SyCip. Gorres, Velayo & Co 6760 Ayala Avenue Makati, Rizal MEMO TO AUDIT STAFE ACCOUNTING FOR TIMING DIFFERENCES ARISING FROM INCOME TAX COMPUTATIONS ‘The APB of the AICPA has recently released Opinion No. 11 entitled | "Accounting for Income Taxes.” The sections of this Opinion on “timing \ differences" and “tax allocation within a period" are applicable to local situations and therefore must be considered in preparing financial statements for use in the United states (c.g., subsidiaries and branches of U.S. firms), in which adoption of the Opinion is a must for those with fiseal periods beginning after December 31, 1967, However, as in the case of all other Opinions, APB No, 11 is not intended to apply to immaterial items, The staff is also reminded that the partner or manager in charge of the job be Informed of the applicability of the APB before such is discussed with the client, Likewise, if a locel client wishes to apply the Opinion, the matter should first be referred to the partner or manager in-charge. Timing Differences By “timing differences” is meant the differences between the periods in which transactions affect taxable income and the periods in which they enter into the determination of pretax accounting income. Some timing differences reduce income taxes thar would otherwise be payable currently; others increase income taxes that would otherwise be payable currently. Four types of transactions are identifiable which give rise co timing differences. Revenues of gains are included in taxable income later than they Included in pretax accounting income. Example: Gross profits on installment sales recognized for accounting purposes in the period of sale but reported for tax purposes in the period the installments are collected. 2, Expenses of losses are deducted in determining taxable income later than they are deducted in determining pretax accounting Income. Example: Estimated costs of guarantees and of product wartanty contracts are recognized for accounting purposes tn the current period but reported for tax purposes in the petiod paid or in which the Ifability becomes fixed In the Philippines the more typical example is provision for doubtful accounts recorded for accounting purposes in the current period but reported for tax purposes in the perlod losses are ac- tually sustained, (This bulletin ts for the use of SGV staff members only; At should not be shown to persons not associated with the Firm.) Kogust 13, 1968 Audit Bulletin No. 118-68-2- 4. Revenues or gains are included in taxable income earlier than they are included in pretax accounting income. | Example: Rents collected in advance are reported for tax pure pores in the period in which they are received but are deferred for accounting purposes until later periods when they are earned. 4. Expenses of losses ace deducted in determining taxable income safle than they are deducted in determining pretax accounting Trample: Depreciation reported on an accelerated basis for tan perposer but reported on a steaight-line basis for account ing purposes. Additional examples of each type of timing difference are presented ta Appendix A of APB No. 11, These have also been reproduced in The SGV Research Newsletter dated February 1968. Treatment of Timing Differences The process of spportioning income taxes among periods (termed sinterperiod tax allocation") {s done by means of the deferred methods that In, the tax effects of current timing differences are deferred and are allocated tovincome tax expense of future periods when the timing differences tever The deferred taxes are determined on the basis of the tax races in effect a the time the timing differences originate and are nor adjusted for subsequent Changes In tax rates of to teflect the imposition of new taxes, The tax effects Sf trensactions which reduce taxes currently payable are treated as deferced Credits, the tax effects of transactions which increase taxes currently payable are treated as deferred charge Thus, income tax expense should include the tax effects of revenue and expense transactions included in the determination of pretax accounting in= Come. The tax effects of transactions which enter into the determination of pretax accounting income (cither earlier or later than they enter into the de~ Termination of taxable income) should be recognized First, in the periods in which the differences between pretax account ing Income and taxable income arise: and Second, in the periods in which the differences reverie, Computation of the Tax Effect of & Timlag Difference The tax effect of a timing difference is measured by the differential between income taxes computed with and Income taxes computed without ine Clusion of the transaction creating the difference between taxable Income and pretax accounting income. The resulting income tax expense for the period includes the tax effects of transactions entering Into the determination of results of operations for the period, The resulting deferred tax amounts reflect the tax effects which will reverse in future periods, August 18, 1968 Audit Bulletin No. 22ane Measurement of tax effects is bared om parallel of dual com Pulst’ as. The first computation shows the amount of taxes that would have been payable Te ihe yeat on the income shown io the tax return. The second computation iran the amount of taxes that would have been payable for the year based on pretax accounting income adjusted for any perme differences. "* The PT iicrenccloetmben) distamauate(to) com pelea eine cata of the tax effects (See Illustrative computations, last part of this bulletin.) ‘Tax Allocation Within a Perled tax allocation within a period ts applied in order to obtain £8 appro- priate relationship between income sax expense and 1, income before extraordinary items, 2, extraordinary items, 4, adjustments of prior periods of of the opening balance of retained earnings, and 4 direct entries to other stockholders’ equity accountty the income tax expense attributable to income before extiserdinery ttems is computed by determining the income tax expense related to revenue LM peace transnctions entering into the determination of ¢uch income, Nithour giving effect to the tax consequences of the treme excluded from the wirbent Eiiomof income before extraordinary items, The income 0% Stent dere rm iaple co other items i determined by the tax consequences of L’Att” seeesbuiable ving chese items. If an operating lost exists befoce extrscrsnaly setlent lhe vax consequences of such loss should be associated with (he loss. fu Reportin Following are guidelines for balance sheer aad Income statement Pi sentation of the tax effects of timing differences. Balance Sheet Deferred charges and deferred credits relating to timing differ cancer should be classified in two categories - one for the net Current amount and the other for the net noncurrent amounts This preventation is consistent with the customary distinction between current and noncurrent categories and also recognizes “Defined a1 differences between taxable income and pretax accounting income arising from tranractions that, under applicable tx laws and regulations, will fot be offaet BY corresponding difference or “turn amound™ 48 that period tnamplen: 18% of dividends received by a domestic corfarsiion from another Mlomestic corporation, ineeat recelved an government bands, August 19, 1968 Audit Bulletin No, 128-68the close relationship among the various deferred .ax accounth, dil of which bear upon the determination of income tax expense. The current portions of such deferted charges and credits should re thove amounts which relate to assets and liabilities classified ts current, Thus, if installment receivables are a current asset. tne deferred credits representing the tax effects of uncollected Installment sales should be a current item; if an estimated proe vision for warranties is a current liability, the deferred charge Tepresencing the tax effect of such provision should be # current item. Deferred taxes represent tax effects recognized in the determina” tion of income tax expense in current and prior periods, and they [nould, therefore, be excluded from retained earnings of from any Sther account in the stockholders’ equity section of the basance sheet. Income Statement w 2 Avguer 18, 1968 Audit Bulletin No. 32 In reporting the results of operations the components of Income tax expente for the period should be disclosed, for example. . Taxes estimated to be payable b. Tax effects of timing differences ‘These amounts should be allocated to (a) Income before extra~ Grdinaty items and (b) extraordinary items and may be presented ai separate items in the Income statement or, alternatively, a1 fombined amounts with disclosure of the components parenthe- tically of in & note to the financial stacements, ‘Tax effects attributable to adjustments of prior periods (or of the Opening balance of retained earnings) and direct entries to other ceoeuneldert’ equity accounts should be presented as adjustments of auch items with disclosure of the amounts of the tax effects, The nature of significant differences between pretax accounting Income and taxable income should be disclosed. ‘The “net of tax" form of presentation (in which the tex effects are considered to be valuation adjustments to the assets or Liable Litter giving rise to the adjustments) should not be used for fi- nancial reporting. The tax effects of transactions entering into the determination of pretax accounting income for one period but Affecting the determination of taxable income aa different pes tiod should be reported in the income statement as elements of income tax expense and in the balance sheet as tax allocation accounts (deferred taxes) and not as elements of valuation of assets of Iabilities,General 1. If destred, the foregoing recommendations on income tax account~ ing may be applied revsoactively to periods prior to the effective dave in order to obtain comparability in financial presentations for the cuctent and future periods, If the procedures are applied retroactively, they should be applied to all material items of those periods insofar as the recognition of prior period tax effects of timing differences and other deductions of credits Is concerned. 2, Any adjustments made to give retroactive effect to the conclusions atated in this Opinion should be considered adjustments of prior periods and treated accordingly. Wusteative Computation - Timing Differences Following are {Llustrations of the dual computation of timing differenc for three consecutive years. Assumed data in all cases are pretax accounting income of P120,000 and income tax rate of 30% Fist Year Pretax accounting income (per Statement of Income) Initial timing difference + Provision for doubtful account Permanent difference + Interest received ‘on DBP bonds ‘Taxable Income ‘Tax (assumed at 90% Difference = Income tax expeme applicable to furure years, wlien bad debts are actually written off land deducted for tax purposes ery Provision for income tax + P35, 400 Deferred income tax - 1,500 Income tax payable - 738,900, ‘The deferred income tax in this case will be shown in the balance August 13, 1968 Audis Bulletin No, 328-6855 i . sheet as a current asset since it relates to accounts receivable which {s ; current asset. t Second Ye : Income Tax Statement of ee eee Pretax accounting income (per Statement of Income) 120,000, 120,000 ¢ Initial timing difference ~ Provision for doubtful accounts 6,000 Reversal of timing difference - Bad debur written off charged against allowance for doubrful accounts 3,000) : Permanent difference - Interest received . ‘on DBP bonds 12,900) 2,000) ‘Taxable Income 123,000 £218,000 ‘Tax (assumed at 30% 236,300 35,400 Difference + Income tax expense applicable to future years, when bad debus are actually writen off and deducted for tax purposes 200 Book entry: Provision for income t. - 735,400 Deferred income tax - 900 Income tax payable Balance of deferred income tax in the balance sheet at this time will be P2,400 (P1,500 last year plus P900 this year) representing 30% of total provision for doubtful accounts of P8,000 (PS, 000 Last year plus P3,000 - net this yeas) not yet charged with actual accounts written off. ‘Thicd Year Pretax accounting income (per Statement of Income) 120, 000 P120,000 Initial timing difference - Provision for doubtful accounts 4,000 4 (Forward) Augu 1s, 168 Audit Bulletin No. 118-68-1- : tncome Tax suaemest of a ome fever of timing difference ~ Bad debu ‘ten of charged again allowance for doubeful accounts © 6,000 Permanent difference ~ Inert received os 2 Dpe bonds 2,000) 2,000) ‘op of dividends received from another : domestic corporation 0 (2,000 Taxable come 5,000 211,000 Tax (asumed at 30%) 34,00 £25,200 Difference ~ Reduction in tax payable : forthe euent yea, repretnting txcea of amounts actually weiten off over entimated provision for doubt accounts £300 Book entry: e@ provision for income tax = 35, 100 Deferred income tax = 300 Tacome tax payable ~ 34,800 ‘At this time the balance of deferred income tax in the balance sheet Will be P2,100 (P2, 400 last year less P3900 this year) representing 30% of total provision for doubtful accounts of 7,000 (8,000 last year reduced this year by P1,000, excess of bad debt write-offs over provision for doubtful decounts). lu n dh (This bultecia ty for the use of SGV staff members only: e@ in mould not be shown to persons nor associated with the Firm.) Nogust 18, 1968 Audie Bulletia No, 116-68