Accounting for Income

Tax
Valix
Introduction

• Deferred tax accounting is applicable to all entities, whether

public or nonpublic entities.
• A public entity is an entity:
• Whose equity and debt securities are traded in a stock exchange or over-
the-counter market.
• Whose equity or debt securities are registered with SEC in preparation for
sale of the securities.
Accounting Income

• Accounting income or financial income is the net income for the

period before deducting income tax expense.
• This is the income appearing on the traditional income statement
and computed in accordance with accounting standards.
Taxable income

• Taxable income is the income for the period determined in

accordance with the rules established by the taxation authorities
upon which income taxes are payable or recoverable.
• Taxable income is the income appearing on the income tax return
and computed in accordance with the income tax law.
• Taxable income may be defined also as the excess of taxable
revenue over tax deductible expense and exemptions for the
period as defined by the BIR.
Differences between accounting and taxable
income

• Differences between accounting income and taxable income may

be classified into two, namely:
• Permanent differences
• Temporary differences
Permanent Differences

• Permanent differences are items of revenue and expense which are

included in either accounting income or taxable income but will never
be included in the other. Actually, permanent differences pertain to
nontaxable revenue and nondeductible expenses. Example:
• Interest income on deposits
• Dividend received
• Life insurance premium(when the entity is the beneficiary of a life insurance
policy on an officer or employee, the premium paid by the entity is not
deductible as expense for tax purposes but said premium is an expense for
financial reporting purposes)
• Tax penalties, surcharges and fines are nondeductible
Temporary differences

• Temporary differences are differences between the carrying

amount of an asset or liability and the 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.
• Timing differences are items of income and expenses which are
included in both accounting income and taxable income but at
different time periods.
Temporary differences

• Temporary differences give rise either to:

• Deferred tax liability
• Deferred tax asset
Kinds of temporary difference

a) Taxable temporary difference is the temporary difference that

will result in future taxable amount in determining taxable
income of future periods when the carrying amount of the asset
or liability is recovered or settled.
b) Deductible temporary difference is the temporary difference
that will result in future deductible amount in determining
taxable income of future periods when the carrying amount of
the asset or liability is recovered or settled.
Tax base

• The tax base of an asset or a liability is the amount attributable to

the asset or liability for tax purposes.
• Worded in another way, the tax base of an asset or a liability is the
amount of the asset or liability that is recognized or allowed for tax
purposes.
Tax base of an asset- Tax base of an asset is the amount that will be
deductible for tax purposes against future income.
For example: if an entity has appropriately capitalized P1,000,000 as
software development cost, the carrying amount is P1,000,000 for
accounting purposes.
Tax base of an asset

• If this amount is allowed as 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

• The tax base of a liability is normally the carrying amount less the
amount that will be deductible for tax purposes in the future.
• For example, if an entity has recognized an estimated warranty
liability of P500,000, the carrying amount is P500,000 for
accounting purposes.
• However, an estimated warranty cost is deductible only when
actually paid.
• Thus, the tax base is zero because the estimated warranty cost is
a future deductible amount.
Deferred tax liability

• Deferred tax liability is the amount of income tax payable in

future periods with respect to a taxable temporary differences.
• A deferred tax liability is the deferred tax consequence
attributable to a taxable temporary difference or future taxable
amount.
• Actually, a deferred tax liability arises from the following:
• When the accounting income is higher than taxable income because of timing
differences
• When the carrying amount of an asset is higher than the tax base
• When the carrying amount of a liability is lower than the tax base
Accounting income higher than taxable
income

• Temporary differences that result in accounting income higher

than taxable income include the following:
1. Revenues and gains are included in accounting income of the current
period but are taxable in future periods. For example, an installment sale
is included in accounting income at the time of sale and included in
taxable income when cash is collected in future period.
2. Expenses and losses are deductible for tax purposes in the current period
but deductible for accounting purposes in future periods.
a) Accelerated depreciation for tax purposes and SLM for accounting purposes
b) Development cost may be capitalized and amortized over future periods in
determining accounting income but deducted in determining taxable income in the
period in which it is paid.
Accounting income higher than taxable
income

c. Prepaid expense has already been deducted on a cash basis in

determining taxable income of the current period.
Other taxable temporary differences

• Most taxable temporary differences arise because of differences in

the timing of the recognition of the transaction for accounting and
tax purposes. However, there are other taxable temporary
differences that technically are not timing differences but
nevertheless give rise to deferred tax liability. Such other taxable
temporary differences include:
a) Asset is revalued upward and no equivalent adjustment is made for tax
purposes.
b) The carrying amount of investment in subsidiary, associate or joint venture
is higher than the tax base because the subsidiary, associate or joint
venture has not distributed its entire income to the parent or investor.
Other taxable temporary differences

c. The cost of a business combination that is accounted for as an

acquisition is allocated to the identifiable assets and liabilities
acquired at fair value.
Recognition of a deferred tax liability

