Accounting for Income Tax

Mary Cris L. Luzada, CPA, MSA

Accounting Income vs. Taxable Income

• Accounting income – the net income for the

period before deducting income tax expense

• Taxable Income – the income for the

period determined in accordance with
the rules established by taxation authorities.
 Classification of Accounting Income &
Taxable Income Differences

• Permanent Differences

• Temporary 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

- pertain to non-taxable revenue and nondeductible expenses

Examples:

1. Interest income on deposits

2. Dividends received
3. Life insurance premium
4. Tax penalties, surcharges and fines are nondeductible
 Temporary Differences
- are differences between the carrying amount of an asset or liability
and its tax base.

- Include timing differences

Timing differences – are items of income and expenses which are

included in both accounting income and taxable income but at
different time periods.
- give rise either to a deferred tax asset or deferred tax liability
 Kinds of Temporary Difference

Taxable Temporary Difference – will result in

future taxable amount in determining taxable
income of future periods when the carrying amount
of the asset or recovered or settled.

- will result to a Deferred Tax Liability

 Kinds of Temporary Difference

Deductible Temporary Difference – 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.

- will result to a Deferred Tax Asset

 Deferred Tax Liability vs. Deferred Tax Asset
Deferred Tax Liability Deferred Tax Asset

arises when:
1. Accounting income is higher than 1. Accounting income is lower than
taxable income. taxable income.

2. The carrying amount of an asset is 2. The carrying amount of the asset

higher than the tax base. is lower than the tax base.

3. The carrying amount of a liability is 3. The carrying amount of a liability

lower than the tax base. is higher than the tax base.
 Accounting Income Higher than Taxable Income
(DTL)
1. Revenues and gains included in accounting
income but are taxable in the future periods.
(installment sale)

2. Expenses and losses deductible for tax

purposes in the current period but deductible for
accounting purposes in future periods.
(accelerated depreciation, capitalized development cost, prepaid expense)
 Other Taxable Temporary Differences (DTL)

1. Upward revaluation of asset per accounting records

2. CA amount of investment in subsidiary or associate or

joint venture is higher than the tax base because of
non-distribution of its entire income to the parent or
investor

3. The cost of a business combination that is accounted

for as an acquisition is allocated to the identifiable
assets acquire at fair value
 Taxable Income Higher than Accounting Income
(DTA)
1. Revenues and gains included in taxable
income of current period but are included in the
accounting income of future periods.
(deferred revenue)

2. Expenses and losses deducted from accounting

income in the current period but are deductible for
tax purposes in future periods.
(provision, research cost expensed immediately for accounting purposes,
impairment loss, doubtful accounts)
 Other Deductible Temporary Differences (DTA)

1. Downward revaluation of asset per accounting records

2. The tax base of investment in subsidiary or associate or

joint venture is higher than the CA because of
continuing losses in current and prior years.

3. The cost of a business combination that is accounted

for as an acquisition is allocated to the identifiable
assets acquire at fair value
 Tax Base
- the amount of the asset or liability that is
recognized or allowed for tax purposes.

Tax base of an asset – the amount that will

be deductible for tax purposes against
future profits.
 Tax Base
Tax base of a liability – the carrying
amount less the amount that will
be deductible for tax purposes in
the future.
 Methods of Accounting
• Income Statement Approach – focuses on
timing differences only in the computation
of deferred tax asset or deferred tax liability

• Statement of financial position approach

- considers all temporary differences

PAS 12 requires the use of statement of

financial position approach
Income Statement Approach – Accounting Procedures

1. Determine the taxable income.

Taxable Income x Tax Rate = Current Tax Expense

Journal Entry:
Income tax expense xx
Income tax payable xx
Income Statement Approach – Accounting Procedures

2. Determine the taxable temporary differences.

Taxable temporary difference x Tax Rate = Deferred Tax Liability

Journal Entry:

Income Tax Expense xx

Deferred Tax Liability xx
Income Statement Approach – Accounting Procedures
3. Determine the deductible temporary differences
Deductible Temporary Difference x Tax Rate = Deferred Tax Asset

Journal Entry:

Deferred tax asset xx

Income tax benefit* xx

* Deduction from current tax expense

Income Statement Approach – Accounting Procedures

4. Total Income Tax Expense is computed.

Current Tax Expense xx
Add: Deferred Tax Expense xx
Less: Income Tax Benefit xx
Total Income Tax Expense xx

or

Accounting Income x Tax Rate = Total Income Tax Expense

 Practice Problem
During the current year, Everlasting Company reported accounting
income of P9,000,000 before income tax. The entity revealed the
following information for the current year:

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 at year-end?

a. 2,130,000 b. 2,250,000 c. 2,490,000 d. 2,700,000

 Practice Problem
Marie Company reported a pretax accounting income of
P5,000,000 for the current year. To compute taxable
income, the following items are noted:
Depreciation deducted for tax purposes in
excess of book depreciation P200,000
Proceeds received from life insurance on
death of officer 500,000
Cash received included in accounting income of
which P120,000 will be taxable next year 200,000
Income tax rate 30%

