DEVELOPMENTAL ACTIVITIES

 Accounting for Income Tax

Deferred tax accounting is applicable to all entities, whether public or nonpublic entities.

Accounting income or financial income (accounting per book/record) is the net income for the
period before deducting income tax expense. It is the traditional income statement.

Taxable income is the net income for the period determined in accordance with the rules
established by the taxation authorizes upon which income taxes are payable or recoverable. It is the
income appearing in the income tax return (BIR).

Taxable income= Taxable revenue-tax deductible expense-exemptions

Two (2) differences between accounting and taxable income

1. Permanent differences
-items of revenue and expense which are included in either accounting income or taxable
income but will never be included in the other. It pertains to
1.1 nontaxable revenue
1.2 nondeductible expense

- Do not give rise to deferred tax asset (DTA) and deferred tax liability (DTL) because they
have no future tax consequences.
- Examples include the ffg.
a. Interest income
b. Dividends received
c. Life insurance premium
d. Tax penalties, surcharges and fines are nondeductible

2. Temporary differences
-are differences between the carrying amount of an asset or liability and the tax base.
-include timing difference.

Timing differences are differences between accounting and taxable income that originate in
one period and reverse in one or more time periods. These are items of income and expense
which are included in both accounting and taxable income but at different time periods.

-it gives rise to;

2.1 DTL- temporary difference that would result to future taxable amount
2.2 DTA-temporary difference that would result to future deductible amount

The tax base of an asset or a liability is the amount attributable to the asset or liability for tax
purposes.

Tax base of an asset-will be deductible for tax purposes against future income.

Ex. An entity capitalized P1,000,000 as software development cost.

Carrying Amount Tax Base Difference
Software 1,000,000 0 1,000,000

*if the amount is allowed as a one-time deduction for tax purposes, the tax base is zero because the
entire amount is expensed in the current year.

Tax base of a liability- Carrying amount less amount that will be deductible for tax purposes in the

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future.

An entity has recognized an estimated warranty liability of P500,000.

Carrying Amount Tax Base Difference
Warranty liability 500,000 0 500,000

*the tax base is zero because the estimated warranty liability cost is a future deductible amount.

DTL arises from the following:

a. Accounting income >Taxable income
b. CA of an asset > tax base
c. CA of a liability < tax base

Accounting income (AI) higher than taxable income (TI)

1. Revenues and gains are included in AI of the current period but are taxable in future periods.
Ex. Installment sale is included in AI but included in TI upon collection.

2. Expenses and losses are deductible for tax purposes in the current period but deductible for
accounting purposes in future periods.
2.1 accelerated depreciation for tax purposes and SL depreciation for accounting purposes
2.2 Development cost capitalized and amortized over future periods in AI but deducted in TI
upon payment.
2.3 Prepaid expense already deducted on a cash basis in TI.

Other taxable temporary differences that technically are not timing differences but gives rise to DTL.
1. Asset revalued upward
2. CA of investment in subsidiary, associate, joint venture is higher than its tax base
3. Cost of business combination that is accounted as acquisition is allocated to identifiable
asset and liabilities at FV.

DTA arises from the ffg:

a. Accounting income < Taxable income
b. CA of an asset < tax base of asset
c. CA of a liability > tax base of a liability

Taxable income higher than accounting income

1. Revenues and gains are included in TI higher than AI of current period but are included in
future in AI of future periods.
Ex. rent received in advance is taxable at the time of receipt but deferred in future periods
for accounting purposes.
2. Expenses and losses are deducted from AI but are deductible for tax purposes in future
periods.

Future deductible temporary difference:

1. Probable and measurable litigation loss
2. Estimated product warranty cost
3. Research cost is recognized as expensed in AI but not permitted as deduction to TI until later
period
4. Impairment loss is recognized in AI but ignored to Ti until the asset is sold or realized.
5. Doubtful accounts are recognized as expense in AI but deductible for tax purposes upon
written off.

Other deductible temporary differences that technically are not timing differences but gives rise to
DTA.
1. Asset revalued downward
2. CA of investment in subsidiary, associate, joint venture is lower than its tax base

Method of accounting

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 1. Income statement approach-focuses on timing differences only in the computation of DTA or
DTL.
2. Statement of financial position approach-considers all temporary differences including
timing differences. There are temporary differences that affect the statement of financial
position only and technically are not timing differences but nonetheless are recognized in
computing DTA or DTL.

