INCOME TAXES

RELATED STANDARDS: PAS 12 – INCOME TAXES

TOPIC OUTLINE
Basic Concepts

Temporary Differences

Tax Base

Accounting for Deferred

INCOME TAXES (PAS 12) Taxes

Initial Recognition

Presentation and
Disclosure
Intraperiod vs. Interperiod Tax
Allocations
LECTURE NOTES
BASIC CONCEPTS
PAS 12 prescribes the accounting for income taxes. This standard applies to ALL ENTITIES, whether
public or non-public entities. A public entity is one whose equity and debt securities are traded in a stock
exchange or over-the-counter market or whose equity or debt securities are registered with SEC in
preparation for sale of the securities in the exchange market.
According to PAS 12, there are two types of income resulting to different computation of income tax.
Accounting or Financial Income Taxable Income
❖ Income and expenses are recorded and ❖ Income and expenses are recorded and
computed using PFRS. computed using TAX LAWS.
❖ Income computation is to be used for ❖ Income computation is to be used for
EXTERNAL REPORTING. DETERMINATION OF TAX PAYABLE or
RECOVERABLE.
Since there is a varying treatment of transactions and events between PFRS and the tax code, the following
differences were created:
✓ Permanent differences are items of revenue and expenses which are included in either accounting
income or taxable income but will never be included in the other.
✓ Temporary differences are differences between the carrying amount of an asset or liability and its tax
base. Temporary differences include timing differences. Timing differences are differences between
accounting income and taxable income that originate in one period and reverse in one or more
subsequent periods.
Examples of Permanent Differences
✓ Non-taxable income (e.g. interest income from government securities)
✓ Non-deductible expense (e.g. life insurance premium where the entity is the irrevocable beneficiary,
fines and penalties, loss on expropriation of property, goodwill impairment loss
✓ Income subject to final tax
Simply stated, these are items excluded in the income tax return.
TEMPORARY DIFFERENCES
Temporary differences may be either:
(1) Taxable temporary difference (TTD) – results to future taxable amounts when the carrying amount of
the asset or liability is recovered or settled.
(2) Deductible temporary difference (DTD) – results to future deductible amounts when the carrying
amount of the asset or liability is recovered or settled.

Taxable Temporary Difference (TTD) Deductible Temporary Difference (DTD)

