of computers 9,000
Repair of furniture 1,000 .
P20,000 P110,000
Problem 8 – 8 A
Salaries net of tax P100,000
Withholding tax 5,000
Deductible business expense P105,000
Problem 8 – 9 A
General rule: No personal or business expense is deductible from compensation income.
Problem 8 – 10 D
Depreciation expense (P1,000,000 x 40%)/25 P16,000
Loss of business equipment 38,000
Deductible expense P54,000

Problem 8 – 11 D
1. A
No personal or business expense is deductible.

2. B
Depreciation (P20,000 x 10%) P 2,000
Repair (P100,000 x 10%) 10,000
Office supplies 6,000
Total deduction P18,000

Problem 8 – 12 B
Tax laws GAAP
Salary expense (P180,000 + P20,000) P200,000 P200,000
Estimated uncollectible accounts 10,000
Compromise penalty 50,000
Depreciation expense 30,000 30,000
Miscellaneous expense . 5,000
Deductible from earnings P230,000 P295,000
Note: For tax purposes, the miscellaneous expense is not deductible because it was not
reported last year. For accounting purposes, the miscellaneous expense can be deducted as
prior period adjustment from retained earnings.

Problem 8 – 13 C
Gross income (P300,000 + P20,000 + P180,000) P500,000
Multiplied by OSD rate 40%
Optional standard deduction P200,000

Problem 8 – 14
1. B
Gross income (P870,000 – P10,000 – P380,000)) P480,000
Add: Gains from sale of capital asset 40,000
Total P520,000
Multiplied by OSD rate 40%
Optional standard deduction P208,000

2. B
OSD P208,000
Less: Operating expense 20,000
INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) 53
SUGGESTED ANSWERS
Chapter 8: Deductions from Gross Income

Amount of income enjoying tax savings P188,000

Problem 8 – 15 D
Gross receipts from profession P100,000
Rent income 450,000
Total gross income P550,000
Multiplied by percent of OSD 40%
Optional standard deduction P220,000

Problem 8 – 16 C
Operating expense before representation expense
(P2,000,000 – P300,000) P1,700,000
Representation expense – Actual P300,000
- Limit (P20,000,000 x 0.005) 100,000
- Lower 100,000
Allowable itemized deductions P1,800,000

Problem 8 – 17 B
Salary expense P120,000
Rent expense 24,000
Advertising expense 6,000
Depreciation expense 5,000
Interest expense 60,000
Tax differential on interest income (P30,000 x 33%) ( 9,900)
Total itemized deductions P205,100

Problem 8 – 18 A
Gross salaries of employees P6,000,000
Grossed-up monetary value of fringe benefits 1,000,000
Deductible salaries and fringe benefits expenses P7,000,000

Problem 8 – 19 D
Allowable deduction – fringe benefit expense (P102,000/68%) P150,000

Problem 8 – 20 D
Assume bonus is computed after tax but before bonus. The answer is letter D = P8,143,
computed as follows:

Net income before charitable contribution (P75,000 + P 80,000

P5,000)
Less: Deductible contribution (P80,000 x 5%) – lower of 4,000
actual
Net income before income tax and bonus P 76,000

B = 15% (76,000 – T)
T = 30% (76,000 – B)

B = 15% [76,000 – 30% (76,000 – B)]

B = 15% (76,000 – 24,320 + 30%B)
B = 11,400 – 3,420 +0.045B

B – 0.045B = 7,980
0.952B = 7,980/0.955
B = 8,356
INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) 54
SUGGESTED ANSWERS
Chapter 8: Deductions from Gross Income

Proof:
Income before bonus and tax P76,000
Less: Income tax (P76,000 – P8,356) x 30% 20,293
Income after tax but before bonus P55,707
Multiplied by rate of bonus 15%
Bonus P 8,356

Problem 8 – 21 B
Monthly salary P 5,000
Death benefits 50,000
Terminal pay 25,000
Continuous compensation after the burial for three months 15,000
Total deductible expenses P95,000

Note: Donation for coffin and other wake expenses is not business or compensation related
and, hence, not deductible. (Sec. 72, Rev. Regs. 2)

Problem 8 – 22 C
Inventoriable Supplies expense
cost
Purchases P300,000 P40,000
Decreased in inventory 20,000
Increased in inventory . ( 3,000)
P320,000 P37,000

Problem 8 – 23 D
Traveling expenses (P50,000 + P200,000) P250,000
Fringe benefit expense (P68,000/68%) 100,000
Transportation expense – messenger 40,000
Total allowable expense P390,000

Problem 8 – 24 D
Total rent expenses paid P150,000
Rent last year (10,000)
Prepaid rent (20,000)
Deductible rent expense P120,000

Problem 8 – 25 C
Monthly rent (P20,000 x 60%) x 2 mos from Oct. 31 to Dec. 31 P24,000
Insurance premium (P3,000 x 60%) x 2/12 300
Real property tax (P1,500 x 60%) x 2/12 150
Deductible rent expense P24,450

Note: The city services is not a rent expense.

