Topic 5

Income taxes
PAS 12 prescribes the accounting for income taxes.
Income taxes refer to taxes that are based on taxable
profits.

Income tax expense reported in the statement of

comprehensive income may be different from the amount
of income tax required to be paid to the BIR. Income tax
expense in the statement of comprehensive income is
computed using PFRSs. Current tax expense om the
income tax return (ITR) is computed using Philippine tax
laws.
Income taxes
Some items are appropriately recognized as income
(expense) under financial reporting but are either (a)
non-taxable (non-deductible) or (b) taxable (deductible)
only at some other periods under Philippine tax laws.
The varying treatments result to permanent and
temporary differences.
ACCOUNTING PROFIT AND TAXABLE PROFIT

Accounting profit is profit or loss for a period before

deducting tax expense.

Taxable profit (tax loss) is profit (loss) for a period,

determined in accordance with the rules established by
the taxation authorities, upon which income taxes are
payable (recoverable).
ACCOUNTING PROFIT AND TAXABLE PROFIT

The varying treatments of economic activities between

the PFRSs and the tax laws result to following
differences:
a. Permanent differences
b. Temporary differences
Permanent Differences
Permanent differences arise when income and expenses
enter in the computation of either accounting profit or
taxable profit but not both. If an item is included in the
computation of one, it will never enter in the
computation of the other.
Permanent Differences
Permanent differences usually arise from non-taxable
and non-deductible expenses and those that have already
been subjected to final taxes. These items are excluded
from the income tax return.

Permanent differences do not have future tax

consequences and do not give rise to deferred tax assets
and liabilities.
Permanent Differences
Examples of permanent differences:
a. Interest income on bank deposits
b. Interest income on government bonds and treasury
bills
c. Dividend income
d. Life insurance premiums on employees where the
entity is the irrevocable beneficiary
Temporary Differences
Temporary differences are differences between the carrying
amount of an asset or liability in the statement of financial
position and its tax base. Temporary differences may be either:
a. Taxable temporary differences – those that result to future
taxable amounts when the carrying amount of the asset or
liability is recovered or settled; or
b. Deductible temporary differences – those that result to
future deductible amounts when the carrying amount of
the asset or liability is recovered or settled.
Temporary Differences
Temporary differences include timing differences. Timing
differences arise when income and expenses are recognized for
financial reporting purposes in one period but are recognized
for taxation purposes in another period. It is called temporary
difference because their effect reverses in one or more
subsequent periods.

Taxable temporary differences give rise to deferred tax

liabilities. Deductible temporary differences give rise to
deferred tax assets.
Taxable Temporary Differences
Taxable temporary differences arise when:
a. Financial income (accounting profit) is greater than the taxable
income (taxable profit);
b. The carrying amount of an asset is greater than its tax base; or
c. The carrying amount of a liability is less than its tax base.

Taxable temporary difference multiplied by the tax rate results to

deferred tax liability.

Deferred tax liabilities are the amounts of income taxes payable in

future periods in respect of taxable temporary differences.
Deductible Temporary Differences
Deductible temporary differences arise when:
a. Financial income (accounting profit) is less than taxable
income (taxable profit);
b. The carrying amount of an asset is less than its tax base; or
c. The carrying amount of a liability is greater than its tax
base.

Deductible temporary difference multiplied by the tax rate

results to deferred tax asset.
Deductible Temporary Differences
Deferred tax assets are the amounts of income taxes
recoverable in future periods in respect of: (a) deductible
temporary differences; (b) the carryforward of unused
tax losses; and (c) the carryforward of unused tax credits.
THE ASSET-LIABILITY METHOD (BALANCE SHEET
LIABILITY METHOD)

PAS 12 requires the use of the asset-liability method in

accounting for deferred taxes. This method is a
comprehensive approach in accounting for deferred taxes
in that it accounts both (a) timing differences and (b)
differences between the carrying amounts and tax bases
of assets and liabilities.
THE ASSET-LIABILITY METHOD (BALANCE SHEET
LIABILITY METHOD)

Timing differences are differences between accounting

profit and taxable profit that originate in one period and
reverse in one or more subsequent periods. Temporary
differences are differences between the carrying amount
of an asset or liability in the statement of financial
position and its tax base. Temporary differences include
all timing differences; however, not all temporary
differences are timing differences.
Tax Base
Tax base of an asset or liability is the amount attributed
to the asset or liability for tax purposes.