❖ F.I. > T.I ❖ F.I. < T.I
❖ For Assets: CA > TB ❖ For Assets: CA < TB
❖ For Liabilities: CA < TB ❖ For Liabilities: CA > TB
❖ Gives rise to Deferred Tax Liability (DTL) ❖ Gives rise to Deferred Tax Asset (DTA)
Examples of TTD
✓ Installment sales
✓ Prepayments
✓ Straight-line depreciation for financial reporting while accelerated depreciation expense for taxation
✓ Revaluation surplus
Examples of DTD
✓ Unearned income
✓ Accrued expenses
✓ Accelerated depreciation for financial reporting while straight-line depreciation expense for taxation
✓ Bad debt expense
TAX BASE
The tax base of an asset or a liability is the amount attributable to the asset or liability for tax purposes.
Simply stated, tax base is the carrying amount of asset or liability under tax laws.
The tax base of an asset is the amount that will be deductible for tax purposes against future profit. On the
other hand, the tax base of a liability is normally the carrying amount less the amount that will be
deductible for tax purposes in the future.
Simple guide in determining the tax base:
❖ If the asset is a depreciable or amortizable asset:
Tax base = Cost less accumulated depreciation/amortization per tax laws.
❖ If the transaction is taxable only when cash is collected
Tax base = Zero
❖ If the transaction has no future tax consequence
Tax base = Carrying Amount
ACCOUNTING FOR DEFERRED TAXES
(1) Income Statement Method - This approach focuses on timing differences only in the computation of
deferred tax asset or deferred tax liability.
NOTE: Not all temporary differences are timing differences.
(2) Balance Sheet Method - This approach considers all temporary differences including timing
differences. There are temporary differences that affect the statement of financial position only and
therefore technically are not timing differences but nonetheless are recognized in computing deferred
tax asset or liability. PAS 12 requires the use of the statement of financial position approach.
COMPUTATION AND MEASUREMENT OF TAX EXPENSE
The following template shall be used in computing the current tax expense (benefit), deferred tax expense
(benefit) and total tax expense (benefit):
Accounting Income xx
Permanent Differences:
Less: Non-deductible
Income & Income Subj.
to Final Tax (xx)
Add: Non-deductible
Expense xx
Profit Subj. to Tax xx
Temporary Differences:
TTD:
↑ (Increase) (xx)
Deferred Tax Liability
↓ (Decrease) xx Multiply by
DTD: Future Enacted Tax Rate
↑ (Increase) xx
Deferred Tax Asset
↓ (Decrease) (xx)
Taxable Income xx Multiply by Current Tax Rate Current Tax Expense
NOTES:
❖ When different tax rates apply to different levels of taxable income, use average rates.
❖ Only the expense and benefit can be offset, DTA and DTL are presented separately.
❖ DTA and DTL are NOT DISCOUNTED and are presented as non-current items.
❖ Generally current tax expense (CTE) is equal to current tax liability (CTL) unless there are quarterly
tax payments and tax credits which should be deducted to arrive at CTL or CTA.
❖ Total income tax expense (TITE) is the total amount of current tax expense and net movement of
deferred tax expense or benefit.
INITIAL RECOGNITION
(1) Deferred Tax Liability:
It is recognized for all taxable temporary differences, except those that arise from the following:
❖ Goodwill resulting from a business combination and which is nondeductible for tax purposes.
 ❖ Initial recognition of an asset or liability in a transaction that is not a business combination and
affects neither accounting income nor taxable income.
❖ Undistributed profit of subsidiary, associate or joint venture when the parent, investor or
venturer is able to control the timing of the reversal of the temporary difference and it is
probable that the temporary difference will not reverse in the foreseeable future.
(2) Deferred Tax Asset:
A deferred tax asset shall be recognized for all deductible temporary differences and operating loss
carry-forward when it is probable that taxable income will be available against which the deferred tax
asset can be used.
INTRAPERIOD AND INTERPERIOD TAX ALLOCATIONS
Intraperiod tax allocation is the allocation of income tax expense to the various revenues that brought
about the tax. Accordingly, income tax is allocated to the following:
(a) Profit or loss from continuing operations
(b) Profit or loss from discontinued operations
(c) Components of other comprehensive income
(d) Items recognized directly in retained earnings
Interperiod tax allocation is the recognition of a deferred tax asset or deferred tax liability. It is concerned
with the accounting for temporary differences
PRESENTATION
Current and deferred taxes - Generally presented in profit or loss, exception is presented in OCI or OCL or
directly to equity (according to intraperiod allocation).
Current tax liability or asset – Presented in the current liability or asset section of balance sheet.
Deferred tax liability or asset - Presented in the non-current liability or asset section of balance sheet.

QUIZZER (DO-IT-YOURSELF DRILL)

THEORIES
1. I. All entities, whether public or non-public, are required to prescribe the requirements of PAS 12
in accounting their income tax.
II. Accounting profit or income refers to profit or loss as determined by relevant tax laws
established by taxing authorities.
A. True, false C. False, false
B. False, true D. True, true
2. These are differences that result in future deductible amount in determining taxable profit in future
periods when the carrying amount of the asset or liability recovered or settled.
A. Taxable temporary differences
B. Deductible temporary differences
C. Taxable temporary and permanent differences
D. Deductible temporary and permanent differences
3. Permanent differences exclude the following except:
I. Interest income from bank deposits
II. Installment sale recognized fully based from PFRS but income when cash is received for tax
purposes.
III. Dividend Income from a domestic corporation (the company is also a domestic corporation)
A. I and II D. I, II and III
B. II and III E. Answer not given
C. I and III
4. Which of the following differences would result in future taxable amount?
A. Revenues or gains that are taxable before they are recognized in accounting income.
B. Expenses or losses that are deductible after they are recognized in accounting income.
C. Expenses or losses that are deductible before they are recognized in accounting income.
D. Revenues or gains that are recognized in accounting income but are never included in taxable
income.
5. Which of the following statements is (are) incorrect?
I. If financial accounting income is greater than taxable income, it will result to a taxable
temporary difference, thus a deferred tax asset.
II. The tax base of an asset is the amount that will be deductible for tax purposes against future
profit, while the tax base of a liability is normally the carrying amount less the amount that will
be deductible for tax purposes in the future.
III. If the carrying amount of the asset is less than its tax base, it will result to a taxable temporary
difference, thus a deferred tax liability.
 A. I and II D. I, II and III
B. II and III E. Answer not given
C. I and III
6. An example of a deductible temporary difference occurs when
I. An asset is revalued upward and no equivalent adjustment is made for tax purposes.
II. Warranty expenses are recognized on the accrual basis for financial accounting purposes but
recognized for tax purposes as the warranty conditions are met.
III. Accelerated depreciation was used under financial reporting while straight-line method was used
for taxation purposes.
A. I and II D. I, II and III
B. II and III E. Answer not given
C. I and III
7. Which of the following is an example of a temporary difference that would result in a deferred tax
liability?
A. Investment losses recognized earlier for accounting purposes than for tax purposes.
B. Use of a shorter depreciation period for accounting purposes than is used for income tax
purposes.
C. Use of straight-line depreciation for accounting purposes and an accelerated rate for income tax
purposes.
D. Rent revenue collected in advance when included in taxable income before it is included in
pretax accounting income.
8. I. All timing differences are temporary differences but not all temporary differences are timing
differences.
II. The deferred tax expense is equal to amount of the current liability plus the sum of the net
changes in deferred tax assets and deferred tax liabilities
III. In computing the current tax expense, future enacted tax rate shall be used.
A. False, true, true D. True, true, false
B. True, false, false E. False, false, false
C. False, true, false

