Income Taxes: Basic Concepts

Page 1 of 7 | FAR Handouts No.
26
INCOME TAXES
KARIM G. ABITAGO, CPA
INCOME TAXES
BASIC CONCEPTS
PAS 12 prescribes the accounting for income taxes. This standard applies to ALL ENTITIES, whether public or non-
public entities. A public entity is one whose equity and debt securities are traded in a stock exchange or over-the-counter
market or whose equity or debt securities are registered with SEC in preparation for sale of the securities in the exchange
market.
According to PAS 12, there are two types of income resulting to different computation of income tax.
Accounting or Financial Income Taxable Income
 Income and expenses are recorded and  Income and expenses are recorded and
computed using PFRS. computed using TAX LAWS.
 Income computation is to be used for  Income computation is to be used for
EXTERNAL REPORTING. DETERMINATION OF TAX PAYABLE or
RECOVERABLE.
Since there is a varying treatment of transactions and events between PFRS and the tax code, the following differences
were created:
 Permanent differences are items of revenue and expenses which are included in either accounting income or
taxable income but will never be included in the other.
 Temporary differences are differences between the carrying amount of an asset or liability and its tax base.
Temporary differences include timing differences. Timing differences are differences between accounting income
and taxable income that originate in one period and reverse in one or more subsequent periods.
Examples of Permanent Differences
 Non-taxable income (e.g. interest income from government securities)
 Non-deductible expense (e.g. life insurance premium where the entity is the irrevocable beneficiary, fines and
penalties, loss on expropriation of property, goodwill impairment loss
 Income subject to final tax
Simply stated, these are items excluded in the income tax return.
TEMPORARY DIFFERENCES
Temporary differences may be either:
(1) Taxable temporary difference (TTD) – results to future taxable amounts when the carrying amount of the asset or
liability is recovered or settled.
(2) Deductible temporary difference (DTD) – results to future deductible amounts when the carrying amount of the
asset or liability is recovered or settled.
Taxable Temporary Difference (TTD) Deductible Temporary Difference (DTD)

 F.I. > T.I  F.I. < T.I
 For Assets: CA > TB  For Assets: CA < TB
 For Liabilities: CA < TB  For Liabilities: CA > TB
 Gives rise to Deferred Tax Liability (DTL)  Gives rise to Deferred Tax Asset (DTA)
Examples of TTD
 Installment sales
 Prepayments
 Straight-line depreciation for financial reporting while accelerated depreciation expense for taxation
 Revaluation surplus
Examples of DTD
 Unearned income
 Accrued expenses
 Accelerated depreciation for financial reporting while straight-line depreciation expense for taxation
 Bad debt expense
TAX BASE
The tax base of an asset or a liability is the amount attributable to the asset or liability for tax purposes. Simply stated, tax
base is the carrying amount of asset or liability under tax laws.
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Page 2 of 7 | FAR Handouts No.26

INCOME TAXES
The tax base of an asset is the amount that will be deductible for tax purposes against future profit. On the other hand, the
tax base of a liability is normally the carrying amount less the amount that will be deductible for tax purposes in the future.
Simple guide in determining the tax base:
 If the asset is a depreciable or amortizable asset:
Tax base = Cost less accumulated depreciation/amortization per tax laws.
 If the transaction is taxable only when cash is collected
Tax base = Zero
 If the transaction has no future tax consequence
Tax base = Carrying Amount
ACCOUNTING FOR DEFERRED TAXES
(1) Income Statement Method - This approach focuses on timing differences only in the computation of deferred tax
asset or deferred tax liability.
NOTE: Not all temporary differences are timing differences.
(2) Balance Sheet Method - This approach considers all temporary differences including timing differences. There are
temporary differences that affect the statement of financial position only and therefore technically are not timing
differences but nonetheless are recognized in computing deferred tax asset or liability. PAS 12 requires the use of
the statement of financial position approach.
COMPUTATION AND MEASUREMENT OF TAX EXPENSE
The following template shall be used in computing the current tax expense (benefit), deferred tax expense (benefit) and
total tax expense (benefit):
Accounting Income xx
Permanent Differences:
Less: Non-deductible
Income & Income Subj. to
Final Tax (xx)
Add: Non-deductible
Expense xx
Profit Subj. to Tax xx
Temporary Differences:
TTD:
↑ (Increase) (xx) Multiply by Deferred Tax Liability
↓ (Decrease) xx Future Enacted Tax Rate
DTD:
↑ (Increase) xx
Deferred Tax Asset
↓ (Decrease) (xx)
Taxable Income xx Multiply by Current Tax Rate Current Tax Expense
NOTES:
 When different tax rates apply to different levels of taxable income, use average rates.
 Only the expense and benefit can be offset, DTA and DTL are presented separately.
 DTA and DTL are NOT DISCOUNTED and are presented as non-current items.
 Generally current tax expense (CTE) is equal to current tax liability (CTL) unless there are quarterly tax payments
and tax credits which should be deducted to arrive at CTL or CTA.
 Total income tax expense (TITE) is the total amount of current tax expense and net movement of deferred tax
expense or benefit.
INITIAL RECOGNITION
(1) Deferred Tax Liability:
It is recognized for all taxable temporary differences, except those that arise from the following:
 Goodwill resulting from a business combination and which is nondeductible for tax purposes.
 Initial recognition of an asset or liability in a transaction that is not a business combination and affects neither
accounting income nor taxable income.
 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 and it is probable that the temporary difference
will not reverse in the foreseeable future.
(2) Deferred Tax Asset:
A deferred tax asset shall be recognized for all deductible temporary differences and operating loss carry-forward
when it is probable that taxable income will be available against which the deferred tax asset can be used.
INTRAPERIOD AND INTERPERIOD TAX ALLOCATIONS
Intraperiod tax allocation is the allocation of income tax expense to the various revenues that brought about the tax.
Accordingly, income tax is allocated to the following:
(a) Profit or loss from continuing operations
(b) Profit or loss from discontinued operations


