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ACCOUNTING FOR INCOME TAX

DARRELL JOE O. ASUNCION, CPA, MBA

ACCOUNTING FOR INCOME TAX

DARRELL JOE O.ASUNCION, CPA MBA

ACCOUNTING FOR INCOME TAX

Accounting profit is profit or loss for a period before deducting tax expense.

Taxable profit (tax loss) is the profit (loss) for a period, determined in accordance with the rules established by the
taxation authorities, upon which income taxes are payable (recoverable).

Permanent differences are items of revenue and expense which are included in either accounting income or taxable income
but will never be included in the other.
Two types of permanent differences
1. Nontaxable Revenues
2. Nondeductible Expenses

Examples of Nontaxable Revenues

1 Gain from settlement of ins. Co. (company is the beneficiary)
2 Intercompany dividends from a domestic corp.
3 Interest income on time deposits.
4 Interest revenue on government bonds
5 Interest income on treasury bills
6 Interest income on municipal bonds

NONTAXABLE
REVENUES

NONTAXABLE
INCOME SUBJECT TO REVENUES (e.g. GAINS SUBJECT TO
FINAL TAX intercompany CAPITAL GAINS TAX
dividends)

Examples of Nondeductible expenses

1 Fines penalties for violations of laws.
Charitable contribution in excess of what is allowed by law as tax
2 deductible
3 Premiums on life insurance for officers and employees
4 Loss on expropriation of property
5 Goodwill impairment loss not deductible in the tax return

Tax expense (tax income) is the aggregate amount included in the determination of profit or loss for the period in respect of
current tax and deferred tax.

Current tax is the amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period.
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DARRELL JOE O.ASUNCION, CPA MBA

ACCOUNTING FOR INCOME TAX

Temporary differences are differences between the carrying amount of an asset or liability in the statement of
financial position and its tax base. Temporary differences may be either:

(a) taxable temporary differences, which are temporary differences that will result in taxable amounts in
determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled;
or
(b) deductible temporary differences, which are temporary differences that will result in amounts that are deductible in
determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled.

The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.

Deferred tax liability is the amount of income tax payable on future periods with respect to a taxable temporary difference.

Taxable temporary difference and DTL if

1 If Financial Income is > than taxable income
2 Financial expense<tax expense
3 Carrying amount of asset is > than its tax base
4 Carrying amount of liab is < than its tax base

Recognition of deferred tax asset

Recognized 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 a year that may be carried forward to reduce taxable income in a future
years. Thus, an operating loss carryforward will give rise to a deferred tax asset.

Method of accounting
1. Income statement liability method-this method focuses on timing differences only in the computation of deferred tax
asset or deferred tax liability.
2. Asset- liability method-this method considers all temporary difference’s including timing differences.

Accounting procedures
1. Determine the taxable income
Income tax expense XX
Income tax payable XX
(Taxable income X tax rate= current tax expense)
2. Determine the taxable temporary differences

Income tax expense XX

Deferred tax liability XX
(Taxable temp. difference X tax rate=DTL)
3. Determine the deductible temporary differences
Deferred tax asset XX
Income tax benefit XX
(deductible temp. difference X tax rate=DTA)

Income tax benefit account reduces the current tax expense or the year and is a deduction from the current tax
expense.
4. The total income tax expense for the year is the current tax expense plus the deferred tax expense arising from
taxable temporary difference minus the income tax benefit. (Acctg. Profit X tax rate)
rate
Appl.

Basic Formula
Pretax Financial Income XX
Add Nondeductible expenses XX
Tax

less Nontaxable Revenues XX

Financial Income subject to tax XX
Add Increase in Deductible Temporary difference XX % Inc. in DTA =Inc. tax benefit
Decrease in (or reversal of) Taxable Temp. XX % Dec. in DTL =Inc. tax benefit
difference
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DARRELL JOE O.ASUNCION, CPA MBA

ACCOUNTING FOR INCOME TAX

less Increase in Taxable temp. difference XX % Inc. in DTL =Inc. tax exp.
Deferred
Decrease in (or reversal of) deductible Temp. XX % Dec. in DTA =Inc. tax exp.
difference Deferred
Taxable Income XX % Income tax exp.- =current inc. tax
current payable

Applicable tax rates:

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.

Deferred tax assets and liabilities shall be measured at the tax rates that are expected to apply to the period when the
asset is realised 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.

