BALIUAG UNIVERSITY

Integrated Accounting Course II

Summer 2017

MODULE 10: Income Taxes LVC

 RELATED STANDARD: IAS 12 – Income Taxes

 Definition of Terms
Accounting profit – It is the profit or loss for a period before deducting tax expense.
Taxable profit (tax loss) - The profit (loss) for a period, determined in accordance with the rules established by the
taxation authorities, upon which income taxes are payable (recoverable).
Tax expense (tax income) - The aggregate amount included in the determination of profit or loss for the period in respect
of current tax and deferred tax.
Current tax - The amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period.
Deferred tax liabilities - The amounts of income taxes payable in future periods in respect of taxable temporary
differences.
Deferred tax assets - 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.
Temporary differences - The 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 - Temporary differences that will result in taxable amounts in determining
taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or
settled.
b. Deductible temporary differences - Temporary differences that will result in amounts that are deductible in
determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is
recovered or settled.
Tax base of an asset or liability - The amount attributed to that asset or liability for tax purposes.

 Current Tax
 Current tax for the current and prior periods is recognized as a liability to the extent that it has not yet been settled,
and as an asset to the extent that the amounts already paid exceed the amount due. The benefit of a tax loss which
can be carried back to recover current tax of a prior period is recognized as an asset.
 Current tax assets and liabilities are measured at the amount expected to be paid to (recovered from) taxation au-
thorities, using the rates/laws that have been enacted or substantively enacted by the balance sheet date.

 Permanent and temporary difference

 Permanent difference are items included in either accounting income or taxable income but not in both.
 Permanent differences pertain to nontaxable revenue and nondeductible expenses. Examples are:
 Interest income on deposits (subject to final tax)
 Dividends income (subject to final tax)
 Life insurance premium (expense for financial reporting but not deductible for tax purposes)
 Tax penalties, surcharges and fines (nondeductible)
 Temporary differences include timing difference. Items of expenses and revenues are included in both accounting
income and tax income, but at different periods.
a. Taxable temporary difference creates deferred tax liability
b. Deductible temporary difference creates deferred tax asset

 Tax bases
 The tax base of an item is crucial in determining the amount of any temporary difference, and effectively represents
the amount at which the asset or liability would be recorded in a tax-based balance sheet. IAS 12 provides the
following guidance on determining tax bases:
 Assets. The tax base of an asset is the amount that will be deductible against taxable economic benefits from re-
covering the carrying amount of the asset. Where recovery of an asset will have no tax consequences, the tax
base is equal to the carrying amount.
 Revenue received in advance. The tax base of the recognized liability is its carrying amount, less revenue that will
not be taxable in future periods.
 Other liabilities. 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.
 Unrecognized items. If items have a tax base but are not recognized in the statement of financial position, the
carrying amount is nil.

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 Tax bases not immediately apparent. If the tax base of an item is not immediately apparent, the tax base should
effectively be determined in such as manner to ensure the future tax consequences of recovery or settlement of
the item is recognized as a deferred tax amount.
 Consolidated financial statements. In consolidated financial statements, the carrying amounts in the consolidated
financial statements are used, and the tax bases determined by reference to any consolidated tax return (or
otherwise from the tax returns of each entity in the group).

 Deferred tax liability and deferred tax asset

Deferred Situation Temporary differences
tax
Deferred  Accounting income is higher  Revenue and gains included in accounting income for
tax liability than taxable income current period but taxable in the future.
 Carrying amount of asset is  Expenses and losses deducted from taxable income
higher than its tax base but deductible for accounting purposes in the future.
 Carrying amount of liability is
lower than tax base
Deferred  Taxable income is higher  Revenue and gains included in taxable income for
tax asset than accounting income current period but included in accounting income in
 Tax base of assets is higher the future.
than its carrying amount  Expenses and losses deducted from accounting
 Tax base of liabilities is lower income but deductible for tax purposes in the future.
than carrying amount of
liability.