INCOME TAXES
(c) Components of other comprehensive income

(d) Items recognized directly in retained earnings
Interperiod tax allocation is the recognition of a deferred tax asset or deferred tax liability. It is concerned with the
accounting for temporary differences
PRESENTATION
Current and deferred taxes - Generally presented in profit or loss, exception is presented in OCI or OCL or directly to
equity (according to intraperiod allocation).
Current tax liability or asset – Presented in the current liability or asset section of balance sheet.
Deferred tax liability or asset - Presented in the non-current liability or asset section of balance sheet.


INCOME TAXES
DISCUSSION EXERCISES
STRAIGHT PROBLEMS
TAX BASE DETERMINATION
1. Under the following cases, determine the what is the tax base:
(a) The company spent P100,000 in developing a new product. The costs met the definition of an intangible
asset and the recognition criteria prescribed by PAS 38, and thus capitalized. The intangible asset is being
amortized over 5 years. Under taxation, the whole amount was expensed on the day it was incurred.
(b) An entity has recognized an estimated warranty liability of P120,000. However an estimated warranty cost is
deductible only when actually paid.
(c) The company recognized a dividend receivable amounting to P30,000. The dividend receivable was from a
subsidiary which is also a domestic corporation, thus not taxable.
(d) The company accrued fines and penalties amounting to P45,000, which is treated by taxation as non-
deductible.
(e) The company acquired a PPE at a cost of P1,000,000. It is to be depreciated in the books over 5 years using
straight-line method. Under the tax code, such PPE shall be depreciated using double-declining balance
method.
INCOME STATEMENT METHOD AND BALANCE SHEET METHOD
2. In 2019, LOYALTY COMPANY received interest income of P50,000 on government obligations and P200,000 in
royalties under a licensing agreement. Royalties are reported as taxable income in the year received, but in the
financial statements, royalties are recognized as income in the year earned and amount to P50,000 for the year
ended December 31, 2019.
Early in 2019, LOYALTY recognized an instalment receivable of P300,000. Income from instalment sales are
recognized under the tax code in the year received. The effective income tax rate of LOYALTY is 30%.
REQUIREMENTS: (a) Using the income statement method, by what amount would the deferred income tax asset
and deferred income tax liability account balances increase? (b) Using the balance sheet method, by what amount
would the deferred income tax asset and deferred income tax liability account balances increase?
DEFERRED TAX ASSET AND LIABILITY; TAXABLE INCOME AND TOTAL TAX EXPENSE
3. As of December 31, 2018, FAITH COMPANY has a pretax income of P350,000. The following information was
gathered in connection with the computation of its income tax payable:
Loss on expropriation of property P15,000
Premiums on life insurance of key employees
(FAITH was the irrevocable beneficiary) 20,000
Interest income from government treasury bills 10,000
Fines and penalties 5,000
Excess of accelerated depreciation used in taxation over
Straight-line method in financial reporting 40,000
Accrued warranty expense 12,000
Advance rental received 30,000
Interest receivable 8,000
Bad debts recognized under allowance method 26,000
Other Information:
• The quarterly tax payments of the company (cumulative from 1st – 3rd quarter) was P50,000.
• The current tax rate and expected enacted tax rate in the future is 30%.
• Beginning balance of taxable and deductible temporary difference was P30,000 and P50,000, respectively
• For income tax computation, the tax laws prescribe cash basis of accounting for the company’s revenues and
expenses. All of the expenses and revenues are recognized by FAITH under accrual basis.
REQUIREMENTS:
(a) How much is the taxable income under taxation law?
(b) Compute for the current tax expense.
(c) How much is the current tax payable?
(d) How much is the deferred tax expense or benefit?
(e) How much is the total income tax expense?
(f) What amount is to be presented in the statement of financial position as deferred tax liability on December
31, 2018?
(g) What amount is to be presented in the statement of financial position as deferred tax asset on December 31,
2018?
4. BRAVE CORP. was organized on January 1, 2019. The entity had pretax accounting income of P300,000 and
taxable income of P600,000 for the year ended December 31, 2014. The only temporary difference is accrued
product warranty costs that are expected to be paid as follows:
2020 80,000 2022 50,000
2021 120,000 2023 50,000
The entity has never had any net operating losses and does not expect any in the future. The enacted income tax
rates are 35% for 2019, 30% for 2020 through 2022, and 25% for 2023.
REQUIREMENT: On December 31, 2014, what amount should be reported as deferred tax asset?


