PAS 12 - Accounting for Income Tax

Deferred tax accounting is applicable to all entities, whether public or nonpublic entities.

Public entity is an entity whose equity or debt securities are:

(a) traded in a stock exchange;
(b) over-the-counter market; or
(c) whose equity or debt securities are registered with SEC in preparation for sale of the securities.

Accordingly, differences between accounting income and taxable income arise. These differences may be
classified into two, namely:
1. Permanent differences pertain to nontaxable revenue and nondeductible expenses. Permanent
differences do not give rise to deferred tax asset and liability because they have no future tax
consequences. Examples include the following: (1) Interest income on deposit (2) Dividends received (3)
Life insurance premium (if the entity is the beneficiary of a life insurance policy on its officer or employee,
the premium paid by the entity is not deductible as expense for tax purposes but said premium is an
expense for financial reporting purposes) (4) Tax penalties, surcharges and fines are not deductible.

2. Temporary differences are differences between the carrying amount of an asset or liability and its
tax base. Temporary differences include timing differences. Timing differences are differences between
accounting income and taxable income that originate in one period and reverse in one or more subsequent
periods. Timing differences are items of income and expenses which are included in both accounting
income and taxable income but at different periods. For every temporary difference, eventually that items
treatment will be the same in accounting and taxable income. Accordingly, temporary differences give rise
either to a deferred tax asset or deferred tax liability.

Kinds of temporary difference

(1) Taxable temporary difference FUTURE TAXABLE AMOUNT (Deferred tax liability)
(2) Deductible temporary difference FUTURE DEDUCTIBLE AMOUNT (Deferred tax asset)

Deferred tax liability arises when: Deferred tax asset arises when:
1. Accounting income is > Taxable income 1. Accounting income is < Taxable income
2. Carrying amount of Asset is > Tax base 2. Carrying amount of Asset < Tax base
3. Carrying amount of Liability is < Tax base 3. Carrying amount of Liability > Tax base
NOTE: Operating loss carryforward is an excess of tax deductions over gross income in a year that may be carried
forward to reduce taxable income in a future year. Thus, an operating loss carryforward will give rise to a deferred tax
asset.

Method of accounting

1. Income statement approach This method focuses on timing differences only in the computation of
deferred tax asset or deferred tax liability.
2. Statement of financial position approach This method considers all temporary differences including
timing differences.

NOTE: PAS 12 requires the use of the statement of financial position approach.

FORMULA:

Taxable Income x Tax rate = Current tax expense

Taxable temporary differences x Tax rate = + Deferred tax liability

Deductible temporary differences x Tax rate = - Deferred tax asset

Accounting income subject to tax x Tax rate = Total income tax expenses

Applicable only to subsequent period:

Total income tax expenses

Add: Increase in Deferred tax asset
Decrease in Deferred tax
liability
Less: Increase in Deferred tax liability
Decrease in Deferred tax asset
Total Current tax expense
Divided by: Tax rate
Taxable income
(1)1n 2016, an entity reported in accounting a gross profit on installment sale of 1,000,000 but not in
taxable income. This temporary difference is expected to be reported in taxable income equally in 2017
and 2018. The income tax rate is 30%.
The income statement and tax return showed the following:

2016 2017 2018

Accounting income 4,000,000 5,000,000 7,000,000
Taxable Income 3,000,000 5,500,000 7,500,000

1. Current tax expense for 2016, 2017, and 2018:

a. 300,000, 1,650,000, 2,100,000 c. 900,000, 1,650,000, 2,250,000
b. 1,000,000, 1,500,000, 2,250,000 d. 1,200,000, 1500,000, 2,100,000

2. Deferred tax liability (deferred tax expense) for 2016:

a. 300,000 c. 900,000
b. 1,000,000 d. 1,200,000

3. Decrease in deferred tax liability for 2017 and 2018:

a. 150,000 and 300,000 c. 300,000 and 0
b. 150,000 and 150,000 d. 150,000 and 0

4. Total income tax expense for 2016, 2017 and 2018:

a. 1,200,000, 1,500,000, 2,100,000 c. 1,200,000, 1,500,000, 2,250,000
b. 900,000, 1,500,000, 2,100,000 d. 1,200,000, 1,500,000, 2,100,000

5. What is the balance of deferred tax liability on December 31, 2018?

a. 300,000 c. 150,000
b. Zero (0) d. None of the choices

(2) In 2016, an entity received an advance rental payment of 600,000 which is subject to tax but not
reported in accounting income until 2017. The income tax rate is 30%.

