Module 2 Packet: College of Commerce

COLLEGE OF COMMERCE
BACHELOR OF SCIENCE IN ACCOUNTANCY
MODULE 2 PACKET
ELEC 2 – Valuation Concepts and Methods
MODULE 2 ACCOUNTING FOR INCOME TAX
Welcome to Module 2
In this module, we will discuss the differences between accounting income and taxable income.
CONSULTATION HOURS:
Virtual time: During your class schedule (either Monday or Tuesday)
Phone or Messenger: Every Thursday from 8am to 11am and 1pm to 4pm
MODULE 2 LEARNING OBJECTIVES:

By the end of this module, the students will be able to:
1. Know the distinction between accounting income and taxable income.
2. Distinguish permanent differences and temporary differences between accounting income and taxable
income
3. Know the recognition and measurement of deferred tax asset and deferred tax liability.
4. Know the recognition and measurement of current tax asset and current tax liability.
5. Distinguish interperiod tax allocation and intraperiod tax allocation.
COURSE CONTENT FOR MODULE 2:
ACTIVITY DESCRIPTION TIME TO COMPLETE

Lecture discussion Accounting for Income Tax 2 hour
Activity Problem Solving 2 hour
Quiz Summative quiz for module 2 (to be announced) 1 hour
2020-2021 Module Packet for ELEC 2 (Valuation Concepts and Methods) | College of Commerce |
University of San Agustin, Iloilo City, 5000, Philippines Page 1 of 17
COLLEGE OF COMMERCE
LECTURE DISCUSSIONS
Deferred tax accounting is applicable to all entities, whether public or nonpublic.
A public entity is one whose equity and debt securities are traded in a stock exchange or over-the-counter
market, and are registered with the Securities and Exchange Commission (SEC) in preparation for sale of
the securities.
Accounting Income
Accounting income or financial income is the net income for the period before deducting income tax
expense. This is the income appearing on the traditional income statement and computed in accordance
with accounting standards.
Taxable Income
Taxable income is the income for the period determined in accordance with the rules established by the
taxation authorities upon which income taxes are payable or recoverable.
Taxable income is the income appearing on the income tax return and computed in accordance with the
income tax law. It is the excess of taxable revenue over tax deductible expense and exemptions for the
period as defined by the BIR.
Differences between accounting and taxable income
Differences between accounting income and taxable income may be classified as:
1. Permanent differences – items of revenue and expense which are included in either accounting
income or taxable income but will never be included in the other. They pertain to nontaxable
revenue and nondeductible expenses. They do not give rise to deferred tax asset and liability
because they have no future tax consequences.
a. Interest income on deposits
b. Dividends received
c. Life insurance premium – premium paid is not deductible as expense for tax purposes, but is
an expense for financial reporting purposes.
d. Tax penalties, surcharges and fines are nondeductible
2. Temporary differences – are those between the carrying amount of an asset or liability and the tax
base. For every temporary difference, the item’s treatment will eventually be the same in
accounting and taxable income.
Timing differences are differences between accounting income and taxable income that originate
in one period and reverse in one or more subsequent periods. They are items of income and
expenses which are included in both accounting income and taxable income but at different time
periods due to timing differences.
COLLEGE OF COMMERCE
Temporary Differences give rise to a deferred tax liability or deferred tax asset.
Kinds of Temporary Difference:
1. Taxable temporary difference will result in future taxable amount in determining taxable income of
future periods when the carrying amount of the asset or liability is recovered or settled.
2. Deductible temporary differences will result in future deductible amount in determining taxable
income of future periods when the carrying amount of the asset or liability is recovered or settled.
Tax Base
Tax base of an asset or liability is the amount attributable to the asset or liability for tax purposes or that is
recognized or allowed for tax purposes.
The tax base of an asset is the amount that will be deductible for tax purposes against future income. For
example if an entity has appropriately capitalized P1,000,000 as software development cost, the carrying
amount is P1,000,000 for accounting purposes. However if this amount is allowed as a one-time deduction
for tax purposes, the tax base is zero because the amount entire amount is expensed in the current year.
The tax base of a liability is normally the carrying amount less the amount that will be deductible for tax
purposes in the future. For example if an entity has recognized an estimated warranty liability of P500,000,
the carrying amount is P500,000 for accounting purposes. However, an estimated warranty cost is
deductible only when actually paid. Thus, the tax base is zero because the estimated warranty cost is a
future deductible amount.
Deferred Tax Liability
Deferred tax liability is the amount of income tax payable in future periods with respect to a taxable
temporary difference.
A deferred tax liability is the deferred tax consequence attributable to a taxable temporary difference or
future taxable amount. It may arise from the following:
a. When the accounting income is higher than taxable income because of timing differences.
b. When the carrying amount of an asset is higher than the tax base.
c. When the carrying amount of a liability is lower than the tax base.
Temporary differences that result in accounting income higher than taxable income:
1. Revenues and gains are included in accounting income of the current period but are taxable in
future periods. An installment sale is included in accounting income at the time of sale and included
in taxable income when cash is collected in future periods.
2. Expenses and losses are deductible for tax purposes in the current period but deductible for
accounting purposes in future periods.
a. Accelerated depreciation for tax and straight line depreciation for accounting purposes.
b. Development cost may be capitalized and amortized over future periods in determining
accounting income but deducted in determining taxable income in the period in which it is paid.
c. Prepaid expense has already been deducted on a cash basis in determining taxable income of
the current period.
COLLEGE OF COMMERCE
Most taxable temporary differences arise because of the timing of recognition of transactions for accounting
and tax purposes. There are other taxable temporary differences that technically are not timing differences
but nevertheless give rise to deferred tax liability. Examples include:
a. Asset is revalued upward and no equivalent adjustment is made for tax purposes
b. The carrying amount of investment in subsidiary, associate or joint venture is higher than the tax
base because the subsidiary, associate or joint venture has not distributed its entire income to the
parent or investor.
c. The cost of a business combination that is accounted for as an acquisition is allocated to the
identifiable assets and liabilities acquired at fair value.
PAS 12 provides that a deferred tax liability shall be recognized for ALL taxable temporary differences.
However, a deferred tax liability is not recognized when the taxable temporary difference arises from:
a. Goodwill resulting from a business combination and which is non-deductible for tax purposes.
b. Initial recognition of an asset or liability in a transaction that is not a business combination and
affects neither accounting income nor taxable income.
c. Undistributed profit of subsidiary, associate or joint venture when the parent, investor or venturer is
able to control the timing of the reversal of the temporary difference.
Deferred Tax Asset
Deferred tax asset is the amount of income tax recoverable in future periods with respect to deductible
temporary difference and operating loss carryforward. It is the deferred tax consequence attributable to a
future deductible amount and operating loss carryforward. It may arise from the following:
a. When the taxable income is higher than accounting income because of timing differences.
b. When the tax base of asset is higher than the carrying amount.
c. When the tax base of a liability is lower than the carrying amount.
Temporary differences that result in taxable income higher than accounting income:
1. Revenues and gains are included in taxable income of current period but are included in accounting
income of future periods. Rent received in advance is taxable at the time of receipt but deferred in
future periods for accounting purposes.
2. Expenses and losses are deducted from accounting income of current period but are deductible for
tax purposes in future periods.
Future deductible temporary differences include the following:

