Chapter 4 - Accounting

for other liabilities

A. Accounting for
Income Tax
 Distinction between Accounting
Income & Taxable Income
Accounting Taxable income
income or
financial income
It is the net It is the income for the period
income for the determined in accordance with the
period before rules established by the taxation
deducting income authorities upon which income taxes
tax expenses. are payable or recoverable. Taxable
This is the income income is the income appearing on the
appearing on the income tax return and computed in
traditional income accordance with the income tax law.
statement and Taxable income may be defined as the
computed in excess of taxable revenue over tax
according with deductible expense and exemptions
accounting for the period as defined by the BIR.
standards.
Accordingly, the difference between accounting income
 Permanent Differences
Permanent Differences are items of revenue and expenses
which are included in either accounting income or taxable
income but will never be included in the other. This
pertain to nontaxable revenue and nondeductible
expenses. Permanent differences do not give rise to
deferred tax asset and liability because they have no
future tax consequences, this include the following:
1. Non-taxable revenue
a) Interest income on deposits
b) Dividends received
c) Proceeds from life insurance policies
2. Non-deductible expenses
a) Life insurance premium
b) Tax penalties
c) Impairment on goodwill
d) Charitable contributions in excess of what is
allowed
 Temporary Differences
Temporary differences are differences between the
carrying amount of an asset or liability in the
balance sheet and its tax base. This may be either
1. Taxable temporary differences – are those 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 settle
2. Deductible temporary differences – are those
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 settle
Temporary differences arise because the rules for
measuring taxable profit are different from those
for measuring accounting profit; hence it give rise
either to a deferred tax asset or deferred tax
 Examples: Temporary Differences
1. Tax and Book depreciation on fixed asset differ
 Different treatment of fixed assets for tax and
book purpose
2. Certain income or expenses is taxed on a cash
basis
 Certain items of income or expense (such as
prepaid rent) may be recognized in taxable
profit on a cash basis while being accounted
for on a accrual basis
3. Assets are revalued for book but not for tax
purpose
 Assets may be revalued for book purposes
under the revaluation model in PAS 16, while
the tax base remains unchanged
4. Fair values are allocated following an acquisition
 Allocation of fair values to assets and
 Distinction between
deferred tax asset and tax liability
Deferred tax asset Deferred tax liability
Deferred tax asset is the Deferred liability is the
amount of income tax amount of income tax
recoverable in future payable in future periods
periods with respect to with respect to a taxable
deductible temporary temporary differences.
differences and operating Deferred tax liability arises
loss carrying forward. from the following.
Deferred tax asset arises
from the following.
1 When the taxable income 1 When the accounting
. is higher than accounting . income is higher than the
income because of timing taxable income because
differences of timing differences
2 When the tax base of 2 When the carrying
. asset is higher that its . amounts of an asset is
carrying amounts higher than its tax base
3 When the tax base of a 3 When the carrying
. liability is lower than its . amount of a liability is
Effect of revenue and expenses
Reven Expen Effe
ue ses ct
1 Accounting income
. included in current
period xx DTL
2 Taxable income
. included in current xx DTA
period
3 Deductible from
. accounting income
in current period xx DTA
4 Deductible for
. taxable income in xx DTL
current period
 Other Temporary Differences
Taxable Deductible
1. Asset is revalued 1. Asset is revalued
upward and no downward and no
equivalent adjustments equivalent adjustments
is made for tax is made for tax
purposes. purposes
2. The carrying amount of 2. The tax base of
investment is subsidiary investment in
or joint venture is higher subsidiary or joint
than its tax base ventures is higher than
(because the entire its carrying amount
income is not distributed (because it has suffered
to the parent or continuing losses in
investor) current and prior years
3. The cost of business
combinations that is
accounted for as
purchase is allocated to
the identifiable assets
 Recognition
Deferred Tax Asset Deferred Tax Liability
PAS 12, paragraph 24, PAS 12, paragraph 15,
provides that a deferred provides that a
tax asset shall be “deferred tax liability
recognized for all shall be recognized for
deductible temporary all taxable temporary
differences and operating differences”. However,
loss carry forward “when a deferred tax liability is
it is probable that taxable not recognized when
