WHAT IS AN INCOME?

CASH BASIS ACCOUNTING

● It is an increase in the equity or capital ● Incomes are reported when cash is
during the period other than capital collected, and expenses are reported when
contributions made by the owner or paid.
stockholders. ● Commonly used for servicing business.
● According to Black’s Law Dictionary,
income is the return in money from one’s ACCRUAL BASIS ACCOUNTING
business, labor, or capital invested. ● Incomes are reported when earned, and
● “Return” means the money or value expenses are reported when incurred.
derived from the use of money or capital ● Taxpayers report their incomes when the
invested. right to ownership over goods sold is
● For income taxation purposes, an income transferred from the seller to the buyer,
is described as a return on the capital, irrespective of the period or date of
rather than the return of the capital itself. collection.
● In other words, it is the excess of money ● Example:
or money’s worth received for the capital
used.
● To illustrate:

ACCOUNTING METHODS
● The following methods shall be used in
computing income, depending on the
nature of the business:
○ Cash Basis Accounting
○ Accrual Basis of Accounting
○ Accounting for Leasehold
ACCOUNTING FOR LEASEHOLD
Improvements
IMPROVEMENTS
○ Accounting for Long-term Contracts
● Any improvement made by the lessee on
○ Installment Basis of Reporting
the leased property, in pursuant to the
○ Deferred Reporting
agreement between the lessor and the
○ Accounting for Farming Business
lessee, for which will become the property
○ Hybrid Accounting
of the lessor upon the expiration or
termination of the contract of lease.
● Always remember that the lessor is a to the fair value of the improvement. The
service-oriented party. Therefore, income improvement’s useful life is 15 years.
payments to him are recognized on a cash
basis.
● Also, a lessee may be engaged in
servicing or merchandising business.
Therefore, payments made by him is an
Spread-Out Method
expense either using cash basis or accrual
● The estimated book value of the
basis.
improvement at the end of the lease period
● The value of such improvement will become
is amortized or spread-out over the term of
an income of the lessor using either of the
the lease, and the income computed is
following methods:
reported every year until the lease is over.
● Example:
Outright Method
SAME WITH THE PROBLEM ABOVE
● Improvement is recognized as income when
the improvement is completed.
● Example:
Miguel, the owner of one hectare land,
entered into a lease agreement with Luigi for
a period of 10 years beginning January 1,
2018. The terms of the lease provide that:
(1) the lessee shall pay the lessor an
amount of P 150,000 as two-year deposit,
and P50,000 annual lease fee; and (2) the
lessee shall erect a building the ownership
of which shall transfer to the lessor upon the
expiration of the term of the lease or upon
termination. The advance payment is a
security deposit which shall be paid back to
Luigi upon expiration, but in case of default
of payment, such amount shall be
appropriated.
The construction of the building began
on January 1, 2018, and was completed on
August 1, 2018 with a total cost of P
2,000,000. The cost of construction equates
Changes in Fair Value What about the estimated costs?
● If at the end of the lease contract, the fair ● For accounting purposes, estimated costs
value of the improvement is greater or lesser are necessary to estimate the revenue
than the book value, the lessor shall (conservatism principle).
recognize an additional income or loss, ● However, for taxation purposes, these
respectively. costs are not necessary since they are not
actually incurred.
ACCOUNTING FOR LONG-TERM ● Hence, they are ignored in the computation
CONTRACTS of income.

● ‘Long-term contracts' means building,

installation or construction contracts INSTALLMENT BASIS OF REPORTING

covering a period in excess of one (1) ● Accounts for income at the time collection

year. rather than at the time of sale, for which

● Persons whose gross income is derived in collection of the payment from

whole or in part from such contracts shall customers extends over several years

report such income upon the basis of subsequent to the sale.

percentage of completion. ● The customers are required to make regular

● Example: payments with a likelihood that full collection

Emerald Information Engineering Inc. cannot be made, or customers may default

closed a 30 million-peso deal with Diamond one or few payments in the future.

