ACCOUNTING FOR INCOME TAXES

IAS 12

Accounting Income vs. Taxable Income:

Accounting Income Taxable Income

Nature The net income for the period The income for the for the period
before deducting income tax. determined in accordance with the
Also known as Financial Income rules established by tax
or Pre-tax Income. authorities.
Where is it Income Statement Income Tax Return
reported?
Basis of Financial Reporting Standards Tax laws and BIR issuances.
Computation
Formula Revenues XX Taxable Revenues XX
Expenses (XX) Deductible Expenses (XX)
Net Income XX Taxable Income XX

Differences between Accounting Income and Taxable Income:

Permanent Differences Temporary Differences

Nature Income and expense items which Income and expense items which are
are included in either accounting or included in both accounting and
taxable income but will never be taxable income but at different
included in the other. periods. (Timing differences)

These items are excluded from the

income tax return and do not have
future tax consequences.
Types Non-taxable income: Taxable temporary differences:
These are income items that will no Results in future taxable amount in
longer be subjected to income tax determining taxable income of future
because they are either exempted periods. Gives rise to a deferred tax
from income tax or already liability.
subjected to final tax.
Deductible temporary differences:
Non-deductible expenses: Results in future deductible amount in
These are expense items that are determining taxable income of future
not allowed to be recognized or periods. Gives rise to deferred tax
deducted for tax purposes. asset.

Tax Base:
Tax base of an asset or liability is the amount of the asset or liability that is
recognized or allowed for tax purposes. In other terms, it is the amount attributable to
the asset or liability for tax purposes.
It is the amount that will be deductible for tax purposes against future income.

Computed as: Carrying value - Temporary Difference

Examples:
1. The accrued interest receivable account has a carrying amount of P5,000. The
related interest income will be taxable when collected.
• The tax base of the accrued interest receivable account is Zero (5,000 5,000)
since the related interest will be taxable only when collected.

2. Current liabilities include accrued operating expenses with a carrying amount of

P10,000. The related expense will be deductible for tax purposes when paid.
• The tax base of the accrued operating expenses is Zero (10,000 -10,000)
since the related expense will be deductible only when paid.

Deferred Tax Liability:

The amount of income tax payable in future periods with respect to a taxable
temporary difference or future taxable amount.

Arises from the following:

• Accounting income > Taxable income
• Asset's carrying amount > Asset's tax base
• Liability's carrying amount < Liability's tax base

Examples:
• Income items are included in accounting income but are taxable in future periods
(i.e., accrual of income for accounting purposes but taxable only when collected).
• Expenses are deductible for tax purposes but deductible for accounting purposes in
future periods (ie., higher depreciation charges for tax purposes, prepaid expenses).

Recognition:
Deferred tax liability shall be recognized for all taxable temporary differences.

Deferred tax liability shall not be recognized when the taxable temporary
difference arises from the following:
▪ Goodwill resulting from business combinations.
▪ Asset or liability that affects neither accounting nor taxable income.
▪ Undistributed profit of subsidiary, associate or joint venture.

Other taxable temporary differences:

Most taxable temporary differences arise because of timing differences.

The following are not timing differences but gives rise to deferred tax liability:
• Upward revaluation of an asset.
• Carrying amount of investment in subsidiary, associate, or joint venture which
is higher than its tax base.
• Cost of business combination accounted for as an acquisition.

Problem 1:
During December 2022, an entity billed a customer amounting to P10 for services
rendered during December. The said income will be collected in January 2023.

The entity reported profit amounting to P210 for the year 2022.
Is the billed income during December 2022 already taxable for the year 2022?
Problem 2:
On January 1, 2022, an entity paid in advance a 3-year rent for an office space amounting
to P300,000. The advance rental payment covers the years 2022 through 2024.

For accounting purposes, the prepaid rent is amortized over 3 years. The entity reported
profit amounting to P2,500,000 for the year 2022.
How much rent expense is allowed to be deducted from taxable income for the
year 2022?

Deferred Tax Asset:

The amount of income tax recoverable in future periods with respect to deductible
temporary difference (or future deductible amount) and operating loss carryforward.

Arises from the following:

• Accounting income < Taxable income
• Asset's carrying amount < Asset's tax base
• Liability's carrying amount > Liability's tax base

Examples:
• Income is included in taxable income of current period but included in accounting
income of future periods (ie., advance collections).
• Expenses are deducted from accounting income but are deductible for tax purposes
in future periods (ie., estimated liabilities, impairment losses, doubtful accounts).

