ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY

CPA Review Batch 44  October 2022 CPA Licensure Examination

FARAP-4412
FINANCIAL ACCOUNTING AND REPORTING / AUDITING PRACTICE
S. IRENEO  C. UBERITA  G. MACARIOLA  C. ESPENILLA  J. BINALUYO

INCOME TAXES
When a company prepares its tax return for a particular year, the revenues and expenses (and losses) included
on the return are, by and large, the same as those reported on the company's statement of comprehensive
income for the same year. However, in some instances tax laws and financial accounting standards differ. The
reason they differ is that the fundamental objectives of financial reporting and those of taxing authorities are not
the same.
Financial accounting standards are established to provide useful information to investors and creditors. The
government through its tax authority, on the other hand, is primarily concerned with raising public revenues in a
socially acceptable manner and, frequently, with influencing the behavior of taxpayers. In pursuing the latter
objective, the government uses tax laws to encourage activities it deems desirable, such as investment in
productive assets, and to discourage activities it deems undesirable, such as violations of laws.
As consequence of differences between IFRS and tax rules is that tax payments frequently occur in years different
from when the revenues and expenses that cause the taxes are generated.
Methods of Accounting for Deferred Tax
DEFERRAL METHOD – the original amount set aside for deferred tax is retained without alteration for subsequent
changes in tax rate. The deferral method does not keep the deferred tax amount up to date as tax rates change,
and is thus generally held to be inferior to the liability method.
The liability method - the deferred tax balance is adjusted as tax rates changes, thus maintaining the amount
at the actual liability expected to arise. It is subdivided into:
The original IAS permitted a free choice of either the deferral method or liability method and the focus was on
the profit or loss. The revised version of the standards prohibits the use of the deferral method. It requires
application of the liability method that focuses on the statement of financial position (known as the balance
sheet liability method).
LIABILITY METHOD
1) Income Statement Liability method – it focuses on the differences between taxable profit and accounting
profit (timing differences).
Timing differences – these are differences between accounting profits and taxable profits that arise because
the period in which some items of income and expenses are included in accounting profits does not coincide with
the period in which they are included in taxable profits. These differences arise because accounting profits are
determined by accounting standards, such as those of the IAS or IFRS, whereas taxable profits are governed by
tax laws, which set out the basis for the computation of income tax payable. It shall be emphasized that for timing
differences to arise, the items of income and expenses must differ only with respect to the periods in which they
are included. The total of each income or expense item included in accounting profits and taxable profits will
eventually be the same. Therefore, the central characteristic of timing differences is that they originate (arise) in
one or more periods, and reverse (or turnaround) in one or more subsequent periods. Timing differences give
rise to tax effects that are carried forward to one or more subsequent future periods so and accounting entry or
entries should be made to reflect these differences between accounting profits and taxable profits.
Permanent differences – these are the differences between taxable profits and accounting profits for a period
that originate in the current period but are not capable of reversal (or turnaround) in one or more subsequent
future periods. They relate to items of income that are tax-free and items of expenses that are disallowed for
income tax purposes. The permanent differences arise because the items of income or expenses are either
included in accounting profits without a corresponding inclusion in taxable profit. Permanent differences do not
give rise to tax effects in one or more future periods as they are not capable of reversal or turnaround. They do
not normally pose an accounting issue. With their presence, the tax expense in a period may be high or low
compared to the profit before taxation, but there are no accounting entries to be made. IAS 12 do not permit an
entity to correct for the distortion of the effective tax expense rate caused by such permanent difference.
There is a deferred tax asset on timing difference when:
• The amount of revenue recognized for taxation exceeds the amount of revenue recognized for financial
purposes; or
• The amount of expense recognized for financial purposes exceeds the amount of expense recognized for
taxation purposes.
There is a deferred tax liability on timing difference when:
• The amount of expense recognized for taxation purposes exceeds the amount recognized for financial
purposes; or
• The amount of revenue for financial purposes exceeds the amount recognized for taxation purposes.
2) Balance Sheet Liability method – the calculation is made by reference to difference between balance sheet
values and tax values of assets and liabilities (temporary differences). Temporary differences are defined in IAS
12 as differences between the carrying amount of an asset or liability and its tax base. The temporary difference
is used because ultimately all differences between the carrying amount of assets and liabilities and their tax bases
will reverse.
The deferred tax is calculated by reference to the tax base of an asset or liability. The tax base is the amount
attributed to the asset or liability for tax purposes.