The income statement and tax return showed the following:

2016 2017
Accounting income 5,000,000 7,000,000
Taxable income 5,600,000 6,400,000

1. Current tax expense for 2016 and 2017:

a. 1,680,000 and 1,920,000 c. 1,680,000 and 2,100,000
b. 1,680,000 and 1500,000 d. 1, 5000,000 and 1,920,000

2. Deferred tax asset (income tax benefit) for 2016:

a. 180,000 c. 600,000
b. 780,000 d. 1,680,000

3. Decrease in deferred tax asset for 2017:

a. 240,000 c. 180,000
c. 600,000 d. 360,000

4. Deferred tax liability (deferred tax expense) for 2017:

a. 180,000 c. 600,000
b. 240,000 d. Zero (0)

5. Total income tax expense for 2016 and 2017:

a. 1,500,000 and 2,100,000 c. 1,500,000 and 1,920,000
b. 1,500,000 and 2,000,000 d. 1,680,000 and 1,920,000

(3) EZGGWP Company provided the following information for its first year of operations ended December
31, 2016:

Accounting income per book 8,000,000

Nondeductible expense 500,000
Nontaxable revenue 200,000
Net income (after income tax expense) 5,395,000
Income tax benefit 245,000

1. Current tax expense:

a. 3,190,000 c. 3,045,000
b. 2,800,000 d. 3,150,000

2. Taxable Income:
a. 8,700,000 c. 9,300,000
b. 8,400,000 d. 9,000,000

3. Total income tax expense:

a. 3,010,000 c. 2,945,000
b. 2,800,000 d. 2,905,000
4. Tax rate:
a. 30% c. 32%
b. 35% d. 33%

(4) An entity reported the following for the year ended December 31, 2016.

Accounting income per book 6,000,000

Nondeductible expenses 500,000
Nontaxable revenue 300,000
Doubtful accounts 200,000
Estimated warranty cost that had been recognized
as expense in 2016 when the products sales were
made but is deductible for tax purposes when paid 400,000
Accounting depreciation 600,000
Tax depreciation 800,000
Gross income on installment sale included in accounting
income but taxable only in 2017 100,000
Income tax rate 30%

1. Current tax expense:

a. 1,860,000 c. 1,950,000
b. 1,890,000 d. 1,710,000

2. Deferred tax asset:

a. 90,000 c. 180,000
b. 150,000 d. 30,000

3. Deferred tax liability:

a. 90,000 c. 180,000
b. 150,000 d. Zero (0)

4. Total income tax expense:

a. 1,800,000 c. 1,770,000
b. 1,860,000 d. 1,950,000

5. Net deferred tax expense(benefit):

a. (90,000) c. (180,000)
b. 90,000 d. Zero (0)

(5) Complex Company reports pretax accounting income of 5,000,000 for the year ended December 31,
2016. This income includes uncollected installment receivable of 500,000. The entitys installment sales
are taxable when cash is collected, so the uncollected installment receivable would not be part of taxable
income. The income tax rate is 30%. The entity had no deferred taxes at the beginning of 2016.Complex
Company reports pretax income of 6,000,000 for the year ended December 31, 2017. The accounting
income includes uncollected installment receivable of 300,000 on December 31, 2017. The installment
receivable of 500,000 on December 31, 2016 is collected in 2017.

1. Current tax expense for 2016 and 2017:

a. 1,650,000 and 1,860,000 c. 1,500,000 and 1,710,000
b. 1,350,000 and 1,860,000 d. 1,650,000 and 1,710,000

2. Deferred tax asset/liability for 2016:

a. 500,000 deferred tax asset c. 150,000 deferred tax liability
b. 150,000 deferred tax asset d. Zero (0)

3. Decrease in deferred tax asset for 2017:

a. 60,000 c. 200,000
b. 90,000 d. Zero (0)

4. Decrease in deferred tax liability for 2017:

a. 60,000 c. 200,000
b. 90,000 d. Zero (0)

5. Total income tax expense for 2016 and 2017:

a. 1,500,000 and 1,800,000 c. 1,500,000 and 1,860,000
b. 1,200,000 and 1,800,000 d. 1,200,000 and 1,860,000

(6) Simple Company reports pretax accounting income of 7,000,000 for the year ended December 31,
2016. An unearned rent income of 800,000 is excluded from this income. Simple Company follows the cash
basis for tax purposes and the accrual basis for accounting purposes. Accordingly, such amount is included
in taxable income. The tax rate is 30%. Simple Company reports pretax accounting income of 8,000,000
for the year ended December 2017. The unearned rent income on December 31, 2016 is included in this
income. On December 31, 2017, the unearned rent income is 1,500,000. Moreover, Simple Company
reports an estimated liability for product warranty of 500,000 on December 31, 2017. The warranty cost is
deductible only for tax purposes when actually paid.

1. Current tax expense for 2016 and 2017:

a. 2,340,000 and 2,760,000 c. 1,860,000 and 2,760,000
b. 1,860,000 and 3,000,000 d. 2,340,000 and 3,000,000

2. Deferred tax asset/liability for 2016:

a. 800,000 deferred tax asset c. 240,000 deferred tax liability
b. 240,000 deferred tax asset d. Zero (0)

3. Increase in deferred tax asset for 2017:

a. 360,000 c. 240,000
b. 120,000 d. Zero (0)

4. Increase in deferred tax liability for 2017:

a. 360,000 c. 240,000
b. 120,000 d. Zero (0)

5. Total income tax expense for 2016 and 2017:

a. 2,100,000 and 2,160,000 c. 1,860,000 and 2,160,000
b. 1,860,000 and 2,400,000 d. 2,100,000 and 2,400,000

Answer Key:

(1) 1. C (2) 1. A (3) 1.D (4) 1. C (5) 1. B (6) 1. A

2. 2. A 2. D 2. C 2. C 2. B
A
3. 3.C 3.D 3. A 3. D 3.A
B
4. 4. D 4.B 4. B 4. A 4.D
D
5. 5.A 5.A 5.A 5.D
B