Solution to

Problem 1-3

Liability for Bonuses

How are bonuses as part of executive compensation
treated?

• Sometimes, companies do reward their top executives or managers, as part of their

compensation program, bonuses as a result of an exceptional financial
performance (e.g. meeting or exceeding a certain profit target or sales target).

• In that case, bonuses are treated as compensation expense and a corresponding

liability will be recognized if it is to be paid at a later date.

• Being part of the company’s operating expenses, this also affects the computation
of the company’s income tax expense and liability at the end of the reporting
period.
A comparison:
bonuses to managers versus bonuses to partners
BONUSES TO EXECUTIVES AND
MANAGERS
Provided as a reward for an exceptional
financial performance of the business.
Basically follow the same approach in
computing for the amount of bonus.
Treated as an operating expense of the
company.
Being an operating expense, it affects the
computation of income tax expense and
liability.
BONUSES TO PARTNERS
Provided as a reward for an exceptional
financial performance of the partnership.
Basically follow the same approach in
computing for the amount of bonus.
Treated as distribution of partnership
profits.
Being a distribution of profit to partners, it
did not affect the computation of the
partnership’s income tax expense and
liability.
Illustrative Case:

Garfield Company pays its general managers an annual bonus. For the
year ended December 31, 2020, the company reported a profit of
P8,000,000 before deductions for bonus and corporate income taxes.
The corporate income tax is 30%.
Case A: Bonus is based on profit before deductions for
bonus and income tax

Bonus is 8% of profit before deductions for bonus and income tax. In this case,

B = 8% (P8,000,000) -> which is the profit before bonus and income tax.
B = P640,000

Journal entry:
Compensation expense P 640,000
Liability for bonuses P 640,000
Case A: Bonus is based on profit before deduction for
bonus and income tax

The company’s income tax expense and liability are as follows:

T = 30% (P8,000,000 – P640,000) -> take note that the bonus given to the general
manager is an operating expense; therefore, it is an allowable deduction for income
tax purposes.
T = 30% (P7,360,000) = P2,208,000

Journal entry:
Income tax expense P 2,208,000
Income tax payable P 2,208,000
Case B: Bonus is based on profit after deduction for bonus
but before income tax

Bonus is 8% of profit after deduction for bonus but before deduction for income tax. In this case,

B = 8% (P8,000,000 - B) -> which is the profit after bonus but before income tax.
B = P640,000 – 0.08B -> need to transpose similar variables.
B + 0.08B = P640,000
1.08B = P640,000 -> divide 1.08 on both sides.
B = P592,593

Journal entry to record the bonus is the same as Case A.

Case B: Bonus is based on profit after deduction for bonus
but before income tax

The company’s income tax expense and liability are as follows

T = 30% (P8,000,000 – P592,593) -> take note that the bonus given to the general
manager is an operating expense; therefore, it is an allowable deduction for income tax
purposes.
T = 30% (P7,407,407) = P222,222

Journal entry to record the income tax expense and liability is the same as Case A.
Case C: Bonus is based on profit before deduction for
bonus but after income tax

Bonus is 8% of profit before deduction for bonus but after deduction for income tax. In this case,

B = 8% (P8,000,000 - T) -> which is the profit before bonus but after income tax.
T = 30% (P8,000,000 – B) -> take note that the bonus given to the general manager is an operating expense;
therefore, it is an allowable deduction for income tax purposes.
B = 8% [P8,000,000 – 30% (P8,000,000 – B)]
B = 8% (P8,000,000 – P2,400,000 + 0.30B)
B = P640,000 – P192,000 + 0.024B -> need to transpose similar variables.
0.976B = P448,000 -> divide both sides by 0.976
B = P459,016

Journal entry to record the bonus is the same as Case A.

Case C: Bonus is based on profit before deduction for
bonus but after income tax

The company’s income tax expense and liability are as follows:

T = 30% (P8,000,000 – P459,016) -> take note that the bonus given to the general manager is
an operating expense; therefore, it is an allowable deduction for income tax purposes.
T = 30% (P7,540,984)
T = P2,262,295

Journal entry to record the income tax expense and liability is the same as Case A.
Case D: Bonus is based on profit after deductions for
bonus and income tax

Bonus is 8% of profit after deductions for bonus and income tax. In this case,

B = 8% (P8,000,000 – B - T) -> which is the profit before bonus but after income tax.
T = 30% (P8,000,000 – B) -> take note that the bonus given to the general manager is an operating expense;
therefore, it is an allowable deduction for income tax purposes.
B = 8% [P8,000,000 – B – 30% (P8,000,000 – B)]
B = 8% (P8,000,000 – B – P2,400,000 + 0.30B)
B = P640,000 – 0.08B – P192,000 + 0.024B -> need to transpose similar variables.
1.056B = P448,000 -> divide both sides by 1.056
B = P424,242

Journal entry to record the bonus is the same as Case A.

Case D: Bonus is based on profit after deductions for
bonus and income tax

The company’s income tax expense and liability are as follows:

T = 30% (P8,000,000 – P424,242) -> take note that the bonus given to the general manager is
an operating expense; therefore, it is an allowable deduction for income tax purposes.
T = 30% (P7,575,758)
T = P2,272,727

Journal entry to record the income tax expense and liability is the same as Case A.
Solution to
Problem 1-5

Liability for Corporate Income Tax

Illustrative Case:

Cleveland, Inc. pays its general manager an annual bonus of 6% of profit after
deduction for both bonus and corporate income tax. For the year ended
December 31, 2020, the company realized profit of P9,000,000 before said
deductions. The income tax rate is 30%.
Bonus is based on profit after deductions for bonus and
income tax

Bonus is 6% of profit after deductions for bonus and income tax. In this case,

B = 6% (P9,000,000 – B - T) -> which is the profit before bonus but after income tax.
T = 30% (P9,000,000 – B) -> take note that the bonus given to the general manager is an operating
expense; therefore, it is an allowable deduction for income tax purposes.
B = 6% [P9,000,000 – B – 30% (P9,000,000 – B)]
B = 6% (P9,000,000 – B – P2,700,000 + 0.30B)
B = P540,000 – 0.06B – P162,000 + 0.018B -> need to transpose similar variables.
1.042B = P378,000 -> divide both sides by 1.042
B = P362,764
Bonus is based on profit after deductions for bonus and
income tax

The company’s income tax expense and liability are as follows:

T = 30% (P9,000,000 – P362,764) -> take note that the bonus given to the general manager is an operating expense;
therefore, it is an allowable deduction for income tax purposes.
T = 30% (P8,637,236)
T = P2,591,171

Journal entry to record the income tax expense and liability is as follows:

Income tax expense P 2,591,171

Income tax payable P 2,591,171