RIZAL TECHNOLOGICAL UNIVERSITY

Cities of Mandaluyong and Pasig

SESSION NO. / WEEK NO. 4

MODULE NO.4: INCOME TAXES

1. Nature of Income Taxes

2. Difference of Accounting Income and Taxable Income
3. Recognize current income tax arising from taxable income
4. Recognize deferred income tax arising from temporary differences
between accounting income and taxable income.
5. Recognize tax consequence of operating loss carry forward
6. Present income tax expense and current income tax assets and
liabilities and deferred tax assets and liabilities in the financial
statements.
7. Identify the required disclosures related to income tax

Overview

This module is prepared for the students to understand the nature of

income taxes.
This module discusses the nature of income taxes, difference of
accounting income from taxable income, recognition of current income tax
from taxable income and recognition of deferred income tax arising from
temporary differences between accounting income and taxable income,
consequences of operating loss carry forward and presentation in the
financial statements.
This module will cover a brief discussion of the theory and standard
behind the topic, exercises and practice problem the cover the said topic.

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

Study Guide

This module is designed for the students to understand provisions,

contingencies and other liabilities. This module includes:
1. Topic Discussions - to be read by the students to fully understand the
topic.
2. Guided Exercises/Learning Activities - to be done simultaneously by
the instructor and the students during discussion to apply the lesson to
situations and problems in relation to the topic.
3. Assessment – to be accomplished by the students after the
discussion to test their skills and understanding to the subject matter.
4. Assignment – activity to be done by students to be submitted to the
instructor. This is to reinforce or advance the student’s learning. It is
relevant to the past, current, and future lessons.

To complete the requirements of this module, the students are required to:
1. Read and understand the topic discussion and the guided exercises
2. Accomplish the assessment.
3. Accomplish the assignment due on next meeting.

Learning Outcomes

At the end of the discussion, the students are expected to:

1. Describe and distinguish accounting income from taxable income.
2. Recognize current income tax arising from taxable income
3. Recognize deferred income tax arising from temporary differences
between accounting income and taxable income.
4. Calculate the correct amount of income tax expenses.
5. Present income tax expense and current income tax assets and
liabilities and deferred tax assets and liabilities in the financial
statements.

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

Topic Presentation

NATURE OF INCOME TAXES

Income taxes are normally treated as a cost of doing business and therefore, require
recognition in the same period as the related income. Two types of income or profit are
reported: taxable income is reported to taxing authority for imposition of income taxes;
whereas for financial reporting purposes, profit is measured in accordance with the financial
reporting standards. Because tax laws and financial reporting standards differ, differences
arise between the amounts of taxable income and pretax financial income for a year, as well
as the tax bases of assets and liabilities and their reported amounts in the financial
statements.

IAS 12, income taxes, prescribes the accounting treatment for income taxes. The
principal issue in accounting for income taxes is how to account for the current and future tax
consequences of –

 The future recovery (settlement) of the carrying amount of assets (liabilities) that are
recognized in an enterprise’s statement of financial statement and, 
 Transactions and other events of the current period that are recognized in an
enterprise’s financial statements.

IAS 12 applies to all enterprises that are subject to income tax. The fundamental principle
is the recognition of deferred tax liability (or asset) by enterprises arising from the differences
between tax bases of assets and liabilities and their carrying amounts in the statement of
financial position.

On the statement of financial position, the effect of income taxes is recognized as current
tax liabilities (or current tax assets) or deferred tax liabilities (or deferred tax assets)

CURRENT TAX LIABILITIES AND CURRENT TAX ASSETS

Income tax for current and prior periods should, to the extent unpaid, be recognized
as a liability. If the amount already paid in respect of the current and prior periods exceeds the
amount due for those periods, the excess should be recognized as asset. Current tax
liabilities (current tax assets) are computed based on taxable profit (or tax loss) determined in
accordance with the rules established by the taxation authorities. In the Philippines, the rules,
and regulations established are based on the provisions of the National Internal Revenue
Code (NIRC) and other Bureau of Internal Revenue regulations.

The revenues recognized for tax purposes are termed as taxable revenues while the
expenses allowed to be deducted therefrom are called allowed deductions or deductible
expenses. The resulting act amount is the taxable income (or loss). The applicable income
tax rate is the applied to this taxable income to determine the income taxes currently payable.

For example, total taxable revenues during 2020 of ABC Company were P5,000,000
while allowed deductions were P3,800,000. The taxable income is P1,200,000. If the income
tax rate is 30%, then the company’s current tax is P360,000. If the company remitted no taxes
yet pertaining to the year 2020 to the BIR, the entry to recognize the current income tax is 

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

Income tax expense           P360,000

Income tax payable           P360,000

The income tax payable is presented as a current liability on December 31, 2020 statement of
financial position.

ACCOUNTING PROFIT AND TAXABLE PROFIT

Accounting profit is pre-tax profit computed based on the requirements of the

accounting standards and the definition, recognition, and measurement criteria in the
Conceptual Framework. Accounting profit (or financial income) is sometimes called pre-tax
financial income.

Because accounting profit is derived based o accounting principles and taxable

income is derived based on regulation of the tax code and taxing authorities, deference exists
between accounting income and taxable income. These differences are:

(a.) Permanent differences and 

(b.) Temporary differences

Permanent differences are revenue and expense items recorded for accounting
purposes because they meet the recognition criteria in the Conceptual Framework and the
accounting standards, but they are never included in the computation of taxable profit,
because the revenue items are non-taxable and the expense items are non-deductible.

