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Page 1 of 32LEARNING ADVANCEMENT REVIEW CENTERRM 413 DONA AMPARO BUILDING ESPANA BOULEVARD CORNER G. TOLENTINO ST. SAMPALOC, MANILA(4)FAR 28CONTACT # (02) 244 6342 / 0915 537 1189 / 0943 595 5364FINANCIAL ACCOUNTING AND REPORTING JINCOME TAXESWhat is the objective of PAS 12? The objective of PAS 12 ...

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LEARNING ADVANCEMENT REVIEW CENTER RM 413 DONA AMPARO BUILDING ESPANA BOULEVARD CORNER G. TOLENTINO ST. SAMPALOC, MANILA CONTACT # (02) 244 6342 / 0915 537 1189 / 0943 595 5364

(4) FAR 28

FINANCIAL ACCOUNTING AND REPORTING

J.CO

INCOME TAXES

What is the objective of PAS 12? The objective of PAS 12 is to prescribe the accounting treatment for income taxes. The main issue here is how to account for the current and future consequences of  The future recovery (settlement) of the carrying amount of assets (liabilities) recognized in the entity’s financial statements.



Here, if the future recovery or settlement will make future tax payments larger or smaller than they would be if such recovery or settlement were to have no tax consequences, then an entity must recognize deferred tax liability or asset. Transactions and other events of the current period recognized in the entity’s financial statements. PAS 12 requires accounting for current and deferred income tax from certain transaction or event exactly in the same way as the transaction or event itself.

1. IAS 12 Income Taxes IAS 12 Income Taxes states that there are two elements of tax that will need to be accounted for: 1. Current tax (the amount of tax payable/recoverable in respect of the taxable profit/loss for a period). 2. Deferred tax (an accounting adjustment aimed to match the tax effects of transactions to the relevant accounting period).  Intraperiod tax allocation relates to the allocation of income tax expense during the period to various items of the income statement.  Interperiod tax allocation relates to the recognition of deferred tax assets and deferred tax liabilities. It relates to accounting for temporary differences. The figure for tax on profits is an estimate of the amount that will be eventually paid (or received) and will appear in current liabilities (or assets) in the statement of financial position. To introduce tax payable by the company: Dr. Income tax expense (in statement of profit or loss) Cr. Income tax payable (in the statement of financial position as current liability) Note therefore that the balance on the statement of financial position for taxation will be only the current year’s provision. Under/over provisions Any under or over provision from the prior year is dealt with in the current year’s tax charge. This does not affect the year-end tax liability. All we need to do is take the under-or-over-provided amount to the statement of profit or loss.  An under-provision increases the tax charge.  An over-provision decreases the tax charge. Under/over-provision The taxation account will only have two entries in a year balance bought forward and payment. If the payment is the same as the balance bought forward then the balance on the trial balance will be zero. If the payment is not the same as the balance bought forward then there will be a balance on the trial balance which will represent the under-or over-provision. A debit balance will represent an under-provision and should be charged to the statement of profit or loss. A credit balance will represent an over-provision and should be credited to the statement of profit or loss. Example: Simple has estimated its income tax liability for the year ended 31 December 20x8 at P180,000. In the previous year the income tax liability had been estimated as P150,000. Required: Calculate the tax expense that will be shown in the statement of profit and loss for the year ended 31 December 20x8 if the amount that was actually agreed and settled with the tax authorities in respect of 20x7 was: (a) P165,000 (b) P140,000

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LEARNING ADVANCEMENT REVIEW CENTER

LEAD

Solution (a)

Under provision Statement of profit or loss charge: Year end estimate Under provision re: 20x7 (165,000 - 150,000) Income tax expense

(b)

180,000 15,000 195,000

Over provision Statement of profit or loss charge: Year end estimate Over provision re: 20x7 (150,000 - 140,000) Income tax expense

180,000 (10,000) 170,000

2. Deferred tax What is deferred tax? Deferred tax is:  The estimated future tax consequences of transactions and events recognized in the financial statements of the current and previous periods.   

Deferred taxation is a basis of allocating tax charges to particular accounting periods. The key to deferred taxation lies in the two quite different concept of profit: the accounting profit (or the reported profit), which is the figure of profit before tax, reported to the shareholders in the published accounts. The taxable profit, which is the figure of profit on which the taxation authorities base their tax calculations.

Accounting profit and taxable profit The difference between accounting profit and taxable profit is caused by:  Permanent differences  Temporary differences The accounting problem One important reason why deferred tax should be recognized is that profit for tax purposes may differ from the profit shown by the financial statements. Such a difference may be caused by permanent or temporary factors. For example, if an expense in the statement of profit or loss is not allowed for tax purposes (e.g. excess limit in entertaining expenses), a permanent difference arises, and the tax expense increases as a result. A temporary difference arises when an expense is allowed for both tax and accounting purposes, but within different accounting periods. For example, if relief for capital expenditure is given at a faster rate for tax purposes than the depreciation in the financial statements, the tax change will be lower in the earlier years than it would have been if based on the accounting profit, but in subsequent years the tax change will be higher. Permanent differences Permanent differences are:  One-off differences between accounting and taxable profits caused by certain items not being taxable/allowable.  Differences which only impact on the tax computation of one period.  Differences which have no deferred tax consequences whatever. An example of a permanent difference could be client excess limit in entertaining expenses or fines. 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 (IAS 12, para 5) An asset or liability’s tax base is the amount attributed to that asset or liability for tax purposes. Examples of temporary differences include:  Certain types of income and expenditure that are taxed on a cash, rather than accruals, basis, e.g. certain provisions.  The difference between a non-current asset’s depreciation charged and the tax allowances (tax depreciation) given. This is the most common practical example of a temporary difference.