Journal entries:

To record the current tax expense

Income tax expense XX
Income tax payable XX
(TI x Tax rate)

To record the taxable temporary differences

Income tax expense XX
Deferred tax liability XX

To record the deductible temporary differences

Deferred tax asset XX
Income tax benefit XX

Note: to get the total income tax expense for the year
Total income tax expense=current tax expense + deferred tax expense-income tax benefit or
Total income tax expense= accounting income subject to tax x tax rate.

Illustration 1- DTL
In 2019, an entity reported AI a gross profit on installment sale of P1M but not in TI. This temporary
difference is expected to be reported in TI equally in 2020 and 2021. Income tax rate is 30%.

2019 2020 2021

AI 4M 5M 7M
TI 3M 5.5M 7.5M

Journal Entries in 2019:

To record the Current tax expense (CTE)

Income tax expense 900,000
Income tax payable 900,000
(3M x 30%)

To record the DTL

Income tax expense 300,000
DTL 300,000
(1m x 30%)

Note: Income tax payable-Current liability

DTL- noncurrent liability

Income statement presentation for 2019

Income before income tax 4,000,000

Income tax expense:
Current tax expense 900,000
Deferred tax expense 300,000 1,200,000
Net income 2,800,000

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  AI subject to tax x Tax rate= total income tax expense
 (4M x .30) 1.2M

Journal Entries in 2020:

To record the Current tax expense (CTE)

Income tax expense 1,650,000
Income tax payable 1,650,000
(5,500,000 x 30%)

To decrease the DTL

DTL 150,000
Income tax expense 150,000
(30% x 500,000)

Income statement presentation for 2020

Income before income tax 5,000,000

Income tax expense:
Current tax expense 1,650,000
Dec. in DTL ( 150,000) 1,500,000
Net income 3,500,000

Journal Entries in 2021:

To record the CTE

Income tax expense 2,250,000
Income tax payable 2,250,000
(30% x 7,500,000)

To record the DTL

DTL 150,000
Income tax expense 150,000
(30% x 500,000)

Note: by this time the DTL is now fully reversed.

Income statement presentation for 2021

Income before income tax 7,000,000

Income tax expense:
Current tax expense 2,250,000
Dec. in DTL (150,000) 2,100,000
Net income 4,900,000

Illustration II- DTA

In 2019, an entity received an advance rental payment if P600,000 which was subject to tax but not
reported in AI until 2020. The income tax rate is 30%.

2019 2020
AI subj to tax 5M 7M
TI 5.6M 6.4M

Journal Entries in 2019:

To record the CTE

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Income tax expense 1,680,000
Income tax payable 1,680,000
(5.6M x 30%)

To record the deferred tax asset:

DTA 180,000
Income tax benefit 180,000
(30% x 600,000)

Note: DTA is classified as noncurrent asset.

Income statement presentation for 2019

Income before income tax 5,000,000

Income tax expense:
Current tax expense 1,680,000
Income tax benefit (180,000) 1,500,000
Net income 3,500,000

Journal Entries in 2020:

To record the CTE

Income tax expense 1,920,000
Income tax payable 1,920,000
(30% x 6,400,000)

To decrease the DTA

Income tax expense 180,000
DTA 180,000

Income statement presentation for 2020

Income before income tax 7,000,000

Income tax expense:
Current tax expense 1,920,000
Dec. in DTA 180,000 2,100,000
Net income 4,900,000

Example of adjusting AI to TI
Accounting income per book XX
Permanent differences:
Nondeductible expenses XX
Nontaxable revenue (XX)
Accounting income subject to tax XX
Deductible temporary differences:
Doubtful accounts XX
Estimated warranty cost ```````````XX
Taxable temporary differences:
Excess tax depreciation (XX)
Gross income on installment sale (XX)
Taxable income XX

Note: AI subject to tax must exclude permanent differences.

Net deferred tax benefit or expense

Net deferred tax benefit P50 = P100 DTA – P50 DTL
Net deferred tax expense P100= P200 DTL –P100 DTA

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Current tax liability (CTL) is the current tax expense or payable.
Current tax asset (CTA) is a prepaid income tax shall be classified as current asset.
CTL and CTA shall be measured using the tax rate that has been enacted and effective at the end of
the reporting period.
DTA shall be classified as noncurrent asset and DTL as noncurrent liability.

Intraperiod tax allocation is the allocation of income tax to the various revenues that brought about
the tax.
Interperiod tax allocation is the recognition of a deferred tax asset or deferred tax liability.

