ACCOUNTING FOR INCOME TAX
Lecture Notes
Relevant Standards: PAS 12; (PAS 29 and Section 29 PFRS for SMEs)
Income Taxes include all domestic and foreign taxes which are based on taxable profits.
Accounting profit (income) is profit or loss for a period before deducting tax expense.
Taxable profit (income) is the profit or loss for a period, determined in accordance with the rules
established (i.e. NIRC, Revenue Regulations, etc.) by the taxation authorities (i.e. BIR) upon which income
taxes are payable (recoverable).
The main basis of accounting for income taxes is the recognition of the current and future tax
consequences of:
• The transactions that are recognized in the current period;
• Future recovery of assets in the entity’s statement of financial position; and
• Future settlement of liabilities in the entity’s statement of financial position.
For transactions and other events recognized in profit or loss, any related tax effects are also recognized
in profit or loss. For transactions and other events recognized directly in equity, any related tax effects
are also recognized in equity.
Tax Base
Tax Base of an Asset
The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.
The tax base of an asset is the amount that will be deductible for tax purposes against any taxable
economic benefits that will flow to an entity when it recovers the carrying amount of the asset. If those
economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount.
Tax Base (Asset) = Carrying Amount – Future Taxable Amounts + Future Deductible Amounts
Carrying amounts are asset and liability balances net of valuation allowances, accumulated depreciation,
amortization and impairment losses (for example, accounts receivable less allowance for doubtful debts)
Illustration
Assets Carrying Future Future Tax
Amount Taxable Deductible Base
Amount Amount
Prepayments P3,000 (deductible P3,000 (P3,000) - -
when paid)
Trade Receivables, net of P2,000 50,000 - 2,000 52,000
allowance for bad debts (Sales
already included in taxable income)
PPE costing P10,000; carried at 5,400 (5,400) 3,500 3,500
P5,400; Accumulated depreciation
at tax rates is P6,500
Loan receivable (collection will have 25,000 - - 25,000
no tax consequences)
Interest receivable P1,000 (taxable 1,000 (1,000) - -
income when received)
Dividends receivable from a 5,000 - - 5,000
subsidiary (not taxable)
Tax Base of a Liability
The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes
in respect of that liability in future periods. Liabilities, other than those relating to unearned revenues
(i.e. revenues received in advance), do not create taxable amounts. Instead, settlement gives rise to
deductible items.
PAS 12, paragraph 8 “…In the case of revenue received in advance, the tax base of the
resulting liability is its carrying amount, less any amount of the revenue that will not be
taxable in future periods.”
Tax Base (Liability) = Carrying Amount + Future Taxable Amounts – Future Deductible Amounts
Illustration
Liabilities Carrying Future Future Tax
Amount Taxable Deductible Base
Amount Amount
Provision for annual leave P3,900 P3,900 - (P3,900) -
(deductible when paid)
Trade payables P34,000 (expense 34,000 - - 34,000
already deducted from taxable
income)
Subscription revenue received in 500 (500) - -
advance P500 (taxed when
received)
Loan payable P20,000 (repayment 20,000 - - 20,000
will have no tax consequences)
Accrued expenses P6,700 6,700 - (6,700) -
(deductible when paid)
Accrued fines and penalties P700 700 - - 700
(not tax deductible)
Accounting income (AI) Taxable Income (TI)
Net Income – (accrual basis) Taxable revenue – deductible expense
Traditional income – Income statement Income that appears in the ITR (tax law)
Accordance with accounting standards Accordance with the rules by taxation authorities
Arising differences between accounting and taxable income
Permanent difference Temporary difference
- Included in either Accounting Income or - Difference between carrying (CA) of assets/
Taxable Income but never included in the liabilities and its tax base (TB).
other.
- Nontaxable revenue and nondeductible - Include timing difference (included in both
expenses but at different time periods)
- No future tax consequence - Give rise to deferred tax asset or deferred
tax liability
- EXAMPLES .
Non-deductible Non-taxable Income already Taxable Temporary Deductible Temporary
expenses Revenue subjected to Difference Difference
final
- results in taxable - results in deductible
withholding tax
Premiums paid on Gains from the Interest income amount in amount in
any life insurance sale of bonds, on deposits determining taxable determining taxable
policy covering the debentures or (usually subject income (loss) of income (loss) of
life of any officer or other certificates to 20% final tax)
future periods when future periods when
employee when the of indebtedness
taxpayer is directly with maturity of the carrying amount the carrying amount
or indirectly a more than 5 of the asset or liability of the asset or
beneficiary under years is settled. liability is recovered
such policy.
