IA3 - Accounting for income taxes PDF

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ACCOUNTING FOR INCOME TAXES (PAS 12)- normally treated as cost; require recognition in the same period as the related incomePrincipal issues: How to account for current & future consequences: - the future recovery (settlement) of the CV of assets (liabilities) recognized in an enterprise’s SFP -...

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ACCOUNTING FOR INCOME TAXES (PAS 12) - normally treated as cost; require recognition in the same period as the related income Principal issues: How to account for current & future consequences: - the future recovery (settlement) of the CV of assets (liabilities) recognized in an enterprise’s SFP - transactions and other events of the current period recognized in an enterprise’s FS.

ILLUSTRATION 1. 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 or the officer, premiums of P28,000 were paid by the company. Tax rate is 30%. Assume further that the permanent 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:

PAS 12 applies to all entities subject to income tax, public or not. A public entity is an entity: - securities (E&D) are traded in a stock exchange or OTC market - securities are registered with SEC in preparation of its sale On SFP, the effect of income taxes is recognized as either:  current tax liabilities (or current tax assets); or  deferred tax liabilities (or deferred tax assets)  Fundamental principle (PAS 12): recognition of deferred tax liability (or asset). Deferred tax liability (asset) = tax base of assets and liabilities – their carrying amounts in SFP.

The bal. of income tax payable is the current tax liability on the SFP. The lower portion of the P/L section of the SCI would appear as:

CURRENT TAX LIABILITIES AND CURRENT TAX ASSETS - computed based on taxable profit (or tax loss) determined by tax authorities (National Internal Revenue Code and BIR regulations) - unpaid income taxes for current and past periods: liability - excess between income taxes and amount due: asset Taxable revenues – revenues recognized for tax purposes. Expenses allowed to be deducted therefrom are deductible expenses. Resulting net amount is taxable income (or loss). ACCOUNTING PROFIT AND TAXABLE PROFIT Accounting income – pre-tax profit computed in accordance with the accounting standards and is reported in traditional income statement. Taxable income – appears on the ITR, computed in accordance with the income tax law; income taxes are payable or recoverable. The varying treatments of economic activities between PFRS and tax laws result to the following differences: a. permanent differences b. temporary differences PERMANENT DIFFERENCE – items of revenue and expenses which are included in either accounting income or taxable income but will never be included in the other. This pertains to: - nontaxable revenue - nondeductible expenses - subject to final tax (excluded from ITR) Permanent differences do not give rise to deferred tax liabilities and assets as they do not have future tax consequences. Examples:  interest income on bank deposits, gov’t bonds and treasury bills  dividend income (by a dom. corp. or NRC from a dom. corp.)  life insurance premium (corporation is the beneficiary)  fines, surcharges and penalties arising from law violation  gains already subjected to final withholding tax (e.g., cap. gains)  When computing income tax, tax laws govern so accounting profit should be reconciled to taxable income (tax exempt revenues are deducted and nondeductible expenses are added back).

TEMPORARY DIFFERENCES – definition:  Balance sheet perspective: difference between the carrying amount of an asset or liability in the SFP and its tax base.  Income statement perspective: occurs when a revenue or expense is included in financial profit in one period but reported for tax purposes in another period/vice versa (timing differences)  temporary differences are temporary as their effects reverses in one or more subsequent periods (bc of timing of recognition between taxation and financial reporting)  has future tax consequences (gives rise to deferred tax asset/liab) (par. 5, IAS 12 Income Taxes) Temporary differences may be either: a. taxable temporary differences – those that result to future taxable amounts (def. tax liability) when the CV of the liability or asset is recovered or settled b. deductible temporary differences – those that result to future deductible amounts (def. tax asset) when the CV of the liability or asset is recovered or settled Tax base – amount attributable to the asset or liability for tax purposes. Tax base of an asset is the amount deductible for tax purposes against future income. If the tax deduction is allowed as one-time deduction for tax purposes, tax base is zero because the entire amount is expensed in the current year. Tax base of a liability is the CV less the amount deductible for tax purposes in the future. An estimated warranty cost is deductible only when actually paid, so tax base is zero as an EWC is a future deductible amount. Taxable Temporary Differences (TTD) arise when: a. [ISP] financial income is greater than taxable income (FI > TI) i. financial revenue > taxable revenue ii. financial expense < taxable expense b. [BSP] CV of an asset is greater than its tax base (CVA > TB) c. [BSP] CV of a liability is less than its tax base (CVL < TB)

Deferred tax liabilities – amounts of income taxes payable in future periods in respect of TTD. (PAS 12.5) The cumulative amount of TTD multiplied by the tax rate equals the amount of deferred tax liability recognized in the SFP. Entry to set-up the liability assuming that def. tax liability has a zero beginning balance: Income Tax Expense – Deferred Deferred Tax Liability

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Examples of circumstances resulting to TTD: 1. Revenue is recognized at point of sale under financial reporting but is taxable only when installment payments are received. Analysis: Fin. income Taxable income Revenue is recognized In full In installments Effect FI > TI Conclusion: the difference between the income recognized for financial reporting and the taxable income represents TTD. 2. Prepayment is capitalized and amortized as expense under financial reporting while deducted in full upon payment under taxation. Analysis: Fin. income Taxable income Expense is recognized In installments In full Result Lower expense Higher tax deduc. Effect FI > TI Conclusion: exp. recognized for finrep. less tax deduction = TTD. 3. An asset is revalued upward and no equivalent adjustment is made for tax purposes Analysis: Carrying value Tax base Asset Increased No adjustment Effect CV > TB Conclusion: CV of the asset less its tax base = TTD. 4. Income is accrued for financial reporting but is taxable only when cash is collected. Analysis: Fin. income Taxable income Revenue is recognized Accrued When collected Effect FI > TI Conclusion: FI less TI = TTD. 5. Straight line method of depreciation is used under fin. reporting while the accelerated depreciation is used for taxation purposes. Analysis: Fin. income Taxable income Expense recognized Less More Effect FI > TI Conclusion: FI less TI = TTD. 6. The identifiable assets acquired and liabilities assumed in a business combination are recognized at their FV (PFRS 3 Business Combinations), but no equivalent adjustment is made for taxation. Analysis: If the asset is recognized at FV that is higher than the TB, CV > TB. Difference is equal to TTD.

7. The CV of investment in subsidiary, associate, or joint venture, is greater than its tax base because income of the investee is not entirely distributed to investors. Analysis: CA > TB. Difference is equal to TTD. More examples: (ROBLES-EMPLEO BOOK) Balance sheet approach Income statement approach Interest revenue is recognized in accounting profit on a time CV of interest receivable is proportion basis but reported more than its tax base (tax in taxable profit when base is zero). collected Dep. expense for tax purposes is more than dep. expense for CV of PPE > its tax base accounting in the earliest years of the asset life. Expense is recognized in accounting profit using CV of prepaid exp. is more than its tax base (tax base = 0) accrual basis but reported in taxable profit when paid Revenue for sales is recognized in accounting CV of installment receivable is profit during period of more than its tax base (TB = 0) delivery but reported in taxable profit during period of collection. Deductible Temporary Difference (DTB) a. [ISP] financial income is less than taxable income (FI < TI) i. financial revenue < taxable revenue ii. financial expense > taxable expense b. [BSP] CV of an asset is less than its tax base (CVA < TB) c. [BSP] CV of a liability is greater than its tax base (CVL > TB) Deferred tax assets – amounts of income taxes recoverable in future periods in respect of (a) DTB, (b) the carryforward of unused tax losses, and (c) the carryforward of unused tax credits....