INCOME TAXES
5. LOVE COMPANY reported net income for the current year 2019 at P5,000,000 before taxes. Included in the
determination of the said net income were:
Permanent differences:
Non-deductible expenses P150,000
Non-taxable income 50,000
Temporary differences at the beginning of the year:
Cumulative temporary differences creating future deductible amount P1,200,000
Cumulative temporary differences creating future taxable amount 800,000
Temporary differences at the end of the year:
Cumulative temporary differences creating future deductible amount P1,600,000
Cumulative temporary differences creating future taxable amount 500,000
The income tax rate is 40% and is not expected to change in the future.
REQUIREMENTS:
(a) Compute for the current tax expense.
(b) How much is the total income tax expense?
(c) What amount is to be presented in the statement of financial position as deferred tax liability on December
31, 2019?
(d) What amount is to be presented in the statement of financial position as deferred tax asset on December 31,
2019?
6. PEACE CORP. started operations on January 4, 2019. Information of temporary and permanent difference during
the first two years of operations was as follows:
December 31, 2019 (all amounts in pesos)
Carrying amount Tax base Difference
Assets 300,000 260,000 40,000
Liabilities 150,000 100,000 50,000
December 31, 2020 (all amounts in pesos)
Carrying amount Tax base Difference
Assets 320,000 270,000 50,000
Liabilities 120,000 90,000 30,000
The pretax income for the years 2019 and 2020 was P330,000 and P380,000, respectively. On 2019, the entity
accrued an interest as an income from its investment on government bonds amounting to 45,000. The income tax
rate for December 31, 2019 was 30% and the enacted income tax rate for the subsequent years will be 35%.
The quarterly tax payments in 2019 and 2020 of PEACE CORP. are as follows:
2019 2020
1st Quarter 5,000 4,000
2nd Quarter 10,000 8,000
3rd Quarter 4,000 3,000
REQUIREMENTS:
(a) How much is the taxable income under taxation law in 2019 and 2020?
(b) Compute for the current tax expense in 2019 and 2020.
(c) How much is the current tax payable in 2019 and 2020?
(d) How much is the deferred tax expense or benefit in 2019 and 2020?
(e) How much is the total income tax expense in 2019 and 2020?
(f) What amount is to be presented in the statement of financial position as deferred tax liability on December
31, 2019 and December 31, 2020?
(g) What amount is to be presented in the statement of financial position as deferred tax asset on December 31,
2019 and December 31, 2020?
7. PRIDE COMPANY started to manufacture in 2019 copy machines that are sold on the installment basis. The entity
recognized revenue when equipment is sold for financial reporting purposes, and when installment payments are
received for tax purposes.
The following information is provided for the computation of income tax expense:
 In 2019, PRIDE recognized gross profit of P3,000,000 for financial reporting purposes, and P750,000 for tax
purposes. The amounts of gross profit expected to be recognized for tax purposes in 2020 and 2021 are
P1,250,000 and P1,000,000, respectively.
 The entity guaranteed the copy machines for two years. Warranty costs are recognized on the accrual basis
for financial accounting purposes and when paid for tax purposes. Warranty expense accrued in 2019 is
P1,250,000, but only P250,000 of warranty cost is paid in 2019. It is expected that in 2020 and 2021,
P500,000 and P500,000 respectively, of warranty costs will be paid.
 In addition during 2019, P250,000 interest was received and earned, and P50,000 insurance premium on life
insurance policy that covered the life of the president was paid. The entity is the beneficiary.
 The tax rate is 30%. Pretax accounting income in 2013 was P1,000,000. Any 2019 operating loss will be
carried to 2020.