Journal entries:
Deferred tax asset XX
Inc. tax benefit XX
To record the increase in Deferred tax asset (Increase in deductible temporary difference x applicable tax rate)

Deferred tax liability XX

Inc. tax benefit XX
To record the decrease in Deferred tax liability (Decrease in taxable temporary difference x applicable tax rate)

Income tax exp-deferred XX

Deferred tax tax liability XX
To record the increase in Deferred tax liability (Increase in taxable temporary difference x applicable tax rate)

Income tax exp-deferred XX

Deferred tax asset XX
To record the decrease in Deferred tax asset (Decrease in deductible temporary difference x applicable tax rate)

Income tax expense-current XX

Income tax payable XX
to record the current tax expense (taxable income x current rate)

Formula for net income tax expense (income)

Net income tax expense (Income)
Income tax expense-deferred XX
Income tax benefit (XX)
Net income tax expense (Income) XX
OR
Net income tax expense (Income)
Increase in Deferred tax Asset XX
less Increase in Deferred tax liability (XX)
Net income tax expense (Income) XX

Formula in Computing for the Net Income

Pretax Financial Income XX
less income tax expense
Current tax expense XX
Income tax expense-deferred XX
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DARRELL JOE O.ASUNCION, CPA MBA

ACCOUNTING FOR INCOME TAX

Income tax benefit (XX) XX

Net income XX

PROBLEM NO. 1 (Income Statement Method)

You have taken the following information from the records of NCPAR Company as of December 31, 20Y1:

1 Gain from settlement of ins. Co. (company is the beneficiary) 50,000

2 Intercompany dividends from a domestic corp. 60,000
3 Interest income on time deposits. 35,000
4 Interest revenue on government bonds 10,000
5 Interest income on treasury bills 8,000
6 Interest income on municipal bonds 3,600
7 Fines penalties for violations of laws. 3,000
8 Charitable contribution in excess of what is allowed by law as tax deductible 12,000
9 Premiums on life insurance for officers and employees 28,000
10 Loss on expropriation of property 15,000
11 Depreciation in excess of financial depreciation for the machinery 20,000
12 Gross Income from installment sales are recognized as goods are sold but are taxed only when 12,000
installment payments are collected.
13 Accounts written off recognized as expense for tax purposes 10,000
15 Retirement benefit costs are deducted for financial reporting as services are rendered by 20,000
employees but are tax deductible only when actually paid to retiring employees. Current service
cost recognized during the year is ₱40,000 while benefits paid to retiring employees amounted
to ₱60,000.
16 Revenues are recognized for financial reporting at point of sale while revenues are taxed on cash 80,000
basis. Gross profit recognized for financial reporting amounted to ₱500,000 while taxable gross
profit is ₱420,000.
17 Warranty expense has been recognized but is tax deductible only when actually paid 13,500
20 Excess of depreciation for building recognized for financial reporting over depreciation recognized 8,000
for taxation purposes due to shorter depreciation period used for financial reporting
21 Rent received in advance 5,000
22 Annual leave of expense has been recognized but is tax deductible only only when paid 12,000
23 Provision for probable loss has been recognized but is tax deductible only when paid 3,000
24 Research costs amounting to ₱24,000 are expensed immediately during the year for financial 18,000
reporting. For taxation purposes, research costs are amortized over a four-year period.
Amortization of research cost deducted for taxation purposes is ₱6,000.
25 Unrealized losses of ₱6,000 was recognized during the year in profit or loss on an investment in 6,000
held for trading equity securities. No equivalent adjustment was made for taxation purposes. Any
gain or loss on actual disposal of such securities is taxable (tax deductible).

Additional information:
Pretax profit for 20Y1 500,000
Income tax rate 30%

Compute for the following:

1. Taxable Income
a. 314,900 c. 321,400
b. 334,900 d. 308,900

2. Income tax payable-current

a. 94,470 c. 96,420
b. 100,470 d. 92,670

3. Net income tax expense (benefit)

a. 42,600 c. 22,950
b. (19,650) d. 25,650
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DARRELL JOE O.ASUNCION, CPA MBA

ACCOUNTING FOR INCOME TAX

4. Deferred tax liability

a. 42,600 c. (22,950)
b. 19,650 d. 25,650

5. Deferred tax asset

a. 42,600 c. (22,950)
b. 19,650 d. 25,650

6. Total Income tax expense

a. 117,420 c. 119,370
b. 123,420 d. 115,620

7. Net income
a. 382,580 c. 380,630
b. 376,580 d. 384,380

Formula in computing Deferred tax asset arising from Net operating loss carryforward
Net operating loss carrying forward XX
x applicable tax rate %
Deferred tax asset XX