Permanent differences are of two types:

(a.) Non-taxable revenue; and

(b.) Non-deductible expenses.

Revenues they have been included in financial income but will never but included in
taxable income are called non-taxable revenues.

Examples of non-taxable or tax-exempt revenues are:

 Gain from settlement of life insurance of officers and employees where the
corporation is the named beneficiary.
 Dividend revenue received by a domestic corporation or non-resident corporation
from a domestic corporation.
 gains that are already subjected to final withholding such as capital gains and taxes
withheld on bank deposits

Expenses that are deducted from accounting revenues (to arrive at accounting profit )
but will never be allowed to be deducted from taxable revenues (to arrive at taxable income)
are called non-deductible expenses. Examples of non-deductible expenses are: 

 fines and penalties for violation of law 

 charitable contributions in excess of tax limitation
 insurance premiums for life insurance of officers, where the corporation is the
designated beneficiary

When reconciling accounting profit to taxable income , non-taxable revenues are to

be deducted from accounting income and non- deductible expenses are to be added back to
accounting income. 

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

To illustrate, assume that a corporation has pretax financial income of P2,920,000 in

2020. Included in this amount was P1,000,000 of non-taxable gain from the life insurance as
a result of the death of an officer. During the same period, prior to the death of the officer,
premiums amounting to P28,000 were paid by the company. Assume a tax rate of 30%. 

Assume further that the non-temporary differences are the only differences between
accounting profit and taxable income and that neither payment nor accrual of income tax was
made during the year. 

Pretax financial profit is reconciled to taxable income as follows: 

Pretax financial profit                                          P2,920,000

Add nondeductible expense 
        Premiums on officer's life insurance                  28,000
Deduct nontaxable income 
        Gain from life insurance settlement             (1,000,000)
Financial income subject to income tax               P1,948,000

The income tax for 2020 is recorded as follows: 

Income Tax Expense - Current                   584,400

Income Tax Payable                                     584,400
   1,948,000 x 30% 

The lower portion of the profit or loss section of the statement of comprehensive
income for the year ended December 31, 2020 would appear as follows:

Profit before Income Tax                                  P2,920,000

Income Tax Expense                                             584 400
Profit                                                                 P2,335,600

The balance of income tax payable is the resulting current tax liability on the
statement of financial position. 

DEFERRED TAX LIABILITIES AND DEFERRED TAX ASSETS

An enterprise shall recognize in its statement of financial position any deferred tax
liability or deferred tax asset, in addition to current tax liability or current tax asset. 

Deferred tax liabilities are the amounts of income taxes payable in future periods in
respect of taxable temporary differences. Deferred tax assets are 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 

From a balance sheet perspective, a temporary difference is the difference between

the carrying amount of an asset or liability in the statement of financial position and its tax
base. From an income statement perspective, a temporary difference occurs when a revenue
or expense is included in financial profit in one period but reported for tax purposes in another
period. 

Temporary differences may be either (par. 5, LAS12 Income Taxes) 

a. taxable temporary differences or 
b. deductible temporary differences 

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

Taxable Temporary Difference 

From a balance sheet perspective, when the carrying value of an asset exceeds its tax base
or when the carrying value of the liability is less than its tax base, the temporary difference is
a taxable temporary difference. From an income statement perspective, when a temporary
difference results in accounting profit being more than taxable profit the the temporary
difference is a taxable temporary difference. 
Examples of taxable temporary differences are shown in the following table: 
Taxable Temporary Differences 

Balance Sheet Approach  Income Statement Approach 

Carrying amount of interest Interest revenue is recognized in accounting profit

receivable is more than its tax base on a time proportion basis but reported in taxable
(Note: tax base is zero)  profit when collected. 

Carrying amount of property plant Depreciation expense for tax purpose is more than
and equipment is more than its tax depreciation expense for accounting purposes in
base.  the earlier years of the asset life

Carrying amount of prepaid expense Expense is recognized in accounting profit using

is more than its tax base (Note: tax accrual basis but reported in taxable profit when
base is zero)  paid: 

Carrying amount of installment Revenue for sales is recognized in accounting

receivables is more than ita tax base profit during period of delivery but reported in
(Note: tax base is zero)  taxable profit during period of collection.

A taxable temporary difference creates a deferred tax liability. The cumulative amount of
taxable temporary difference multiplied by the tax rate is the amount of deferred tax liability
that is recognized in the statement of financial position. Thus, the entry to set up the liability is
as follows, assuming that deferred tax liability has a zero balance at the beginning of the
current year: 
Income Tax Expense-deferred.                           xxx
Deferred Tax Liability.                                             Xxx
Deductible Temporary Difference 
From a balance sheet perspective, when the carrying value of a! asset is less than its tax
base or when the carrying value of the liability exceeds its tax base, the temporary difference
is a deductible temporary difference. From an income statement perspective, when
accounting profit is less than taxable profit, the temporary difference is a deductible temporary
difference. 
An example of deductible temporary differences are shown in the of table: : 
Deductible Temporary Differences 

Balance sheet approach Income statement approach

Carrying amount of accounts receivable Uncollectible account expense is recognized

is less than its tax base (Note: the using the allowance method for financial
difference is due to the balance of reporting purposes, but recognized for tax
allowance for uncollectible account)  purposes using the direct write off method. 