Payments for fines, Gifts or Dividend income
- Results to future or settled
penalties and/or donations received by a taxable amount (SEE - Results to future
EXAMPLES BELOW)
surcharges received non-resident deductible amount
foreign (SEE EXAMPLES BELOW)
corporation from - Deferred Tax Liability - Deferred Tax Asset
a domestic
(DTL) (DTA)
corporation is - AI >TI - TI > AI
subject to 20%
- (SEE EXAMPLES BELOW) - (SEE EXAMPLES BELOW)
final tax (rule of
reciprocity)
- CA of Asset > TB - CA of Asset < TB
Representation Dividend income Royalty income: - CA of Liabilities<TB - CA of Liability >TB
expenses received by a Generally subject
(entertainment, domestic or to 20% final tax
.
amusement and resident foreign If royalty is on
recreation expense), corporation from books, literary
in excess of the a domestic works and
ceilings prescribed corporation musical
by taxation subject to tax composition, it is
authorities. (For (inter-corporate subject to 10%
taxpayers engaged dividend) final tax
in sale of
goods/properties,
ceiling is ½% of net
sales; for taxpayers
engaged in sale of
services, ceiling is
1% of net revenue)
NOTE: Also, there are items of income that are, though taxable, excluded in the determination of the
taxable income in determining the current tax payable for the taxable period, the current tax payable being
the normal tax or regular corporate income tax (i.e. 30%). The reason why these taxable items are not
included in taxable income for purposes of computing current tax payable is because they are already
taxed at source, that is, the tax has been already computed and deducted/withheld by the source upon
receipt and taxation for these items is already ended at that point in time, hence the caption “final
withholding tax”.
Examples of TAXABLE TEMPORARY DIFFERENCES:
Item Financial Accounting Applicable Income Taxation Rules
Treatment (PASs/PFRSs) (NIRC)
Interest Income Earned: Effective interest method Collected: Cash basis
Depreciation SLM, DBM, SYD, Output Method: SLM, DBM, SYD & other methods prescribed
Rational and systematic allocation by Sec. of Finance: Reasonable allowance
to reduce useful value (tax depreciation
may set by authorities may differ from that
used by the entity on its books)
Development costs Capitalized and amortized over Either:
useful life - Deducted from gross income in the year
incurred, or
- Deferred and amortized over a period of
not less than 60 months beginning with
the month in which the taxpayer first
realizes benefits from such expenditures
Write-off of bad debts No effect on net income: Deduction from net income:
Allowance method Direct write-off method
Prepaid expenses Recognized initially as asset and A deduction in the year paid
expense in the period incurred:
Expense recognition principle
Examples of DEDUCTIBLE TEMPORARY DIFFERENCES:
Item Financial Accounting Applicable Income Taxation Rules
Treatment (PASs/PFRSs) (NIRC)
Retirement benefit Expense as service is rendered by Deduction is lower of:
cost employees: Defined Benefit Plan Contributions paid by the entity to the fund
or Defined Contribution Plan or trustee (actual contribution), and
Provision for the payment of reasonable
pensions to employees (actuarial valuation)
: Reasonable private benefit plan approved
by the BIR (RA 4917)
(add’l note: excess of actual contribution
Item Financial Accounting Applicable Income Taxation Rules
Treatment (PASs/PFRSs) (NIRC)
over actuarial valuation is to be amortized
over 10 years, Sec 34j, NIRC)
Research costs Expense when incurred Either:
Deducted from gross income in the year
incurred, or
Deferred and amortized over a period of not
less than 60 months beginning with the
month in which the taxpayer first realizes
benefits from such expenditures
Provision for bad Affects net income: Allowance Not a deduction until write-off: Direct write-
debts method off method
Provisions for Recognized if both probable and Deduction when actually paid
estimated liabilities measurable: Conservatism
(e.g. warranties,
premiums, litigation
losses
Unearned rent (rent Recognized initially as liability and Treated by the lessor as taxable income
received in advance) recorded as revenue in the period when received regardless of the basis of
earned: Revenue recognition accounting used
principle
SITUATIONS, when;
Accounting Income is higher than taxable income Taxable income higher than accounting income
- Tax consequence - Deferred tax liability - Tax consequence - Deferred tax asset
- Revenue and gains included in accounting but - Rev and gains included in tax’l income in
taxable in future periods. “Accrued income” current period but in future for accounting.
“Cash collected”
- Expenses and losses are deductible for tax - Expenses and losses deducted in
purposes in the current period but deductible accounting at current but future for tax.
in future for accounting income computation. - Provision for litigation; included in tax
- Actual payment of development cost when actually paid
- Prepaid expenses - Provision for warranty; included in tax
when actually paid
- Research cost
- Impairment loss for accounting but when
actually sold for tax
- Bad debts for accounting but when written
off in tax
Other taxable temp differences Other deductible temp differences
- Asset revalued upward for accounting but no - Assets revalued downward and no
equiv. adjustment for tax equivalent adjustment for tax purposes
- Carrying amount of investment in subsidiary, - Carrying amount of investment in
associate, joint venture is higher than tax subsidiary, associate, joint venture is lower
base – entire income not distributed to than tax base – suffered continuing loss in
parent the current and past years
- Fair Value in business combination accounted - AFS carried at fair value which is less than
for as fair value but no equivalent adjustment cost but no equivalent adjustment for tax
for tax base purposes
Also, a deferred tax asset shall be recognized for the carry-forward of unused tax losses and unused tax
credits to the extent that it is probable that future taxable profit will be available against which the unused
tax losses and unused tax credits can be utilized. Therefore, deferred tax assets may be recognized for
Net operating loss carry-over (NOLCO) for losses sustained during the year and Prepaid/Unused Minimum
Corporate Income Tax (MCIT) in cases where current tax payable is based on 2% of gross income rather
than the 30% normal tax for corporate taxpayers.