Understand the differences The primary reason to this is financial statements are prepared in accordance with PFRS, whereas, income tax return prepared using Philippine tax laws.

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Any differences that could possibly arise from varying treatments of PFRS and Philippine tax laws for assets, liabilities, income and expenses shall be properly accounted for and disclosed. In order to understand the meaning and the rules of PAS 12 fully, you need to understand the meaning of and differences between  Accounting profit and taxable profit, and  Current income tax and deferred income tax.

Accounting versus taxable profit Accounting profit is profit or loss for a period before deducting tax expense. Please note that PAS 12 defines accounting profit as a before-tax figure (not after tax as we normally do) in order to be consistent with the definition of a taxable profit. Taxable profit (tax loss) is the profit (loss) for a period determined in accordance with the rules established by the taxation authorities upon which income taxes are payable (recoverable). You can clearly see here that these 2 numbers can differ significantly because accounting and tax rules are not the same. A number of differences can pop out between accounting profit and taxable profit you have to make the following adjustments to your accounting profit:  Add back the expenses recognized but non-deductible for tax purposes  Add income not recognized but included under tax regulations  

Deduct expenses not recognized but deductible for tax purposes Deduct income recognized but not taxable under tax regulations.

To determine accounting income and taxable income, below calculation is made. Again, accounting income uses PFRS provisions, while taxable income uses Philippine tax laws. Revenues Less: expenses Accounting Profit

X (x) X

Taxable revenue Less: deductible expenses Taxable income

X (x) X

Differences Between Accounting and Taxable Income  Differences between accounting and taxable income may be classified into either permanent differences or temporary differences. Permanent Differences These are items of revenue and expense which are included in either accounting income or taxable income but will never be included in the other.

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.

This classification will include non-taxable revenue and nondeductible expense.

When the carrying amount of an asset or a liability is greater than its tax base, then there is a taxable temporary difference and it gives rise to deferred tax liability.

Since permanent differences are either non-taxable revenue or non-deductible, these items do not have future tax consequence and do not give rise to deferred tax asset or deferred tax liability.

In the opaque situation, when the carrying amount of an asset or a liability is lower than its tax base, then there is a deductible temporary difference and it gives rise to deferred tax asset. What is a tax base Tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. Careful about items not shown in your balance sheet! If you review all your assets and liabilities calculating their tax bases, be careful! There could be some items not recognized in your balance sheet that still do have a tax base. For example, you might have incurred some research costs included in the profit or loss in the past that you could not deduct for tax purposes until later periods. In such a case, the research costs are not shown in your statement of financial position but they do have a tax base.

Non-taxable revenues are items that will no longer be subjected to income tax and may include the following: a. Income already subjected to final tax such as  Interest income on time or savings deposits  Interest revenue from government bonds, treasury bills or municipal bonds  Gains subject to capital gains tax b. Income exempted from income taxation such as

Tax base of an asset 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. For example, when you have an interest receivable and interest revenue is taxed on a cash basis, then the tax base of interest receivable is 0. Why? Because when you

 

Intercompany dividends received from a domestic corporation Proceeds from life insurance where the company is the beneficiary

Non-deductible expenses are items which are not allowed to be deducted from taxable revenue and may include the following: a. Fines, penalties and/or surcharges for violation of laws. b. Premiums paid on life insurance for officers and employees (company is the beneficiary) c. Loss on expropriation of property d. Impairment of loss on goodwill (if the problem is silent) e. Charitable contribution in excess of tax liabilities.

actually receive the cash and remove the interest receivable from your books, you will need to include full amount of cash received into your tax return. At the same time you cannot deduct anything from this amount for tax purposes. Tax base of a liability 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. For example, when you accrue some expenses that will be deductible when paid, then the tax base of a liability from accrued expenses is 0.

TIMING DIFFERENCES  Timing differences represents differences between accounting and taxable income arising from revenues and expenses recognized in one period but will reverse in one or more subsequent periods.  However, in totality, the item will be treated the same in accounting and taxable income Reasons for recognizing deferred tax  The accruals concept requires its recognition.  The deferred tax is a liability (or asset) which will eventually be settled.  The overstatement of profit caused by failing to allow for deferred tax liabilities can lead to:  Over-optimistic dividend payments based on inflated profits.  Distortion of earnings per share (EPS) and of the price/earnings (P/E) ratio, both important indicators of a company’s performance.  Shareholders being misled. IAS 12 and deferred tax The fundamental principle of IAS 12 is that:  An entity should recognize a deferred tax liability or asset whenever the recovery or settlement of the carrying amount of an asset or liability would make future tax payments larger or smaller than they would be if such recovery or settlement were to have no tax consequences.  Deferred tax is calculated using the liability method, in which deferred tax is calculated by reference to the tax base of an asset or liability compared to its carrying amount.

