PAS 12

INCOME TAXES
Introduction

PAS 12 prescribes the accounting for income taxes. For purposes

of PAS 12, income taxes refer to taxes that are based on taxable
profits.

The income tax expense reported in the statement of

comprehensive income may be different from the amount of
income tax required to be paid to the Bureau of Internal Revenue
(BIR). This is because the income tax expense in the statement of
comprehensive income is computed using PFRSs while the
current tax expense in the income tax return (ITR) is computed
using Philippine tax laws, and the PFRSs and tax laws have
different accounting treatments for some economic activities.
Some items are appropriately recognized as income
(expense) under financial reporting but are either (a) non-
taxable (non-deductible) or (b) taxable (deductible) only at
some other periods under Philippine tax laws. These varying
treatments result to permanent and temporary differences.
PAS 12 addresses the accounting, presentation and
reconciliation of these differences.

For example, assume Entity A accrues bad debts expense of

P100 under financial reporting. However, under taxation,
this amount is tax deductible only when it is deemed
worthless. The difference is analyzed in the next slide:
 Financial reporting Taxation Difference
Profit before bad debts 1,000 1,000 -
Bad debts (100) -_______________
Accounting / Taxable profit 900 1,000 (100)
Tax rate 30% 30%______________
Income / Current tax expense 270 300 (30)___

Amount of income tax

expense presented in Amount of current Difference to be
the statement of tax expense to be reconciled in the
comprehensive income paid to the BIR notes
Accounting profit and Taxable profit

Accounting profit is “profit or loss for a period

before deducting tax expense”.

Taxable profit (tax loss) is “profit (loss) for a

period, determined in accordance with the rules
established by the taxation authorities, upon which
income taxes are payable (recoverable)”. (PAS
12.5)
 Accounting profit Taxable profit (Tax
or loss loss)
 Computed using  Computed using
PFRSs tax laws
 Total income less  Taxable income
total expenses, less tax-deductible
excluding tax expenses
expense

 Other terms:  Other term: taxable

pretax income, income
financial income
and accounting
income.
Income tax expense and Current tax expense

 Tax expense or income tax expense (tax income) – is the total

amount included in the determination of profit or loss for the
period. It “comprises current tax expense (current tax income)
and deferred tax expense (deferred tax income)”. (PAS 12.6)
 Current tax or current tax expense – is “the amount of income
taxes payable (recoverable) in respect of the taxable profit (tax
loss) for a period”. (PAS 12.5)
 Deferred tax expense (income or benefit) – is the sum of the
net changes in deferred tax assets and deferred tax liabilities
during the period.
 If the increase in deferred tax liability exceeds the increase in
deferred tax asset, the difference is deferred tax expense.
 If the increase in deferred tax asset exceeds the increase in
deferred tax liability, the difference is deferred tax income or
benefit.
Let’s continue the example from the previous slide (i.e., Entity A):

Accounting profit 900 Income tax expense 270

Temporary difference 100 Deferred tax (expense) benefit 30
Taxable profit 1,000 Current tax expense 300

Using the definition above, we can reconcile the income tax expense as follows:

Income tax expense = Current tax expense + Deferred tax expense / - Deferred
tax benefit

Income tax expense = 300 computed using tax laws – 30 determined using
PFRSs = 270 amount presented in the statement of comprehensive income

or

Income tax expense 270

Deferred tax (expense) benefit 30
Current tax expense 300
The varying treatments of economic activities
between the PFRSs and the tax laws results to
following differences:

a. Permanent differences

b. Temporary differences
Permanent differences

Permanent differences arise when income and expenses enter in the

computation of either accounting profit or taxable profit but not
both. If an item is included in the computation of one, it will never
enter in the computation of the other.

Permanent differences usually arise from non-taxable and non-

deductible expenses and those that have already been subjected to
final taxes. In other words, these are items excluded from the
income tax return.

Since permanent differences are non-taxable, nontax-deductible or

have already been taxed under final taxation, they do not have future
tax consequences, and hence do not give rise to deferred tax assets
and liabilities.
Examples of permanent differences:

a. Interest income on government bonds and treasury bills

b. Interest income or bank deposits
c. Dividend income
d. Fines, surcharges, and penalties arising from violation of
law
e. Life insurance premium on employees where the entity
is the irrevocable beneficiary
Temporary differences

Temporary differences are “differences between the carrying

amount of an asset or liability in the statement of financial
position and its tax base”. (PAS 12.5) Temporary differences
may be either:

a. Taxable temporary differences – those that result to future

taxable amounts when the carrying amount of the asset or
liability is recovered or settled; or
b. Deductible temporary differences – those that result to
future deductible amounts when the carrying amount of the
asset or liability is recovered or settled.
Temporary differences have future tax consequences; hence they
give rise to either deferred tax assets or deferred tax liabilities.

