A GUIDE TO SOLVING ACCOUNTING PROBLEMS IN INCOME TAX (PAS 12)

1. 2. 3. Determine the ACCOUNTING INCOME (Earnings before tax). Look for permanent differences, if there are any. If there are permanent differences, add nondeductible expenses to and deduct nontaxable revenues from accounting income to get ACCOUNTING INCOME SUBJECT TO TAX/ PRETAX FINAL INCOME. NONDEDUCTIBLE EXPENSES Life insurance premium when the entity is the beneficiary* Tax penalties, surcharges & fines *Expense for financial reporting purposes 4. 5. NONTAXABLE REVENUES Interest income on deposits Dividends received

Look for temporary differences, if there are any. If there are temporary differences, add deductible temporary differences to and deduct taxable temporary differences from accounting income subject to tax to get TAXABLE INCOME. DEDUCTIBLE TEMPORARY DIFFERENCES Revenues and gains: Rent received in advance Expenses and losses: A probable and measurable litigation loss Estimated product warranty cost Research cost Impairment loss Doubtful accounts 1. Asset is revalued downward and no equivalent adjustment is made for tax purposes. 2. The tax base of investment in subsidiary, associate or joint venture is higher than its carrying amount because the subsidiary, associate or joint venture has suffered continuing losses in current and prior years. TAXABLE TEMPORARY DIFFERENCES Revenues and gains: Installment sale Expenses and losses: Excess tax depreciation Development cost Prepaid expense

TIMING DIFFERENCES

OTHERS

1.

RESULTS TAX PURPOSES

Taxable income > accounting income Deferred tax asset NOW FUTURE Low deductions High deductions High revenues Low revenues

Asset is revalued upward and no equivalent adjustment is made for tax purposes. 2. The CA of investment in subsidiary, associate, or joint venture is higher than its tax base because the subsidiary, associate or joint venture has not distributed its entire income to the parent or investor. 3. The cost of a business combination that is accounted for as purchase is allocated to the identifiable assets and liabilities acquired at fair value and no equivalent adjustment is made for tax purposes. Accounting income > taxable income Deferred tax liability NOW FUTURE High deductions Low deductions Low revenues High revenues

6.

Recognize current tax expense for the year. Formula: taxable income X tax rate Journal entry: Income tax expense XXXX Income tax payable

XXXX

7. 8.

Determine which income is higher. If accounting income is greater than taxable income, recognize a DEFERRED TAX LIABILITY. Journal entry: Income tax expense XXXX Deferred tax liability XXXX If taxable income is greater than taxable income, recognize a DEFERRED TAX ASSET. Journal entry: Deferred tax asset XXXX Income tax benefit XXXX When a problem includes both a deferred tax liability and deferred tax asset, separate the TTD from the DTD to determine the amount to be recognized as DTL and DTA, respectively.

9.

10.

SUBSEQUENT COMPUTATIONS
1. To reverse temporary taxable difference (a.k.a DTL account decreased): Deferred tax liability (TTD for the year X tax rate) Income tax expense 2. To reverse deductible taxable difference: Income tax expense XXXXX XXXX XXXX

Deferred tax asset (DTD for the year X tax rate)

XXXX

PRESENTATION OF INCOME TAX EXPENSE IN THE FINANCIAL STATEMENT

Earnings before tax Income tax expense: Current tax expense Deferred tax expense (Income tax benefit) Net income REVERSAL OF TTD: Earnings before tax Income tax expense: Current tax expense (Decrease in deferred tax liability) Net income REVERSAL OF DTD: Earnings before tax Income tax expense: Current tax expense Decrease in deferred tax asset Net income XXXX XXXX XXXX (XXXX)

XXXX XXXX

XXXX XXXX (XXXX)

XXXX XXXX

XXXX XXXX XXXX

XXXX XXXX

CLASSIFICATION OF ACCOUNTS IN THE BALANCE SHEET

Noncurrent Asset Deferred tax asset Current Liability Income tax payable Noncurrent Liability Deferred tax liability

