ACYFARP: Accounting for Income Taxes

Accounting Income

The net income for the period before deducting income tax.

Taxable Income

The income for the period determined in accordance with the rules established by tax authorities (the Bureau of Internal Revenue) upon which income taxes are payable or recoverable.

Accounting Income

Reported in the income statement.

Taxable Income

Reported in the income tax return.

Accounting Income

Computed in accordance with financial reporting standards.

Taxable Income

Computed in accordance with BIR tax laws.

Accounting Income

Revenues - Expenses = Net Income

Taxable Income

Taxable Revenues - Deductible Expenses = Taxable Income

Accounting Income

Also called as financial income or pre-tax income.

Permanent Differences and Temporary Differences

The two classifiable differences between accounting income and taxable income.

Permanent Differences

Income and expense items which are included in either accounting income or taxable income but will never be included in the other. These items are excluded from the income tax return and do not have future tax consequences.

Temporary Differences

Income and expense items which are included in both accounting income and taxable income but at different periods. Include timing differences:

a. These are income and expense items recognized for accounting purposes in one period but recognized for tax purposes in another period (vice versa).

b. These items have future tax consequences and give rise to either: Deferred Tax Asset or Deferred Tax Liability

Non-Taxable Income and Non-Deductible Expenses

These are the two types of permanent differences.

Non-Taxable Income

These are income items that will no longer be subjected to income tax because they are either exempted from income tax or already subjected to final tax. (Ex: Interest income on time or savings deposits, government bonds, and treasury bills or municipal bonds, Gains subject to capital gains tax, Dividends received by domestic corporations from a domestic corporation, Gain from settlement of life insurance of officers and employees where the entity is the beneficiary of the insurance policy, Life insurance premium paid when the entity is the irrevocable beneficiary of the life insurance policy, fines, penalties, and/or surcharges for violations for laws, and charitable contributions in excess of tax limitation ).

Non-Deductible Expenses

These are expense items that are not allowed to be recognized or deducted for tax purposes.

Taxable Temporary Differences

Results in future taxable amount in determining taxable income of future periods. It gives rise to a deferred tax liability.

Deductible Temporary Differences

Results in future deductible amount in determining taxable income of future periods. Gives rise to a deferred tax asset.

Tax Base

Is the amount of the asset or liability that is recognized or allowed for tax purposes. In other terms, it is the amount attributable to the asset or liability for tax purposes. It is the amount that will be deductible for tax purposes against future income.

Tax Base - Asset

Is the amount that will be deductible for tax purposes against future profit.

Tax Base

It is the carrying amount of asset or liability under tax laws.

Tax Base - Liability

Is normally the carrying amount less the amount that will be deductible for tax purposes in the future.

Tax Base of a Depreciable or Amortizable Asset

Cost - Accumulated Depreciation/Amortization

Tax Base of a Transaction that is Taxable Only When Cash is Collected

Zero

Tax Base of a Transaction that has No Future Consequence

Carrying Amount

Deferred Tax Liability

The amount of income tax payable in the future periods with respect to a taxable temporary difference or future taxable amount.

Deferred Tax Liability

Arises from the following:

a. Accounting Income > Taxable Income

b. Asset's Carrying Amount > Asset's Tax Base

c. Liability's Carrying Amount < Liability's Tax Base

Deferred Tax Liability

Examples include:

a. Income items that are included in accounting income but are taxable in future periods (accrual of income for accounting purposes but taxable only when collected).

b. Expenses that are deductible for tax purposes but deductible for accounting purposes in future periods (higher depreciation charges for tax purposes, prepaid expenses).

Deferred Tax Liability

Shall be recognized for all taxable temporary differences. It shall not be recognized when the taxable temporary differences arise from the following:

a. Goodwill resulting from business combinations

b. Asset or liability that affects neither accounting nor taxable income

c. Undistributed profit of subsidiary, associate or joint venture

True

(True or False) Goodwill resulting from business combinations is treated as a nondeductible expense for tax purposes.

Other Taxable Temporary Differences

Most taxable temporary differences arise because of timing differences. The following are not timing differences but give rise to deferred tax liability:

a. Upward revaluation of an asset.

b. Carrying amount of investment in subsidiary, associate, or joint venture which is higher than its tax base.

c. Cost of business combination accounted for as an acquisition.

Deferred Tax Asset

The amount of income tax recoverable in future periods with respect to deductible temporary difference (or future deductible amount) and operating loss carryforward.

Deferred Tax Asset

Arises from the following:

a. Accounting Income < Taxable Income

b. Asset's Carrying Amount < Asset's Tax Base

c. Liability's Carrying Amount > Liability's Tax Base

Deferred Tax Asset

Include the following:

a. Income that is included in taxable income of current period but included in accounting income for future periods (i.e., advance collections).

b. Expenses that are deducted from accounting income but are deductible for tax purposes in future periods (i.e., estimated liabilities, impairment losses, doubtful accounts).

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

Is an excess of tax deductions over gross income in a year that may be carried forward to reduce taxable income in a future period.

Other Deductible Temporary Differences

Most deductible temporary differences arise because of timing differences.

