AP.

114-Deferred Income Tax Accounting

LECTURE NOTES
Definition of terms
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).

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.

Deferred tax liabilities are the amounts of income taxes payable in future periods in
respect of taxable temporary differences.

Deferred tax assets are the amounts of income taxes recoverable in future periods
in respect of:
(a) deductible temporary differences;
(b) the carryforward of unused tax losses; and
(c) the carryforward of unused tax credits.

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.

Tax expense (tax income) comprises current tax expense (current tax income) and
deferred tax expense (deferred tax income).

Current Tax
Current tax for the current and prior periods should be recognized as a liability to
the extent that it has not yet been settled, and as an asset to the extent that the
amounts already paid exceed the amount due. The benefit of a tax loss which can
be carried back to recover current tax of a prior period should be recognized as an
asset. Current tax assets and liabilities should be measured at the amount
expected to be paid to (recovered from) taxation authorities, using the rates/laws
that have been enacted or substantively enacted by the end of the reporting period.

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Recognition of Deferred Tax Liabilities
The general principle in PAS 12 is that deferred tax liabilities should be recognized
for all taxable temporary differences. There are 3 exceptions to the requirement to
recognize a deferred tax liability, as follows:
• liabilities arising from goodwill for which amortization is not deductible for tax
purposes;
• liabilities arising from the initial recognition of an asset/liability other than in a
business combination which, at the time of the transaction, does not affect either
the accounting or the taxable profit; and
• liabilities arising from undistributed profits from investments where the
enterprise is able to control the timing of the reversal of the difference and it is
probable that the reversal will not occur in the foreseeable future.

Recognition of Deferred Tax Assets

A deferred tax asset should be recognized for deductible temporary differences,
unused tax losses and unused tax credits to the extent that it is probable that
taxable profit will be available against which the deductible temporary differences
can be utilized, unless the deferred tax asset arises from the initial recognition of an
asset/liability other than in a business combination which, at the time of the
transaction, does not affect the accounting or the taxable profit.

Deferred tax assets for deductible temporary differences arising from investments
in subsidiaries, associates, branches and joint ventures should be recognized to the
extent that it is probable that the temporary difference will reverse in the
foreseeable future and that taxable profit will be available against which the
temporary difference will be utilized.

The carrying amount of deferred tax assets should be reviewed at the end of each
reporting period and reduced 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 utilized. Any such reduction should be subsequently
reversed to the extent that it becomes probable that sufficient taxable profit will be
available.

A deferred tax asset should be recognized for an unused tax loss carryforward or
unused tax credit if, and only if, it is considered probable that there will be sufficient
future taxable profit against which the loss or credit carryforwards can be utilized.

Measurement of Deferred Tax Assets and Liabilities

Deferred tax assets and liabilities should be measured at the tax rates that are
expected to apply to the period when the asset is realized or the liability is settled
(liability method), based on tax rates/laws that have been enacted or substantively
enacted by the end of the reporting period. The measurement should reflect the
entity's expectations, at the end of the reporting period, as to the manner in which
the carrying amount of its assets and liabilities will be recovered or settled.

Deferred tax assets and liabilities should not be discounted.

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Recognition of Tax Expense or Income
Current and deferred tax should be recognized as income or expense and included
in net profit or loss for the period, except to the extent that the tax arises from:
• a transaction or event that is recognized directly in equity; or
• a business combination accounted for as an acquisition.
If the tax relates to items that are credited or charged directly to equity, the tax
should also be charged or credited directly to equity.

If the tax arises from a business combination that is an acquisition, it should be

recognized as an identifiable asset or liability at the date of acquisition in
accordance with PFRS 3 Business Combinations (thus affecting goodwill or negative
goodwill).

Presentation
Current tax assets and current tax liabilities should be offset on the statement of
financial position only if the enterprise has the legal right and the intention to settle
on a net basis.

Deferred tax assets and deferred tax liabilities should be offset on the statement of
financial position only if the enterprise has the legal right to settle on a net basis
and they are levied by the same taxing authority on the same entity or different
entities that intend to realize the asset and settle the liability at the same time.

- done -

REVIEW QUESTONS

MULTIPLE CHOICE PROBLEMS

1. D’Silva Limited has a product warranty liability amounting to P10,000. The
product warranty costs are not tax deductible until paid out to customers. The
company tax rate is 30%. The company has:
a. a deductible temporary difference of P10,000;
b. an assessable temporary difference of P10,000;
c. a tax base of P10,000;
d. a future deductible amount of P0.

