ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY

CPA Review Batch 41  May 2021 CPA Licensure Examination  Week No. 17
FINANCIAL ACCOUNTING & REPORTING C. Uberita  G. Macariola  J. Binaluyo

FAR-4116: DEFERRED TAX

When a company prepares its tax return for a particular year, the revenues and expenses (and losses) included
on the return are, by and large, the same as those reported on the company's statement of comprehensive
income for the same year. However, in some instances tax laws and financial accounting standards differ. The
reason they differ is that the fundamental objectives of financial reporting and those of taxing authorities are
not the same. Financial accounting standards are established to provide useful information to investors and
creditors. The government through its tax authority, on the other hand, is primarily concerned with raising
public revenues in a socially acceptable manner and, frequently, with influencing the behavior of taxpayers. In
pursuing the latter objective, the government uses tax laws to encourage activities it deems desirable, such as
investment in productive assets, and to discourage activities it deems undesirable, such as violations of laws.
As consequence of differences between IFRS and tax rules is that tax payments frequently occur in years
different from when the revenues and expenses that cause the taxes are generated.

Methods of Accounting for Deferred Tax

DEFERRAL METHOD – the original amount set aside for deferred tax is retained without alteration for
subsequent changes in tax rate. The deferral method does not keep the deferred tax amount up to date as tax
rates change, and is thus generally held to be inferior to the liability method.

The liability method - the deferred tax balance is adjusted as tax rates changes, thus maintaining the amount at
the actual liability expected to arise. It is subdivided into:

The original IAS permitted a free choice of either the deferral method or liability method and the focus was on
the profit or loss. The revised version of the standards prohibits the use of the deferral method. It requires
application of the liability method that focuses on the statement of financial position (known as the balance
sheet liability method).

LIABILITY METHOD
1) Income Statement Liability method – it focuses on the differences between taxable profit and accounting
profit (timing differences).

Timing differences – these are differences between accounting profits and taxable profits that arise
because the period in which some items of income and expenses are included in accounting profits does not
coincide with the period in which they are included in taxable profits. These differences arise because
accounting profits are determined by accounting standards, such as those of the IAS or IFRS, whereas
taxable profits are governed by tax laws, which set out the basis for the computation of income tax payable.
It shall be emphasized that for timing differences to arise, the items of income and expenses must differ only
with respect to the periods in which they are included. The total of each income or expense item included in
accounting profits and taxable profits will eventually be the same. Therefore, the central characteristic of
timing differences is that they originate (arise) in one or more periods, and reverse (or turnaround) in one or
more subsequent periods. Timing differences give rise to tax effects that are carried forward to one or more
subsequent future periods so and accounting entry or entries should be made to reflect these differences
between accounting profits and taxable profits.

Permanent differences – these are the differences between taxable profits and accounting profits for a
period that originate in the current period but are not capable of reversal (or turnaround) in one or more
subsequent future periods. They relate to items of income that are tax-free and items of expenses that are
disallowed for income tax purposes. The permanent differences arise because the items of income or
expenses are either included in accounting profits without a corresponding inclusion in taxable profit.
Permanent differences do not give rise to tax effects in one or more future periods as they are not capable of
reversal or turnaround. They do not normally pose an accounting issue. With their presence, the tax
expense in a period may be high or low compared to the profit before taxation, but there are no accounting
entries to be made. IAS 12 do not permit an entity to correct for the distortion of the effective tax expense
rate caused by such permanent difference.

There is a deferred tax asset on timing difference when:

 The amount of revenue recognized for taxation exceeds the amount of revenue recognized for financial
purposes; or
 The amount of expense recognized for financial purposes exceeds the amount of expense recognized for
taxation purposes.

There is a deferred tax liability on timing difference when:

 The amount of expense recognized for taxation purposes exceeds the amount recognized for financial
purposes; or
 The amount of revenue for financial purposes exceeds the amount recognized for taxation purposes.