a. A probable and measurable litigation loss is recognized for accounting purposes but deducted in
determining taxable income when actually incurred or paid.
b. Estimated product warranty cost is recognized for accounting purposes in the current period but
deducted in determining taxable income when actually incurred or paid.
c. Research cost is recognized as expense in determining accounting income but not permitted as a
deduction in determining taxable income until later period.
d. An impairment loss is recognized for accounting purposes but ignored for tax purposes until the
asset is sold.
e. Doubtful accounts are recognized as expense for accounting purposes but deductible for tax
purposes only with written off as worthless.
COLLEGE OF COMMERCE
PAS 12 provides that a deferred tax asset shall be recognized for ALL deductible temporary differences
and operating loss carryforward when it is probable that taxable income will be available against which the
deferred tax asset can be used.
Operating loss carryforward is an excess of tax deductions over gross income in the year that may be
carried forward to reduce taxable income in a future year.
Methods of Accounting
INCOME STATEMENT APPROACH STATEMENT OF FINANCIAL POSITION APPROACH

Timing differences only in deferred tax All temporary differences as well as timing differences
asset or liability computation Those that affect the statement of financial position
Effect on income statement of one only and are not timing differences but recognized in
period will reverse in next period(s) computing deferred tax asset or liability
Accounting Procedures
Recognition of a deferred tax asset or liability is known as intraperiod tax allocation.
Determine the taxable Current tax Expense = Income tax expense xxx
income Taxable income * tax rate Income tax payable xxx
Determine the taxable Deferred tax liability = Income tax expense xxx
temporary differences Taxable temporary differences * tax rate Deferred tax liability xxx
Determine deductible Deferred tax asset = Deferred tax asset xxx
temporary differences Deductible temp differences * tax rate Income tax benefit xxx
Determine total income Current tax exp PLUS Deferred tax expense from taxable temp differences
tax expense MINUS Income tax benefit from deductible temporary differences
Accounting income subject to tax * tax rate (assuming there is no future
enacted income tax rate)
The income tax benefit account reduces the current tax expense for the year. The deferred tax asset may
be credited directly to income tax expense.
COLLEGE OF COMMERCE
4,000,000 x 30%
COLLEGE OF COMMERCE
Illustration from Intermediate Accounting Vol. 2, 2020 by Valix
COLLEGE OF COMMERCE
Illustration 2 – Deferred tax asset
In 2020, an entity received an advance rental payment of P600,000 subject to tax but not reported in
accounting income until 2021. Tax rate is 30%. Income statement and tax return showed the following:
COLLEGE OF COMMERCE
The permanent differences do not give rise to deferred tax asset or deferred tax liability and thus eliminated
from the reported accounting income. The accounting income subject to tax must exclude permanent
differences.
COLLEGE OF COMMERCE
Income tax expense for the year is the accounting income subject to tax of P6,200,000 x 30%
COLLEGE OF COMMERCE
Net deferred tax expense or benefit
Tax benefit from (increase) / decrease in deferred tax asset (180,000)