9. PAS 12 requires the use of _________ method is accounting for deferred taxes.
I. Balance sheet liability method II. Income statement liability method
A. I only C. Either I or II
B. II only D. Neither I nor II
SOLUTION:
PAS 12 requires the use of balance sheet liability method is accounting for deferred taxes.
10. An entity shall offset a deferred tax asset and deferred tax liability when
I. The deferred tax asset and deferred tax liability relate to income taxes levied by the same
taxing authority.
II. The entity has a legal enforceable right to offset a current tax asset against a current tax
liability.
A. I only C. Both I and II
B. II only D. Neither I nor II
11. A deferred tax liability may be recognized on which of the following situation?
I. Undistributed profit of an associate where the investor has no control of timing of reversal of the
taxable temporary difference.
II. Initial recognition of goodwill
III. A prepayment is capitalized and amortized as expense under financial reporting but deducted in
full as expense upon full payment of such.
A. I and II D. I, II and III
B. II and III E. Answer not given
C. I and III
12. A deferred tax asset shall be recognized for all deductible temporary differences and operating loss
carry-forward when
A. It is probable that taxable income will be available against which the deferred tax asset can be
used.
B. It is possible that taxable income will be available against which the deferred tax asset can be
used.
C. It is probable that accounting income will be available against which the deferred tax asset can
be used.
D. It is possible that accounting income will be available against which the deferred tax asset can
be used.
13. Which of the following statements is true about intraperiod tax allocation?
A. The purpose is to relate the income tax expense to the items which affect the amount of tax.
B. It is required for the cumulative effect of accounting changes but not for prior period errors.
C. The purpose is to allocate income tax expense evenly over a number of accounting periods.
D. It arises because certain revenue and expense items appear in the income statement either
before or after they are included in the tax return.
14. Based from intraperiod allocation, income tax expense should be allocated to which of the following?
I. Income from continuing operations III. Prior period error
II. Item of other comprehensive income IV. Gross Margin
A. I and II only D. I, II, III and IV
B. II and IV only E. I only
C. I, II and III only
15. Deferred taxes are classified in the statement of financial positions as:
A. Current asset
B. Non-current items
C. Non-current liability
D. Either current or non-current depending on the date of reversal of temporary differences
16. S1: Temporary differences are items of revenue and expenses which are included in either accounting
income or taxable income but will never be included in the other.
S2: Permanent differences are differences between the carrying amount of an asset or liability and its
tax base.
A. True, false C. False, false
B. False, true D. True, true
17. Recognizing tax benefits in a loss year due to a loss carry-forward requires
A. Only a footnote disclosure.
B. Creating a deferred tax asset.
C. Creating a deferred tax liability.
D. Creating a new carry-forward for the next year.
18. Which of the following statements is true in relation to deferred tax?
I. Development costs have been capitalized and amortized but were deducted in determining
taxable profit in the period in which they were incurred. This will give rise to a deferred tax
asset.
II. The tax base for a machine for tax purposes is greater than the carrying amount in the financial
statements up to the end of the reporting period. This will give rise to a deferred tax asset.
A. I only C. Both I and II
B. II only D. Neither I nor II
19. S1: If the carrying value of an asset is less than the tax base, tax on the difference is a deductible
temporary difference
S2: If the carrying value of a liability is less than the tax base, tax on the difference is a deductible
temporary difference
A. True, false C. False, false
B. False, true D. True, true
20. An entity reported deferred tax assets and deferred tax liabilities at the end of the prior year and at
the end of the current year. For the current year, the entity should report deferred income tax
expense or benefit equal to the
A. Decrease in the deferred tax assets
B. Increase in the deferred tax liabilities
C. Sum of the net changes in deferred tax assets and deferred tax liabilities
D. Amount of the current liability plus the sum of the net changes in deferred tax assets and
deferred tax liabilities