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FAR-4115
Week No. 17: LEASES

2) Balance Sheet Liability method – the calculation is made by reference to difference between balance
sheet values and tax values of assets and liabilities (temporary differences). Temporary differences are
defined in IAS 12 as differences between the carrying amount of an asset or liability and its tax base. The
temporary difference is used because ultimately all differences between the carrying amount of assets and
liabilities and their tax bases will reverse.

The deferred tax is calculated by reference to the tax base of an asset or liability. The tax base is the
amount attributed to the asset or liability for tax purposes.

The tax base of an asset is therefore the amount that will be deductible for tax purposes against any future
taxable benefits derived from the asset. If the benefits will not be taxable, the tax base of the asset is
equal to its carrying amount.

The tax base of a liability is the carrying amount less any amount that will be deductible for tax purposes in
respect of that liability in future periods. In the case of revenue received in advance, the tax base of the
resulting liability is its carrying amount, less any amount of the revenue that will not be taxable in future
periods.
The difference between the tax base of an asset or liability and its carrying value is described as a
temporary difference:
 If the carrying value of an asset exceeds the tax base, tax on the difference is taxable temporary
difference (deferred tax liability).
 If the carrying value of an asset is less than the tax base, tax on the difference is a deductible
temporary difference (deferred tax asset).
 If the carrying value of a liability exceeds the tax base, tax on the difference is a deductible temporary
difference (deferred tax asset).
 If the carrying value of a liability is less than the tax base, tax on the difference is a taxable temporary
difference (deferred tax liability).

Measurement
a) Current tax liabilities (assets) for the current and prior periods shall be measured at the amount expected
to be paid to (recovered from) the taxation authorities, using the tax rates (and tax laws) that have been
enacted or substantively enacted by the end of the reporting period.
b) Deferred tax assets and liabilities shall be measured at the tax rates that are expected to apply to the
period when the asset is realized or the liability is settled, based on tax rates (and tax laws) that have been
enacted or substantively enacted by the end of the reporting period.
c) When different tax rates apply to different levels of taxable income, deferred tax assets and liabilities are
measured using the average rates that are expected to apply to the taxable profit (tax loss) of the periods
in which the temporary differences are expected to reverse.
d) The measurement of deferred tax liabilities and deferred tax assets shall reflect the tax consequences that
would follow from the manner in which the entity expects, at the end of the reporting period, to recover or
settle the carrying amount of its assets and liabilities.
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01. Taxable income of a corporation
a. differs from accounting income due to differences in intraperiod allocation between the two methods of income
determination.
b. differs from accounting income due to differences in interperiod allocation and permanent differences
between the two methods of income determination.
c. is based on international financial reporting standards.
d. is reported on the corporation's income statement.

02 Taxable income of a corporation differs from pretax financial income because of

Permanent Temporary
Differences Differences
a. No No
b. No Yes
c. Yes Yes
d. Yes No

03. The deferred tax expense is the

a. increase in balance of deferred tax asset minus the increase in balance of deferred tax liability.
b. increase in balance of deferred tax liability minus the increase in balance of deferred tax asset.
c. increase in balance of deferred tax asset plus the increase in balance of deferred tax liability.
d. decrease in balance of deferred tax asset minus the increase in balance of deferred tax liability.

04. Each of the following is determined according to IFRS except

a. income before taxes.
b. taxable income.
c. income for financial reporting purposes.
d. income for book purposes.

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FAR-4115
Week No. 17: LEASES

05. An assumption inherent in a company’s IFRS statement of financial position is that companies recover and settle the
assets and liabilities at
a. the amount that is probable where “probable” means a level of likelihood of at least more than 50%.
b. the present value of future cash flows.
c. their reported amounts.
d. their net realizable value.