PROBLEM NO. 2 Deferred tax asset from loss carry forward

You have taken the following information from the records of NCPAR Company as of December 31, 20Y1:
1 Gain from settlement of ins. Co. (company is the beneficiary) 50,000
2 Interest income on time deposits. 35,000
3 Interest revenue on government bonds 10,000
4 Interest income on municipal bonds 3,600
5 Premiums on life insurance for officers and employees 10,000
6 Loss on expropriation of property 15,000
7 Unrealized gain of ₱4,000 was recognized during the year in profit or loss on an investment in 4,000
held for trading equity securities. No equivalent adjustment was made for taxation purposes. Any
gain or loss on actual disposal of such securities is taxable (tax deductible).
8 Accounts written off recognized as expense for tax purposes 10,000
9 Gross Income from installment sales are recognized as goods are sold but are taxed only when 12,000
installment payments are collected.
10 Retirement benefit costs are deducted for financial reporting as services are rendered by 10,000
employees but are tax deductible only when actually paid to retiring employees. Current service
cost recognized during the year is ₱70,000 while benefits paid to retiring employees amounted
to ₱60,000.
11 Warranty expense has been recognized but is tax deductible only when actually paid 13,500
12 Revenues are recognized for financial reporting at point of sale while revenues are taxed on cash 20,000
basis. Gross profit recognized for financial reporting amounted to ₱280,000 while taxable gross
profit is ₱300,000.

Additional information:
Pretax profit for 20Y1
40,000
Income tax rate 30%
Any operating loss can be carried over to the next period. NCPAR expects to realize the economic benefit
of any operating loss carry forward.

1. Income tax payable-current

a. Nil c. (4,230)
b. (3,630) d. (10,830)
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DARRELL JOE O.ASUNCION, CPA MBA

ACCOUNTING FOR INCOME TAX

2. Net income tax expense (benefit)

a. 7,800 c. (10,080)
b. (13,050) d. 17,880

3. Deferred tax liability

a. 7,800 c. 10,080
b. 13,050 d. 17,880

4. Deferred tax asset

a. 7,800 c. 10,080
b. 13,050 d. 17,880

5. Total Income tax expense

a. (5,250) c. (9,480)
b. (8,880) d. (16,080)

PROBLEM NO. 3
The following information was extracted from the records of NCPAR Company on December 31 of the current year. Assume
the differences are temporary in nature:
Accounting
Tax return record
Depreciation 150,000 50 ,000
Rent income 200,000 220,000
Warranty expense 100,000 -
Gross income on installment sales 200,000 130,000
Provision for doubtful accounts - 30,000
Annual leave expense 400,000 350,000
Rent revenue 110,000 130,000

The pretax accounting income is ₱6,000,000

Required:
Compute for the following:
1. Taxable income
2. Current tax expense or payable
3. Deferred tax liability
4. Deferred tax asset
5. Net income

COMPUTATION OF DTA AND DTL USING BALANCE OF ASSET AND LIABILITY

FIRST RECOGNITION
Carrying amount of the asset (first recognition-e.g., date of revaluation) XX
Less Tax base of the asset XX
Increase (or decrease) XX
X tax rate XX
Deferred tax liability (or asset) XX

Carrying amount of the liability (date of revaluation) XX

Less Tax base of the liability XX
Increase (or decrease) XX
X tax rate XX
Deferred tax asset (or liability) XX

PROBLEM NO. 4
The following information was extracted from the records of NCPAR Company on December 31 of the current year. Assume
the differences are temporary in nature:
Carrying amount Tax Base
Accounts receivable 2,000,000 2,250,000
Motor vehicle 1,000,000 800,000
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DARRELL JOE O.ASUNCION, CPA MBA

ACCOUNTING FOR INCOME TAX

Inventory 3,000,000 1,800,000

Litigation liability 200,000 -
Provision for warranty 300,000 -
Deposit received in advance 150,000 -

Assume that the pretax accounting income is ₱6,000,000, compute for the following:
1. Taxable income
2. Current tax expense or payable
3. Deferred tax liability
4. Deferred tax asset
5. Net income

Deferred tax liability arising from Compound Financial Instrument

Total Proceeds XX
less Present value of the fin. Liabilty without the equity component XX
Residual amount allocated to Equity XX
x Applicable tax rate %
Deferred tax liability XX