2. The current liabilities of an entity include fines and penalties for environmental
damage. The fines and penalties are stated at P10 million. The fines and
penalties are not deductible for tax purposes. What is the tax base of the fines
and penalties?
a. P10 million b. P3 million c. P13 million d. P0

3. An entity has spent P600,000 in developing a new product. These costs meet
the definition of an intangible asset under PAS 38 and have been recognized in
the statement of financial position. These costs have been recognized as an
expense for tax purposes. At the year-end the intangible asset is deemed to be
impaired by P50,000. The tax base of the intangible asset at year-end is
a. P600,000 b. P550,000 c. P50,000 d. P0

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4. The Waloneke Company has a policy of using non-current asset until they can no
longer be operated and are worthless. On 1 January 2016 it acquired an item of
plant and machinery for P100,000. It is being depreciated over 10 years on a
straight-line basis. For tax purposes there is an allowance of 20% per annum on
a reducing balance basis. There are two rates of tax: 15% on trading profits and
25% on gains on disposal.

What deferred tax balance should Waloneke recognize at 31 December 2016,

according to PAS12 Income taxes?
a. Deferred tax asset of P2,500 c. Deferred tax liability of P2,500
b. Deferred tax asset of P1,500 d. Deferred tax liability of P1,500

5. Black Co., organized on January 2, 2016, had accounting profit of P500,000 and
taxable profit of P800,000 for the year ended December 31, 2016. The only
temporary difference is accrued product warranty costs that are expected to be
paid as follows:

Year 2017 2018 2019 2020

Amount P110,000 P50,000 P50,000 P100,000

Black has never had any net operating losses (book or tax) and does not expect
any in the future. There were no temporary differences. The enacted income
tax rates are 35% for 2016; 30% for 2017 through 2019, and 25% for 2020. In
Black’s December 31, 2016 statement of financial position, the deferred income
tax asset should be
a. P105,000 b. P85,000 c. P70,000 d. P60,000

6. D Company had the following deferred tax balances at reporting date - Deferred
tax assets, P1,200,000; Deferred tax liabilities, P3,000,000. Effective from the
first day of the next financial period, the company rate of income tax was
reduced from 40% to 30%.

The adjustment to income tax expense to recognize the impact of the tax rate
change is:
a. DR P600,000 b. CR P600,000 c. DR P450,000 d. CR P450,000

7. The following facts relate to Whammy Corporation for the current year:
• Taxable profit, P430,000.
• Deferred tax liability, January 1, P48,000.
• Deferred tax asset, January 1, P16,000.
• Cumulative temporary difference at December 31, giving rise to future taxable
amounts, P230,000.
• Cumulative temporary difference at December 31, giving rise to the future
deductible amounts, P95,000.
• Tax rate for all years, 35%.

No permanent differences exist. The company is expected to operate profitably

in the future. What is the total tax expense?
a. P150,500 b. P103,250 c. P165,750 d. P135,250

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8. The following differences enter into the reconciliation of financial income and
taxable income of Celtics Company for the year ended December 31, 2016, its
first year of operations.

Accounting profit P4,500,000

Excess tax depreciation 3,000,000
Litigation accrual 450,000
Unearned rent income deferred on the books but
appropriately recognized in taxable income 250,000
Interest income from long-term certificate of deposit 100,000

• Excess tax depreciation will reverse equally over a four-year period, 2017-
2020.
• It is estimated that the litigation liability will be paid in 2020.
• Rent income will be recognized during the last year of the lease, 2020.
• Interest income from long-term certificate of deposit is expected to be
P100,000 each year until their maturity at the end of 2020.
• Tax rate is 35%.

Compute for the current income tax expense for 2016.

a. P735,000 b. P647,500 c. P560,000 d. P770,000

9. Salisbury Ltd made an accounting profit before tax of P40,000 for the year ended
30 June 22016 Included in the accounting profit were the following items of
revenue and expense.