Tax base of assets is the amount that will be deductible

for tax purposes against any taxable economic benefits
that will flow to the 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
Tax base of liabilities is the carrying amount, less any
amount that will be deductible for tax purposes in
respect of that liability in future periods. In the case of
revenue which is 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.
INCOME TAX EXPENSE AND CURRENT TAX
EXPENSE

Tax expense or income tax expense (tax income) is the

total amount included in the determination of profit or
loss of the period. It comprises current tax expense
(current tax income) and deferred tax expense
(deferred tax income).
INCOME TAX EXPENSE AND CURRENT TAX
EXPENSE

Current tax (current tax expense) is the amount of

income taxes payable (recoverable) in respect of the
taxable profit for a period.

Deferred tax expense (income or benefit) is the sum of

the net changes in deferred tax assets and deferred tax
liabilities during the period.
INCOME TAX EXPENSE AND CURRENT TAX
EXPENSE

If the increase in deferred tax liability exceeds the

increase in deferred tax asset, the difference is deferred
tax expense. If the increase in deferred tax asset
exceeds the increase in deferred tax liability, the
difference is deferred tax income or benefit.
Accounting for Current Taxes
An entity uses relevant tax laws in computing for its
current taxes. Unpaid current taxes are recognized as
current tax liability. Excess tax payments over the
current tax due are recognized as current tax asset.
Accounting for Current Taxes
Businesses are required to pay quarterly income taxes.
At the end of the year, quarterly payments may exceed
or fall short of the computed current tax expense for
the year. If the payments fall short of the annual current
tax expense, the deficiency is presented as “Income Tax
Payable”. If the payments exceed the annual current tax
expense, the excess is presented as “Prepaid Income
Tax”.
Formula 2
The excess of an asset’s carrying amount over its tax
base results to taxable temporary difference.

For an asset:
CA > TB = TTD or FI > TI; TTD multiplied by tax rate
results to DTL.

The amount of DTL or DTA computed using Formula 2

represents the ending balance.
RECOGNITION OF DEFERRED TAXES
The fundamental principle under PAS 12 is that “an
entity shall, with certain limited exceptions, recognize a
deferred tax liability (asset) whenever recovery or
settlement of the carrying amount of an asset or
liability would make future tax payments larger
(smaller) than they would be if such recovery or
settlement were to have no tax consequences.
RECOGNITION OF DEFERRED TAXES
Deferred tax liability is recognized for all taxable temporary
differences, except those that arise from the following:
a. Initial recognition of goodwill
b. Initial recognition of an asset or liability in a transaction
which is not a business combination and, at the time of the
transaction, affects neither accounting profit nor taxable
profit (tax loss).
c. Investment in subsidiaries, branches, and associates, and
interests in joint arrangements to the extent that the entity
is able to control the timing of the reversal of the
differences and it is probable that the reversal will occur in
the foreseeable future.
RECOGNITION OF DEFERRED TAXES
Deferred tax asset is recognized for all deductible
temporary differences, including unused tax losses and
unused tax credits, to the extent that it is probable that
taxable profit will be available against which the deductible
temporary difference can be utilized, unless the deferred
tax asset arises from the initial recognition of an asset or a
liability in a transaction that is not a business combination
and, at the time of the transaction, affects neither
accounting profit nor taxable profit (tax loss).
Limitation on the Recognition of Deferred
Tax Asset
A deferred tax asset reduces the tax payment when it
reverses in a future period. However, an entity can
benefit from this reduction only if it earned sufficient
taxable profit against which the reduction can be
applied.
Limitation on the Recognition of Deferred
Tax Asset
PAS 12 permits an entity to recognize deferred tax
assets only when it is probable that taxable profits will
be available against which the deductible temporary
differences can be utilized or there are sufficient
taxable temporary differences that are expected to
reverse in the same period that the deductible
temporary differences are expected to reverse.
Limitation on the Recognition of Deferred
Tax Asset
When it is not probable that a deferred tax asset will be
realized, it is either (a) not recognized or (b) reduced to
its realizable value, whichever is appropriate. The
reduction in deferred tax asset increases income tax
expense but does not affect current tax expense.
MEASUREMENT
Current tax assets and Current tax liabilities
Current tax assets and liabilities are measured at the tax rate
that is applicable to the period in which the taxable profit has
been earned.