Problem 8 – 26 B
1. B Accrual Cash
Rent for 6 months based on usage (P20,000 x 6) x 80% P96,000
Rent based on usage and payments (P80,000 x 80%) P64,000

2. A
Actual cash collection for rent P150,000 P150,000

Problem 8 – 27 D
Monthly rental expense P2,000
Monthly depreciation (P600,000/8)/ 12 6,250
Monthly deductible expense P8,250
INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) 55
SUGGESTED ANSWERS
Chapter 8: Deductions from Gross Income

Problem 8 – 28
1. B
Trading - Limit lower (P5,000,000 x .005) P25,000

2. C
Servicing – actual lower P30,000

Problem 8 – 29 B
Operating Expense before representation P80,000
Representation expense (P300,000 x .01) 3,000
Deductible operating expense P83,000

Problem 8 – 30 C
Interest expense P40,000
Tax differential (P50,000 x 33%) (16,500)
Deductible interest expense P23,500

Problem 8 – 31 D
Sole proprietor Corporation
Interest expense P50,000 P50,000
Tax differential (P30,000 x 38%) (11,400)
(P30,000 x 33%) . (9,900)
Deductible interest expense P38,600 P40,100

Problem 8 – 32 B
Deductible Nondeductible
Interest paid in advanced P 20,000
Interest paid to a brother 12,000
Interest paid on deliquency taxes P 8,000
Interest on borrowings to finance his family home 30,000
Interest paid to finance petroleum exploration . 100,000
Total P 8,000 P162,000

Problem 8 – 33 A
Tax savings from interest expense (P100,000 x 30%) P30,000
Final tax on interest income (P1,000,000 x 12%) x 24,000
20%
Actual tax savings P 6,000

Problem 8 – 34 A
Documentary stamp taxes P 1,000
Local tax (P6,000 – P800 – P200) 5,000
Municipal tax 2,000
Community tax 1,500
Deductible taxes P9,500

Note: The fringe benefit income taxes to key officers and rank-in-file employees are to be
classified as deductible fringe benefit expense and not tax expense.

Problem 8 – 35 D
Unadjusted net income (P520,000 – P200,000) P320,000
Add back: Income tax foreign country 10,000
Adjusted net income P330,000
Personal exemption (50,000)
Net taxable income P280,000
INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) 56
SUGGESTED ANSWERS
Chapter 8: Deductions from Gross Income

Note: The P10,000 income tax paid to foreign country is better to be treated as tax credit
rather than as operating expense.

Problem 8 – 36 A
Asset of Oliva P 60,000
Payment to government (P200,000 x 50%) (100,000)
Balance (P40,000)

Deductible bad debts is the entire amount of P100,000

collectibles

Problem 8 – 37 B
Bad debts from business actual written off (P100,000 x P40,000
40%)
Bad debts from profession actual written off 50,000
Deductible bad debts expense P90,000

Problem 8 – 38 D
Annual depreciation expense (P50,000 – P5,000)/5 P9,000
Multiplied by ratio of months used during the year 1/2
Depreciation expense 200B P4,500

Problem 8 – 39 A
Annual depreciation (P2,300,000/11.5 years) P200,000
Multiplied by ratio of months used in 2007 (July 1 to Dec.) 6/12
Depreciation expense P100,000

Problem 8 – 40 D
Oil drilling machine (P800,000 x 90%) / 8 years P 90,000
Oil extracting machine (P900,000 x 90% / 10 years – limit 81,000
Computers (P100,000 x 90%)/4 years 22,500
Delivery truck (P200,000 x 90%)/ 5 years – limit 36,000
Annual depreciation expense P229,500

Problem 8 – 41 C
Depletion base (P6,000,000 – P1,000,000 + P300,000) P5,300,000
Divided by number of extractible estimated tons 5,000,000
Depletion per ton P 1.06
Multiplied by number of tons extracted during the year 800,000
Depletion expense P 848,000