Page 1 of 6 0915-2303213  www.resacpareview.com

ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
INCOME TAXES FARAP-4412
The tax base of an asset is therefore the amount that will be deductible for tax purposes against any future
taxable benefits derived from the asset. If the benefits will not be taxable, the tax base of the asset is equal to
its carrying amount.
The tax base of a liability is the carrying amount less any amount that will be deductible for tax purposes in
respect of that liability in future periods. In the case of revenue received in advance, the tax base of the resulting
liability is it’s carrying amount, less any amount of the revenue that will not be taxable in future periods.
The difference between the tax base of an asset or liability and its carrying value is described as a temporary
difference:
• If the carrying value of an asset exceeds the tax base, tax on the difference is taxable temporary
• difference (deferred tax liability).
• If the carrying value of an asset is less than the tax base, tax on the difference is a deductible temporary
difference (deferred tax asset).
• If the carrying value of a liability exceeds the tax base, tax on the difference is a deductible temporary
difference (deferred tax asset).
• If the carrying value of a liability is less than the tax base, tax on the difference is a taxable temporary
difference (deferred tax liability).
Measurement
1. 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.
2. Deferred tax assets and liabilities shall be measured at the tax rates that are expected to apply to the period
when the asset is realized 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.
3. When different tax rates apply to different levels of taxable income, deferred tax assets and liabilities are
measured using the average rates that are expected to apply to the taxable profit (tax loss) of the periods in
which the temporary differences are expected to reverse.
4. The measurement of deferred tax liabilities and deferred tax assets shall reflect the tax consequences that
would follow from the manner in which the entity expects, at the end of the reporting period, to recover or
settle the carrying amount of its assets and liabilities.
FINANCIAL ACCOUNTING AND REPORTING - THEORIES
1. Which of the following statements is correct regarding deferred taxes under IFRS?
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.
2. At financial reporting purposes but not for tax purposes. When this asset is recovered in 20121, a future
taxable amount will occur and
a. pretax financial income will exceed taxable income in 2021.
b. X Company will record a decrease in a deferred tax liability in 2021.
c. total income tax expense for 2021 will exceed current tax expense for 2021.
d. X Company will record an increase in a deferred tax asset in 2021
3. Assuming a 40% statutory tax rate applies to all years involved, which of the following situations will give
rise to reporting a deferred tax liability on the balance sheet?
I. A revenue is deferred for financial reporting purposes but not for tax purposes.
II. A revenue is deferred for tax purposes but not for financial reporting purposes.
III. An expense is deferred for financial reporting purposes but not for tax purposes.
IV. An expense is deferred for tax purposes but not for financial reporting purposes.
a. item II only
b. items I and II only
c. items II and III only
d. items I and IV only
4. Which of the following is a temporary difference classified as a revenue or gain that is taxable after it is
recognized in financial income?
a. Subscriptions received in advance.
b. Prepaid royalty received in advance.
c. Sales accounted for on the accrual basis for financial reporting purposes and on the installment (cash)
basis for tax purposes.
d. Interest received on government obligations.
5. Which of the following differences would result in future taxable amounts?
a. Expenses or losses that are tax deductible after they are recognized in financial income.
b. Revenues or gains that are taxable before they are recognized in financial income.
c. Revenues or gains that are recognized in financial income but are never included in taxable income.
d. Expenses or losses that are tax deductible before they are recognized in financial income.