What amount should be reported as total income tax expense for the
current year?
a. 1,350,000 c. 1,500,600
b. 1,254,000 d. 1,650,000
 Practice Problem
Hilton 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?
a. 1,770,000 c. 1,830,000
b. 1,800,000 d. 1,860,000
 Practice Problem
Pat Company reported a pretax accounting income of
P5,000,000 for the current year. The following items are
included in the determination of the accounting income:
Estimated litigation loss which will become
tax deductible when settled in the future P300,000
Dividend received – net of final tax 100,000
Revenue from an installment sale which will
be recognized as taxable income as received
over the next three years 600,000
Income tax rate 30%

What amount should be reported as current tax expense for the

current year?
a. 1,380,000 c. 1,500,000
b. 1,470,000 d. 1,560,000
 Practice Problem
Viking Company reported in the income statement for the year
ended December 31, 2017 pre-tax income of P1,000,000.

Tax return Accounting record

• Rent income 70,000 120,000
• Depreciation 280,000 220,000
• Premium on officers’ life insurance 90,000
• Income tax rate 30%

What is the current provision for income tax for 2017?

a. 294,000 c. 300,000
b. 327,000 d. 360,000
 Statement of financial position approach
1. Determine tax base of assets & liabilities

2. Compare carrying amounts with the tax base

3. Difference between CA and tax base will result

to either DTA or DTL
 Statement of financial position approach
4. Permanent differences will not give rise to deferred tax
asset or liability.

5. Apply tax rate

6. Determine 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.
 Practice Problem
1. Presented below are the differences between the book basis and tax basis of the assets and
liabilities of Photograph Company at the end of 2014:

Book Basis Tax Basis

• Installment accounts receivable P300,000 P0

• Litigation liability 60,000 0

• It is estimated that the litigation liability will be settled in 2015. The difference in accounts
receivable will result in taxable amounts of P180,000 and P120,000 in 2016. Photograph has
taxable income of P1,050,000 in 2014 and is expected to have taxable income in each of the
following two years. Tax rate is 32%. The company’s operating cycle is two years and this is
the first year of the company’s operation. What are the net deferred tax expense/current tax
expense/income tax expenses of the company?
Deferred Current Income
Tax expense Tax Expense Tax Expense
A) P75,000 P345,600 P451,200
B) P76,800 P336,000 P412,800
C) P96,000 P326,400 P412,800
D) P113,200 P336,000 P432,000
 Practice Problem
Aloha Company provided the following information on December 31, 2017:
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
Deposit 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
debts has been raised against accounts receivable for accounting purposes but such debts are
deductible only when written off as uncollectible. The tax rate is 30%.

What amount should be reported as deferred tax liability on December 31, 2017?

a. 36,000 b. 81,000 c. 120,000 d. 156,000

 Practice Problem
West Company reported the following carrying amount of assets and liabilities on December 31,
2017:
Property 10,000,00
Plant and equipment 5,000,000
Inventory 4,000,000
Trade receivables 3,000,000
Trade payables 6,000,000
Cash 2,000,000
The value for tax purposes for property and for plant and equipment was P7,000,000 and
P4,000,000, respectively. The entity has made a provision for inventory obsolescence of
P2,000,000 which is not allowable for tax purposes. Further, an impairment loss against trade
receivables of P1,000,000 has been made. This charge will not be allowed in the current year for
tax purposes. The tax rate is 30%.

What amount should be recognized as deferred tax expense for 2017?

a. 1,400,000 b. 1,200,000 c. 350,000 d. 300,000
 Practice Problem
On December 31, 2017, the accounts of Simple Company have the same basis for accounting and tax purposes,
except for following: Carrying amount Tax Base
Difference
Computer software cost 4,000,000 0 4,000,000
Equipment 15,000,000 12,000,000 3,000,000
Accrued liability-health care 2,000,000 0 2,000,000

• In January 2017, the entity incurred cost of P6,000,000 in relation to the development of a computer
software product. The software cost was appropriately capitalized and amortized over 3 years for accounting
purposes using straight line. However, the total amount was expensed in 2017 for tax purposes.
• The equipment was acquired on January 1, 2017 for P20,000,000. The useful life is 4 years with no residual
value. The equipment is depreciated using the straight line for accounting purposes and sum of year’s digit
method for tax purposes.
• In January 2017, the entity entered into an agreement with the employees to provide health care benefits.
The cost of such plan for 2017 was P2,000,000. This amount was accrued as expense in 2017 for
accounting purposes. However, health care benefits are deductible for tax purposes only when actually paid.
• The pre-tax accounting income for 2017 is P13,000,000. The tax rate is 30% and there are no deferred
taxes on January 1, 2017.

1.What is the current tax expense for the current year?

a. 1,500,000 b. 2,400,000 c. 3,300,000 d. 3,900,000

2. What is the deferred tax expense for the current year?

a. 600,000 b. 1,500,000 c. 2,100,000 d. 2,700,000

3. What is the total tax expense for the current year?

a. 1,500,000 b. 3,900,000 c. 4,500,000 d. 5,100,000