 Calculation of deferred taxes

 Deferred tax assets and deferred tax liabilities can be calculated using the following formulae:
Temporary difference = Carrying amount – Tax base
Deferred tax asset or liability = Temporary difference x Tax rate
Deferred tax expense = Increase in deferred tax liability – Increase in deferred tax asset
Tax expense = Current tax expense + Deferred tax expense
 The following formula can be used in the calculation of deferred taxes arising from unused tax losses or unused tax
credits:
Deferred tax asset = Unused tax loss or unused tax credits x Tax rate

 Presentation
 Current tax assets and current tax liabilities can only be offset in the statement of financial position if the entity has
the legal right and the intention to settle on a net basis.
 Deferred taxes shall be classified as noncurrent asset or liability, as the case may be. Deferred taxes shall not be
discounted.
 Deferred tax assets and deferred tax liabilities can only be offset in the statement of financial position if the entity
has the legal right to settle current tax amounts on a net basis and the deferred tax amounts are levied by the same
taxing authority on the same entity or different entities that intend to realize the asset and settle the liability at the
same time.

 Recognition of deferred tax liabilities

 The general principle in IAS 12 is that a deferred tax liability is recognized for all taxable temporary differences.
There are three exceptions to the requirement to recognize a deferred tax liability, as follows:
 Liabilities arising from initial recognition of goodwill
 Liabilities arising from the initial recognition of an asset/liability other than in a business combination which, at
the time of the transaction, does not affect either the accounting or the taxable profit.
 Liabilities arising from temporary differences associated with investments in subsidiaries, branches, and associ-
ates, and interests in joint arrangements, but only 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 not occur in the foreseeable future.

 Recognition of deferred tax assets

 A deferred tax asset is recognized for deductible temporary differences, 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 differences
can be utilized, unless the deferred tax asset arises from the initial recognition of an asset or liability other than in a
business combination which, at the time of the transaction, does not affect accounting profit or taxable profit.
 Deferred tax assets for deductible temporary differences arising from investments in subsidiaries, branches and
associates, and interests in joint arrangements, are only recognized to the extent that it is probable that the
temporary difference will reverse in the foreseeable future and that taxable profit will be available against which
the temporary difference will be utilized.
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 The carrying amount of deferred tax assets are reviewed at the end of each reporting period and reduced to the
extent that it is no longer probable that sufficient taxable profit will be available to allow the benefit of part or all of
that deferred tax asset to be utilized.
 A deferred tax asset is recognized for an unused tax loss carry forward or unused tax credit if, and only if, it is con-
sidered probable that there will be sufficient future taxable profit against which the loss or credit carry forward can
be utilized.

 Illustration
Given are the data of ABC Corporation for the current year ended:
Accounting net income P 12,000,000
Permanent difference:
Nontaxable income 1,200,000
Nondeductible expenses 700,000
Temporary difference
Revenues per books 2,000,000
Taxable revenues per ITR 1,200,000
Expenses per books 1,400,000
Allowable deductions per ITR 900,000
Tax rate 30%

Requirements: Determine and record the following

a. Current tax expense
b. Deferred tax expense
c. Total tax expense
d. Income tax payable
e. Deferred tax liability
f. Deferred tax asset