Illustration III
Darna Company paid P400,000 in January 2019 for fire insurance premiums on a two-year policy.
Additional, the financial statements for the year ended December 31, 2019 revealed that the entity
paid P1,050,000 in income tax during the year and also accrued estimated litigation loss of
P2,000,000. The lawsuit was resolved in February 2020 at which time a P2,000,000 loss was
recognized for tax purposes. The entity used the cash basis for tax purposes. The tax rate is 30% for
both 2019 and 2020.

1. What amount should be reported as DTA on December 31, 2019? 600,000

(30% x 2,000,000) 600,000

2. What amount should be reported as DTL on December 31, 2019? 60,000

(30% x 200,000) 60,000

Illustration IV
Ding Company reported in the income statement for the first year of operations pretax accounting
income of P6,000,000. The current year tax rate is 30% and the enacted rate for future years is 25%.
The following differences existed between the tax return and accounting record:
Tax return Accounting record
Uncollectible accounts expense 200,000 300,000
Depreciation expense 800,000 500,000
Tax-exempt interest revenue 50,000

1. What is the current tax expense? 1,725,000

Pretax accounting income 6,000,000
Tax-exempt revenue (50,000) Current tax expense (30% x
Accounting income subject to tax 5,950,000 5,750,000)
1,725,000
Uncollectible accounts (300,000-200,000) 100,000
Depreciation (800,000-500,000) (300,000) 2. What is the net
Taxable income 5,750,000 deferred tax
expense? 50,000
Deferred tax expense (25% x 300,000) 75,000
Deferred tax benefit (25% x 100,000) (25,000)
Net deferred tax expense 50,000
Note: The future enacted tax rate of 25% is used in determining deferred tax asset and liability.

Illustration V
Lenard Company reported pretax financial income of P6,200,000 for the current year. Included in
other income was P200,000 of interest revenue from government bonds held by the entity. The
income statement also included depreciation expense of P500,000 for a machine costing P3,000,000.
The income tax return reported P600,000 as depreciation on the machine. The enacted tax rate is
30% for the current year and future years. What is the current tax expense for the current year?
1,770,000

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 Pretax Financial income 6,200,000
PD-Nontaxable revenue-interest revenue (200,000)
Accounting income subject to tax 6,000,000
TD-Excess tax depreciation (100,000)
Taxable income 5,900,000
Enacted taxable rate 30%
1,770,000
*PD-permanent difference
*TD-temporary difference

Illustration VI
Val Company began operations at the beginning of current year. At the end of the first year of
operations, the entity reported P6,000,000 income before income tax in the income statement but
only P5,100,000 taxable income in the tax return. Analysis of the P900,000 difference revealed that
P500,000 was a permanent difference and P400,000 was a temporary tax liability difference related
to a current asset.

The enacted tax rate for the current year and future years is 30%. What is the total income tax
expense to be reported in the income statement for the current year? 1,650,000

Accounting or financial income per book 6,000,000

Permanent difference Nontaxable revenue (500,000)
Accounting income subject to tax 5,500,000
Enacted tax rate 30%
1,650,000

Illustration VII
Caleb Company has three financial statement elements for which the year-end carrying amount is
different form the tax base:
Carrying Amount Tax base Difference
Equipment 2,000,000 1,200,000 800,000
Prepaid officers' insurance policy 750,000 0 750,000
Warranty liability 500,000 0 500,000

The entity is the beneficiary of the officers’ life insurance policy. As a result of these differences,
what is the future taxable amount? 800,000

750,000 is a PD
500,000 is a future deductible amount (DTA)

Illustration VIII
On June 30, 2019, Liza Corporation prepaid a P380,000 premium on an insurance policy. The
premium payment was a tax-deductible expense in Liza’s 2019 cash basis tax return. The accrual
basis income statement will report a P190,000 insurance expense in 2019 and 2020. Assume the
income tax rate is 32%.
1. Using the income statement liability method, in Liza’s December 31, 2019 statement of financial
position, what amount related to the insurance should be reported as deferred liability? 60,800

Income Statement Method:

Insurance expense-financial (accrual basis) 190,000
Insurance expense-taxation (cash basis) 380,000
Future taxable amount 190,000
x tax rate 32%
Deferred tax liability 60,800

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2. Using the balance sheet liability method, in Liza’s December 31, 2019 statement of financial
position, what amount related to the insurance should be reported as deferred liability? 60,800

Balance Sheet Method:

Prepaid insurance-December 31, 2019 190,000
Less: Tax base -
Future taxable amount 190,000
x Tax rate 32%
Deferred tax liability 60,800
CLOSURE ACTIVITIES
Accounting for Income Tax

The following work exercises intend to evaluate what the learners have learned in this topic. Write
your answers in your portfolio journal. Show your solutions in good form.

