INCOME TAXES

PAS12 Income Taxes

implements a so-called ‘comprehensive balance sheet method of accounting for income
taxes which recognizes both the current tax consequences of transactions and events and the
future tax consequences of the future recovery or settlement of the carrying amount of an entity’s
assets and liabilities. Differences between the carrying amount and tax base of assets and
liabilities, and carried forward tax losses and credits, are recognized, with limited exceptions, as
deferred tax liabilities or deferred tax assets, with the later also being subject to a probable
profits tests.

Key Definitions
Tax Base The Tax Base of an asset or liability is the
amount attributed to that asset or liability for
tax purposes.
Temporary Differences Differences between the carrying amount of
an asset or liability in the statement of
financial position and its tac bases
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.
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.
Deferred Tax Liabilities The amounts of income taxes payable in
future periods in respect of taxable temporary
differences
Deferred Tax Assets The amount 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

Calculations:
Temporary Difference = Carrying amount - Tax Base
 Deferred Tax Asset or = Temporary Difference X Tax Rate
Liability
Deferred Tax Asset = Unused tax loss or Unused tax X Tax Rate
credits

Introduction
Deferred tax accounting is applicable to all entities, whether public or nonpublic
entities.
A public entity is an entity:
a. Whose equity and debt securities are traded in a stock exchange or over-the-counter
market
b. Whose equity or debt securities are registered with Securities and Exchange Commission
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 Bureau of Internal Revenue.
Accounting profit or loss Taxable profit (Tax loss)
Computed using PFRSs Computed using tax laws
Equal to the profit or loss for a period Equal to Taxable income less Tax-
before deducting income tax expense deductible expenses
Similar Term: Pretax Income, Similar term: Taxable Income
Financial Income, and Accounting
Income

Difference between Accounting Income and Taxable Income

Differences between accounting income and taxable income may be classified into two, name:
a. Permanent Differences
b. 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 nondedcuctible
expenses.
 Permanent Differences do not give rise to deferred tax asset and liability because they
have no future tax consequences.
Examples include the following:
a. Interest income on deposits/bank deposits
b. Interest income on government bonds and treasury bills
c. Dividends received/received
d. Life insurance Premium – (when the entity is the beneficiary of a life insurance policy.
Temporary if the beneficiary is the officer)
e. Tax penalties, Surcharges and fines are nondeductible.

Temporary Differences
Temporary differences are differences between carrying amount of an asset or liability
and the tax base.
Temporary differences include timing differences.
Timing Differences are items of income and expenses which are included in both accounting
income and taxable income that are originate in one period and reverse in one or more
subsequent periods.
For every temporary difference, eventually that item’s treatment will be the same in
accounting and taxable income.
Accordingly, temporary differences give rise either to:
a. Deferred tax liability
b. 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 the
future deductible amounts in determining taxable income of future periods when the
carrying amount of the asset or liability is recovered or settled.
Taxable Temporary Difference Deductible Temporary Difference
Arises when Financial income is Arises when Financial income is less
greater than the taxable income than the taxable income
(FI>TI)
If multiplied by the tax rate, results If multiplies by the tax rate, results to
to deferred tax liability. deferred tax asset

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 liability is the amount of the asset or
liability that is recognized or allowed for tax purposes.
Determining Tax Bases:
a. ASSET – The tax base of an asset is the amount that will be deductible against taxable
economic benefits from recovering 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.
b. 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.
c. 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.
d. UNRECOGNIZED ITEMS – If items have a tax base but are not recognized in the
statement of financial position, the carrying amount is nil.
e. 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
endure the future tax consequences of recovery or settlement of the item is recognized as
deferred tax amount.
f. CONSOLIDATED FINANCIAL STATEMENT – In consolidated financial
statements, the carrying amount in the consolidated financial statements are used, and the
tax bases determined by reference to any consolidated tax return or otherwise from the
tax retrns of each entity in the group.
Tax Base of an Asset
The tax base of an asset is the amount that will be deductible for tax purposes against
future income.
If an entity has appropriately capitalized P1,000,000 as software development cost, the carrying
amount is P1,000,000 for accounting purposes.
(If this 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

The tax base of a liability is normally the carrying amount less the amount that
will be deductible for tax purposes in the future.
If an entity has recognized an estimated warranty liability of P500,000 the carrying amount is
P500,000 for accounting purposes.
(An estimated warranty cist is deductible only when actually paid.)
Thus, the tax 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 the future periods with
respect to a taxable temporary difference.
A deferred tax liability is the deferred tax consequences attributable to a taxable
temporary difference or future taxable amount.
Deferred tax liability arises from the following:
a. When the accounting income is higher than taxable income because of timing
differences.
b. When the carrying amount of an asset is higher than the tax base.
c. 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 following:
1. Revenues and gains are included in accounting come of the current period but are taxable
in future periods.
An installments included in accounting income at the time of sale and included in
taxable income when cash is collected in future periods.

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 straight line depreciation 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.
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 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.
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

Deferred tax liability shall be recognized for all taxable temporary differences.
Deferred tax liability is NOT RECOGNIZED when the taxable temporary difference arises
from:
 a. Goodwill resulting from 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 reversal of the temporary difference.

Deferred Tax Asset

A deferred tax asset is the amount of income tax recoverable in future periods with
respect to deductible temporary difference and operating loss carryforward.
In other words, 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 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 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. Revenues and gains are included in taxable income of current periods but are included in
accounting income of future periods.
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

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.
(Warranty obligation)
c. Research cost are expensed outright under financial reporting but amortized under
taxation.
d. Retirement benefits are accrued as employees render services, but are tax deductible only
when the employer pays contributions to a fund or pays retiring employees.
e. Bad debts are accrued as an employees render services, but are tax deductible only
when accounts become worthless.
f. The depreciation period used for financial reporting purposes is shorter than the
depreciation period used for taxation.
 g. Accelerated depreciation is used under financial reporting while the straight-line
method is used for taxation purposes.
h. Advances from customers are treated as liability for financial reporting purposes but are
taxable upon collection.
i. Rent received in advance is treated as unearned income for financial reporting purposes
but is included as taxable income upon receipt of cash.

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 he subsidiary, associate or joint venture has suffered
continuing losses in current and prior years.

Recognition of Deferred Tax Asset

Deferred tax asset shall be recognized for all deductible temporary differences and operating loss
carryforward 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.
Noted: Entities registered with the Board if Investments are permitted to carry over net
operating loss for the tax purposes subject to limitations of the relevant law and implementing
regulations of the Board if Investments.

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.
 Timing differences affect the income statement of one period and will reverse in the
income statement of one or more subsequent periods.
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. Determine the taxable income
The taxable income multiplied by the tax rate equals the current tax expense.
 Income tax expense P xxx
Income tax payable P xxx
Current tax expense is amount of income tax paid or payable for a year as
determined by applying the provision of the enacted tax law to the taxable income.

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 P xxx
Deferred tax liability P xxx

3. Determine the deductible temporary differences

The amount of deductible
4. `