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

Carrying amount of unearned rent is Rent collected applicable to future period/s is

more than its tax base (Note: tax base is note yet recorded as revenue but is taxable
zero)  during period of collection. 

Carrying amount of warranty liability is Estimated cost of warranty is reported as

more than its tax base (Note: tax base is expense for financial reporting during period of
zero)  sales of goods but is deducted for tax
purposes when repair is actually made. 

Deductible temporary difference creates a deferred tax asset. The cumulative amount of
deductible temporary difference multiplied by the tax rate is the amount of deferred tax asset
that is recognized in the statement of financial position. Thus, the entry to set up the asset is
as follows, assuming that deferred tax asset has a zero balance at the beginning of the
current year: 
Deferred Tax Asset.                                                                        xxx   
 Income Tax Expense (Benefit)-deferred.                            xxx
The following summary may facilitate in determining the taxable temporary difference (TTD),
otherwise known as future taxable amount (FTA) leading to recognition of deferred tax liability
(DTL). 

              Meanwhile, the deductible temporary difference (DTD), otherwise known as future

deductible amount (FDA) leading to recognition of deferred tax asset (DTA), is determined as
follows: 

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

INCOME TAX EXPENSE

The income tax expense shown in the statement of comprehensive income is
composed of two components: the current income tax and deferred income tax. The current
income tax expense results from taxable income while the deferred tax expense results from
the change in deferred tax liability plus or minus the change in deferred tax asset.
Considering both the permanent differences and the temporary differences, taxable
income may be computed by making reconciliations with pre-tax financial profit, as follows:
Pre-tax financial income             Pxx
Permanent differences:                                  
Non-deductible expenses       xx
Non-taxable revenues                                             (xx)
Accounting profit subject to tax                                           Pxx
Temporary differences:
Deductible temporary differences                            xx
Taxable temporary differences                                (xx)
Taxable income                                                                  Pxx

For a complete illustration, assume the following information.

A corporation has pretax financial profit of P1,200,000 and taxable income of P930,000 for
the year 2020. The difference was attributable to the following: 

 During the year gain from settlement of the life insurance of the president, who died
on July 1, 2020 was recognized in the books in the amount of P650,000.

 Included in the determination of pretax financial profit are charitable contributions in

excess of the amount allowed by the revenue code in the amount of P350,000,
premiums paid on the life insurance of the president during the first half of the year of
P25,000 and fines and penalties paid by the company in the amount of P75,000.

 Tax depreciation is P200,000 greater than book depreciation.

 Rent collected in advance, P50,000 reported as revenue for tax purposes but not
recognized for financial accounting purposes.

 Warranty provision of P80,000 accrued in the books but not recognized for tax
purposes until paid.

Reconciliation of financial profit and taxable income is presented below;

Pretax financial profit P1,200,000
Nondeductible expenses 
Charitable contributions in excess of 
the amount allowed     P350,000
Premiums paid on the life insurance                         25,000
Fines and penalties                                                  75,000               450,000
Nontaxable revenue 
Gain from settlement of the life insurance                                        (650,000)
Financial income subject to income tax                                                      P1,000,000
Future taxable amount
Tax depreciation in excess of book depreciation                              (200,000)
Future deductible amounts
Rent collected in advance     P50,000

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

Warranty provision                                                 80,000         130,000

Taxable income                                                                                           P 930,000

Assuming that neither payment nor accrual of income tax was made during the year and a tax
rate of 30%, the journal entries to record the income tax are as follows:
Based on taxable income
Income Tax Expense-Current 279,000
Income Tax Payable 279,000
930,000 x 30%

Based on future taxable amount

Income Tax Expense-Deferred 60,000
Deferred Tax Liability 60,000

Based on future deductible amount

Deferred Tax Asset 39,000
Income Tax Expense – Deferred 39,000
130,000 x 30%
Income tax expense – deferred is the increase deferred is the increase in deferred tax
liability of P60, 000 minus the increase in deferred tax asset of P39, 000. The income tax
expense-deferred is P21, 000. Income tax expense for the year is the sum of current and
deferred income tax expense (P279, 000 + P21,000)  or a total of P300,000, which is 30% of
the financial income subject to income tax (30% x P1, 000, 000)
Financial Statement Presentation
On the enterprise’s statement of financial position at December 31, 2020, the income
tax payable of P279, 000 is reported as a current liability. Assuming that there is no valid
basis for offsetting, P39,000 deferred tax asset is reported as non-current asset and P60, 000
deferred tax liability is reported as non-current liability.
The lower portion of the profit or loss section of the statement comprehensive income
for year ended December 31, 2020 shall appear as follows:
Profit before income tax P1, 200, 000
Income tax expense
Current P279, 000
Deferred     21, 000       300, 000
Profit P    900, 000
IAS 12, Income Taxes, requires that the carrying amount of a deferred tax asset be
reviewed at the end of each reporting date. An enterprise should reduce the carrying amount
of a deferred tax asset 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.
Any such reduction should be reversed to the extent that it becomes probable that
sufficient taxable profit will be available (Paragraph 56, IAS 12). The reversal of deferred tax
asset or the reduction of the amount of deferred tax asset previously recognized is recorded
as follows:

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

Income Tax Expense – Deferred xx

Deferred Tax Asset xx
Tax Rate Considerations
Current tax liabilities (assets) for the current and prior periods should be measured at
the amount expected to be paid to (recovered from) the taxation authorities, using the tax
rates (and tax laws) that have been enacted or substantially enacted by the end of the
reporting period (Paragraph 46, 1AS 12)
Deferred tax assets and liabilities should be measured at the tax rates that are
expected to apply to the period when the asset is realized or the liability is settled, based on
tax rates (and tax laws) that have been enacted or substantially enacted by the end of the
reporting period (Paragraph 47, IAS 12)
Thus, tax laws and tax rates for the current year are used to measure deferred tax
asset or deferred tax liability if at the end of the reporting period, there are no changes that
have been enacted or substantially enacted for future years.
If tax rates are different for future years, the deferred income tax amount to be
reported in the statement of financial position is obtained by multiplying the temporary
difference expected to reverse in future years by the enacted tax rates applicable to the
year/s when the temporary differences are expected to reverse. Tax rates other than the
current rate shall be used only when the future tax rates have been enacted or substantially
enacted into law. If new tax rates are only proposed for future years and not yet substantially
enacted into law, the current rate should be used. 
To illustrate, consider the following information taken from ABC Company’s 2020
financial records:
Pretax accounting income P 1, 500, 000
Excess tax depreciation             (45,000)
Taxable income P 1, 455, 000
The temporary difference was created entirely in 2020 and will reverse in equal
amounts in the next three years. Tax rates are: 30% in 2020; 35% in 2021; and 37% in 2023.
The deferred tax liability at December 31, 2020 is computed as follows:
15,000                     x                              35%                                  5,250
15,0000                   x                              36%                                  5,400
15,000                     x                              37%                                  5,550
Total                                                                                                16,200
The income tax for 2020 is recorded as follows:
Income Tax Expense            436,500
   Income Tax Payable               436,500
     1,455,000 x 30% 

Income Tax Expense-Deferred      16,200

    Deferred Tax Liability                        16,200

The total income tax expense for the year is P452,700, which is the sum of P436,500 and
P16,200. The profit for the year is computed as follows:

Profit before income tax                            P1,500,000

Income tax expense

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

      Current                      P436,500
      Deferred                      16,200                 452,700
                                                                P1,047,300
REVERSAL OF TEMPORARY DIFFERENCES
The accounting procedures previously discussed relate to the period when the
deferred tax liability or deferred tax asset is originally created. When the temporary difference
reverses, the future taxable amount computed in the period origin becomes taxable and the
future deductible amount computed in the period of origin becomes deductible. Hence, the
previously recognized deferred tax liability or deferred tax asset reverses. 
Consider the following complete illustration for the initial recognition and reversal of
deferred tax liability:
An equipment costing 1800000 with an estimated useful life of five years and no
residual value, was acquired on January 1, 2020. The equipment is being depreciated using
straight line method for accounting purposes and using sum of the years’ digit method for
income tax purposes. The accounting profit before income tax of the company for years 2020
through 2024 are as follows:
2020  -  P1,400,000
2021  -  P1,500,000
2022  -  P1,600,000
2023  - P1,700,000
2024  - P1,800,000

No permanent difference exists between accounting profit and taxable income and
the difference in depreciation is the only temporary difference. Assume the tax rate for all
years is 30%. 
The following table summarizes the depreciation expense recognized for financial
statement purposes and tax purposes:
Depreciation Expense
Year                              Accounting                                           Tax                           
Difference
2020                              P360,000                                       P600,000                        P(240000)
2021                                360,000                                          480,000                         
(120000)
2022                                360,000                                          360,000                                 0
2023                                360,000                                          240,000                            
120000
2024                                360,000                                          120,000                            
240000
A comparison of the carrying amount of the equipment and its tax base at the end of each
year follows:
     Date                      Carrying Amount                 Tax Base                      Difference
12/31/2020                    P1,440,000                   P1,200,000                     P240,000
12/31/2021                      1,080,000                        720,000                        360,000
12/31/2022                         720,000                        360,000                        360,000
12/31/2023                         360,000                        120,000                        240,000
12/31/2024                             0                                  0                                     0
The following table shows computation of the company’s taxable income for years 2020
through 2024:
                                                           2020             2021          2022           2023          2024
                                                                                    In thousands of pesos 

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Cities of Mandaluyong and Pasig

Accounting income                            P1,400       P1,500       P1,600       P1,700        P1,800

Future taxable amount                        (240)          (120)           -                   -                 -
Additional taxable                                                                                            120            240   
    amount
Taxable income                                 P1,160        P1.380       P1,600       P1,820         P2,040

The following are the entries for years 2020 through 2024 to record the company’s income
tax.
December 31, 2020
Income Tax Expense-Current 348,000
Income Tax Payable 348,000
1,160,000 x 30%

Income Tax Expense-Deferred 72,000

Deferred Tax Liability 72,000
240,000 x 30%

The difference between carrying amount of the asset and its tax base on December 31, 2020,
which amounts to P240,000, is scheduled to reverse in 2021 through 2024 in the following
pattern:
2021 (120,000) x 30% (36,000)
2022 0 x 30% 0
2023   120,000 x 30% 36,000
2024   240,000 x 30% 72,000
Total P72,000