• PAS12 par15, provides that a deferred tax liability shall be recognized

for all taxable temporary differences. However, a deferred tax
liability is not recognized when the taxable temporary difference
arises from:
a) Goodwill resulting from a business combination and which is nondeductible
for tax purposes.
b) Initial recognition of an asset or liability in a transaction that is not a business
combination and affects neither accounting income nor taxable income.
c) 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.
Deferred tax asset

• A deferred tax asset is the amount o income tax recoverable in

future periods with respect to deductible temporary difference
and operating loss carryforward. In otherwords, a deferred tax
asset is the deferred tax consequence attributable to a future
deductible amount and operating loss carryforward.
• A deferred tax asset arises from the following:
a) When the taxable income is higher than the accounting income because
of timing differences.
b) When the tax base of asset is higher than the carrying amount
c) When the tax base of a liability is lower than the carrying amount.
Taxable income higher than accounting
income

• Temporary differences that will result to taxable income higher

than accounting income because of timing differences include the
following:
1. Revenue and gains are included in taxable income of current period but
are included in accounting income 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 accounting income of current
period but are deductible for tax purposes in future periods.
Future deductible temporary differences

• Future deductible temporary differences include the following:

a) A probable and measurable litigation loss is recognized for accounting
purposes but deducted in determining taxable income when actually
incurred or paid.
b) Estimated product warranty cost is recognized for accounting purposes in
the current period but deducted in determining taxable income when
actually incurred or paid.
c) Research cost is recognized as expense in determining accounting income
but not permitted as a deduction in determining taxable income until a
later period.
Future deductible temporary differences

d. An impairment loss is recognized for accounting purposes but

ignored for tax purpose until the asset is sold.
e. Doubtful accounts are recognized as expense for accounting
purposes but deductible for tax purposes only when written off as
worthless.
Other deductible temporary differences

• Temporary differences that technically are not timing differences

but nevertheless give rise to deferred tax asset include the
following:
a) Asset is revalued downward and no equivalent adjustment is made for
tax purposes.
b) The tax base of investment in subsidiary, associate or joint venture is
higher than the carrying amount because the subsidiary, associate or joint
venture has suffered continuing losses in current and prior years.
Recognition of deferred tax asset

• PAS12, par 24, provides that a deferred tax asset shall be

recognized for all deductible temporary differences and operating
loss carrying forward when it is probable that taxable income will
be available against which the deferred tax asset can be used.
Operating loss carryforward

• Operating loss carryforward is an excess of tax deductions over

gross income in a year that may be carried forward to reduce
taxable income in a future year.
• Certain entities registered with the Board of Investments (BOI) are
permitted to carry over net operating loss for tax purposes subject
to limitations of the relevant law and implementing regulations of
the BOI.
Method of accounting

a) Income statement approach

This method focuses on timing differences only in the
computation of deferred tax asset or deferred tax liability.
As the method suggests, timing differences affect the income
statement of one period and will reverse in the income statement of
one or more subsequent periods.
Method of accounting

b. Statement of financial position approach

This method 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.
Accounting procedures

• The recognition of a deferred tax asset or deferred tax liability is

known as interperiod tax allocation.
1. Determined the taxable income- the taxable income multiplied by the
rate equals the current tax expense.
Income tax expense xx
Income tax payable xx

Current tax expense is the amount of income tax paid or payable for a year as
determined by applying the provisions of the enacted tax law to the taxable
income.
Accounting procedures

2. Determine the taxable temporary differences- The amount of

taxable temporary differences multiplied by the tax rate equals the
deferred tax liability.
Income tax expense xx
Deferred tax liability xx

3. Determine the deductible temporary differences- the amount of

deductible temporary differences multiplied by the tax rate equals
the deferred tax asset.
Deferred tax asset xx
Income tax benefit xx
Accounting procedures-start

The “income tax benefit account” reduces the current tax expense
for the year and is a deduction from current tax expense. The
deferred tax asset may be credited directly to “income tax expense”.
4. The total income tax expense for the year is the current tax
expense plus the deferred tax expense arising from taxable
temporary differences minus the income tax benefit arising from
deductible temporary differences.
The total income tax expense for the year is equal to the accounting
income subject to tax multiplied by the rate, assuming there is no
future enacted income tax rate.
Illustration 1- Deferred tax liability

• In 2020, an entity reported in accounting income a gross profit on

installment sale of P1M but not in taxable income. This temporary
difference is expected to be reported in taxable income equally in
2021 and 2022. The income tax rate is 30%.
2020 2021 2022