Problem 8 – 42
1 D
.
Depletable costs, January 1, 200x P12,500,000
Exploration costs 1,000,000
Intangible development costs 1,500,000
Total P15,000,000
Less: Depletion expense (P15,000,000/7,500,000) x 1,200,000 2,400,000
Adjusted basis P 1,260,000
Divided by remaining reserves
(5,000,000 + 2,500,000 – 1,200,000) 6,300,000
New depletion rate/ unit P 2.00

2 A
.
INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) 57
SUGGESTED ANSWERS
Chapter 8: Deductions from Gross Income

Depletion cost 2007 (P2 x 1,200,000 units) P2,400,000

3 B
.
Value of production (P12 x 1,200,000 units) P14,400,000
Less: Production and selling costs:
Mining costs P2,000,00
0
Milling costs 3,000,000
Marketing expenses 1,500,000
Depreciation expense 1,000,00 7,500,000
0
Net income from operation P 6,900,000
Multiplied by limit percentage 25%
Deductible amount fro exploration and development cost P 1,725,000

4 B
.
Current exploration and development cost (P1,500,000 + P2,500,000
P1,000,000)
Less: Deductible amount of exploration and development cost (see 1,725,000
3)
Exploration and development cost chargeable to succeeding years P 775,000

Problem 8 – 43 B
Deductible expense: Capitalized Outright expense
Depreciation expense (P10,000,000 x 90%)/50 P180,000
Capital outlay P10,000,000

Problem 8 – 44
1 B 200A 200B 200C
Lower of actual contribution or normal 800,000 800,000 500,000
valuation
Add: Amortization of excess
200A (P200,000/10) 20,000 20,000 20,000
200B (P100,000/10) . 10,000 10,000
Deductible retirement expense 820,000 830,000 530,000

2. A 200A 200B 200C

Actual retirement payments 0 400,000 300,000

Problem 8 – 45 P610,000 = Not in the choices

Year X Year Y
Actual contribution or normal valuation, lower 700,000 600,000
Add: Amortization (P100,000/10) 10,000 10,000
Deductible retirement expense 710,000 610,000

Note: Only the excess of the actual contribution over the normal valuation is to be amortized
over 10 years.

Problem 8 – 46 B
Allowed deductible contribution (P200,000 x 5%) P10,000

Problem 8 – 47 C
Allowed deductible contribution – actual P5,000
INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) 58
SUGGESTED ANSWERS
Chapter 8: Deductions from Gross Income

Problem 8 – 48 B
Income before charitable contribution (P500,000 – P130,000) P370,000
Multiplied by percent of limit 5%
Allowed deductible contribution - lower P 18,500

Problem 8 – 49 C
Actual value of donation – priority program P1,000,000
Adopt a school program – incentive (P1,000,000 x 50%) 500,000
Deductible donation P1,500,000

Problem 8 – 50
Net sales P5,000,000
Less: Cost of goods manufactured and sold:
Raw materials used:
Raw materials, beginning P 200,000
Net purchases of raw materials 2,000,000
Raw materials, ending ( 400,000) P1,800,000
Direct labor 600,000
Factory overhead:
Indirect labor – factory supervisor P 120,000
Depreciation (P100,000 x 90%) 90,000
Light and water (P150,000 x 80%) 120,000
Miscellaneous factory expenses 20,000 350,000
Cost of goods manufactured P2,750,000
Finished goods, ending ( 750,000) 2,000,000
Gross income P3,000,000
Less: Optional standard deduction (P3,000,000 x 40%) 1,200,000
Income from operations P1,800,000

Problem 8 – 51
1. Salaries of barbers P200,000
Depreciation of barbershop equipment 50,000
Cost of service P250,000

2. Rent expense P 20,000

Utility expense 30,000
Janitorial expense 15,000
Bookkeeping expense 10,000
Itemized deductions P 75,000

Problem 8 – 52
Salaries of assistants P 96,000
Traveling expenses 11,000
Light and water – office 7,890
Stationeries and supplies 1,960
Office rent 60,000
Total operating expenses before contribution P176,850
Add: Contribution subject to limit (P500,000 – P176,850) x 10%) 32,315
Allowable itemized deductions P209,165

Problem 8 – 53
Sole
Proprietorship Corporation Partnership
INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) 59
SUGGESTED ANSWERS
Chapter 8: Deductions from Gross Income

Bad debts written-off (P35,000 – P30,000) P 5,000 P 5,000 P 5,000

Depreciation expense (P140,000 – P100,000) 40,000 40,000 40,000
Donation to the government – priority 50,000 50,000 50,000
program
Donations subject to limit:
Lower of actual, P170,000 or 170,000
(P2,500,000 x 10%) . 125,000 125,000
(P2,500,000 x 5%) P 265,000 P 220,000 P 220,000
Total allowable deductions

The research and development cost is to be treated as a deferred expense, hence, its
amortization shall be made in the succeeding five years when the taxpayer realizes
benefits from such expenditures (Sec. 341, NIRC).