December 31, 2021

Income Tax Expense-Current 414,000
Income Tax Payable 414,000
1,380,000 x 30%

Income Tax Expense-Deferred 36,000

Deferred Tax Liability 36,000

The difference between carrying amount of the asset and its tax base on December 31, 2021,
which amounts to P360,000, is scheduled to reverse in 2022 through 2024 in the following
pattern:
2022 0 x 30%   0
2023   120,000 x 30% 36,000
2024   240,000 x 30% 72,000
Total       P108,000

Cumulative deferred tax liability, 12/31/22 P108,000

Balance, 12/31/21     72,000
Increase in deferred tax liability  P36,000

After the foregoing entries on December 31, 2021 have been posted the deferred tax liability
account would show a balance of P108,000.

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

December 31, 2022

Income Tax Expense-Current 480,000
Income Tax Payable 480,000
1,600,000 x 30%

The difference between carrying amount of the asset and its tax base on December 31, 2021,
which amounts to P360,000, is scheduled to reverse in 2022 through 2024 in the following
pattern:
2023   120,000 x 30% 36,000
2024   240,000 x 30% 72,000
Total       P108,000

Cumulative deferred tax liability, 12/31/22 P108,000

Balance, 12/31/21   108,000
Increase in deferred tax liability   0

For the year 2022, the company will show income tax expense of P480,000, comprising solely
of current income tax.

December 31, 2023

Income Tax Expense-Current 546,000
Income Tax Payable 546,000
1,820,000 x 30%

Income Tax Expense-Deferred 36,000

Deferred Tax Liability 36,000
120,000 x 30%

The difference between carrying amount of the asset and its tax base on December 31, 2023,
which amounts to P240,000, is scheduled to reverse in 2024 through 2024.

2024. 240,000 x 30% = P72,000

Cumulative deferred tax liability, 12/31/23 P72,000

Balance, 12/31/22    108,000
Increase in deferred tax liability P36,000

The statement of comprehensive income for the year ended December 31, 2023 would show
an income tax expense of P510,000. The lower portion of the profit or loss section would
show the following:

Profit before income tax        P 1,700,000

Less: Income Tax Expense (benefit) 
          Current P 546,000
          Deferred     (36,000) 510,000
Profit       P1,190,000

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

December 31, 2024

Income Tax Expense – Current   612,000

Income Tax Payable       612,000
  2,040,000 x 30%

Deferred Tax Liability     72,000

Income Tax Benefit – Deferred         72,000
  240,000 x 30%

At December 31, 2024 both the tax base and the carrying amount of the asset show a
zero balance. Thus, the deferred tax liability completely reverses. The previous balance of
deferred tax liability is debited to bring it to zero. The income tax expense on the company’s
statement would be shown at P 540,000, which is equal to P 612,000 minus income tax
benefit of P 72,000.

Computation of Deferred Tax Based on the Difference Between the

Book Basis and Tax Basis of Assets and Liabilities
IAS 12 uses the statement of financial position (balance sheet) approach to measure
deferred tax asset and liability. Accounting for deferred tax involves the following procedures:
a. Determine the difference between the tax and book bases of assets and liabilities.
Identify those that are temporary differences. If the difference is a debit on the
statement of financial position (for example: prepaid expense, accrued income,
excess of book basis of asset over tax basis), the difference is a future taxable
amount. If the difference is a credit on the statement of financial position (for
example: allowance for uncollectible account, accrued warranty cost, unearned
revenue), the difference is a future deductible amount.
b. Measure the required balance of deferred tax asset and deferred tax liability by
applying the applicable tax rates to the temporary difference. 
c. Deduct the beginning balance of deferred tax asset and deferred tax liability from
their respective required balances. Record the change accordingly based on the rules
of debit and credit for asset and liability.
d. The net change in deferred tax liability plus (or minus) the net change in deferred tax
asset is the deferred tax that forms part of the income tax expense or benefit for the
current period.

To illustrate application of the foregoing procedures, assume the following carrying

amounts and tax bases for assets and liabilities of Ethan Corporation as of December 31,
2020:
  (In Millions of Pesos)
  Carrying Amount Tax Base
Cash P  5.0 P 5.0
Receivables, net 10.0   11.0
Inventory 9.0    9.5
Property, Plant and Equipment 36.0   32.0
Trade Payables 6.0   6.0
Other Accrued Expenses 0.5       -

The balances of January 1, 2020 are as follows:

Deferred Tax Asset P    800,000
Deferred Tax Liability   1,000,000

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

The company is subject to uniform tax rates for all years of 30%. Taxable income for
2020 is computed at P 8,000,000.