Taxable temporary differences give rise to deferred tax

liabilities while Deductible temporary differences give rise to
deferred tax assets.

Temporary differences include timing differences. Timing

differences arise when income and expenses are recognized for
financial reporting purposes in one period but are recognized for
taxation purposes in another period (or vice versa). They are
called “timing differences” because only the timing or period of
their recognition differs between financial reporting and taxation.
They are temporary differences because their effect reverses in
one or more subsequent periods.
Taxable temporary differences

Taxable temporary differences arises when:

a. Financial income (accounting profit) is greater
than the Taxable income (taxable profit);
b. The carrying amount of an asset is greater than
its tax base; or
c. The carrying amount of a liability is less than its
tax base.
Examples of Taxable temporary differences:

a. Revenue is recognized in full under financial reporting but is taxable

only when collected.
b. A prepayment is capitalized and amortized to expense under
financial reporting but is tax deductible in full upon payment.
c. An asset is revalued upward and no equivalent adjustment is made
for tax purposes.
d. Depreciation recognized under financial reporting is lower than the
depreciation recognized for taxation purposes.

Taxable temporary difference multiplied by the tax rate results to

deferred tax liability.

 Deferred tax liabilities are “the amounts of income taxes payable in

future periods in respect of taxable temporary differences.” (PAS 12.5)
Deductible temporary differences

Deductible temporary differences arise when:

a. Financial income (accounting profit) is less than
the Taxable income (taxable profit);
b. The carrying amount of an asset is less than its
tax base; or
c. The carrying amount of a liability is greater than
its tax base.
Examples of Deductible temporary differences:

a. Rent received in advance is treated as unearned income

(liability) under financial reporting but is taxable in full upon
receipt of cash.
b. Bad debts expense is recognized for financial reporting when the
collectability of accounts receivable becomes doubtful while it is
tax deductible only when the accounts receivable is deemed
worthless.
c. Warranty obligation is recognized as expense when a product is
sold under financial reporting but is tax deductible only when
actually paid.
d. Depreciation recognized under financial reporting is higher than
the depreciation recognized for taxation purposes.
e. Losses and tax credits that can be carried forward and deducted
from future taxable profits.
Deductible temporary difference multiplied by the tax rate results
to deferred tax asset.

 Deferred tax assets are “the amounts of income taxes

recoverable in future periods in respect of: (a) deductible
temporary differences; (b) the carry forward of unused tax
losses; and (c) the carry forward of unused tax credits.

The recognition of deferred tax assets and liabilities does not

alter the amount of tax to be paid to the BIR in the current
period. However, when they reverse in a future period:
a. Deferred tax liability results to a higher amount of tax to be
paid to the BIR.
b. Deferred tax asset results to a lower amount of tax to be paid
to the BIR.
Summary of concepts:

Taxable temporary Deductible temporary

difference difference
• Financial income greater • Financial income less
than taxable income. than taxable income.
• Carrying amount of asset • Carrying amount of asset
greater than tax base. less than tax base.
• If multiplied by the tax • If multiplied by the tax
rate, it results to deferred rate, it results to deferred
tax liability. tax asset.
• When it reverses in a • When it reverses in a
future period, it results to future period, it results to
higher tax payment. a lower tax payment.
Accounting for Deferred Taxes

PAS 12 requires the use of the asset-liability method (also called

‘balance sheet liability method’) in accounting for deferred
taxes. This method is a comprehensive approach in accounting
for deferred taxes in that it accounts both (a) timing differences
and (b) differences between the carrying amounts and tax bases
of assets and liabilities.

Timing differences are differences between accounting profit and

taxable profit that originate in one period and reverse in one or
more subsequent periods. Temporary differences are differences
between the carrying amount of an asset or liability in the
statement of financial position and its tax base. Temporary
differences include all timing differences; however, not all
temporary differences are timing differences.
 “The tax base of an asset or liability is the amount attributed to
that asset or liability for tax purposes”. (PAS 12.5)

 Tax base of an asset – is “the amount that will be deductible

for tax purposes against any taxable economic benefits that
will flow to an entity when it recovers the carrying amount of
the asset. If those economic benefits will not be taxable, the tax
base of the asset is equal to its carrying amount”. (PAS 12.8)
 Tax base of a liability – is “its carrying amount, less any
amount that will be deductible for tax purposes in respect of
that liability in future periods. In the case of revenue which is
received in advance, the tax base of the resulting liability is its
carrying amount, less any amount of the revenue that will not
be taxable in future periods”. (PAS 12.8)
Examples:
1. An asset has a carrying amount of P1,000 and a tax base of P400.