Kinds of temporary difference Taxable Temporary Difference (TTD) or Future Taxable Amount (FTA) 



It is the temporary difference that will result in taxable amount in determining taxable income of future periods when the carrying amount of the asset or liability is settled. This difference give rise to deferred tax liability. Deferred tax liabilities are the amounts of income taxes payable in future periods in respects of taxable temporary differences.

This is calculated by multiplying the FTA with tax rate applicable in the future period. DTL =

FTA

x

Future enacted tax rate

Deductible Temporary Difference (DTD) or Future Deductible Amount (FDA) 



It is temporary difference that will result in deductible amount in determining taxable income of future periods when the carrying amount of the asset or liability is recovered or settled. This difference gives rise to deferred tax asset. Deferred tax assets (DTA) are the amounts of income taxes recoverable in future periods in respect of: 1. Deductible temporary differences 2. The carryforward of unused tax losses and 3. The carryforward of unused tax credits. This is calculated by multiplying the FTA with tax rate applicable in the future DTA =

FDA

x

Future enacted tax rate

TEMPORARY DIFFENCES Case 1: (Tax Base : Assets) The following items are illustration of determining tax base of an asset: 1. Interest receivable has a carrying amount of P15,000. The related interest revenue will be tax on a cash basis. 2. Trade receivables have a carrying amount of P100,000. The related revenue has already been included in taxable profit (tax loss).

Answer: The tax base of the interest received is P0 since tax laws do not recognized accrued interest and only recognize interest income when the related cash is received. Answer: The tax base of the trade receivables is P100,000 since the item had already been recognized and included in taxable profit (tax loss)

3. A machine cost P1,000,000. For tax purposes, depreciation of P100,000 has already been deducted in the current and prior periods and the remaining cost will be deductible in future periods, either as depreciation or through a deduction on disposal. Revenue generated by using the machine is taxable, any gain on disposal of the machine will be taxable and any loss on disposal will be deductible for tax purposes. 4. Dividend receivable from a subsidiary have a carrying amount of P15,000. The dividends are not taxable. 5. A loan receivable has a carrying amount of P500,000. The repayment of the loan will have no tax consequences.

Answer: The tax base of the machine would be at P900,000.

Answer: The tax base of the receivable is P15,000 since the amount is not taxable. Answer: The tax base of the loan receivable is P500,000 since the loan will have no tax consequence.

Case 2: (Tax Base : Liabilities) The following items are illustration of determining tax base on a liability: 1. Current liabilities include accrued expenses with a carrying amount of P5,000. The related expense will be deducted for tax purposes on a cash basis. 2. Current liabilities include interest revenue received in advance, with carrying amount of P5,000. The related interest revenue was taxed on a cash basis. 3. Current liabilities include accrued expenses with a carrying amount of P5,000. The related expense had already been deducted for tax purposes. 4. Current liabilities include accrued fines and penalties with a carrying amount of P5,000. Fines and penalties are not deductible for tax purposes. 5. A loan payable has a carrying amount of P5,000. The repayment of the loan will have no tax consequences.

Answer: The tax base of the accrued expense is P0 since the item will only be recognized for tax purposes when the related expense is paid. Answer: The tax base of the interest received in advanced is P0 since the item had already been recognized as revenue when received. Answer: The tax base of the accrued expenses is P5,000 since the item was also recognized for tax purposes. Answer: The tax base of the accrued fines and penalties is P5,000 since the item is non-deductible expense. Answer: The tax base of the loan is P5,000 since the loan will have no future tax consequence.

Note: It is important to note that there will be no difference between the carrying amount and tax base if the amount is not taxable, not deductible or will have no future tax consequence. In other words, if the item creates a permanent difference, the carrying amount to be presented in the statement of financial position will be equal to its tax base.

Accounting entries for deferred tax

Carrying amount Tax base Temporary difference

x (x) x

Deferred tax = temporary difference x tax rate It is the movement on deferred tax that will need to be accounted for: Increase in deferred tax provision

Dr. Income tax expense/OCI Cr. Deferred tax (SFP)

x x

Reduction in deferred tax provision

Dr. Deferred tax (SFP) Cr. Incoem tax expense /OCI

x x

Deferred tax assets A deductible temporary difference arises where the tax base of an asset exceeds its carrying amount. “A deferred tax asset shall be recognized for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilized” (IAS 12, para 24). If a deferred tax asset arises from an entity making losses previously, the entity must be able to demonstrate that sufficient forecasted profits will be available to utilize the asset in order to recognize it.

Deferred tax liabilities IAS 12 requires:  A deferred tax liability to be recognized for all taxable temporary differences, with minor exceptions. A taxable temporary difference arises where the carrying amount of an asset is greater than its tax base.  The liability to be calculated and provided in full.  No discounting of the liability. ACCOUNTING PROCEDURES Financial / Acco...