The carrying amount of deferred tax asset shall be reviewed at each balance sheet date. An entity shall
reduce the carrying amount of a deferred tax asset to the extent that it is no longer probable that sufficient
taxable profit will be available to allow the benefit of part or that entire deferred tax asset to be utilized.
No tax consequence on the following:
Deferred tax liability not recognized
1. GOODWILL from business combination is nondeductible for tax purposes.
2. Initial recognition of asset or liability which is not a business combination and at the time of the
transaction affects neither Accounting Income or Taxable Income
3. Undistributed profit of subsidiary, associate., joint venture, when
- Parent able to control the timing or reversal of temporary difference
- Probable that temporary difference will not reverse in the future
As previously indicated, when the carrying amount of the asset exceeds its tax base, the amount of taxable
economic benefits will exceed the amount that will be allowed as a deduction for tax purposes. This
creates an additional income tax obligation to pay for the difference, the payment of which is postponed or
deferred to the future, hence the deferred tax liability. The future period in which the deferred tax
obligation becomes payable is the period of reversal.
Method of accounting
Income statement approach Statement of financial position approach
- Computation of timing differences only - Considers all temporary difference
Deferred Tax Asset and Deferred Tax Liability - REQUIRED by PAS 12
Accounting procedures:
1. Determine tax’l income. TI time current tax rate = current tax expense
Entry:
Income tax expense -------------xx
Income tax payable --------------xx
2. Determine the taxable temporary differences. TTD X TR = DTL
Entry:
Income tax expense ------------xx
Deferred tax liability -------------xx
3. Determine the deductible temp differences; DTD X TR = DTA
Entry:
DTA --------------------xx
Income tax benefit/ ITE ---------------xx
4. Total income tax expense – use T account to summarize
The total income tax expense is actually the accounting income subject to tax X tax rate
Current Tax Liabilities and Current Tax Assets
An entity should recognize a liability in the statement of financial position to the extent of the unpaid
current tax relating to the current and prior years. If the amount of tax already paid in respect of current
and prior periods exceeds the amount due for those periods, the excess shall be recognized as an asset.
Current tax should be recognized as income or expense and included in the net profit or loss for the period.
The current tax liabilities and current tax assets for the current and prior periods should be measured at
the amount that is expected to be paid to, or recovered from, the tax authorities, using the tax rates and
the tax laws that relate to the reporting period (i.e. enacted current tax rates).
Measurement of Deferred Taxes
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 by the balance sheet date.
In some cases, the manner in which an entity recovers (settles) the carrying amount of an asset (liability)
may affect either or both of:
(a) The tax rate applicable when the entity recovers (settles) the carrying amount of the asset or
(liability); and
(b) The tax base of the asset (liability)
In such cases, an entity measures deferred tax liabilities and deferred tax assets using the tax rate and the
tax base that are consistent with the expected manner of recovery or settlement.
At any rate, deferred tax assets and liabilities shall not be discounted. [Applying full PFRS]
For deferred tax assets, an entity shall recognize a valuation allowance against deferred tax assets so
that the net amount equals the highest amount that is more likely than not to be realized on the basis of
current or future taxable profit. [Applying PFRS for SMEs]
Under PAS 12, the tax basis of assets and liabilities is determined by the manner it is recovered through
“use”. [Applying full PFRS]
However, under the changes proposed in the Exposure Draft from which the guidance on income taxes for
SMEs are based, the tax basis of assets and liabilities is determined by the consequences of the sale of the
assets or settlement of liabilities for their present carrying amounts. [Applying PFRS for SMEs]
Illustration
An asset has a carrying amount of P100,000 and a tax base of P60,000. A tax rate of 20% would apply if
the asset were sold and a tax rate of 30% would apply to other income. Determine the deferred tax
liability assuming the entity expects to:
a) Sell the asset without further use Answer: P8,000
b) Retain the asset and recover its carrying amount through use Answer: 12,000
Presentation of DTA/ DTL
- Shall not classify DTA/DTL as current. DTA – noncurrent asset; DTL – noncurrent liabilities
regardless of their reversal period; the amount shall not be discounted
- PAS 1 prohibits the offset of DTA and DTL unless otherwise permitted by other standard.
- PAS 12 provides for offset when:
1. DTA and DTL relate to income taxes levied by the same tax authority
2. The entity has legal enforceable right to offset current tax asset against current tax liability
An entity shall offset current tax assets and current liabilities if, and only if, the entity:
(a) Has a legally enforceable right to set off the recognized amounts; and
(b) Intends either to settle on a net basis, or to realize the asset and settle the liability simultaneously
Intra-period tax allocation Inter-period tax allocation
- Allocation of income tax to various revenues that - Recognition of DTA and DTL
brought about the tax; from continuing operation,
discontinued operation; Prior Period Errors