Analysis:
The difference of P600 (1,000 – 400) is a taxable temporary
difference, i.e., carrying amount of an asset is greater than its tax
base. If the tax rate is 30%, the deferred tax liability is P180 (600 x
30%).

2. Entity A has dividends receivable with carrying amount of

P1,000. The dividends are not taxable.

Analysis:
Since the dividends are not taxable, the tax base is equal to the
carrying amount of P1,000. No temporary difference or deferred tax
arises from the dividends, i.e., 1,000 carrying amount – 1,000 tax
base = 0 difference.
3. Entity A has accounts receivable with carrying amount
of P1,000. The receivable is taxable only when collected.

Analysis:
Since the carrying amount is taxable in full when collected,
the tax base is zero. The difference of P1,000 (1,000
carrying amount – 0 tax base) is a taxable temporary
difference. If the tax rate is 30%, the deferred tax liability is
P300 (1,000 x 30%).
Recognition

The fundamental principle under PAS 12 is that “an

entity shall, with certain limited exceptions,
recognize a deferred tax liability (asset) whenever
recovery or settlement of the carrying amount of an
asset or liability would make future tax payments
larger (smaller) than they would be if such recovery
or settlement were to have no tax consequences”.
(PAS 12.10)
Measurement

Deferred tax assets and liabilities are measured at the tax rates that are
expected to apply to the period of their reversal, based on tax rates that
have been substantively enacted by the end of the reporting period.
PAS 12 prohibits the discounting of deferred tax assets and liabilities.

Illustration:
Entity A has a taxable temporary difference of P2,000 in Year 1. The
difference is expected to reverse as follows: P1,000 in Year 2 and
P1,000 in Year 3. The tax rate in Year 1 is 30%. However, by the end
of Year 1, a tax law is enacted which requires tax rates of 32% in Year
2 and 35% in Year 3 and in succeeding years.

Entity A recognizes a deferred tax liability of P670 at the end of

Year 1, computed as follows: [(1,000 x 32%) + (1,000 x 35%)].
Presentation in the Statement of financial position

Deferred tax assets and deferred tax liabilities are presented

separately as noncurrent assets and noncurrent liabilities,
respectively, in a classified statement of financial position.

PAS 12 permits offsetting of deferred tax assets and deferred tax

liabilities only if:
a. The entity has a legally enforceable right to offset 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.
Accounting for Current Taxes

An entity uses relevant tax laws in computing for its current

taxes. Unpaid current taxes are recognized as current tax
liability, e.g., income tax payable. Excess tax payments over the
current tax due are recognized as current tax asset, e.g., prepaid
income tax.

PAS 12 permits offsetting of current tax assets and current tax

liabilities only if the entity has:
a. A legally enforceable right to offset the recognized amounts;
and
b. An intention to settle/realize the recognized amounts on a net
basis or simultaneously.
Presentation in Statement of comprehensive
income

Tax consequences are accounted for in the same way

as the related transactions or events. Thus, if a
transaction is recognized in profit or loss, its tax
effect is also recognized in profit or loss. If a
transaction is recognized outside profit or loss, the
tax effect is also recognized outside profit or loss
(e.g., in other comprehensive income or directly in
equity).
Current and deferred taxes are usually recognized in profit or loss. The
following are examples of taxes that are outside the profit or loss:
 Taxes recognized in other comprehensive income:
a. Revaluation of property, plant and equipment.
b. Exchange differences arising on the translation of the financial
statements of a foreign corporation.

 Taxes recognized directly in equity:

a. Adjustment to the opening balance of retained earnings resulting from
a change in accounting policy or correction of a prior-period error.
b. Amounts arising on initial recognition of the equity component of a
compound financial instrument. (PAS 12.62)

A tax effect that is recognized directly in equity is accounted for as a direct

adjustment to the related component of equity, e.g., retained earnings or
share premium, rather than presented in the profit or loss or other
comprehensive income sections of the statement of comprehensive income.