Problem A- The following information was extracted from the records of Keri Company on
December 31, 2019:

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
Deposits 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 accounts of P250,000 has been raised against accounts receivable for
accounting purposes but such accounts are deductible only when written off as uncollectible.

Keri Company showed net income of P8,000,000 in the income statement for 2019. There are no
temporary differences at the beginning of the current year. The tax rate is 30%.

1. Determine the deferred tax liability on December 31, 2019.

2. Determine the deferred tax asset on December 31, 2019.
3. Determine the net deferred tax expense or benefit.
4. Determine the current tax expense for 2019.
5. Determine the total income tax expense for 2019.

Problem B- Hopeful Company is preparing its 2019 year-end income tax returns and the following
differences were noted between financial reporting and tax reporting:

Financial Tax
Warranty expense 360,000 200,000
Revenue from installment sales 1,800,000 1,200,000
Premiums on officers’ life insurances for
which the company as the beneficiary 120,000 None

Hopeful Company reported a pretax income of P4,500,000 in its financial reporting. Income tax rate
is 30% for all years.

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6. How much is the current portion of Hopeful’s income tax expense?

Problem C- For the year ended December 31, 2019, Timothy Corporation reported pretax financial
income of P6,000,000. Its taxable income was P8,000,000. The difference is due to rental received in
advance. Rental income is taxable when received. The income tax rate is 30% for all years and
Timothy made estimated tax payment of P1,000,000.

7. What should Timothy report as 2019 total income tax expense?

Problem D- On its December 31, 2019 balance sheet, Mother Company had income tax payable of
P520,000 and a current deferred tax asset of P800,000. Mother had reported current deferred tax
asset of P600,000 at December 31, 2018. No estimated tax payments were made during 2019.

8. In its 2019 profit or loss of Mother Company, what amount should be reported as total income tax
expense?

Problem E- Daughter Corporation reported a pretax financial income of P6,000,000 for the year
2019. Among the items reported in the 2019 profit or loss are:

Interest on time deposit P 240,000

Proceeds received from life insurance on death of officer 1,200,000

Income tax rate is 30% for all years. There are no timing or permanent differences in prior years.

9. What amount should Daughter report as deferred tax liability on December 31, 2019?

Problem F- Flames Corporation has three financial statement elements for which the December 31,
2019 book value is different than the December 31, 2019 tax basis.

Book Value Tax Basis Difference

Equipment P1,000,000 P600,000 P400,000
Prepaid officers’ insurance policy 375,000 -0- 375,000
Warranty liability (250,000) -0- (250,000)

10. As a result of these differences, what is the future taxable amount?

Problem G- Dainty included the following items in pretax accounting income for 2019:

 Litigation loss estimated at P75,000 which will become tax deductible when settled in the
future.
 Revenue from an installment sale of P112,500, which will be recognized as part of taxable
income as received over the next three years.
 Pretax financial income is P437,500

11. How much should be the pretax financial income subject to income tax?

Problem H- Columbia Corporation has one temporary difference at the end of 2019 that will reverse
and cause deductible amounts of P100,000 in 2020, P130,000 in 2021 and P80,000 in 2022.
Columbia’s pretax financial income for 2019 is P400,000 and tax rate is 30% for all years. There are
no deferred taxes at the beginning of 2019.

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12. What is the amount of current tax expense to be reported for 2019?

Problem I- Papasa Company reported taxable income of P8,000,000 in its income tax return for the
year ended December 31, 2019, its first year of operations. Temporary differences between financial
income and taxable income for the year are as follows:

Tax depreciation in excess of book depreciation 800,000

Accrual for product liability claim in excess of actual claim 1,200,000
Reported installment sales income in excess of taxable
installment sales income 2,600,000
Income tax rate 30%

13. What is the total income tax expense to be reported in the 2019 income statement?
14. What is the deferred tax asset on December 31, 2019?
15. What is the deferred tax liability on December 31, 2019?

Problem J -Psalm Company’s income statement for the year ended December 31, 2019 shows pretax
income (accounting income per book) of P2,000,000. The following items are treated differently on
the tax returns and on the accounting records.

Financial Accounting Income Tax Return

Rent expense P200,000 P 0
Depreciation expense 500,000 800,000
Interest on government bonds 50,000 0

Income tax rate is 30%.