Donations to political parties (non-deductible) P5,000

Depreciation – machinery (20%) 15,000
Annual leave expense 5,600
Rent revenue 12,000

For tax purposes the following applied:

Annual leave paid P 6,500
Rent Received 10,000
Depreciation rate for machinery 25%
Income tax rate 35%

Calculate the current tax liability for the year ended30 June 2016.
a. P13,423 b. P14,000 c. P15,750 d. P15,050

10. The following information was extracted from the records of Obduracy
Corporation as at 31 December 2016:
Carrying
Asset (liability) amount Tax base
Accounts receivable P 150,000 P175,000
Motor vehicles 165,000 125,000
Provision for warranty (12,000) 0
Deposits received in advance (15,000) 0

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 The depreciation rates for accounting and taxation are 15% and 25%
respectively. Deposits are taxable when received, and warranty costs are
deductible when paid. An allowance for doubtful debts of P25,000 has been
raised against accounts receivable for accounting purposes, but such debts are
deductible only when written off as uncollectible. The net journal entry to record
deferred tax for the year ended 31 December 2016 assuming no deferred items
had been raised in prior years, will increase (decrease) profit by
a. P3,600 b. P3,600 c. P12,000 d. P15,600
increase decrease increase decrease

11. Entity Y Company started to manufacture in 2016 copy machines that are sold
on the installment basis. Entity Y recognizes revenue when equipment is sold for
financial reporting purposes, and when installment payments are received for tax
purposes. In 2016, Entity Y recognized gross profit of P6,000,000 for financial
reporting purposes, and P1,500,000 for tax purposes. The amounts of gross
profit expected to be recognized for tax purposes in 2017 and 2018 are
P2,500,000 and P2,000,000, respectively. Entity Y guarantees 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 2016 is P2,500,000, but only P500,000 of warranty cost is
paid in 2016. It is expected that in 2017 and 2018, P1,000,000 and P1,000,000,
respectively, of warranty costs will be paid. In addition during 2016, P500,000
interest, net of 20% final income tax, was received and earned, and P200,000
insurance premium on life insurance policies that covered the life of Entity Y’s
president was paid. Entity Y is the beneficiary for this policy. The tax rate is
35%. Accounting profit in 2016 was P2,000,000.

Assuming any 2016 net loss will be carried to 2017, how much is the deferred
tax asset to be recognized as of December 31, 2016?
a. P700,000 b. P980,000 c. P1,575,000 d. P770,000

12. Jenkins limited acquired an item of Property at a cost of P50,000. At reporting

date accumulated depreciation amounted to P15,000. The asset was revalued on
reporting date to P45,000. If the company rate of tax is 30%, the deferred tax
item that must be recognized at reporting date is:
a. deferred tax asset P3,000 c. deferred tax liability P7,000
b. deferred tax liability P3,000 d. deferred tax asset P7,000

13. Sagay Company provides the following tax effects of temporary differences at
the end of 2016:
Deferred tax Related asset
asset (liability) classification
Accelerated depreciation (P500,000) Noncurrent
Additional cost in inventory for tax purposes 200,000 Current
(P300,000)

Sagay anticipates that P150,000 of the deferred tax liability will reverse in 2017.
In its December 31, 2016 statement of financial position, what amount should
Sagay report as noncurrent deferred tax liability?
a. P300,000 b. P500,000 c. P150,000 d. P200,000

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MULTIPLE CHOICE THEORY
1. Tax expense is
a. The aggregate amount included in the determination of profit or loss for the
period in respect of current tax and deferred tax.
b. The amount of income taxes payable in respect of the taxable profit for a
period.
c. Is the amount attributed to asset or liability for tax purposes.
d. The amount of income taxes recoverable in future periods in respect of
deductible temporary differences.

2. Which of the following statements is correct regarding deferred taxes under PAS
12?
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.

3. Deferred tax liabilities are the amounts of income taxes payable in future periods
in respect of
a. Taxable temporary differences c. Carryforward of unused tax losses
b. Deductible temporary differences d. Carryforward of unused tax credits

4. Under PAS 12, temporary difference is

a. A difference between the carrying amount of an asset or liability and its tax
base.
b. A temporary difference that will result in amounts that are tax deductible in
the future when the carrying amount of the asset is recovered or the liability is
settled.
c. A temporary difference that will result in taxable amounts in the future when
the carrying amount of the asset is recovered or the liability is settled.
d. A difference between taxable profit and accounting profit that originate in one
period and reverse in one or more subsequent periods.

5. Which of the following statements is correct regarding permanent differences

under PAS 12?
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 the choices are correct.

6. 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.

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 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.

7. At the December 31, 2014 statement of financial position date, Unruh

Corporation reports an accrued receivable for financial reporting purposes but not
for tax purposes. When this asset is recovered in 2015, a future taxable amount
will occur and
a. Pretax financial income will exceed taxable income in 2015.
b. Total income tax expense for 2015 will exceed current tax expense for 2015.
c. Unruh will record an increase in a deferred tax asset in 2015.
d. Unruh will record a decrease in a deferred tax liability in 2015.