Other Deductible Temporary Differences

The following are not timing differences but give rise to deferred tax asset:

a. Downward revaluation of an asset.

b. Tax base of investment in subsidiary, associate or joint venture which is higher than the carrying amount.

Income Statement Method and Balance Sheet Method

These are the two (2) methods of accounting for temporary differences.

Income Statement Method

This method focuses on timing differences only in the computation of deferred tax asset or deferred tax liability.

Balance Sheet Method

This approach considers all temporary differences including timing differences. There are temporary differences that affect the financial position only and therefore technically are not timing differences but nonetheless are recognized in computing deferred tax asset or liability.

True

(True or False) PAS 12 requires the use of the statement of financial position approach.

Balance Sheet Method

Future taxable amounts and future deductible amounts are determined by getting the differences between the carrying amount of assets and liabilities and their respective tax bases.

Accounting Procedures in the Balance Sheet Method

First Step - Determine the taxable income. (Accounting Income - Nontaxable income + Nondeductible expenses = Income Subject to Tax - Future taxable amounts + Future deductible amounts = Taxable Income)

Second Step - Determine the current income tax expense (Taxable Income x Current Income Tax Rate)

Third Step - Determine the Deferred Tax Liability (Future taxable amounts or Taxable temporary differences x Enacted Income Tax Rate = Deferred Tax Liability)

Fourth Step - Determine the Deferred Tax Asset (Future Deductible Amounts or Deductible Temporary Differences x Enacted Income Tax Rate = Deferred Tax Asset)

Fifth Step - Determine the Total Income Tax Expense (Income Tax Expense - Current + Net Deferred Tax Expense - Net Deferred Tax Benefit = Total Income Tax Expense)

Taxable Income

Accounting Income - Nontaxable income + Nondeductible expenses = Income Subject to Tax - Future taxable amounts + Future deductible amounts = Taxable Income

Current Income Tax Expense

Is the amount of tax that is required to be paid to the BIR.

Net Deferred Tax Expense

Deferred Tax Liability > Deferred Tax Asset = Net Deferred Tax Expense

Net Deferred Tax Benefit

Deferred Tax Liability < Deferred Tax Asset = Net Deferred Tax Benefit

Measurement of Deferred Tax Asset and Liability

Deferred tax asset and liability shall be measured using the tax rate that has been enacted by the end of the reporting period and expected to apply to the period when the asset is realized or the liability is settled.

Current Tax Liability

Is presented as a current liability in the SFP.

Current Tax Asset (or Prepaid Income Tax)

Is presented as a current asset in the SFP.

Deferred Tax Liability

Is presented as a noncurrent liability in the SFP.

Deferred Tax Asset

Is presented as a noncurrent asset in the SFP.

Current Tax Liability

Current Income Tax Expense > Quarterly Income Tax Payments

Current Tax Asset (Prepaid Income Tax)

Current Income Tax Expense < Quarterly Income Tax Payments.

True

(True or False) A company shall not classify deferred tax liabilities and assets as current and shall not be discontinued.

Rules on Offsetting - Current Tax Asset and Liability

Can be offset only if:

a. The entity has a legal enforceable right to set off the recognized amounts.

b. Intends either to settle on a net basis or to realize the asset and settle the liability simultaneously.

Rules on Offsetting Deferred Tax Asset and Liability

General rule: Not allowed

Exception:

a. The deferred tax asset and liability relate to income taxes levied by the same tax authority.

b. The company has a legal enforceable right to set off a current tax asset against a current tax liability.

Intraperiod Tax Allocation

Pertains to allocation of income tax expense to the various income tax items that brought about the tax. "The tax follows the income".

Intraperiod Tax Allocation

Examples include: The total income tax expense is allocated among income from continuing operations, income from discontinued operations, and prior period errors.

Income Taxes - Recognized Outside Profit or Loss

Examples include:

a. Taxes recognized in other comprehensive income (Rev. Surplus and Exchange Differences Arising on the Translation of the Financial Statements of a Foreign Operation)

b. Taxes recognized in equity (Adjustment to the opening balance of retained earnings resulting from change in accounting policy or correction of errors. Amounts arising on initial recognition of the equity component of a compound financial instrument).

Interperiod Tax Allocation

Is the recognition of deferred tax asset or liability.

Future Taxable Difference

Also referred to as a deferred tax liability. It occurs when the carrying amount of an asset is higher than its tax base.

Increase in Deferred Tax Liability

Is essentially the equivalent to the increase in taxable temporary difference or decrease in deductible temporary difference. Vice versa.

Decrease in Deferred Tax Asset

Is essentially the equivalent to the decrease in deductible temporary difference or the increase in taxable temporary difference. Vice versa.

Deferred Tax Expense

Is the net effect of the changes in deferred tax liability and deferred tax asset.

True

(True or False) Apparently, there is no need to gross-up passive interest income as a result of final taxes since in terms of financial accounting, what is added to the income statement is essentially the passive income, net of final taxes already.

Deferred Tax Asset from NOLCO

NOLCO x Income Tax Rate