ACC 226 – IFRS for SMEs and PFRS for Small Entities – Handout 2.

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Topic: Sample Problems – Accounting for Income Tax
Instructor: Leenuel M. Bernarte, CPA

PAS 12 – Accounting for Income Taxes

Tax Base – an asset or liability amount attributable to the asset or liability for tax purposes.

1. PERMANENT DIFFERENCES
• Included either in accounting income or taxable income but will never be included in the other.
• Non-taxable revenue
a. Interest income on deposits
b. Dividends received
• Non-deductible expenses
a. Life insurance
➔ Entity is the beneficiary on its officers/employees
b. Tax penalties, surcharges, and fines

2. TEMPORARY DIFFERENCES
• Timing differences
• Differences between the carrying amount of an asset or a liability and its tax base

a. Taxable Temporary Differences

➔ Result in future taxable amount in determining taxable income of future periods when the carrying
amount of asset or liability is recovered or settled.
➔ Give rise to DEFERRED TAX LIABILITY

FTD x TAX RATE = DTL

Accounting Income > Taxable Income

CA of asset > Tax Base
CA of liability < Tax Base

Examples:
i. Revenue and gains included in the accounting income (current) but taxable in the future
ii. Expenses and losses are deductible for tax (current) but deductible for accounting in the
future
➢ Accelerated depreciation for tax; SLM for accounting
➢ Development costs are expensed for tax; capitalizable and amortizable for accounting
➢ Prepaid expenses expensed immediately for tax purposes
➢ Assets revalued upward, no adjustment for tax

Journal entry:
Income tax expense/Deferred tax expense xxx
Deferred tax liability xxx

b. Deductible Temporary Differences

➔ Result in future deductible amount in determining taxable income of future periods when the carrying
amount of asset or liability is recovered or settled
➔ Give rise to DEFERRED TAX ASSET

(FDA) x TAX RATE = DTA

Accounting income < Taxable income

CA of asset < Tax Base
CA of liability > Tax Base

Examples:
i. Revenues and gains included in taxable income but not in accounting income
ii. Expenses and losses deducted from accounting income (current) but deductible for tax
purposes in the future
➢ Contingent liability, including warranty
➢ Research costs is expensed immediately in accounting income but deductible for tax
purposes in the future
➢ Impairment loss is recognized in accounting income but ignored for tax purposes until
asset is sold
➢ Doubtful accounts are expensed in accounting income but deductible for tax purposes
once written off

ACC 226-Bernarte-Income-Tax
 ➢ Assets revalued downward, no adjustment for tax
iii. Operating loss carryforward (excess of tax deductions over gross income to reduce taxable
income)

Journal entry:
Deferred tax asset xxx
Income tax expense/Income tax benefit xxx

FORMULA #1
Financial Accounting Income xxx
Less: Nontaxable income (xxx)
Add: Nondeductible expense xxx
Financial Accounting Income after permanent differences xxx
Add: Future deductible differences xxx
Less: Future taxable differences (xxx)
Taxable income xxx

FORMULA #2
Financial Accounting Income xxx
Less: Nontaxable income (xxx)
Add: Nondeductible expense xxx
Financial Accounting Income after permanent differences xxx
Add: Increase in future deductible amount xxx
Less: Decrease in future deductible amount (xxx)
Less: Increase in future taxable amount (xxx)
Add: Decrease in future taxable amount xxx
Taxable income xxx

OTHER FORMULAS:
1. Current tax expense = taxable income x tax rate*
2. Deferred tax expense = temporary differences x tax rate**

* tax rate enacted before end of reporting period

** tax rate applicable after end of reporting period (if silent, current tax rate)

3. Total income tax expense

• If current rate = future rate

FAI after P.D. x Tax Rate

• If current rate ≠ future rate

Current Income Tax Expense xxx

Add/Less: Deferred tax expense (benefit) xxx(xxx)
Total income tax expense xxx

4. Deferred tax asset and deferred tax liability are always NON-CURRENT even if it will reverse by next period
5. Deferred tax asset and deferred tax liability are not allowed to be offset in the balance sheet.

---END OF NOTES---

ILLUSTRATIVE PROBLEMS

ILLUSTRATION 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.

Question:
Is the billed income during December 2022 already taxable for the year 2022?

ILLUSTRATION 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.
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Question:
How much rent expense is allowed to be deducted from the taxable income for the year 2022?

ILLUSTRATION 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.

Question:
How much rental income is reported for tax purposes in 2022?

ILLUSTRATION 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.

Question:
What amount of income should be taxable for the year 2022?

ILLUSTRATION 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 P 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?

