CHAPTER 17
ACCOUNTING FOR INCOME TAX
TECHNICAL KNOWLEDGE
To know the distinction between accounting income and taxable income.
To distinguish permanent differences and temporary differences between accounting
income and taxable income.
To identify temporary differences that result to a deferred tax liability.
To identify temporary differences that result to a deferred tax asset.
To know the recognition and measurement of deferred tax asset and deferred tax
liability.
To know the recognition and measurement of current tax asset and current tax
liability.
To distinguish interperiod tax allocation and intraperiod tax allocation.
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.
Differences between accounting and taxable income
Differences between accounting and taxable income arise. Such differences may be
classified into two, namely:
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 nondeductible
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
b. Dividends received
c. Life insurance premium
When the entity is the beneficiary of a life insurance policy on an officer or
employee, the premium paid by the entity is not deductible as expense for tax
purposes but said premium is an expense for financial reporting purposes.
d. Tax penalties, surcharges and fines are nondeductible.
Temporary differences
Temporary differences are differences between the carrying amount of an asset or
liability and the tax base.
Temporary differences include timing differences.
Timing differences are differences between the accounting income and taxable income
that originate in one period and reverse in one or more subsequent periods.
Timing differences are items of income and expenses which are included in both
accounting income and taxable income but at different time periods.
For every temporary differences, eventually that item’s treatment will be the same
in accounting and taxable income.
Accordingly, temporary diff. give rise either to:
a. Deferred tax liability
b. Deferred tax asset
Kinds of Temporary Differences
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 future deductible amount in determining taxable income of future
periods when the carrying amount of the asset or liability is recovered or
settled.
Tax base
The tax base of an asset or liability is the amount attributable to the asset or liability
for tax purposes.
Worded in another way, the tax base of an asset or a liability is the amount of the
asset or liability that is recognized or allowed for tax purposes.
Tax base of an asset
The tax base of an asset is the amount that will be deductible for tax purposes against
future income.
For example, if an entity has appropriately capitalized P1,000,000 as software
development cost, the carrying amount is P1,000,000 for accounting purposes.
However, 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.
For example, if an entity has recognized an estimated warranty liability of P500,000,
the carrying amount is P500,000 for accounting purposes.
However, an estimated warranty cost is deductible only when actually paid.
Thus, the tax base 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 future periods with
respect to a taxable temporary difference.
A deferred tax liability is the deferred tax consequence attributable to a taxable
temporary difference or future taxable amount.
Actually, a 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 the following:
1. Revenues and gains are included in accounting income of the current period but
are taxable 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 taxable 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 disturbed 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
PAS 12, paragraph 15, provides that a deferred tax liability shall be recognized for
all taxable temporary differences.
However, a deferred tax liability is not recognized when the taxable temporary
difference arises from:
a. Goodwill resulting from a 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 venture is able to control the timing of the 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 a 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 period but are
included in accounting income of future periods.
For example, 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
Future deductible temporary differences include the following:
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