06. Machinery was acquired at the beginning of the year. Depreciation recorded during the life of the machinery could
result in
Future Future
Taxable Amounts Deductible Amounts
a. Yes Yes
b. Yes No
c. No Yes
d. No No

07. A temporary difference arises when a revenue item is reported for tax purposes in a period
After it is reported Before it is reported
in financial income in financial income
a. Yes Yes
b. Yes No
c. No Yes
d. No No

08. Under IFRS

a. “probable” is defined as a level of likelihood of at least slightly more than 60%.
b. a company should reduce a deferred tax asset when it’s likely that some or all of it will not be recognized.
c. a company considers only positive evidence when determining whether to recognize a deferred tax asset.
d. deferred tax assets must be evaluated at the end of each accounting period.

09. Which of the following statements is correct regarding deferred taxes under IFRS?
a. Income tax payable plus or minus the change in deferred income taxes equals income tax expense.
b. The current portion of income tax expense is the amount of change in deferred taxes related to the current period.
c. In computing income tax expense, a company deducts an increase in a deferred tax liability to income tax payable.
d. All of the choices are correct.

10. At the December 31, 2020 statement of financial position date, X Corporation reports an accrued receivable for
financial reporting purposes but not for tax purposes. When this asset is recovered in 20121, a future taxable amount
will occur and
a. pretax financial income will exceed taxable income in 2021.
b. X Company will record a decrease in a deferred tax liability in 2021.
c. total income tax expense for 2021 will exceed current tax expense for 2021.
d. X Company will record an increase in a deferred tax asset in 2021

11. Assuming a 40% statutory tax rate applies to all years involved, which of the following situations will give rise to
reporting a deferred tax liability on the balance sheet?
I. A revenue is deferred for financial reporting purposes but not for tax purposes.
II. A revenue is deferred for tax purposes but not for financial reporting purposes.
III. An expense is deferred for financial reporting purposes but not for tax purposes.
IV. An expense is deferred for tax purposes but not for financial reporting purposes.
a. item II only
b. items I and II only
c. items II and III only
d. items I and IV only

12. A major distinction between temporary and permanent differences is

a. permanent differences are not representative of acceptable accounting practice.
b. temporary differences occur frequently, whereas permanent differences occur only once.
c. once an item is determined to be a temporary difference, it maintains that status; however, a permanent difference
can change in status with the passage of time.
d. temporary differences reverse themselves in subsequent accounting periods, whereas permanent
differences do not reverse.

13. Which of the following are temporary differences that are normally classified as expenses or losses that are deductible
after they are recognized in financial income?
a. Advance rental receipts.
b. Product warranty liabilities.
c. Depreciable property.
d. Fines and expenses resulting from a violation of law.

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FAR-4115
Week No. 17: LEASES

14. Which of the following is a temporary difference classified as a revenue or gain that is taxable after it is recognized in
financial income?
a. Subscriptions received in advance.
b. Prepaid royalty received in advance.
c. Sales accounted for on the accrual basis for financial reporting purposes and on the installment (cash)
basis for tax purposes.
d. Interest received on government obligations.

15. Which of the following differences would result in future taxable amounts?
a. Expenses or losses that are tax deductible after they are recognized in financial income.
b. Revenues or gains that are taxable before they are recognized in financial income.
c. Revenues or gains that are recognized in financial income but are never included in taxable income.
d. Expenses or losses that are tax deductible before they are recognized in financial income.

16. Stuart Corporation's taxable income differed from its accounting income computed for this past year. An item that would
create a permanent difference in accounting and taxable incomes for Stuart would be
a. a balance in the Unearned Rent account at year end.
b. using accelerated depreciation for tax purposes and straight-line depreciation for book purposes.
c. a fine resulting from violations of environmental regulations.
d. making installment sales during the year.

17. An example of a permanent difference is

a. fines resulting from a violation of law.
b. interest expense on money borrowed to invest in government bonds.
c. percentage depletion of natural resources.
d. All of these answer choices are correct.

18. Which of the following will not result in a temporary difference?

a. Product warranty liabilities
b. Advance rental receipts
c. Gain on involuntary conversion of non-monetary asset.
d. All of these answer choices will result in a temporary difference.