Technologies to develop a software for ● Selling price is the sum of amount received

Diamond’s business analytics. The design in exchange for the property sold.

and development of the software would

take three (3) years to finish as projected
by the lead engineer of Emerald, Zack. The
prototype software, after completion, is still
projected to undergo testing and
modification. ● Contract price is the amount the buyer
agreed to the seller. More often than not, the
selling price and contract price are equal.
But in some cases, the contract price may
differ from the selling price computed as:
● Initial payments means the payments units to two different buyers with the
received in cash or property other than following terms:
evidence of indebtedness of the purchaser
during the taxable period in which the sale
or other disposition is made.

● Periodic installment payments after the

year of sale are the remaining balance
collectible on a periodic basis from the
buyer.

● The income reportable is computed as:

● Example:
GM Motors is a regular dealer of
vehicles and automobiles. As part of its
pricing and marketing scheme, it accepts
old owned vehicles by the buyer for a
trade-in value. During the year, it sold two
APPLICABILITY OF INSTALLMENT ● When deferred reporting is more
REPORTING appropriate, the following rules will
In Installment reporting of income may apply:
be allowed to the following persons and under ○ The note evidencing the
certain conditions: obligation shall be converted to
1. Sale of Personal Property (Movable its discounted value.
Property) ○ Interest pertaining to the
● The seller is a dealer. amortization of the loan or
● Non-dealers of personal property obligation shall be reported as
○ The sale is a casual sale or income in the year of collection.
disposition; ● Example:
○ The property sold is not an
inventory;
○ The selling price is more than P
1,000.00; and
○ Initial payments do not exceed 25%
of the selling price.
2. Sales of Real Property (Immovable
Property)
● The seller is a dealer, and:
○ The real property sold was included
as part of the inventory; and
○ Initial payments do not exceed 25%
of the selling price.
● Sale of real property classified as capital
asset (non-dealer)
○ The seller is a non-dealer of realty.
○ The real property sold is not an
inventory nor used in business.
○ The initial payments do not exceed
twenty-five percent (25%) of the
selling price.

DEFERRED REPORTING
● Applicable if the initial payment exceeds
25% of the selling price, which
installment method is not applicable.
 ● Expenses paid or incurred are
deductible only in the year the gross
income from sale of the crops are
realized.
● Example:
ARTEMCO is engaged in log
production and log processing. It
ACCOUNTING FOR FARMING BUSINESS normally grows trees, and after several
● Embraces the farm in ordinary accepted years, usually seven to eight years, it
sense, and includes stock, dairy, poultry, harvests the logs from the trees planted.
fruit and truck farms, also plantations, After cutting the trees, it replenishes the
ranches and all lands used for farming cut trees by planting new ones, while
operations. processing the logs into several wood
● A farmer is an individual, partnership or products. Some logs are not processed,
corporation that cultivates, operates or and are sold directly to buyers, usually
manages farms for gain or profit, either outside the province. While, some
as owner or tenant. Income from undergo manufacturing to make more
farming business may come from: useful products. Wastes from production
a. Selling of farm products raised are normally salvaged at a lower price.
(those which are grown, cultivated,
and harvested by the farmer);
b. Trading farm products purchased
(those which are bought, cultivated
and harvested by the farmer); and
c. Trading of other farm products and
by-products.
● In computing the taxable income of a
farming business, one may choose
using:
1. Cash basis
2. Accrual basis
3. Crop basis
● This method is applicable only to
farmers engaged in the production of
crops which take more than a year from
the time of planting to the process of
gathering and disposal such those
engaged in log production.
HYBRID ACCOUNTING
● A hybrid accounting is one which uses
two or more accounting methods as
discussed previously in computing
reportable income.
● This method is applicable for persons
engaged in two or more lines of
business either as part vertical
integration or diversification.
● A hybrid accounting is one which uses
two or more accounting methods as
discussed previously in computing
reportable income.
● This method is applicable for persons
engaged in two or more lines of
business either as part vertical
integration or diversification.
● When this method is used, incomes are
appropriately reported using a more
relevant accounting method.
● Most often, hybrid accounting methods
involve the cash and accrual methods of
accounting different incomes.
● This is true particularly when the
taxpayer is both engaged in selling of
goods and services.