PROBLEM NO. 5 Compound instruments

On January 1, 20X1, NCPAR Co. issued its 10%, 5-year, ₱5,000,000 convertible bonds for the face amount of ₱5,000,000.
Each ₱5,000 bond is convertible into 10 shares with par value of ₱400 per share at an exercise price of ₱450. At the time
of issuance, the bond is selling at 95 without the conversion feature. Income tax rate is 30%. How much is the deferred tax
liability arising from the issuance of the compound financial instrument on January 1, 20X1?
a. 250,000 b. 175,000 c. 75,000 d. 0

COMPUTATION OF DTL IN REVALUATION

Cost Replacement cost Appreciation
Equipment (e.g.) XX XX XX
Accumulated depreciation
(Depreciable Cost X proportion) XX
(Depreciable replacement cost X proportion) XX XX
Book value/Sound value/Rev. surplus XX XX XX

Net Revaluation surplus
Deferred tax liability, date
revaluation
DTL, end of the period
Revaluation surplus x (100% minus current tax rate)
of Revaluation surplus x current tax rate
(Carrying amount, end of the period less tax base, end of the period) x applicable
tax rate

DTL, end XX
Less DTL, beg XX
Increase (or decrease) in DTL XX

Any increase in DTL is recorded as follows:

INCREASE DECREASE
Income tax expense XX DTL XX
DTL XX Income tax expense (or benefit) XX

PROBLEM NO. 6 (DEFERRED TAX LIABILITY ARISING FROM REVALUATION SURPLUS)

On January 1, 2015, Easy Company acquired an equipment for ₱6,000,000. The equipment is depreciated using straight-
line method based on a useful life of 10 years with no residual value.

On January 1, 2018, after 3 years, the equipment was revalued at a replacement cost of ₱8,000,000 with no change in the
useful life.

The pretax accounting income before depreciation for 2006 is ₱4,000,000. The income tax rate is 30% and there are no
other temporary differences at the beginning of the year.

Questions:
Based on the above date, answer the following:
1. What is the revaluation surplus on January 1, 2018?
a. ₱1,400,000 c. ₱2,000,000
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DARRELL JOE O.ASUNCION, CPA MBA

ACCOUNTING FOR INCOME TAX

b. ₱980,000 d. ₱1,320,000
2. What is the deferred tax liability on January 1, 2018 arising from the revaluation?
a. ₱1,400,000 c. ₱2,000,000
b. ₱980,000 d. ₱600,000
3. What is the current tax expense for 2018?
a. ₱1,020,000 c. ₱960,000
b. ₱1,380,000 d. ₱1,080,000
4. What is the deferred tax liability on December 31, 2018 arising from revaluation?
a. ₱360,000 c. ₱1,080,000
b. ₱1,440,000 d. ₱1,020,000
5. The 2018 income statement shall report total income tax expense at
a. ₱1,020,000 c. ₱960,000
b. ₱1,380,000 d. ₱1,080,000

VALUATION ALLOWANCE
The carrying amount of a deferred tax asset shall be reviewed at the end of each reporting period. An entity shall reduce
the carrying amount of a deferred tax asset to the extent that it is no longer probable that sufficient taxable profit will be
available to allow the benefit of part or all of that deferred tax asset to be utilised. Any such reduction shall be reversed to
the extent that it becomes probable that sufficient taxable profit will be available.

Probable means “more likely than not” and “More likely than not” is at least a likelihood of more than 50%.

Assuming that there is ₱5,000,000 deferred tax asset and the company determines that it is more likely than not that only
₱2,000,000 will ultimately be realized. The appropriate journal entry would be:
Income tax expense (₱5M-₱2M) 3,000,000
Valuation allowance-deferred tax asset 3,000,000

At the end of each reporting period, the valuation needs to be reevaluated and should be adjusted upward or downward.
Assuming on the previous illustration, only ₱1,000,000 will not be realized. The appropriate journal entry:
Valuation allowance-deferred tax asset 2,000,000
Income tax expense (₱3M-₱1M) 2,000,000

EVERY ACCOMPLISHMENT STARTS WITH A DECISION TO TRY-GAIL DEVERS

YOU ARE NEVER TOO OLD TO SET ANOTHER GOAL OR TO DREAM A NEW DREAM-C.S. LEWIS

PERSEVERANCE IS FAILING 19 TIMES AND SUCCEEDING THE 20TH-JULIE ANDREWS

THE DIFFERENCE BETWEEN ORDINARY AND EXTRAORDINARY IS THAT LITTLE EXTRA-UNKNOWN

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