PROBLEMS
1. LOVE INC. has a policy of using non-current assets until they can no longer operate and are
worthless. On January 1, 2015, 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 disposals.
What deferred tax balance should LOVE recognized at December 31, 2015, according to PAS 12
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
2. WISDOM CORP. is determining the amount of pretax accounting income for the current year by
making adjustment to taxable income from income tax return. The tax return showed taxable income
of P4,000,000 on which a tax liability of P1,200,000 has been recognized. Following is the list of items
that may be required to determine pretax accounting income from the amount of taxable income:
• Accelerated depreciation for income tax purposes was P500,000. Straight line financial
depreciation on the assets is P400,000.
• Goodwill impairment loss of P300,000 was not included as a deduction in the tax return but may
be deducted in the income statement.
• Interest income on treasury bills was not included in the tax return. During the year, P600,000
was received on these investments.
What is the pretax accounting income?
A. 4,100,000 C. 4,300,000
B. 4,200,000 D. 4,400,000
Use the following information in answering the next item(s):
In 2014, PEACE COMPANY received interest income of 100,000 on government obligations and
P600,000 in royalties under a licensing agreement. Royalties are reported as taxable income in the
year received, but in the financial statements, royalties are recognized as income in the year earned
and amount to P400,000 for the year ended December 31, 2014. The effective income tax rate of
Collector Corporation is 32%.
3. Using the income statement liability method, by what amount would the deferred income tax asset
account balance increase?
A. P32,000 C. P80,000
B. P64,000 D. P96,000
4. Using the balance sheet liability method, by what amount would the deferred income tax asset
account balance increase?
A. P32,000 C. P80,000
B. P64,000 D. P96,000
5. For the year ended December 31, 2013, INTELLIGENCE COMPANY reported accounting income of
P9,000,000 before income tax. Selected information for the current year is available as follows:
Interest income on government bonds 700,000
Depreciation claimed on tax return in excess
of depreciation per book 1,300,000
Warranty expense on the accrual basis 600,000
Actual warranty payment 300,000
Income from installment sale reported for tax
purposes in excess of income recognized per book 200,000
Income tax rate 30%
What is the current tax liability on December 31,2013?
A. 2,130,000 C. 2,490,000
B. 2,250,000 D. 2,700,000
6. COURAGE CORP. was organized on January 1, 2014. The entity had pretax accounting income of
P500,000 and taxable income of P800,000 for the year ended December 31, 2014. The only
temporary difference is accrued product warranty costs that are expected to be paid as follows:
2015 100,000 2017 50,000
2016 50,000 2018 100,000
The entity has never had any net operating losses and does not expect any in the future. The enacted
income tax rates are 35% for 2014, 30% for 2015 through 2017, and 25% for 2018.
On December 31, 2014, what amount should be reported as deferred tax asset?
A. 60,000 C. 85,000
B. 70,000 D. 105,000
Use the following information in answering the next item(s):
As of December 31, 2018, LOYALTY CORP. has a pretax income of P200,000. The following
information was gathered in connection with the computation of its income tax payable:
Loss on expropriation of property P20,000
Premiums on life insurance of key employees
(LOYALTY was the irrevocable beneficiary) 10,000
Interest income from government treasury bills 5,000
Fines and penalties 7,000
Excess of accelerated depreciation used in taxation over
Straight-line method in financial reporting 20,000
Accrued warranty expense 8,000
 Advance rental received 15,000
Interest receivable 4,000
Bad debts recognized under allowance method 9,000
Other Information:
• The quarterly tax payments of the company (cumulative from 1st – 3rd quarter) was P30,000.
• The current tax rate and expected enacted tax rate in the future is 30%.
• Beginning balance of taxable and deductible temporary difference was P15,000 andP25,000,
respectively
• For income tax computation, the tax laws prescribe cash basis of accounting for the company’s
revenues and expenses. All of the expenses and revenues are recognized by LOYALTY under
accrual basis.
7. How much is the total income tax expense?
A. 72,000 C. 69,600
B. 2,400 D. 4,800
8. Compute for the current tax expense
A. 72,000 C. 69,600
B. 2,400 D. 4,800