Based on the differences identified above, the following are the temporary
differences:
Future Taxable Amounts
Excess of book basis of property, 
plant and equipment over its tax base P4,000,000 

Future Deductible Amounts

Excess of tax base over carrying amounts 
of assets:
Receivables, net P 1,000,000
Inventory       500,000
Excess of carrying amounts of liabilities over
tax basis       500,000
Total future deductible amounts P2,000,000

The required balances at December 31, 2021 of deferred tax liability and deferred tax
asset and the movement in their balances are computed as follows:

Deferred Tax Liability Deferred Tax Asset

Required ending balance     
P4,000,000 x 30%   P1,200,000
  2,000,000 x 30% P600,000
Beginning balances           1,000,000 800,000
Increase (decrease)         P   200,000 P(200,000)

The following are the entries for income taxes:

Income Tax Expense – Current 2,400,000
Income Tax Payable 2,400,000
8,000,000 x 30%
Income Tax Expense – Deferred 200,000
Deferred Tax Liability 200,000
Net change in deferred tax liability
Income Tax Expense – Deferred 200,000
Deferred Tax Asset 200,000

The total income tax expense on statement of comprehensive income for the year
2020 is P2,800,000 consisting of P2,400,000 current and P400,000 deferred. The statement
of financial position shall show deferred tax asset of P600,000 and deferred tax liability of
P1,200,000, unless offsetting is acceptable, in which case only the net deferred tax liability of
P600,000 shall be shown.

OPERATING LOSS CARRYFORWARDS

Operating loss carryforward is an excess of tax reductions over gross income in a
year that may be carried forward to reduce taxable income in a future year. The same
recognition and measurement criteria for the recognition of deferred tax assets from
deductible temporary differences also apply to operating loss carryforwards.
Accordingly, a deferred tax asset should be recognized for the carryforward of
unused tax losses and unused tax credits to the extent that it is probable that future taxable

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 RIZAL TECHNOLOGICAL UNIVERSITY
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profit will be available against which the unused tax losses and unused tax credits can be
utilized.

To illustrate, assume that DEF Company reports in its 2020 income tax return an
operating loss of P1,000,000. It is expected that for the next three years, the company's
operations will result to cumulative taxable profit of more than P1,000,000. Thus, it is believed
that the P1,000,000 loss in 2020 may be deducted from taxable income during the next three
years. A deferred tax asset of P300,000 will be recognized, assuming a tax rate of 30%.

Deferred Tax Asset 200,000

Income Tax Benefit 200,000

Paragraph 35 of IAS 12 states that the existence of unused tax losses is strong
evidence that future taxable profit may not be available. Therefore, when an enterprise has a
history of recent losses, the enterprise recognize a deferred tax asset arising from unused tax
losses or tax credits only to the extent that the enterprise has sufficient taxable temporary
differences, or there is convincing evidence that sufficient taxable profit will be available
against which the unused tax losses or unused tax credits can be utilized by the enterprise.
To the extent that it is not probable that taxable profit will be available against which
the unused tax losses or unused tax credits can be utilized, the deferred tax asset is not
recognized (paragraph 36, IAS12).

MINIMUM CORPORATE INCOME TAX IN THE PHILIPPINES

The National Internal Revenue Code (NIRC) of the Philippines imposes a minimum
corporate income tax to domestic or resident foreign corporation. The minimum corporate
income tax (MCIT) shall be imposed starting the fourth year from the year of corporate
registration when the computed income tax based on taxable income is less than 2% of the
gross income of the corporation. Thus, the corporation is obliged to pay to the Bureau of
Internal Revenue (BIR) an income tax of 30% based on computed taxable profit (considering
taxable revenues and deductible expenses) or 2% of gross income, whichever is higher.
Gross income is gross sales minus the total of cost of goods sold, sales returns and
allowances and sales discounts. In case, the MCIT is higher than the computed taxable profit,
the corporation's tax due is the MCIT.
Any excess of the MCIT over the computed normal tax due based on taxable profit is
recognized as a deferred tax asset if the corporation expects that its operations in the future
years will result to normal tax due higher than the MCIT. The excess of MCIT over the normal
tax due is reported as an asset because the BIR allows a three-year carryover that will reduce
the income tax due on normal income tax. Any resulting deferred tax asset shall be
recognized, only to the extent realizable. This means that if the company expects to be
subjected to the MCIT during the next three years, then no deferred tax asset shall be
recognized for such excess. 

To illustrate, assume that an enterprise in its fourth-year operations had taxable profit
of P1,000,000 (thus its normal tax due is P300,000, which is 30% of P1,000,000). Two
percent of its gross income is P400,000. The amount of income tax due the BIR is P400,000.
The entry is
Income Tax Expense – Current 300,000

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 RIZAL TECHNOLOGICAL UNIVERSITY
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Deferred Tax Asset 100,000

Income Tax Payable 400,000
The above entry assumes that the enterprise will profitably operate in the future, such
that its normal income tax is expected exceed the MCIT. Otherwise, no deferred tax asset
shall be recognized and the full amount of P400,000 above shall be charged to income tax
expense - current.

INCOME TAX TAKEN TO EQUITY AND OTHER COMPREHENSIVE INCOME

The International Financial Reporting Standards provide for recognition of particular
items directly in equity and in other comprehensive income. Examples of items that are
recognized directly in equity are adjustment to the opening balance of retained earnings
resulting from a retrospective treatment of change in accounting policy and correction of prior
period errors. The resulting current and deferred tax effects of these items shall also be taken
directly to equity
Examples of items that are recognized in other comprehensive income are change in
carrying amount arising from revaluation of property, plant and equipment and/or intangible
assets, unrealized gains or losses on financial assets measured at fair value through other
comprehensive income and exchange differences arising on the translation of the financial
statements of a foreign operation. The resulting current and deferred tax effects of such items
are also taken to other comprehensive income.