SIMPLE FORMULAS
Total income tax for the year = accounting income subject to tax X tax rate = current tax expense + deferred tax expense from taxable temporary differences income tax benefit from deductible temporary differences Current tax expense = taxable income X tax rate Deferred tax liability = taxable temporary difference for the year X tax rate Deferred tax asset = deductible temporary difference for the year X tax rate Net deferred tax benefit = tax benefit from increase in DTA tax expense from increase in DTL Net deferred tax expense = tax expense from increase in DTL tax benefit from increase in DTA

DEFINITION OF TERMS
Permanent differences Items of revenue and expense which are included in either accounting income or taxable income but will never be included in the other Do not give rise to deferred tax asset and liability because they have no future tax consequences Temporary differences Differences between the carrying amount of an asset or liability and its tax base Include timing differences Give rise either to a deferred tax asset or deferred tax liability Two kinds: Taxable temporary difference & deductible temporary difference Timing differences Items of income and expenses which are included in both accounting income and taxable income but at different time periods

Taxable temporary difference Result in future taxable amount Deductible temporary difference Result in future deductible amount Tax base Amount attributable to the asset or liability for tax purposes Recognized or allowed for tax purposes Tax base of an asset Amount that will be deductible for tax purposes against future profits Tax base of a liability Normally the carrying amount less the amount that will be deductible for tax purposes in the future Operating loss carryforward Excess of tax deductions over gross income in a year that may be carried forward to reduce taxable income in a future year Give rise to a deferred tax asset Net deferred tax expense or benefit Recognized when a problem has both DTA and DTL Difference between the change in DTA and the change in DTL Current tax liability Current tax expense or the amount of income tax actually payable Measured using the tax rate that has been enacted and effective at the end of the reporting period Current tax asset Amount of tax already paid for the current period exceeds the amount actually payable for the period Prepaid income tax Measured using the tax rate that has been enacted and effective at the end of the reporting period Measurement of deferred tax asset or liability Tax rate that has been enacted at the end of the reporting period and expected to apply to the period when the asset is realized or the liability is settled

WHEN TO RECOGNIZE A DEFERRED TAX LIABILITY AND DEFERRED TAX ASSET

DEFERRED TAX LIABILITY For all taxable temporary differences DEFERRED TAX ASSET For all deductible temporary differences Operating loss carryforward when it is probable that taxable income will be available against which the deferred tax asset can be used* *The carrying amount of the deferred tax asset is reviewed at the end of each reporting period and reduced if appropriate.

WHEN NOT TO RECOGNIZE DEFERRED TAX LIABILITY

Taxable temporary difference arises from: 1. Goodwill resulting from a business combination and which is nondeductible for tax purposes; recognizing a DTL with respect to goodwill would simply increase the value of goodwill. 2. Initial recognition of an asset or liability in a transaction that is not a business combination and affects neither accounting income nor taxable income. 3. Undistributed profit of subsidiary, associate or joint venture when: a. The parent can control the timing of the reversal of the TTD, meaning, the parent can control the dividend policy of the subsidiary. b. It is probable that the TTD will not reverse in the foreseeable future.

DISCLOSURE REQUIREMENTS
1. 2. 3. 4. 5. 6. Components of the total income tax expense, for example, current tax expense, deferred tax expense and deferred tax benefit. An explanation of the relationship between total income tax expense and accounting profit. This essentially discloses the accounting profit subject to tax which is the accounting profit after considering permanent differences. The applicable tax rate, the basis on which the tax rate has been applied, and the explanation for any change in the applicable tax rate. The aggregate amount of current and deferred tax relating to items recognized directly in equity. The aggregate amount of temporary differences associated with investments in subsidiary, associate and joint venture for which no deferred tax liability has been recognized. Analysis of the beginning and ending balance of deferred tax asset and deferred tax liability.