Independent Case:
The enacted income tax rate for future years is 35%.
7. What amount shall be presented as deferred tax liability on December 31?
8. What amount shall be presented as deferred tax asset on December 31?
9. How much is the total income tax expense?

PRACTICE PROBLEMS

PROBLEM 1
Viserys Company reported the following information during the first year of operations:
Pre-tax financial income P 8,000,000
Non-taxable interest received 250,000
Long-term loss accrual in excess of deductible amount 500,000
Tax depreciation in excess of financial depreciation 1,250,000
Income tax rate 30%

Determine the following:

1. Accounting income subject to tax
2. Income tax expense
3. Taxable income
4. Income tax – current
5. Deferred tax asset
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 6. Deferred tax liability

PROBLEM 2
Daemon Company began operations on January 1, 2022 and reported a pre-tax financial income of P2,000,000 as of the year
ending December 31, 2022. This amount includes:
Installment sales of which P250,000 remain uncollected 540,000
Rental income 220,000
Non-taxable revenues 150,000
Warranty expense, yet to be disbursed 125,000
Depreciation expense 115,000
Non-deductible expenses 10,000

Additional information:
• Installment sales and warranty expenses are recognized on cash basis for tax purposes
• The depreciation expense and rental income included in the 2022 tax return were higher by P85,000 and P40,000,
respectively.
• The enacted tax rate in 2022 and future years is 30%.

Determine the following:

1. Accounting income subject to tax
2. Taxable income
3. Income tax – current
4. Deferred tax asset
5. Deferred tax liability
6. Income tax expense

PROBLEM 3
Criston Company provided the following information on December 31, 2022:
Carrying amount Tax Base
Accounts receivable 1,500,000 1,750,000
Motor vehicle 1,650,000 1,250,000
Provision for warranty 120,000 0
Deposit received in advance 150,000 0

The depreciation rates for accounting and taxation are 15% and 25% respectively. The deposits are taxable when received
and warranty costs are deductible when paid. An allowance for doubtful debts has been raised against accounts receivable
for accounting purposes but such debts are deductible only when written off as uncollectible. The tax rate is 30%.
What amount should be reported as deferred tax liability on December 31, 2012?
a. 36,000
b. 81,000
c. 120,000
d. 156,000

PROBLEM 4
Alicent Company reported the following carrying amount of assets and liabilities on December 31, 2022:
Property 10,000,000
Plant and Equipment 5,000,000
Inventory 4,000,000
Trade receivables 3,000,000
Trade payables 6,000,000
Cash 2,000,000

The value for tax purposes for property and for plant and equipment was P7,000,000 and P4,000,000, respectively. The entity
has made a provision for inventory obsolescence of P2,000,000 which is not allowable for tax purposes. Further, an impairment
loss against trade receivables of P1,000,000 has been made. This charge will not be allowed in the current year for tax
purposes. The tax rate is 30%.
What amount should be recognized as deferred tax expense for 2022?
a. 1,400,000
b. 1,200,000
c. 350,000
d. 300,000

PROBLEM 5
On December 31, 2022, the accounts of Otto Hightower Company have the same basis for accounting and tax purposes,
except for following:
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 Carrying amount Tax Base Difference
Computer software cost 4,000,000 0 4,000,000
Equipment 15,000,000 12,000,000 3,000,000
Accrued liability – health care 2,000,000 0 2,000,000

In January 2022, the entity incurred cost of P6,000,000 in relation to the development of a computer software product. The
software cost was appropriately capitalized and amortized over 3 years for accounting purposes using straight line. However,
the total amount was expensed in 2022 for tax purposes.
The equipment was acquired on January 1, 2022 for P20,000,000. The useful life is 4 years with no residual value. The
equipment is depreciated using the straight line for accounting purposes and sum of year’s digit method for tax purposes.
In January 2022, the entity entered into an agreement with the employees to provide health care benefits. The cost of such
plan for 2022 was P2,000,000. This amount was accrued as expense in 2022 for accounting purposes. However, health care
benefits are deductible for tax purposes only when actually paid.
The pre-tax accounting income for 2022 is P13,000,000. The tax rate is 30% and there are no deferred taxes on January 1,
2022.
1.What is the current tax expense for the current year?
a. 1,500,000
b. 2,400,000
c. 3,300,000
d. 3,900,000

2. What is the deferred tax expense for the current year?

a. 600,000
b. 1,500,000
c. 2,100,000
d. 2,700,000

3. What is the total tax expense for the current year?

a. 1,500,000
b. 3,900,000
c. 4,500,000
d. 5,100,000

===END OF HANDOUTS===

ACC 226-Bernarte-Income-Tax