FINANCIAL STATEMENT PRESENTATION AND CLASSIFICATION

Paragraphs 69 through 76 of IAS 12 provide guidance on the presentation and classification
of both current income tax and deferred income tax.
Tax assets and tax liabilities should be presented separately from other assets and liabilities
in the statement of financial position. Deferred tax assets and liabilities should be
distinguished from current tax assets and liabilities. (Paragraph 69).
When an enterprise makes a distinction between current and non-current assets and liabilities
in its financial statements, it should not classify deferred tax assets (liabilities) as current
assets (liabilities). (Paragraph 70).
An enterprise should offset current tax assets and current tax liabilities if, and only if,
the enterprise (Paragraph 71).
(a) has a legally enforceable right to set off the recognized amounts; and
(b) intends either to settle on a net basis, or to realize the asset and settle the liability
simultaneously.
An enterprise should offset deferred tax assets and deferred tax liabilities if, and only if
(Paragraph 74):
(a) the enterprise has a legally enforceable right to set off current tax assets against current
tax liabilities, and 
(b) the deferred tax assets and the deferred tax liabilities relate to income taxes levied by the
same taxation authority on either:
(i) the same taxable entity; or
(ii) different taxable entities which intend either to settle current tax liabilities and assets
on a net basis, or to realize the assets and settle the liabilities simultaneously, in each
future period in which significant amounts of deferred tax liabilities or assets are
expected to be settled or recovered.

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 RIZAL TECHNOLOGICAL UNIVERSITY
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DISCLOSURE REQUIREMENTS
1. The major components of tax expense (income) should be disclosed separately.
Components of tax expense (income) may include
a. Current income tax expense (income)
b. Any adjustment recognized in the period for current tax of prior periods;
c. The amount of deferred tax expense (income) relating to the origination and reversal
of temporary differences;
d. The amount of deferred tax expense (income) relating to changes in tax rates or the
imposition of new taxes;
e. The amount of the benefits arising from previously unrecognized tax loss, tax credit or
temporary difference of prior period that is used to reduce current tax expense;
f. The amount of the benefit from previously unrecognized tax loss, tax credit or
temporary difference of a prior period that is used to reduce deferred tax expense;
g. Deferred tax expense arising from the write down, or reversal of previous written-
down, of a deferred tax asset;
2. The following should also be disclosed separately:
a. The aggregate current and deferred tax relating to items that are changed or credited
to equity;
b. An explanation of the relationship between tax expense (income) and accounting
profit in either or both of the following forms
i. a numerical reconciliation between tax expense (income) and the product
of accounting profit multiplied by the applicable tax rate(s), disclosing
also the basis on which the applicable tax rates(s) is (are) computed;
ii. a numerical reconciliation between the average effective tax rate and the
applicable tax rate, disclosing also the basis on which the applicable tax
rate is computed;

c.an explanation of changes in applicable tax rate(s) compared to the previous accounting
period;
d.the amount (and expiry date, if any) of deductible temporary differences, unused tax losses,
and unused tax credits for which no deferred tax asset is recognized in the statement of
financial position;
e.the aggregate amount of temporary differences associated with investments in subsidiaries,
branches and associates and interest in joint ventures, for which deferred tax liabilities have
not been recognized
f.in respect of each type of temporary difference, and in respect of each type of unused tax
losses and unused tax credits:
g.
i. the amount of the deferred tax asset and liabilities recognized in the statement of
financial position for each period represented;
ii. the amount of the deferred tax income or expense recognized in the income
statement, if this is not apparent from the changes in the amounts recognized in the
statement of position; and 

h.in respect of discontinued operations, the tax expense relating to 

i. the gain or loss on discontinuance; and 
j. The profit or loss of the discontinued operation for the period; together with the
corresponding amounts for each prior period presented.
i.The amount of income tax consequences of dividends to shareholders of the enterprise that
were proposed or declared before the financial statements were authorized for issue, but are
not recognized as a liability in the financial statements
3. An enterprise should disclose the amount of deferred tax asset and the nature of the
evidence supporting its recognition, when;
a. The utilization of the deferred tax asset is dependent on future taxable profit in excess
of the profits arising from the reversal of existing taxable temporary differences; and 

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

b. The enterprise has suffered a loss in either the current or preceding period in tax
jurisdiction to which the deferred tax asset relates.

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

Assignment

4-1. Classify the following items that may

cause discrepancy between accounting profit and taxable income, into the following
A. Non-deductible expenses
B. Non-taxable revenues
C. Deductible temporary difference
D. Taxable temporary difference
1. Uncollectible accounts expense in excess of accounts written off during the
period.
2. Tax depreciation in excess of depreciation for accounting purposes.
3. Interest earned on investments in tax-exempt government securities. 
4. Interest earned on deposits with banks.
5. Excess of profit earned over the period reported under the installment method
for income tax purposes.
6. Deductible insurance premiums paid in excess of insurance expense reported
for financial reporting. 
7. Provision for loss on pending lawsuit expected to be settled during the next
reporting period. 
8. Insurance premiums paid on a life insurance policy where the entity is the
designated beneficiary.
9. Impairment loss attributed to goodwill.
10. Warranty expense reported for financial reporting purposes in excess of
actual costs of repairs done during the period. 
11. Collections of rental in excess of rent revenue reported during the period.
12. Dividends received by a domestic corporation from a domestic corporation.
13. Increase in fair value of equity investments measured at fair value through
profit and loss.