INCOME TAXES
REQUIREMENT: (1) What is the deferred tax asset and deferred tax liability on December 31, 2019? (2) What is the
total tax expense in 2019?
8. ASSURANCE CORP. uses the equity method to account for its 25% investment in associate account. During the
year, the investee reported profits of P1,000,000 and declared dividends of P200,000. Additional information is
shown below:
 ASSURANCE does no control the dividend policy of the investor. It is probable that all undistributed earnings
of the investor will be distributed in future periods.
 In the jurisdiction where ASSURANCE operates, dividends received are eligible for 80% deduction.
 There are no other temporary differences.
 Income tax rate during the year is 30%. Income tax rate in subsequent years based on a substantially
enacted tax law by year-end is 35%
REQUIREMENT: Compute for the deferred tax liability as of year-end.
MULTIPLE CHOICE (THEORIES)
1. S1: Only public entities are required to prescribe the accounting requirements of PAS 12.
S2: Financial income is for external reporting purposes while taxable income is for compliance purposes.
A. True, false C. False, false
B. False, true D. True, true
2. An item that would create a permanent difference in pretax financial and taxable income would be
A. Paying fines for violation of laws.
B. Purchasing equipment previously leased with an operating lease in prior years.
C. Using the percentage of completion method on long-term construction contracts.
D. Using accelerated depreciation for tax purposes and straight line depreciation for book purposes.
3. Which of the following creates a taxable temporary difference?
I. Prepaid expense III. Unearned income
II. Estimated liabilities IV. Installment receivable
A. I, II and IV D. I and IV
B. II and IV E. II and III
C. I, II and III
4. If the carrying amount of a liability is higher than its tax base, the difference is a
A. Deferred tax asset C. Deductible temporary difference
B. Deferred tax liability D. Taxable temporary difference
5. Which of the following is incorrect regarding PAS 12?
A. Deferred tax asset and deferred tax liability are based on future tax rates while current tax asset and current
tax liability are based on current tax rates.
B. DTA and DTL are DISCOUNTED and are presented as non-current items.
C. Deferred tax expense or benefit is the net change in DTL and DTA for the period. If the increase in DTL
exceeds the increase in DTA, the difference is a deferred tax expense.
D. When DTA reverses, income tax payable is reduced, while when DTL reverses, income tax payable is
increased.
E. If the current tax expense is greater than the total income tax expense during the period, there must be a
deferred tax benefit.
6. An entity reported deferred tax assets and deferred tax liabilities at the end of the prior year and at the end of the
current year. For the current year, the entity should report deferred income tax expense or benefit equal to the
A. Decrease in the deferred tax assets
B. Increase in the deferred tax liabilities
C. Sum of the net changes in deferred tax assets and deferred tax liabilities
D. Amount of the current liability plus the sum of the net changes in deferred tax assets and deferred tax
liabilities
7. A deferred tax asset shall.be recognized for all deductible temporary differences and operating loss carryforward
when
A. It is probable that taxable income will be available against which the deferred tax asset can be used.
B. It is possible that taxable income will be available against which the deferred tax asset can be used.
C. It is probable that accounting income will be available against which the deferred tax asset can be used.
D. It is possible that accounting income will be available against which the deferred tax asset can be used.
8. Recognizing tax benefits in a loss year due to a loss carry-forward require
A. Only a footnote disclosure.
B. Creating a new carry-forward for the next year.
C. Creating a deferred tax asset.
D. Creating a deferred tax liability.


INCOME TAXES
9. The amount of income tax applicable to transactions that are not reported in the continuing operations section of
the income statement is computed
A. By multiplying the item by the effective income tax rate.
B. By multiplying the item by the difference between the effective income tax rate and the statutory income tax
rate.
C. As the difference between the tax computed on the item based on the amount used for financial reporting
and the amount used in computing taxable income.
D. As the difference between the tax computed based on taxable income without including the item and the tax
computed based on taxable income including the item.
10. S1: According to intra-period tax allocation, current and deferred taxes are usually presented in profit or loss.
S2: No current and deferred taxes are presented directly in equity.
A. True, false C. False, false
B. False, true D. True, true
--- END OF HANDOUTS ---


Income Taxes: Basic Concepts

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Page 1 of 7 | FAR Handouts No.

Taxable Temporary Difference (TTD) Deductible Temporary Difference (DTD)

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

KARIM G. ABITAGO, CPA

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

KARIM G. ABITAGO, CPA

(c) Components of other comprehensive income

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

KARIM G. ABITAGO, CPA

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

KARIM G. ABITAGO, CPA

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

KARIM G. ABITAGO, CPA

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

KARIM G. ABITAGO, CPA

REO CPA REVIEW PHILIPPINES Effectiveness. Efficiency. Convenience

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