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Illustrative Problems

1. Defined by IAS 12 as the amounts of income taxes recoverable in future periods in respect of deductible temporary
differences, the carryforward of unused tax losses and the carryforward of unused tax credits.
A. Tax expense C. Deferred tax liabilities
B. Current tax D. Deferred tax assets
2. Defined by IAS 12 as the amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for
a period.
A. Tax expense C. Deferred tax liabilities
B. Current tax D. Deferred tax assets
3. Defined by IAS 12 as the amounts of income taxes payable in future periods in respect of taxable temporary
differences.
A. Tax expense C. Deferred tax liabilities
B. Current tax D. Deferred tax assets
4. Defined by IAS 12 as temporary differences that will result in taxable amounts in determining taxable profit (tax
loss) of future periods when the carrying amount of the asset or liability is recovered or settled.
A. Taxable temporary differences C. Current tax
B. Deductible temporary differences D. Tax base
5. Deferred tax expense is equal to
A. Increase in deferred tax liability less increase in deferred tax asset
B. Increase in deferred tax liability plus increase in deferred tax asset.
C. Increase in deferred tax liability
D. Increase in deferred tax asset
6. Deferred tax liability is recognized for all
A. Permanent difference C. Taxable temporary difference
A. Temporary difference D. Deductible temporary difference
7. Which of the following differences would result in future taxable amounts?
A. Expenses or losses that are deductible after they are recognized in accounting income.
B. Revenues or gains that are taxable before they are recognized in accounting income.
C. Expenses or losses that are deductible before they are recognized in accounting income.
D. Revenues or gains that are recognized in accounting income but are never included in taxable income.
8. A temporary difference which would result in deferred tax liability?
A. Interest revenue on bonds investment.
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B. Accrual of warranty expense
C. Excess tax depreciation over accounting depreciation
D. Subscription received in advance
9. A temporary difference which would result in a deferred tax asset?
A. Tax, penalty or surcharges
B. Dividend received on equity securities
C. Excess tax depreciation over accounting depreciation
D. Rent received in advance included in taxable income but deferred for accounting purposes.
10. A temporary difference which would result in a deferred tax liability?
A. Accrual of estimated litigation loss
B. Provision for uncollectible accounts
C. Unearned subscription revenue taxable when collected
D. An installment sales included in accounting income at point of sale and taxable when collected
11. Classification of deferred tax shall be
Deferred tax liability Deferred tax asset
A. Current Current
B. Noncurrent Noncurrent
C. Noncurrent Current
D. Current Noncurrent
12. Which of the following describes deferred tax asset?
A. Tax base of assets is higher than its carrying amount.
B. Accounting income is higher than taxable income
C. Expenses and losses deducted from taxable income but deductible for accounting purposes in the future.
D. Revenue and gains included in accounting income for current period but taxable in the future.
13. For deferred tax accounting, which of the following will have a carrying amount of zero?
A. Revenue received in advance
B. Case when tax bases not immediately apparent
C. Unrecognized items with tax base
D. All of the foregoing
14. Which of the following would not require recognition of a deferred tax liability?
A. Liabilities arising from initial recognition of goodwill.
B. Liabilities arising from temporary differences associated with investments in subsidiaries, branches, and associ-
ates, and interests in joint arrangements.
C. Liabilities arising from the initial recognition of an asset/liability other than in a business combination which, at
the time of the transaction, does not affect either the accounting or the taxable profit.
D. All of the foregoing
15. A deferred tax asset is recognized for the following instances, except?
A. Deductible temporary differences C. Taxable temporary differences
B. Unused tax losses D. Unused tax credits
16. Tax expense to be recognized for the current period includes
A. Current tax expense C. Current tax plus deferred tax expense
B. Deferred tax expense D. Current tax expense minus deferred tax expense
17. Which of the following guidance on measuring deferred taxes is incorrect?
A. Where the tax rate or tax base is impacted by the manner in which the entity recovers its assets or settles its
liabilities, the measurement of deferred taxes is consistent with the way in which an asset is recovered or
liability settled.
B. Where deferred taxes arise from revalued non-depreciable assets, deferred taxes reflect the tax conse-
quences of selling the asset.
C. Deferred taxes arising from investment property measured at fair value reflect the rebuttable presumption
that the investment property will not be recovered through sale.
D. If dividends are paid to shareholders, and this causes income taxes to be payable at a higher or lower rate, or
the entity pays additional taxes or receives a refund, deferred taxes are measured using the tax rate applicable
to undistributed profits.
18. Discounting of tax expense is allowed for
A. Current tax expense C. Current tax and deferred tax expense
B. Deferred tax expense D. None of the foregoing
19. Deferred tax assets and deferred tax liabilities may be offset in the statement of financial position if
A. They qualify to be recognized as current assets and current liabilities, respectively.
B. The entity has the legal right to settle current tax amounts on a net basis and the deferred tax amounts are
levied by the same taxing authority.
C. The entity expects that the temporary difference will reverse within a period of 12 months or less.
D. The entity has the legal right to settle current tax amounts on a net basis and the deferred tax amounts are
levied by different taxing authority.
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20. For Year 1, an entity reported a gross profit on installment sales in its income statement but the item is not included
in the taxable income. Temporary difference is expected to be reported in the taxable income equally in the next
two years. Tax rate is 30%. Accounting and taxable income are presented as follows:
Year 1 Year 2 Year 3
Accounting income 4,000,000 5,000,000 7,000,000
Taxable income 3,000,000 5,500,000 7,500,000
Income tax expense for Year 1 is
A. 300,000 C. 900,000
B. 600,000 D. 1,200,000
21. Refer to no. 20. Income tax expense for Year 2 is
A. 150,000 C. 1,650,000
B. 1,500,000 D. 1,800,000
22. Refer to no. 20. Deferred tax liability on Year 3 is
A. 300,000 C. 450,000
B. 150,000 D. None
23. An entity reported advance rental income of P600,000 which is immediately taxable for Year 1.The rent would be
fully earned the following year. Tax rate is 30%. Accounting and taxable income are presented as follows:
Year 1 Year 2
Accounting income 5,000,000 7,000,000
Taxable income 5,600,000 6,400,000
The deferred tax asset/liability on Year 1
A. 180,000, asset C. 1,500,000, asset
B. 180,000, liability D. 1,500,000, liability
24. Refer to no. 23. The tax expense for year 2 is
A. 2,100,000 C. 1,740,000
B. 1,920,000 D. 1,800,000
25. Hilton company reported pretax accounting income of P6,200,000 for Year 1. It includes P200,000 interest from
investment in government bonds. Accounting depreciation is P500,000 while the depreciation on tax return is
P600,000. Tax rate is 30%. The tax expense for Year 1
A. 1,860,000 C. 1,770,000
B. 1,800,000 D. 1,830,000
26. For Year 1, Tantrum reported pretax financial income of P6,000,000. Analysis revealed that P500,000 is exempted
from income tax and P400,000 is a taxable temporary difference. Tax rate is 30%. The tax expense for Year 1
A. 1,800,000 C. 1,650,000
B. 1,530,000 D. 1,950,000
27. Viking Company shows P1 million pretax net income for Year 1. Tax rate is 30%.The following items were observed:
Item Tax return Income Statement
Rent income 70,000 120,000
Depreciation 280,000 220,000
Premium on officers life 90,000 -
insurance
Provision for income tax for Year 1
A. 294,000 C. 327,000
B. 300,000 D. 360,000
28. For Year 1, Everlasting Company reported accounting income of P9 million before tax. Tax rate is 30%. Other
information follows:
Interest income on government bonds 700,000
Tax return depreciation in excess of depreciation per book 1,300,000
Warranty expense (accrual) 600,000
Actual warranty payment 300,000
Income from installment sales reported per tax return, in excess of income per book 200,000
Income tax expense for Year 1
A. 2,700,000 C. 2,490,000
B. 2,250,000 D. 2,130,000
29. Zambal Company reported depreciation of P2,500,000 in Year 1 tax return and P1,000,000 in Year 1 income
statement. The difference is considered temporary. Tax rate is 30%. Deferred tax liability on Year 1
A. 300,000 C. none
B. 750,000 D. 450,000
30. West Company leased a building and received P4 million annual rental payment on July 1, Year 1 which was the
start of the lease. Rent income is taxable when received. Tax rate is 30%. Deferred tax asset is
A. 300,000 C. 1,200,000
B. 600,000 D. none