Page 2 of 6 0915-2303213  www.resacpareview.com

ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
INCOME TAXES FARAP-4412
6. Stuart Corporation's taxable income differed from its accounting income computed for this past year. An item
that would create a permanent difference in accounting and taxable incomes for Stuart would be
a. a balance in the Unearned Rent account at year end.
b. using accelerated depreciation for tax purposes and straight-line depreciation for book purposes.
c. a fine resulting from violations of environmental regulations.
d. making installment sales during the year.
7. A company uses the equity method to account for an investment. This would result in what type of difference
and in what type of deferred income tax?
Type of Difference Deferred Tax
a. Permanent Asset
b. Permanent Liability
c. Temporary Asset
d. Temporary Liability
8. Which of the following temporary differences results in a deferred tax asset in the year the temporary
difference originates?
I. Accrual for product warranty liability.
II. Subscriptions received in advance.
III. Prepaid insurance expense.
a. I and II only.
b. II only.
c. III only.
d. I and III only.
9. Which of the following is not considered a permanent difference?
a. Interest received on government obligations.
b. Fines resulting from violating the law.
c. Percentage depletion of natural resources.
d. Share-based compensation expense.
10. Statement 1: Permanent differences result from items that enter into pretax financial income but never into
taxable income.
Statement 2: Permanent differences result from items that enter into taxable income but never into pretax
financial income.
Statement 3: Permanent differences affect only the period in which they occur.
a. Only statement 1 is true
b. Only statement 2 is true
c. Only statement 3 is true
d. Only statements 2 and 3 are true
e. All of the statements are true
11. When a change in tax rate is enacted into law, its effect on existing deferred income tax accounts should be
a. handled retroactively in accordance with the guidance related to changes in accounting standards.
b. considered, but it should only be recorded in the accounts if it reduces a deferred tax liability or increases
a deferred tax asset.
c. reported as an adjustment to tax expense in the period of change.
d. applied to all temporary or permanent differences that arise prior to the date of the enactment of the tax
rate change, but not subsequent to the date of the change.
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 or substantially enacted.
d. it appears likely that a future tax rate will be less than the current tax rate.
13. Recognition of tax benefits in the loss year due to a loss carryforward requires
a. the establishment of a deferred tax liability.
b. the establishment of a deferred tax asset.
c. the establishment of an income tax refund receivable.
d. only a note to the financial statements.
14. In determining whether to adjust a deferred tax asset, a company should
a. consider all positive and negative information in determining the need for an adjustment.
b. consider only the positive information in determining the need for an adjustment.
c. take an aggressive approach in its tax planning.
d. pass a recognition threshold, after assuming that it will be audited by taxing authorities.
15. A pretax income always results when
a. revenues exceed operating expenses.
b. revenues exceed the cost of goods sold.
c. the gross margin exceeds operating expenses.
d. the cost of goods sold exceeds operating expenses.
16. How do you call a taxable temporary difference?
a. Current tax asset.
b. Deferred tax asset.
c. Current tax liability.
d. Deferred tax liability.

Page 3 of 6 0915-2303213  www.resacpareview.com

ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
INCOME TAXES FARAP-4412
17. Which of the following differences would result in future taxable amounts?
a. Revenues or gains that are taxable before they are recognized in financial income.
b. Expenses or losses that are deductible after they are recognized in financial income.
c. Expenses or losses that are deductible before they are recognized in financial income.
d. Revenues or gains that are recognized in financial income but are never included in taxable income.
18. A temporary difference that would result in a deferred tax asset is
a. accrued warranty expense.
b. accrual commission income.
c. interest revenue on government bonds.
d. excess of tax depreciation over financial accounting depreciation.
19. The current income tax expense (CITE) is:
a. taxable income multiplied by future enacted tax rate.
b. financial income multiplied by current tax rate.
c. taxable income multiplied by current tax rate.
d. financial income multiplied by future enacted tax rate.
20. The deferred income tax expense (DITE) is the:
a. decrease in balance of deferred tax asset minus the increase in balance of deferred tax liability.
b. increase in balance of deferred tax asset plus the increase in balance of deferred tax liability.
c. increase in balance of deferred tax liability minus the increase in balance of deferred tax asset.
d. increase in balance of deferred tax liability minus the changes in balance of deferred tax liability.
21. The total income tax expense (TITE) is the:
a. the sum of current income tax expense and deferred tax liability
b. the difference of current income tax expense and deferred tax expense.
c. the difference of deferred tax liability and deferred tax asset
d. the current income tax expense plus increase in deferred tax liability less increase in deferred tax asset
22. The deferred tax consequence attributable to a deductible temporary difference and operating loss carry
forward is known as
a. current tax
b. total tax expense
c. deferred tax asset
d. deferred tax liability
23. According to PAS 12, deferred tax assets and liabilities should be reported in the financial statement:
a. as noncurrent asset and noncurrent liability.
b. always net in current asset or net current liability.
c. as current and noncurrent depending on the order of liquidity or maturity.
d. as current and noncurrent assets and liabilities depending on the balance sheet classification of the related
tax basis of the temporary difference.
24. Mahal Ka Pa Ba? Company’s financial reporting basis of its plant assets exceeded the tax basis because it
uses a different method of reporting depreciation for financial reporting purposes and tax purposes. If there
is no other temporary differences, Mahal Ka Pa Ba? should report a:
a. current tax asset.
b. deferred tax asset.
c. current tax payable.
d. deferred tax liability
25. Which of the following is true regarding reporting deferred taxes in the financial statements?
a. deferred tax assets and liabilities may be classified as noncurrent only.
b. deferred taxes of one jurisdiction are offset against another jurisdiction in the netting process.
c. deferred tax assets and liabilities are classified as current and noncurrent based on their expiration date.
d. deferred tax assets are netted with deferred tax liabilities to arrive at one amount presented on the
financial statements.