Tax expense from increase / (decrease) in deferred tax liability 90,000
Net deferred tax (benefit) / expense (90,000)
Current tax liability and current tax asset
A current tax liability is the current tax expense or the amount of income tax actually payable. This is
classified as current liability.
If the amount of tax already paid for the current period exceeds the amount actually payable for the period,
the excess is a current tax asset which is a prepaid income tax and shall be classified as current asset.
A current tax liability or tax asset shall be measured using the tax rate that has been enacted and effective
at the end of the reporting period.
Presentation of deferred tax asset or liability
PAS 12 provides that when an entity makes a distinction between current and noncurrent assets and
liabilities, it shall not classify deferred tax assets as current assets and deferred tax liabilities as current
liabilities.
Accordingly, a deferred tax asset shall be classified as noncurrent asset and a deferred tax liability shall
be classified as noncurrent liability regardless of reversal period. They shall not be discounted.
Offset of deferred tax asset or liability
Under PAS 1, assets and liabilities shall not be offset unless required or permitted by another standard.
PAS 12 provides that an entity shall offset a deferred tax asset against a deferred tax liability when:
a. The deferred tax asset and liability relate to income taxes levied by the same tax authority
b. The entity has a legal enforceable right to set off a current tax asset against a current tax liability
Measurement of deferred tax asset or liability
A deferred tax liability or asset shall be measured using the tax rate that has been enacted by the end of
the reporting period and expected to apply to the period when the asset is realized or the liability is settled.
Intraperiod and interperiod tax allocation
Intraperiod tax allocation is the allocation of income tax expense to the various revenues that brought about
the tax. The total income tax expense is allocated to income from continuing operations, from discontinued
operations and prior period errors or items directly charged or credited with in the earnings.
Intraperiod tax allocation is the recognition of a deferred tax asset or liability.
COLLEGE OF COMMERCE
Preparation of Statement of Financial Position
1. Determine the tax base of the assets and liabilities in the SFP
2. Compare the carrying amounts with the tax base
3. The difference between the carrying amount and the tax base normally will result to a deferred tax
asset or liability
4. Permanent differences do not give rise to deferred tax asset or liability
5. Apply the tax rate to the temporary differences.
6. Determine the beginning and ending balance of deferred tax asset or liability
7. Recognize the net change between the beginning and ending balance of deferred tax asset or
liability
COMPREHENSIVE ILLUSTRATION. On December 31, 2020, the accounts of Easy Company have the
same basis for accounting and tax purposes, except:
COLLEGE OF COMMERCE
COLLEGE OF COMMERCE
COLLEGE OF COMMERCE
COLLEGE OF COMMERCE
ACTIVITY
1.
2.
3.
COLLEGE OF COMMERCE
4.

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COLLEGE OF COMMERCE

BACHELOR OF SCIENCE IN ACCOUNTANCY

MODULE 2 LEARNING OBJECTIVES:

COURSE CONTENT FOR MODULE 2:

ACTIVITY DESCRIPTION TIME TO COMPLETE

Deferred tax accounting is applicable to all entities, whether public or nonpublic.

Differences between accounting and taxable income

Kinds of Temporary Difference:

Deferred Tax Liability

Deferred Tax Asset

Future deductible temporary differences include the following:

INCOME STATEMENT APPROACH STATEMENT OF FINANCIAL POSITION APPROACH

Recognition of a deferred tax asset or liability is known as intraperiod tax allocation.

Illustration from Intermediate Accounting Vol. 2, 2020 by Valix

Illustration 2 – Deferred tax asset

Net deferred tax expense or benefit

Tax benefit from (increase) / decrease in deferred tax asset (180,000)

Current tax liability and current tax asset

Presentation of deferred tax asset or liability

Offset of deferred tax asset or liability

Measurement of deferred tax asset or liability

Intraperiod and interperiod tax allocation

Intraperiod tax allocation is the recognition of a deferred tax asset or liability.

Preparation of Statement of Financial Position

Illustration from Intermediate Accounting Vol. 2, 2020 by Valix

Illustration from Intermediate Accounting Vol. 2, 2020 by Valix

Illustration from Intermediate Accounting Vol. 2, 2020 by Valix

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