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31. Xavier Co. is in the first year of operations. The entity reported pretax accounting income of P4,000,000 and
provided the following items:
Premium on life insurance of key officer 100,000
Depreciation on tax return in excess of book depreciation 120,000
Interest on municipal bonds 53,000
Warranty expense 40,000
Actual warranty repairs 33,000
Bad debt expense 14,000
Beginning balance in allowance for uncollectible accounts 0
Ending balance in allowance for uncollectible accounts 8,000
Rent received in advance that will be recognized evenly over the next three years 240,000
What is the taxable income for 2017?
A. 4,182,000 C. 4,047,000
B. 4,102,000 D. 4,082,000
32. Bio Co. reported the following information during the first year of operations:
Pretax financial income 8,000,000
Nontaxable interest received 250,000
Long-term loss accrual in excess of deductible amount 500,000
Tax depreciation in excess of financial depreciation 1,250,000
Income tax rate 30%
What is the taxable income?
A. 7,000,000 C. 8,500,000
B. 7,250,000 D. 8,750,000
33. Refer to the preceding problem. What is the current tax expense?
A. 2,325,000 C. 2,400,000
B. 2,100,000 D. 1,950,000
34. Refer to the preceding problem. What is the accounting income subject to tax?
A. 8,000,000 C. 8,250,000
B. 7,750,000 D. 7,250,000
35. Refer to the preceding problem. What is the total tax expense?
A. 2,400,000 C. 2,100,000
B. 2,325,000 D. 2,175,000
36. Refer to the preceding problem. What is the deferred tax liability at year-end?
A. 150,000 C. 375,000
B. 225,000 D. 525,000
37. Refer to the preceding problem. What is the deferred tax asset at year-end?
A. 150,000 C. 225,000
B. 375,000 D. 350,000

- End of discussion –

“Always dream and shoot higher than you know you can do. Do not bother just to be better than your contemporaries or
predecessors. Try to be better than yourself.” William Faulkner

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