FINANCIAL ACCOUNTING AND REPORTING - PROBLEMS

Problem 1: Love Ko To Corporation reported pretax income of P4,500,000 for the year ended December 31,
2022. The controller is unfamiliar with required treatment of temporary and permanent differences in reconciling
taxable income to pretax financial income and has contacted you for an advice. The company record shows the
following differences:
Tax depreciation in excess of book depreciation P550,000
Proceeds from life insurance policy upon death of an officer* 250,000
Interest revenue on bank deposits 196,000
*The beneficiary of the insurance policy is Love Ko To Corporation.
Tax rate is 30% in 2022 and in the future. Payments in previous quarters totaled P450,000.
1. How much is the total income tax expense for the year 2022?
a. P1,051,200
b. P1,216,200
c. P1,381,200
d. P1,350,000

Page 4 of 6 0915-2303213  www.resacpareview.com

ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
INCOME TAXES FARAP-4412
2. How much is the income tax payable?
a. P766,200
b. P601,200
c. P931,200
d. P1,051,200
Problem 2: Naniniwala Ka Pa Rin Ba Corporation’s income statement for the year ended December 31, 2022,
shows pretax income of P1,000,000. The following are treated differently on the tax return and in the accounting
records:
Tax Return Book records
Rent income P 120,000 P 70,000
Depreciation 220,000 280,000
Premiums on officer’s life insurance* --- 90,000
*the Corporation is the beneficiary of the insurance policy of the officer.
3. Assume that Naniniwala Ka Pa Rin Ba tax rate for 2022 is 30%, what is the amount of income tax
payable for 2022?
a. P270,000
b. P300,000
c. P306,000
d. P360,000
e. P324,000
Problem 3: Tristan Incorporated’s partial income statement after its first year of operation is as follows:
Income before income taxes P3,750,000
Income tax expense
Current P1,035,000
Deferred 90,000 1,125,000
Net Income P2,625,000
Tristan uses straight-line method of depreciation for financial reporting purposes and accelerated depreciation
method for tax purposes. The amount charged to depreciation expenses on its book this year was P1,500,000.
No other differences existed between book income and taxable income except for the amount of depreciation.
4. Assuming a 30% tax rate, what amount was deducted for depreciation on the company’s tax
return for the current year?
a. P1,200,000
b. P1,425,000
c. P1,500,000
d. P1,800,000
Problem 4: Brunei Co. at the end of 2022, its first year of operation, prepared reconciliation between pretax
financial income and taxable income as follows:
Pretax financial income P400,000
Estimated litigation expense 1,000,000
Installment sales (800,000)
Taxable income P600,000
The estimated litigation expenses of P1,000,000 will be deductible in 2023 when it is expected to be paid. The
gross profit from installment sales will be realized in the amount of P500,000 and P300,000 each of the next two
years. The income tax rate is 30% in current year and 32% in future years.
5. How much is the deferred tax asset at year end?
a. P300,000
b. P320,000
c. P340,000
d. P360,000
6. How much is the deferred tax liability at year end?
a. P240,000
b. P248,000
c. P256,000
d. P260,000
Problem 5: Awtsu Company has taxable income for the year 2022 amounting to P5,000,000, The tax bases for
its assets and liabilities at December 31, 2022 are equal to their carrying amounts except for the following items:
Book Tax
Accounts receivable P1,900,000 P2,100,000
Inventories 950,000 850,000
Buildings – net 10,000,000 8,200,000
Provision for warranty 800,000 –
Unearned rent 500,000 –
The company’s statement of financial position as of December 31, 2021 showed deferred tax liability of
P1,400,000 and deferred tax asset of P525,000. Also, Awtsu Company paid a total of P120,000 as penalties
and fines due to late filling and a total of P175,000 was paid to Sagip Insurance Corporation as a premium of
life insurance of the Company’s president where the beneficiary of the said insurance is Awtsu Company.
Moreover, Awtsu Company reported interest income from bank deposits of P65,000 during 2022.