income will be available the taxable temporary
against which the differences arises from:
deferred tax asset can be 1. Goodwill
used”. The carrying
amount of the deferred 2. Initial recognition of
tax asset is reviewed at an asset or liability
the end of each reporting
period and reduced if
appropriate.
 Goodwill
PAS 12 prohibits a deferred tax
liability for goodwill on initial
recognition or when any reduction in
the value of goodwill is not allowed
for tax purposes. Goodwill is a
residual amount after recognizing
assets and liabilities at fair value, if
a deferred tax liability is recognized
with respect to goodwill, it would
simply increase the value of
goodwill, hence, deferred tax liability
is prohibited. However, deferred tax
liability for goodwill could be
 Initial Recognition of an Asset
PAS 12 prohibits recognition of
deferred tax liability on the
initial recognition of an asset or
liability in a transaction that is
not a business combination for
this could be classified as a
permanent differences. Initial
recognition of an asset and
liability is neither accounting
income nor taxable income.
 Undistributed
Profits of the Subsidiary
PAS 12 prohibits the recognition of a
deferred tax liability for such taxable
temporary differences when the
following conditions are present:
 The parent can control the timing
of the reversal of the taxable
temporary differences, meaning
the parent can control the
dividend policy of the subsidiary.
 It is probable that the taxable
temporary differences will not
reverse in the foreseeable future
 Operating Loss Carry-forward
Operating loss carry-forward 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, thus an operating loss carry-forward will give
rise to a 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 purpose.
 The tax base of an asset is that amount that will
be deductible for tax purposes against future
profits.
 The tax base of a liability is normally the
carrying amount less the amount that will be
deductible for tax purposes in the future.
 Computation of
Income Tax Expense
Current Tax Expense xx
Add/Deduct:
Taxable temporary difference
Increase/(Decrease) in deferred xx /(xx)
tax liability
Deductible temporary difference
Decrease / (Increase ) in deferred xx / (xx) xx /(xx)
tax asset
Income Tax Expense xx
 Current tax liability
And Current tax asset
Current Is the current tax expense
tax or the amount of income
liability tax payable. This is
classified as current
liability.
Current Is the excess of the
tax asset amount of tax already
paid for the current
period over the income
tax payable for the
period.
 Presentation of
deferred tax asset or liability
PAS 12 paragraph 70, provides that
“when an entity makes a distinction
between current and non-current
assets and liabilities, it shall not
classify deferred tax assets as
current assets and deferred tax
liabilities as current liabilities.
Instead, deferred tax assets shall be
classified as non-current asset and
deferred tax liabilities shall be
classified as non-current liabilities.
 Offset of deferred
tax asset and liability
Under PAS 1, assets and liabilities
shall not be offset unless required or
permitted by another standard.
However, PAS 12, paragraph 74
provides that an entity shall offset a
deferred tax asset against a deferred
tax liability when:
1. The deferred tax asset and
deferred tax liability relate to
income taxes levied by the same
authority.
2. The entity has a legal enforceable
 Unused tax losses
and unused tax credits

A deferred tax asset shall be

recognized for the carry forward
of unused tax losses and unused
tax credits to the extent that it
is probable that future taxable
profit will be available against
which the unused tax losses and
unused tax credits can be
utilized
 Disclosure
The major components of tax expense / (income)
shall be disclosed separately. It may include the
following:
1. Current tax expense (income)
2. Any adjustments recognized in the period for
current tax of prior periods
3. The amount of deferred tax expense (income)
relating to the origination and reversal of
temporary differences
4. The amount of deferred tax expense (income)
relating to changes in tax rates or the
imposition of new taxes
5 The amount of the benefit arising from a
previously unrecognized tax loss, tax credit or
temporary difference of a prior period that is
used to reduce current tax expense
 Disclosure (Continuation)
6. The amount of the benefit from a previously
unrecognized tax loss, tax credit or temporary
difference of a prior period that is used to
reduce deferred tax expense
7. Deferred tax expense arising from the write-
down, or reversal of a previous write-down, of a
deferred tax asset in accordance with
paragraph 56
8. The amount of the tax expense (income)
relating to those changes in accounting policies
and errors that are included in profit or loss in
accordance with IAS 8, because they cannot be
accounted for retrospectively
End of Topic