16. How much is the current portion of Psalm’s income tax expense?

Problem K-Mark Company leased a facility and received P600,000 annual rental payment on June
16, 2019. The beginning of the lease was July 1, 2019. Rental income is taxable when received. The
income tax rate is 30%. Mark had no other permanent or temporary differences. Mark determined
that no valuation is needed.

17. Using the income statement approach, what amount of deferred tax asset should Mark report in
its December 31, 2019 statement of financial position?
18. Using the balance sheet approach, what amount of deferred tax asset should Mark report in its
December 31, 2019 statement of financial position?

Problem L-Jason Company has taken out a foreign loan of $100,000 that is recorded at P4,400,000.
At the reporting date, the carrying value of the loan is P4,000,000. The unrealized exchange gain of
P400,000 is included in profit or loss, but will be taxable when the gain is realized on the repayment
of the loan.

19. What is the amount of temporary difference relating to the liability?

20. If the current and future tax rates are 34% and 35%, respectively, what amount of deferred tax
asset should the company recognize?

Problem M- On June 30, 2019, Glory Corporation prepaid a P380,000 premium on an insurance
policy. The premium payment was a tax-deductible expense in Glory’s 2019 cash basis tax return.
The accrual basis income statement will report a P190,0000 insurance expense in 2019. Assume the

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income tax rate is 30%.

21. What is the balance of prepaid expense on December 31, 2019?

22. Using the balance sheet approach, in Glory’s December 31, 2019 statement of financial position,
what amount related to the insurance should be reported as deferred liability?

Problem N- Among the items reported on Son Company’s income statement for the year ended
December 31, 2019 were:
Payment of tax penalty, fine and surcharge 120,000
Insurance premium on life of an officer with Son as the beneficiary 240,000

23. How much should be the timing differences?

Problem O- Dragon Company’s December 31, 2019 pretax financial statement was P5,000,000 and
its taxable income was P3,750,000. The difference is due to the following:
Interest income on savings deposit P1,750,000
Premium expense on life insurance (500,000)
Total P1,250,000

24. The income tax rate is 30%. In its 2019 profit or loss, what amount should Dragon report as
current provision for income tax expense?

Problem P- Valenciano Manufacturing Corporation reports taxable income of P829,000 on its

income tax return for the year ended December 31, 2019, its first year of operations. Temporary
differences between financial income and taxable income for the year are:

Tax depreciation in excess of book depreciation P80,000

Accrual for product liability claims in excess of
actual claims ( estimated product claims
payable is a current liability) 125,000
Reported installment sales income in excess of
taxable installment sales income (installments
receivable is a current asset) 265,000

The enacted income tax rate is 30% for 2019 and all future years.

25. How much should be the total tax expense for 2019?

Problem Q- In its first year of operations, Gummy Corporation reported the following results for the
year ended December 31, 2019:

Income (per books before income taxes) P1,125,000

Taxable income 1,800,000

The disparity between the book income and taxable income is attributable to a timing difference,
which will reverse in 2020. Income tax rate for 2019 and all future years is 30%.

26. What should Gummy record as a deferred tax asset for the year ended December 31, 2019?

Problem R- In 2019, Collector Corporation received interest income of P100,000 on government

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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, 2019. The effective
income tax rate of Collector Corporation is 30%.

27. Using the income statement approach, by what amount would the deferred income tax asset
account balance increase?
28. Using the balance sheet approach, by what amount would the deferred income tax asset account
balance increase?

Problem S- The following facts relate to Sydney Company for the year 2019:

Deferred tax liability, January 1, 2019 P400,000

Deferred tax asset, January 1, 2019 0
Taxable income for 2019 1,600,000
Pretax financial income 1,750,000
Cumulative temporary difference at 12/31/19 giving
rise to future taxable amount 2,400,000
Cumulative temporary difference at 12/31/19 giving
rise to future deductible amount 350,000
Income tax rate for all years 30%

29. What is the amount of deferred tax expense (net) for 2019?

Problem T- The following facts relate to Canberra Company for the year 2019:

Deferred tax liability, January 1, 2019 P864,000

Deferred tax asset, January 1, 2019 576,000
Taxable income for 2019 2,500,000
Cumulative timing difference at 12/31/19 giving rise
to future taxable amount 2,200,000
Cumulative timing difference at 12/31/19 giving rise
to future deductible amount 1,000,000
Income tax rate for all years 30%

30. What is the amount of pretax income in 2019?

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Isaiah 43:2 -When you pass through the waters, I will be with you; and when you pass through the
rivers, they will not sweep over you. When you walk through the fire, you will not be burned; the
flames will not set you ablaze.

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