Deferred tax assets and Deferred tax liabilities

Deferred tax assets and liabilities are measured at the tax
rates that are expected to apply to the period of their
reversal, based on tax rates that have been substantively
enacted by the end of the reporting period.
MEASUREMENT
PAS 12 prohibits the discounting of deferred tax assets
and liabilities. This is because scheduling of the timing
of the reversal of each temporary difference is often
impracticable or highly complex and would undermine
comparability of financial statements between entities.
Different tax rates apply to different levels
of taxable income
When different tax rates apply to different levels of
taxable income, deferred tax assets and liabilities are
measured using the average rates that are expected to
apply to the taxable profit (tax loss) of the periods in
which the temporary differences are expected to
reverse.
Different tax rates apply to different
transactions or events
When different tax rates apply to different transactions
or events, deferred tax assets and liabilities are
measured using the tax rate that reflects the tax
consequences that would result from the manner in
which the carrying amount of an asset or liability is
recovered or settled.
Different tax rates apply to different
transactions or events
The deferred tax liability or asset that arises from the
revaluation of a non-depreciable asset is measured on
the basis of the tax consequences that would follow
from the recovery of the asset’s carrying amount
through sale, regardless of the basis of measuring the
carrying amount of that asset.
PRESENTATION IN THE STATEMENT OF
FINANCIAL POSITION
Current tax assets and current tax liabilities are
presented separately as current assets and current
liabilities, respectively, in a classified statement of
financial position.

Deferred tax assets and deferred tax liabilities are

presented separately as noncurrent assets and
noncurrent liabilities, respectively, in a classified
statement of financial position.
OFFSETTING
PAS 12 permits offsetting of current tax assets and
current tax liabilities only if the entity has:
a. a legally enforceable right to offset the recognized
amounts; and
b. an intention to settle/realize the recognized
amounts on a net basis or simultaneously.
OFFSETTING
PAS 12 permits offsetting of deferred tax assets and
deferred tax liabilities only if:
a. the entity has a legally enforceable right to offset
current tax assets against current tax liabilities;
and
b. the deferred tax assets and the deferred tax
liabilities relate to income taxes levied by the same
taxation authority.
PRESENTATION IN STATEMENT OF
COMPREHENSIVE INCOME
Tax consequences are accounted for in the same way as the
related transaction or events. The tax effect of a transaction
recognized in profit or loss is also recognized in profit or loss.
On the other hand, the tax effect of a transaction recognized
outside profit or loss is also recognized outside profit or loss.

Current and deferred taxes are usually recognized in profit or

loss. Some taxes that are recognized outside profit or loss.
Taxes recognized in other
comprehensive income
a. Revaluation or property, plant and equipment
b. Exchange differences arising on the translation of
the financial statements of a foreign operation.
Taxes recognized directly in equity
a. Adjustment to the opening balance of retained
earnings resulting from a change in accounting
policy or correction of a prior-period error.
b. Amounts arising on initial recognition of the equity
component of a compound financial instrument.
Inter-Period and Intra-Period Tax Allocation

Inter-period tax allocation relates to the recognition of

deferred tax assets and deferred tax liabilities. It is
concerned with the accounting for temporary
differences.

Intra-period tax allocation relates to the allocation of

income tax expense during the period to various items
of income or other sources that brought about the tax.
Income tax is allocated to the following:
Inter-Period and Intra-Period Tax Allocation

a. Profit or loss from continuing operation – tax is

presented separately through the income tax
expense account in the statement of profit or loss.
b. Profit or loss from discontinued operations –
results from discontinued operations are
presented in the statement of profit or loss as a
single amount net of tax. Disclosure of related
taxes is made either in the notes or in the
statement of profit or loss.
Inter-Period and Intra-Period Tax Allocation

c. Components of other comprehensive income –

components of other comprehensive income may
be either presented net or gross of related taxes.
Disclosure or related taxes is made either in the
notes or in the statement of profit or loss and
other comprehensive income.
d. Items recognized directly in retained earnings.
END
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