9. How much is the current tax payable

A. 72,000 C. 42,000
B. 52,000 D. 39,600
10. What amount is to be presented in the statement of financial position as deferred tax liability on
December 31, 2018?
A. 7,200 C. 14,100
B. 11,700 D. Nil
11. What amount is to be presented in the statement of financial position as deferred tax asset on
December 31, 2018?
A. 7,500 C. 14,700
B. 11,700 D. 17,100

12. RESPECT CORP. has three financial statement elements for which the December 31, 2014 book value
is different than the December 31, 2014 tax basis:
Book Value Tax Basis Difference
Equipment P1,000,000 P600,000 P400,000
Prepaid officer's insurance policy 375,000 -0- 375,000
Warranty liability ( 250,000) -0- (250,000)
As a result of these differences, future taxable amounts are
A. P250,000 C. P 775,000
B. P400,000 D. P1,025,000

Use the following information in answering the next item(s):

COMPASSION CORP. started operations on January 4, 2018. Information of temporary and permanent
difference during the first two years of operations was as follows:
December 31, 2018 (all amounts in pesos)
Carrying amount Tax base Difference
Assets 200,000 170,000 30,000
Liabilities 70,000 50,000 20,000
December 31, 2019 (all amounts in pesos)
Carrying amount Tax base Difference
Assets 160,000 125,000 35,000
Liabilities 50,000 40,000 10,000
The pretax income for the years 2018 and 2019 was P250,000 and P300,000, respectively. On 2018,
the entity accrued an interest as an income from its investment on government bonds amounting to
50,000. The income tax rate for December 31, 2018 was 30% and the enacted income tax rate for
the subsequent years will be 32%.
13. What is the total income tax expense for the year 2018?
A. 60,000 C. 75,200
B. 72,000 D. 60,200
14. The current tax expense for 2019 is
A. 91,200 C. 88,000
B. 85,500 D. 82,500
Use the following information in answering the next item(s):
FEAR CORP. reported the following differences between the book basis and tax basis of assets and
liabilities on December 31, 2013:
Carrying amount Tax base
Installment accounts receivable 1,000,000 0
Litigation liability 200,000 0
It is expected that the litigation liability will be settled in 2014. The difference in accounts receivable
will result in taxable amounts of P600,000 in 2014 and P400,000 in 2015. The entity has a taxable
income of P7,000,000 in 2013 and is expected to have taxable income in each of the following two
years. The income tax rate is 30%. This is the first year of operations and the operating cycle of the
business is two years.
15. What is the current tax expense?
A. 2,040,000 C. 2,400,000
B. 2,100,000 D. 2,460,000 P2,100,000
16. What is the deferred tax expense?
A. 60,000 C. 300,000
B. 240,000 D. 360,000

17. What is the total tax expense?

A. 1,860,000 C. 2,340,000
B. 2,400,000 D. 2,460,000
Use the following information in answering the next item(s):
BRIGHT CORP. reports pretax financial income of P700,000 for 2014. The following caused taxable
income to be different than financial income:
❖ Depreciation on the tax return is greater than depreciation on the income statement by
P160,000.
❖ Rent collected on the tax return is greater than rent earned on the income statement by
P220,000.
❖ Fines for pollution appears as an expense of P110,000 on the income statement.
BRIGHT’s tax rate is 32% for all years and the company expects to report taxable income in all future
years. There are no deferred taxes at the beginning of 2014.
18. What is the amount of income tax liability for 2014?
A. P224,000 C. P278,400
B. P259,200 D. P329,600

19. WISDOM CORP. began operations on January 1, 2014. For financial reporting, WISDOM recognizes
revenue from all sales under the accrual method. However, in its income tax returns, Tower reports
qualifying sales under the installment method. Tower's gross profit on these installment sales under
each method was as follows:
Year Accrual method Installment method
2014 P1,600,000 P 600,000
2015 2,600,000 1,400,000
The income tax rate is 30% for 2014 and future years. There are no other temporary or permanent
differences. In its December 31, 2015 balance sheet, what amount should WISDOM report as liability
for deferred income taxes?
A. P360,000 C. P660,000
B. P600,000 D. P840,000