Accounting income 4,000,000.00 5,000,000.00 7,000,000.00

Taxable income 3,000,000.00 5,500,000.00 7,500,000.00

• Since the temporary difference results to a higher accounting

income in 2020, there is a deferred tax liability.
Journal entries in 2020

1) To record the current tax

expense:

Income tax expense 900,000.00

Income tax payable
(30%x3M) 900,000.00

2) To record the deferred tax

liability

Income tax expense (30%x1M) 300,000.00

Deferred tax liability 300,000.00

Total tax expense (30%x4M) 1,200,000.00

-
Current tax expense (30%x3M) 900,000.00

Deferred tax liability 300,000.00

Income statement presentation for 2020
2020 2021 2022

Accounting income 4,000,000.00 5,000,000.00 7,000,000.00

Taxable income 3,000,000.00 5,500,000.00 7,500,000.00

Income before income tax 4,000,000.00

Income tax expense:

Current tax expense 900,000.00

Deferred tax expense 300,000.00 1,200,000.00

Net income 2,800,000.00

• Observe that the accounting income subject to tax of P4M x

30%=P1,200,000 which is the total income tax expense for the year.
Journal entries in 2021

1) To record the current tax

expense:

Income tax expense 1,650,000.00

Income tax payable (30%x 5,500,000) 1,650,000.00

2) To decrease the deferred tax

liability:

Deferred tax liability 150,000.00

Income tax expense (30%x500,000) 150,000.00

Income statement presentation for 2021

Income before income tax 5,000,000.00

Income tax expense:
Current tax expense 1,650,000.00
Decrease in deferred tax liabilty - 150,000.00 1,500,000.00
Net income 3,500,000.00
Journal entries in 2022
1) To record the current tax
expense:

Income tax expense 2,250,000.00

Income tax payable (30%x 7,500,000) 2,250,000.00

2) To decrease the deferred tax

liability:

Deferred tax liability 150,000.00

Income tax expense (30%x500,000) 150,000.00

• The deferred tax liability on December 31, 2022 has a zero

balance because the taxable temporary difference is now fully
reversed.
Income statement presentation for 2022

Income before income tax 7,000,000.00

Income tax expense:

Current tax expense 2,250,000.00

Decrease in deferred tax liabilty - 150,000.00 2,100,000.00

Net income 4,900,000.00

Illustration 2-Deferred tax asset

• In 2020, an entity received an advance rental payment of P600,000

which was subject to tax but not reported in accounting income
until 2021. The income tax rate is 30%. The income statement and
tax return showed the following:
2020 2021
Accounting income subject to
tax 5,000,000.00 7,000,000.00

Taxable income 5,600,000.00 6,400,000.00

• Since the temporary difference results to a higher taxable income

in 2020, thre is a deferred tax asset.
Journal entries in 2020

1) To record the current tax

expense:

Income tax expense 1,680,000.00

Income tax payable (30%x 5,600,000) 1,680,000.00

2) record the deferred tax asset:

Deferred tax asset 180,000.00

Income tax benefit (30% x 600,000) 180,000.00

Total tax expense (30%x5M) 1,500,000.00

Current tax expense -
(30%x5,600,000) 1,680,000.00
-
Deferred tax liability 180,000.00
Income statement presentation for 2020

Income before income tax 5,000,000.00

Income tax expense:
Current tax expense 1,680,000.00
Income tax benefit - 180,000.00 1,500,000.00

Net income 3,500,000.00

Journal entries in 2021

1) To record the current tax

expense:

Income tax expense 1,920,000.00

Income tax payable (30%x 6,400,000) 1,920,000.00

2) To decrease the deferred tax

asset:

Income tax expense 180,000.00

Deferred tax asset 180,000.00

Income statement presentation for 2021

Income before income tax 7,000,000.00

Income tax expense:

Current tax expense 1,920,000.00

Decrease in deferred tax asset - 180,000.00 2,100,000.00

Net income 4,900,000.00

Illustration 3- Deferred tax asset and liability

• An entity reported the following for the year ended Dec 31. 2020
Accounting income per book 6,000,000.00

Nondeductible expenses 500,000.00

Nontaxable revenue 300,000.00

Doubtful accounts 200,000.00

Estimated warranty cost that had been
recognized
as expense in 2020 when the product sales
were
made but is deductible for tax purposes
when paid 400,000.00

Accounting depreciation 600,000.00

Tax depreciation 800,000.00

Gross income on installment sale included
in accounting income but taxable only in
2021 100,000.00
Income tax rate 30%
Computation

Accounting income per book 6,000,000.00

Permanent differences:

Nondeductible expenses 500,000.00

-
Nontaxable revenue 300,000.00

Accounting income subject to tax 6,200,000.00

Deductible temporary differences:

Doubtful accounts 200,000.00

Estimated warranty cost 400,000.00

Taxable temporary differences:
-
Excess tax depreciation 200,000.00
-
Gross income on installment sale 100,000.00