Recognition:
Deferred tax asset shall be recognized for all deductible temporary differences and
operating loss carryforward 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 period.

Other deductible temporary differences:

Most deductible temporary, differences arise because of timing differences.

The following are not timing differences but gives rise to deferred tax asset:
• Downward revaluation of an asset.
• Tax base of investment in subsidiary, associate or joint venture which is higher
than the carrying amount.

Problem 3:
On January 1, 2022, an entity received in advance a 3-year rent for an office space
amounting to P300,000. The advance rental payment covers the years 2022 through
2024.

For accounting purposes, the unearned rent income is amortized over 3 years. The entity
reported profit amounting to P2,500,000 for the year 2022.
How much rental income is reported for tax purposes in 2022?
Problem 4:
An entity set up a provision for doubtful accounts amounting to P100 on December 31,
2022. These accounts are actually written off in January 2023.

The entity reported profit amounting to P500 for the year 2022.
What amount of income should be taxable for the year 2022?

Methods of Accounting for Temporary Differences:

1. Income statement method
• This method focuses on timing differences.
2. Balance sheet method
• This method considers all temporary differences including timing differences.
• Future taxable amounts and future deductible amounts are determined by
getting the differences between the carrying amount of assets and liabilities
and their respective tax bases.
• The method required by IAS 12.

Accounting Procedures:
1. Determine the taxable income:
Accounting Income XX
Permanent Differences:
Nontaxable Income (XX)
Nondeductible Expenses XX
Income Subject to Tax XX
Temporary Differences:
Future Taxable Amounts (XX)
Future Deductible amounts XX
TAXABLE INCOME XX

2. Determine the current tax expense:

Taxable Income XX
X: Current income tax rate %%
Current income tax expense XX

Journal Entry:
Income Tax Expense XX
Income Tax Payable XX

3. Determine the deferred tax liability:

Future taxable amounts (or taxable temporary differences) XX
X: Enacted income tax rate %%
Deferred tax liability XX

Journal entry:
Income tax expense XX
Deferred tax liability XX

4. Determine the deferred tax asset:

Future deductible amounts (or deductible temporary differences) XX
X: Enacted income tax rate %%
Deferred tax asset XX
 Journal Entry:
Deferred tax asset XX
Income tax expense XX

Note: Deferred tax asset and liability shall be measured using the tax rate that has
been enacted by the end of the reporting period and expected to apply to the period
when the asset is realized, or the liability is settled.

5. Determine the total income tax expense:

Income tax expense-current (step 2) XX
Net deferred tax expense/(benefit) XX/(XX)
Total Income Tax Expense XX

• Deferred tax liability > Deferred tax asset = Net deferred tax expense
• Deferred tax liability < Deferred tax asset = Net deferred tax benefit

Problem 5:
During 2022, Plank Company reported accounting income P9,000,000 before income tax.
The company revealed the following information for the current year:

Interest income on government bonds 700,000

Life insurance annual premium
(Plank Company is the beneficiary of this insurance policy) 100,000
Tax penalties and surcharges 40,000
Depreciation claimed on income tax return 2,700,000
Depreciation per accounting records 1,400,000
Rental payments made in advance 400,000
Provisions for probable losses 100,000
Warranty expense on the accrual basis 600,000
Actual warranty payment 200,000
Advance collections from customers 200,000
Income tax rate (not expected to change in the future) 30%

Questions:
1. How much is the income subject to tax?
2. How much is the taxable income?
3. How much is the current income tax expense?
4. What amount shall be presented as deferred tax liability on December 31?
5. What amount shall be presented as deferred tax asset on December 31?
6. How much is the total income tax expense?
Financial Statement Presentation:
• Current tax liability → Current liability.
• Current tax asset (or prepaid income tax) → Current
• Deferred tax liability → Noncurrent liability.
• Deferred tax asset→ Noncurrent asset.

Rules on offsetting:
Current tax asset and liability
Current tax asset and liability can be offset only if:
• The entity has a legal enforceable right to set off the recognized amounts.
• Intends either to settle on a net basis or to realize the asset and settle the liability
simultaneously.

Deferred tax asset and liability

General rule: Not allowed

Exception:
• The deferred tax asset and liability relate to income taxes levied by the same tax
authority.
• The company has a legal enforceable right to set off a current tax asset against
a current tax liability.