8. Which statement is correct regarding recovery of underlying asset in PAS 12?

a. PAS 12 requires an entity to measure deferred tax relating to an asset on a
sale basis.
b. Deferred tax on investment property measured at fair value is always required
to be determined using the presumption that the carrying amount of the
underlying asset will be recovered through sale
c. Deferred tax on non-depreciable assets measured using the revaluation model
in PAS 16 will always be determined on a sale basis.
d. All of the above.

9. A Company reported a tax loss in its first year of operations. The company’s
management believes it is more likely than not that the tax loss will be utilized in
the future. There were no temporary differences during the year. Which of the
following best describes the impact of the tax loss on the financial statements?
a. Tax receivable increases assets; net loss is reduced; retained earnings
increases.
b. Deferred tax asset (loss carryforward) is recognized; net loss is increased;
retained earnings decreases.
c. Deferred tax liability (loss carryforward) is recognized; net loss is reduced;
retained earnings increases.
d. Deferred tax asset (loss carryforward) is recognized; net loss is reduced;
retained earnings increases.

10. The purpose of an interperiod income tax allocation is to

a. Allow reporting entities to fully utilize tax losses carried forward from a
previous year.Deferred tax asset (loss carryforward) is recognized; net loss is
increased; retained earnings decreases.
b. Allow reporting entities whose tax liabilities vary significantly from year to
year to smooth payments to taxing agencies.
c. Recognize an asset or liability for the tax consequences of temporary
differences that exist at the balance sheet date.
d. Amortize the deferred tax liability shown on the balance sheet.

11. Under PAS 12 Incomes Taxes, deferred tax assets and liabilities are measured
at the tax rates that:
a. Are expected to apply when the asset or liability is settled.

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 b. Applied at the beginning of the reporting period.
c. At the end of the reporting period.
d. At the rates that prevail at the reporting date.

12. 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 into law.
d. It appears likely that a future tax rate will be less than the current tax rate.

13. A future taxable amount is exemplified by:

a. Revenue that is included in the tax return before it is included in pretax
accounting income.
b. Gain that is included in the tax return before it is included in pretax accounting
income.
c. Expense that is included in the tax return after it is included in pretax
accounting income
d. Expense that is included in the tax return before it is included in pretax
accounting income

14. Which of the following is an example of a temporary difference which could

result in a deferred tax asset?
a. Prepayments of expenses in year of payment; recognition of expense for
accounting purposes in a later year
b. Use of straight-line depreciation for accounting purposes and an accelerated
rate for income tax purposes
c. Gross margin on installment sales is recognized for accounting purposes
before it is included in taxable income in the income tax return
d. Gain on disposal of an asset when included in taxable income before it is
included in pretax accounting income

15. Which of the following examples would not give rise to a temporary
difference?
a. Revenue from installment sales recognized under the installment method for
taxation.
b. Recognition of goodwill in a business combination.
c. Depreciation used for accounting purposes whilst an accelerated method is
used for tax purposes.
d. Warranty costs recognized for accounting purposes but not recognized for tax
purposes until paid.

16. The tax expense related to profit or loss of the period is required to be
presented:
a. On the face of the statement of financial position
b. On the face of the statement of profit or loss
c. In the statement of cash flows
d. In the statement of changes in equity

17. The rationale for interperiod income tax allocation is to

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 a. Recognize a tax asset or liability for the tax consequences of temporary
differences that exist at the balance sheet date.
b. Recognize a distribution of earnings to the taxing agency.
c. Reconcile the tax consequences of permanent and temporary differences
appearing on the current year's financial statements.
d. Adjust income tax expense on the income statement to be in agreement with
income taxes payable on the balance sheet.

18. Interperiod income tax allocation causes

a. Tax expense shown on the income statement to equal the amount of income
taxes payable for the current year plus or minus the change in the deferred
tax asset or liability balances for the year.
b. Tax expense shown in the income statement to bear a normal relation to the
tax liability.
c. Tax liability shown in the balance sheet to bear a normal relation to the
income before tax reported in the income statement.
d. Tax expense in the income statement to be presented with the specific
revenues causing the tax.

19. 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.
a. Decrease in balance of deferred tax asset minus the increase in balance of
deferred tax liability.

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