19. A company uses the equity method to account for an investment. This would result in what type of difference and in
what type of deferred income tax?
Type of Difference Deferred Tax
a. Permanent Asset
b. Permanent Liability
c. Temporary Asset
d. Temporary Liability

20. A company records an unrealized loss on short-term securities. This would result in what type of difference and in what
type of deferred income tax?
Type of Difference Deferred Tax
a. Temporary Liability
b. Temporary Asset
c. Permanent Liability
d. Permanent Asset

21. Which of the following temporary differences results in a deferred tax asset in the year the temporary difference
originates?
I. Accrual for product warranty liability.
II. Subscriptions received in advance.
III. Prepaid insurance expense.
a. I and II only.
b. II only.
c. III only.
d. I and III only.

22. Which of the following is not considered a permanent difference?

a. Interest received on government obligations.
b. Fines resulting from violating the law.
c. Percentage depletion of natural resources.
d. Stock-based compensation expense.

23. Which of the following statements is correct regarding permanent differences under IFRS?
a. Permanent differences result from items that enter into pretax financial income but never into taxable income.
b. Permanent differences result from items that enter into taxable income but never into pretax financial income.
c. Permanent differences affect only the period in which they occur.
d. All of these answer choices are correct.

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FAR-4115
Week No. 17: LEASES

24. Under IFRS when a change in the tax rates is enacted

I. Companies should record its effect on existing deferred tax accounts immediately.
II. Companies report the effect of changes in tax rates on deferred tax accounts in the period the new rate
becomes effective.
III. Companies report the effect of changes in tax rates on deferred tax accounts that arise in future periods when
the new tax rates are in effect.
a. I Only.
b. II Only.
c. III Only.
d. Either I, II, or III, depending on how frequently tax rates change in the company’s tax jurisdiction.

25. When a change in the tax rate is enacted into law, its effect on existing deferred income tax accounts should be
a. handled retroactively in accordance with the guidance related to changes in accounting standards.
b. considered, but it should only be recorded in the accounts if it reduces a deferred tax liability or increases a
deferred tax asset.
c. reported as an adjustment to tax expense in the period of change.
d. applied to all temporary or permanent differences that arise prior to the date of the enactment of the tax rate
change, but not subsequent to the date of the change.
26. Tax rates other than the current tax rate may be used to calculate the deferred income tax amount on the statement of
financial position if
a. it is probable that a future tax rate change will occur.
b. it appears likely that a future tax rate will be greater than the current tax rate.
c. the future tax rates have been enacted or substantially enacted.
d. it appears likely that a future tax rate will be less than the current tax rate.
27. Recognition of tax benefits in the loss year due to a loss carryforward requires
a. the establishment of a deferred tax liability.
b. the establishment of a deferred tax asset.
c. the establishment of an income tax refund receivable.
d. only a note to the financial statements.
28. In determining whether to adjust a deferred tax asset, a company should
a. consider all positive and negative information in determining the need for an adjustment.
b. consider only the positive information in determining the need for an adjustment.
c. take an aggressive approach in its tax planning.
d. pass a recognition threshold, after assuming that it will be audited by taxing authorities.
29. Under IFRS deferred tax assets are recognized for
I. Deductible temporary differences.
II. Deductible permanent differences.
III. Operating loss carryforwards.
IV. Operating loss carrybacks.
a. I, II, and III.
b. I and III only.
c. I and IV only.
d. II and III only.
30. Under IFRS companies are required to provide a reconciliation between actual tax expense and the applicable tax rate.
The purpose(s) of this reconciliation include
I. Making better prediction of future cash flow.
II. Predicating future cash flows for operating loss carryforwards.
III. Assessing the composition of the net deferred income tax liability.
IV. Assessing quality of earnings.
a. I, III, and IV only.
b. I, II and IV only.
c. I and IV only.
d. I, II, III and IV.
31. Major reason(s) for disclosure of deferred income tax information is (are)
a. better assessment of quality of earnings.
b. better predictions of future cash flows.
c. that it may be helpful in predicating future cash flows for operating loss carryforwards.
d. All of these answer choices are correct.
32. Accounting for income taxes can result in the reporting of deferred taxes as any of the following except
a. a current or non-current asset.
b. a current or non-current liability.
c. a contra-asset account.
d. All of these answer choices are acceptable methods of reporting deferred taxes.