Taxable income 6,500,000.00

Computation

• The permanent differences do not give rise to deferred tax asset

or deferred tax liability and thus eliminated from the reported
accounting income.
• In other words, the accounting income subject to tax must excluse
permanent differences.
Journal entries in 2020
1) To record the current tax
expense:

Income tax expense 1,950,000.00

Income tax payable
(30%x6,500,000) 1,950,000.00

2) To record the deferred tax asset:

Deferred tax asset 180,000.00

Income tax benefit 180,000.00

Doubtful accounts 200,000.00

Estimated warranty cost 400,000.00

Total deductible temporary
differences 600,000.00
Multiply by 30%

Deferred tax asset 180,000.00

3) To record the deferred tax

liability

Income tax expenses 90,000.00

Deferred tax liability 90,000.00

Excess depreciation 200,000.00

Gross income on installment
sale 100,000.00
Income statement presentation 2020

Income before income tax 6,000,000.00

Income tax expense:

Current tax expense 1,950,000.00

Income tax benefit - 180,000.00

Deferred tax expense 90,000.00 1,860,000.00

Net income 4,140,000.00

• Observe that the accounting income subject to tax of P6.2M multiply by

30% = P1,860000 which is the total income tax expense for the year.
Net deferred tax expense or benefit

• The difference between the change in deferred tax asset and the change
in deferred tax liability is the net deferred tax expense or benefit.
• Observe the following using the preceding illustration:

Tax benefit from increase in deferred tax asset - 180,000.00

Tax expense form increase in deferred tax liability 90,000.00

Net deferred tax benefit - 90,000.00

• If the tax expense from the increase in DTL is more than the tax benefit
from the increase in DTA, there is a net deferred tax expense
Current tax liability and current tax asset

• A current tax liability is the current tax expense or the amount of

income tax actually payable. This is classified as current liability.
• Under our income tax law, income tax for corporation is payable
every quarter.
• If the amount of tax already paid for the current period excees the
amount actually payable for the period, the excess is recognized
as current tax asset. Actually, current tax asset is a prepaid
income tax and shall be classified as current asset.
Current tax liability and current tax asset

• A current tax liability or current tax asset shall be measured using

the tax rate that has been enacted and effective at the end of the
reporting period.
Presentation of deferred tax asset or liability

• PAS12 par70, provides that when an entity makes a distinction

between current and noncurrent assets and liabilities, it shall not
classify deferred tax assets as current assets and deferred tax
liabilities as current liabilities.
• Accordingly, a deferred tax asset shall be classified as noncurrent
asset and deferred tax liability shall be classified as noncurrent
liability regardless of reversal period.
• A deferred tax asset or deferred tax liability shall not be
discounted.
Offset of deferred tax asset and liability

• Under PAS1, assets and liabilities shall not be offset unless

required or permitted by another standard.
• PAS12 par 74, provides that an entity shall offset a deferred tax
asset against a deferred tax liability when:
a) The deferred tax asset and deferred tax liability relate to income taxes
levied by the same tax authority.
b) The entity has a legal enforceable right to set off a current tax asset
against a current tax liabilty
Measurement of deferred tax asset or
liability

• A deferred tax liability or deferred tax asset shall be measured

using the tax rate that has been enacted by the end of the
reporting period and expected to apply to the period when the
asset is realized or the liability is settled.
• For ex. The tax rate of 30% is applicable to the taxable year 2020.
by Dec 31, 2020, a new tax law has been enacted imposing 25% tax
rate effective taxable year 2021.
• The current tax liability or current tax asset is measured at 30% but
the deferred tax liability or deferred tax asset is measured using
the new enacted tax rate of 25%.
Intraperiod and interperiod tax allocation

• Intraperiod tax allocation is the allocation of income tax expense

to the various revenues that brought about the tax.
• Thus, the total income tax expense is allocated to income from
continuing operations, income from discontinued operations and
prior period errors or items directly charged or credited to RE.
• Interperiod tax allocation is the recognition of a deferred tax asset
or deferred tax liability.
Statement of financial position approach

• To account for a deferred tax asset or liability, a statement of

financial position that shows all the assets and liabilities at their
carrying amount is first prepared.
• The following procedures are then followed:
1. Determine the tax base of the assets and liabilities in the statement of
financial position.
2. Compare the carrying amounts with the tax base.
3. The difference between the carrying amount and tax base normally will
result to a deferred tax asset or liability.
4. Permanent difference do not give rise to deferred tax asset or liability.
Statement of financial position approach

5. Apply the tax rate, to the temporary differences

6. Determine the beginning and ending balance of deferred tax
asset or liability.
7. Recognize the net change between the beginning and ending
balance of deferred tax asset or liability.
(see excel comprehensive illustration)