Page 5 of 6 0915-2303213  www.resacpareview.com

ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY
INCOME TAXES FARAP-4412
The company is subject to income tax rate of 30%. It is believed that any deferred tax asset is fully realizable.
The company paid no income tax during 2022 relating to 2022 operations.
7. How much is the pretax financial income of Awtsu in 2022?
a. P7,786,667
b. P5,000,000
c. P4,733,333
d. P2,483,333
e. P2,253,333
8. How much is the current income tax expense in 2022?
a. P1,200,000
b. P1,400,000
c. P1,500,000
d. P1,550,000
9. How much is the future taxable amount and deferred tax liability, respectively as of 2022?
a. P1,900,000 and P570,000
b. P1,500,000 and P450,000
c. P1,550,000 and P465,000
d. P2,766,667 and P830,000
10. How much is the future deductible amount and deferred tax asset, respectively as of 2022?
a. P1,900,000 and P570,000
b. P1,500,000 and P450,000
c. P1,550,000 and P465,000
d. P2,766,667 and P830,000
11. How much is the total income tax expense in 2022?
a. P745,000
b. P755,000
c. P1,500,000
d. P1,550,000
e. P2,336,000
Problem 6: Toner Company has revalued its property and has recognized the increase in the revaluation reserve
in its financial statements. The carrying value of the property was P8,000,000, and the revalued amount was
P10,000,000. The tax base of the property was P7,000,000. The tax rate 32%.
12. What amount of deferred tax that should go directly to equity?
a. None
b. P640,000
c. P320,000
d. P960,000
Problem 7: On January 2, 2022, Alison Company acquired from the stock exchange 20,000 shares of Emilia
Company at the prevailing market price of P60 per share. Alison Company has designated the shares as
Investment at Fair Value to Other Income. On December 31, 2022 the shares of Alison are selling at P68 per
share. On July 1, 2022, Alison Company paid P300,000 for one year insurance that will expire on June 30, 2023.
The current year income tax rate is 32% while the future tax rate is 30%.
13. What amount of deferred tax expense(savings) should the Alison Company disclose in its 2022
profit or loss?
a. P45,000
b. P51,200
c. P48,000
d. P93,000

Problem 8: Titan Company issued a convertible bond on January 1, 2022, that matures in five years. The bond
can be converted into ordinary shares at any time. Titan has calculated that the liability and the equity components
of the bond are P3,000,000 for the liability component and P1,000,000 for the equity component, giving a total
amount of the bond of P4,000,000. The interest rate of the bond is 6% and local tax legislation allows a tax
deduction for the interest paid in cash.
14. What amount of deferred tax should be reported in the profit or loss at the time the bonds were
issued? (Tax rate is 32%.)
a. none
b. P320,000
c. P 960,000
d. P1,200,000

- END -

Page 6 of 6 0915-2303213  www.resacpareview.com