33. Deferred taxes should be presented on the statement of financial position

a. as one net debit or credit amount.
b. as a net amount in the non-current section.
c. in two amounts: one for the net debit amount and one for the net credit amount.
d. as reductions of the related asset or liability accounts.

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FAR-4115
Week No. 17: LEASES

34. Tanner, Inc. incurred a financial and taxable loss for 2020. Tanner therefore decided to use the carryback provisions as
it had been profitable up to this year. How should the amounts related to the carryback be reported in the 2020 financial
statements?
a. The reduction of the loss should be reported as a prior period adjustment.
b. The refund claimed should be reported as a deferred charge and amortized over five years.
c. The refund claimed should be reported as revenue in the current year.
d. The refund claimed should be shown as a reduction of the loss in 2020.

35. Companies allocate income tax expense (or benefit) to all of the following except
a. discontinued operations.
b. prior period adjustments.
c. gross profit.
d. other comprehensive income.
36. All of the following are procedures for the computation of deferred income taxes except to
a. identify the types and amounts of existing temporary differences and carryforwards.
b. measure the deferred tax liability for taxable temporary differences.
c. measure the deferred tax asset for deductible temporary differences and loss carrybacks.
d. All of these answer choices are procedures in computing deferred income taxes.

37. The IASB believes that the __________________ method is the most consistent method for accounting for income
taxes.
a. Asset-liability.
b. Income statement.
c. Statement of financial position.
d. Revenue-expense.

38. Joy Corporation computed a pretax financial income of P6,000,000 for the year ended December 31,
2019. In preparing the tax return, the following differences are noted between financial income and
taxable income:

Nontaxable revenue, P600,000; Nondeductible expense, P200,000 Provision for warranty that was
recognized as expense in 2019 but deductible for tax when paid P300,000; Excess tax depreciation over
financial depreciation; P250,000 ; Excess of financial revenue over tax revenue, P200,000.

What is the total tax expense assuming the tax rate for 2019 is 32% and 2020 is 30%?
a. P1,699,000 c. P1,789,000
b. P1,744,000 d. P1,792,000

39. Taft Company leased a facility and received P600,000 annual rental payment on June 16, 2020. The
beginning of the lease was July 1, 2020. Rental income is taxable when received. The income tax rate is
32%. Taft had no other permanent or temporary differences. Taft determined that no valuation is
needed. What amount of deferred tax asset should Taft report in its December 31, 2020 financial
position?
a. P204,000 c. P96,000
b. P192,000 d. none

40. On October 1, 2020, Mania Corporation prepaid a P380,000 premium on an insurance policy. The
premium payment was a tax-deductible expense in Mania’s 2020 cash basis tax return. The accrual basis
income statement will report a P95,000 insurance expense in 2020 and P285,000 in 2020. Assume the
income tax rate is 32%. Using the balance sheet liability method, in Mania’s December 31, 2020 financial
position, what amount related to the insurance should be reported as deferred assets?
a. None c. P91,200
b. P30,400 d. P121,600

41. At the beginning of 2020, Pitman Co. purchased an asset for P600,000 with an estimated useful life of 5
years and an estimated residual value of P50,000. For financial reporting purposes the asset is being
depreciated using the straight-line method; for tax purposes the double-declining-balance method is
being used. Pitman Co.’s tax rate is 40% for 2020 and all future years.