4-2. You are given the following information for Carlos Corporation for the year ended
December 31, 2020.
a. Capital gains subjected to final withholding tax, P2, 000,000.
b. Fines and penalties for violations of law, P400, 000.
c. Premium payment for life insurance policy on president, P 40, 000. The
president designated his family as beneficiary.
c. Tax depreciation in excess of book depreciation, P 1, 5000, 000.
c. Excess of income on installment sales over income reportable for tax
purposes, P 1, 000, 000.
c. Rent collected in advance of period earned, P 750, 000.
c. Warranty provision accrued in advance of period paid, P 400,000.

Pre-tax financial profit is P 10, 000, 000 and income tax rate is 30% for the current
and future years. 
REQUIRED:
a.  Indicate which of the above items permanent differences are and which are
temporary differences. Classify the permanent differences whether non-
taxable revenues or non-deductible expenses. Classify the temporary
differences whether taxable temporary differences or deductible temporary
differences.

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

b.  Calculate the taxable income.

c.  Compute income tax payable, deferred tax asset and deferred tax liability.
d.  Prepare all entries relating to income tax.
e.  Compute the total income tax expense, identifying separately the current
income tax expense and the deferred tax expense.
4-3. Luzon Corporation has one temporary difference at the end of 2020 that will
reverse and cause taxable amounts of P 550, 000 in 2021, P 600, 000 in 2022, and P
650, 000 in 2023. Luzon’s pretax financial income for 2020 is P 3, 000, 000, and the
tax asset and deferred tax liability at the beginning of 2020. 
REQUIRED: 
a.  Compute the taxable income and income tax expense current for 2020.
Compute also the deferred tax liability at December 31, 2020.
b.  Prepare journal entries to record income tax expense for 2020.

4-4 Visayas Corporation has one temporary difference at the end of 2020 that will
reverse and cause deductible amounts of P500,000 in 2021, P650,000 in 2022, and
P400,000 in 2023. Visayas’ pretax financial income for 2020 is P2,000,000, and the
tax rate is 30% for all years. There are no deferred tax assets or liabilities at the
beginning of 2020. Visayas expects profitable operations to continue in the future.
REQUIRED:
Compute the taxable income and income tax expense current for 2020. Compute
also the deferred tax asset at December 31, 2020
Prepare journal entries to record income tax expense for 2020

4-5 
Mindanao Corporation, in its first year of operations, has the following differences
between the book basis and tax basis of its assets and liabilities at the end of 2020.
BOOK BASIS TAX
BASIS
Equipment (net) P 4,000,000 P
3,400,000
Estimated warranty liability P 2,000,000 0
It is estimated that the warranty liability will be settled in 2021. The difference
equipment (net) will result in taxable amounts of P200, 000 in 2021, P300, 000 in
2022, and P100, 000 in 2023. The company has taxable income of P5, 200,000 in
2020. As of the beginning of 2020, its enacted tax rate is 30% for 2020-2022 and
35% for 2023. Mindanao expects to record taxable income through 2023.
REQUIRED:
Journal entries to record income tax expense, current and deferred for 2020

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

4-6
Samar, Inc. reports taxable income of P2, 000,000 on its income tax return for the
year ended December 31, 2020. Timing differences between financial income and
taxable income for the year are:
Tax depreciation in excess of book depreciation- P360,000, Accrual of product
liability claims in excess of actual claims- P240,000; Reported installment sales
income in excess of taxable installment sales income- P530,000
REQUIRED:
Assuming an income tax rate of 30% compute the income tax expense- total and
current portion, deferred tax asset and liability, and income tax payable balances to
be recorded in Samar’s books.
4-7
Bohol Company reported taxable income of P12, 000,000 for the year ended
December 31, 2020. The controller in unfamiliar with the required treatment of
temporary and permanent differences in reconciling taxable income to pretax
financial income and has contracted your firm for advice. You are given company
records that list the following differences:
Book depreciation in excess of tax depreciation P430, 000
Interest earned on government securities  450,000
REQUIRED:
Determine the pretax financial income

4-8
Wall services computed pretax financial income of P2, 200,000 for its first year of
operations ended December 31, 2020. In preparing the income tax return for the
year, the tax accountant determined the following differences between 2020 financial
income and taxable income.
a. Non-deductible expenses P400,000
b. Non-taxable revenues   140,000
c. Temporary differences- installment sales   700,000
Reported in financial income but not in 
 Taxable income
The temporary difference is expected to reverse in the following pattern:
2021- P140,000; 2022- P320,000; 2023- P240,000

The enacted tax rates for this year and the next three years are as follows:
2020- 30% 2022- 34%
2021- 32% 2023- 36%

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 RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig

REQUIRED:

a. Prepare a schedule showing the reversal of the temporary

differences and the computation of income taxes payable and
deferred tax asset or liability as of December 31, 2020.

b. Prepare journal entries to record income taxes payable and deferred

income taxes.

c. Prepare the section of the statement of comprehensive income of

Wall Services beginning with "Income from continuing operations
before income taxes" for the year ended December 31, 2020.

INTERMEDIATE ACCOUNTING PART 3 23