Problem 8 – 54
1. Operating expenses (1,000,000 x 30%) – P50,000 P250,000
Interest expense (P50,000 – (P40,000/80%) x 33%] 33,500
Total itemized deductions P283,500
Add: NOLCO 500,000
Total deductible expenses P783,500

Note: NOLCO is not an itemized deduction but part of deductible

expenses.

2. Gross income (P5,000,000 – P2,000,000) P3,000,000

Multiplied by OSD rate 40%
OSD P1,200,000

Note: NOLCO is not allowed to be deducted if the taxpayer uses OSD.

3. Gross income P3,000,000

Less: OSD 1,200,000
Net taxable income P1,800,000

Problem 8 – 55
1. 200A 200B
Actual contribution or normal valuation, lower 1,000,000 900,000
Add: Amortization - 200A (P250,000/10) 25,000 25,000
Deductible retirement expense 1,025,000 925,000

2. Financial net income 50,000,000 60,000,000

Add: Retirement benefit expense – accounting 1,100,000 1,200,000
Total 51,100,000 61,200,000
Less: Deductible retirement expense – taxation 1,025,000 925,000
Net income for tax purposes 50,075,000 60,275,000

Problem 8 – 56
Corporation Individual
Salary expenses 500,000 500,000
Retirement (P250,000 + P50,000/10) 255,000 255,000
Representation expense (P10,000,000 x .005) 50,000 50,000
Interest expense paid to the BIR - full 20,000 20,000
Interest expense – limit:
Corporation (P100,000 – (P96,000/80%) x 33%) 60,400
Individuals (P100,000 – (P96,000/80%) x 38% 54,400
Depreciation expense 40,000 40,000
Rent expense 250,000 250,000
INCOME TAXATION 5TH Edition (BY: VALENCIA & ROXAS) 60
SUGGESTED ANSWERS
Chapter 8: Deductions from Gross Income

Group insurance expense 50,000 50,000

Bad debts expense (P100,000 x 20%) 20,000 20,000
Contribution expenses:
TESDA priority project (500,000 x 1.5) 750,000 750,000
Local government – limit (lower is actual) 100,000 100,000
Total itemized deductions 2,095,400 2,089,400

Note: NOLCO is an allowable special deduction but not an itemized deduction.

Problem 8 – 57
1. Individual Corporation
Salaries expense (P680,000 – P100,000) 580,000 580,000
Bad debts expense (P370,000 – P270,000) 100,000 100,000
Retirement expense (P1,000,000 – P380,000) 620,000 620,000
Representation expense (P39,000,000 x 0.005) 195,000 195,000
Rent expenses (P200,000 – P20,000) 180,000 180,000
Taxes expense (P300,000 – P270,000) 30,000 30,000
Life insurance expense (P150,000 – P100,000) 50,000 50,000
Total itemized deduction before contributions 1,755,000 1,755,000
Contribution expenses:
Donation to TESDA priority project (P500,000 x 150%) 750,000 750,000
Donations to CHED not priority project
(P200,000 actual is lower + 50% of actual) 300,000 300,000
Donations to government (P100,000 actual is lower) 100,000 100,000
Ind: (P39,000,000 – P30,000,000 – P1,752,500) x
10%=724,500
Corp: (P39,000,000 – P30,000,000 – P1,752,500) x 5%=362,250 . .
Total allowable deductions 2,905,000 2,905,000

Computation of sales:
Financial income P 5,000,000
Cost of sales 30,000,000
Operating expenses deducted
(P680,000 + P370,000 + P1,000,000 + P800,000 + P500,000
+ P200,000 + P300,000 + P150,000) 4,000,000
Total sales P39,000,000

2. Individual Corporation
Gross income (P39,000,000 – P30,000,000) P9,000,000 P9,000,000
Less: Total allowable deductions 2,905,000 2,905,000
Net taxable income P6,095,000 P6,095,000