Question 1: At the end of 2016, what is the book basis and the tax basis of the asset, respectively?
a. P440,000 and P310,000 c. P490,000 and P360,000
b. P490,000 and P310,000 d. P440,000 and P360,000

Question 2: At the end of 2020, which of the following deferred tax accounts and balances is reported on
Pitman’s statement of financial position?
a. P52,000 deferred tax asset c. P78,000 deferred tax asset
b. P52,000 deferred tax liability d. P78,000 deferred tax liability

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FAR-4115
Week No. 17: LEASES

42. Hopkins Co. at the end of 2020, its first year of operations, prepared a reconciliation between pretax
financial income and taxable income as follows:
Pretax financial income P 750,000
Estimated litigation expense 1,000,000
Extra depreciation for taxes (1,500,000)
Taxable income P 250,000
The estimated litigation expense of P1,000,000 will be deductible in 2021 when it is expected to be paid.
Use of the depreciable assets will result in taxable amounts of P500,000 in each of the next three years.
The income tax rate is 30% for all years.
Question 1: Income taxes payable is
a. 0 c. P150,000
b. P75,000 d. P225,000
Question 2: The net deferred tax liability to be recognized is
a. P150,000 c. P450,000
b. P300,000 d. P750,000

43. Eckert Corporation's partial income statement after its first year of operations is as follows:
Income before income taxes P3,750,000
Income tax expense
Current P1,035,000
Deferred 90,000 1,125,000
Net income P2,625,000
Eckert uses the straight-line method of depreciation for financial reporting purposes and accelerated
depreciation for tax purposes. The amount charged to depreciation expense on its books this year was
P1,500,000. No other differences existed between book income and taxable income except for the
amount of depreciation. Assuming a 30% tax rate, what amount was deducted for depreciation on the
corporation's tax return for the current year?
a. P1,200,000 c. P1,500,000
b. P1,425,000 d. P1,800,000

44. Cross Company reported the following results for the year ended December 31, 2020, its first year of
operations: 2020
Income (per books before income taxes) P 750,000
Taxable income 1,200,000
The disparity between book income and taxable income is attributable to a temporary difference which
will reverse in 2021. What should Cross record as a net deferred tax asset or liability for the year ended
December 31, 2020, assuming that the enacted tax rates in effect are 40% in 2020 and 35% in 2021?
a. P180,000 deferred tax liability c. P157,500 deferred tax asset
b. P180,000 deferred tax asset d. P157,500 deferred tax liability

45. Toner Company has revalued its property and has recognized the increase in the revaluation reserve in
its financial statements. The carrying value of the property was P8,000,000, and the revalued amount
was P10,000,000. The tax base of the property was P7,000,000. The tax rate 32%. What amount of
deferred tax that should go directly to equity?
a. none c. P640,000
b. P320,000 d. P960,000

46. On January 2, 2019, Alison Company acquired from the stock exchange 20,000 shares of Emilia
Company at the prevailing market price of P60 per share. Alison Company has designated the shares as
Investment at Fair Value to Other Income. On December 31, 2019 the shares of Alison are selling at
P68 per share. On July 1, 2019, Alison Company paid P300,000 for one year insurance that will expire
on June 30, 2020. The current year income tax rate is 32% while the future tax rate is 30%. What
amount of deferred tax expense(savings) should the Alison Company disclose in its 2019 profit or loss?
a. P45,000 c. P51,200
b. P48,000 d. P93,000

47. Titan Company issued a convertible bond on January 1, 2020, that matures in five years. The bond
can be converted into ordinary shares at any time. Titan has calculated that the liability and the equity
components of the bond are P3,000,000 for the liability component and P1,000,000 for the equity
component, giving a total amount of the bond of P4,000,000. The interest rate of the bond is 6% and
local tax legislation allows a tax deduction for the interest paid in cash. What amount of deferred tax
should be reported in the profit or loss at the time the bonds were issued? (Tax rate is 32%.)
a. none c. P 960,000
b. P320,000 d. P1,200,000

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