ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY FARAP-4912

CPA Review Batch 49  May 2025 CPA Licensure Examination

FINANCIAL ACCOUNTING & REPORTING / AUDITING PRACTICE S. IRENEO  G. MACARIOLA  C. ESPENILLA  J. BINALUYO

INCOME TAXES
When a company prepares its tax return for a particular year, the revenues and expenses (and losses) included
on the return are, by and large, the same as those reported on the company's statement of comprehensive
income for the same year. However, in some instances tax laws and financial accounting standards differ. The
reason they differ is that the fundamental objectives of financial reporting and those of taxing authorities are not
the same.

Financial accounting standards are established to provide useful information to investors and creditors. The
government through its tax authority, on the other hand, is primarily concerned with raising public revenues in a
socially acceptable manner and, frequently, with influencing the behavior of taxpayers. In pursuing the latter
objective, the government uses tax laws to encourage activities it deems desirable, such as investment in
productive assets, and to discourage activities it deems undesirable, such as violations of laws.

As consequence of differences between IFRS and tax rules is that tax payments frequently occur in years different
from when the revenues and expenses that cause the taxes are generated.

Methods of Accounting for Deferred Tax

DEFERRAL METHOD – the original amount set aside for deferred tax is retained without alteration for subsequent
changes in tax rate. The deferral method does not keep the deferred tax amount up to date as tax rates change,
and is thus generally held to be inferior to the liability method.

The liability method - the deferred tax balance is adjusted as tax rates changes, thus maintaining the amount
at the actual liability expected to arise. It is subdivided into:

The original IAS permitted a free choice of either the deferral method or liability method and the focus was on
the profit or loss. The revised version of the standards prohibits the use of the deferral method. It requires
application of the liability method that focuses on the statement of financial position (known as the balance
sheet liability method).

LIABILITY METHOD
1) Income Statement Liability method – it focuses on the differences between taxable profit and accounting
profit (timing differences).

Timing differences – these are differences between accounting profits and taxable profits that arise because
the period in which some items of income and expenses are included in accounting profits does not coincide with
the period in which they are included in taxable profits. These differences arise because accounting profits are
determined by accounting standards, such as those of the IAS or IFRS, whereas taxable profits are governed by
tax laws, which set out the basis for the computation of income tax payable. It shall be emphasized that for timing
differences to arise, the items of income and expenses must differ only with respect to the periods in which they
are included. The total of each income or expense item included in accounting profits and taxable profits will
eventually be the same. Therefore, the central characteristic of timing differences is that they originate (arise) in
one or more periods, and reverse (or turnaround) in one or more subsequent periods. Timing differences give
rise to tax effects that are carried forward to one or more subsequent future periods so and accounting entry or
entries should be made to reflect these differences between accounting profits and taxable profits.

Permanent differences – these are the differences between taxable profits and accounting profits for a period
that originate in the current period but are not capable of reversal (or turnaround) in one or more subsequent
future periods. They relate to items of income that are tax-free and items of expenses that are disallowed for
income tax purposes. The permanent differences arise because the items of income or expenses are either
included in accounting profits without a corresponding inclusion in taxable profit. Permanent differences do not
give rise to tax effects in one or more future periods as they are not capable of reversal or turnaround. They do
not normally pose an accounting issue. With their presence, the tax expense in a period may be high or low
compared to the profit before taxation, but there are no accounting entries to be made. IAS 12 do not permit an
entity to correct for the distortion of the effective tax expense rate caused by such permanent difference.

There is a deferred tax asset on timing difference when:

• The amount of revenue recognized for taxation exceeds the amount of revenue recognized for financial
purposes; or
• The amount of expense recognized for financial purposes exceeds the amount of expense recognized for
taxation purposes.

There is a deferred tax liability on timing difference when:

• The amount of expense recognized for taxation purposes exceeds the amount recognized for financial
purposes; or
• The amount of revenue for financial purposes exceeds the amount recognized for taxation purposes.

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INCOME TAXES

2) Balance Sheet Liability method – the calculation is made by reference to difference between balance sheet
values and tax values of assets and liabilities (temporary differences). Temporary differences are defined in IAS
12 as differences between the carrying amount of an asset or liability and its tax base. The temporary difference
is used because ultimately all differences between the carrying amount of assets and liabilities and their tax bases
will reverse.

The deferred tax is calculated by reference to the tax base of an asset or liability. The tax base is the amount
attributed to the asset or liability for tax purposes.

The tax base of an asset is therefore the amount that will be deductible for tax purposes against any future
taxable benefits derived from the asset. If the benefits will not be taxable, the tax base of the asset is equal to
its carrying amount.

The tax base of a liability is the 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 received in advance, the tax base of the resulting
liability is it’s carrying amount, less any amount of the revenue that will not be taxable in future periods.

The difference between the tax base of an asset or liability and its carrying value is described as a temporary
difference:
• If the carrying value of an asset exceeds the tax base, tax on the difference is taxable temporary
• difference (deferred tax liability).
• If the carrying value of an asset is less than the tax base, tax on the difference is a deductible temporary
difference (deferred tax asset).
• If the carrying value of a liability exceeds the tax base, tax on the difference is a deductible temporary
difference (deferred tax asset).
• If the carrying value of a liability is less than the tax base, tax on the difference is a taxable temporary
difference (deferred tax liability).

Measurement
1. Current tax liabilities (assets) for the current and prior periods shall be measured at the amount expected to
be paid to (recovered from) the taxation authorities, using the tax rates (and tax laws) that have been enacted
or substantively enacted by the end of the reporting period.
2. Deferred tax assets and liabilities shall be measured at the tax rates that are expected to apply to the period
when the asset is realized or the liability is settled, based on tax rates (and tax laws) that have been enacted
or substantively enacted by the end of the reporting period.
3. When different tax rates apply to different levels of taxable income, deferred tax assets and liabilities are
measured using the average rates that are expected to apply to the taxable profit (tax loss) of the periods in
which the temporary differences are expected to reverse.
4. The measurement of deferred tax liabilities and deferred tax assets shall reflect the tax consequences that
would follow from the manner in which the entity expects, at the end of the reporting period, to recover or
settle the carrying amount of its assets and liabilities.

FINANCIAL ACCOUNTING & REPORTING - THEORIES

1. Which of the following is not a permanent difference?
a. Goodwill impairment.
b. Excess of allowable deductions.
c. Impairment loss on property, plant and equipment.
d. Interest and surcharges by the BIR and SEC.

2. Assuming a 25% statutory tax rate applies to all years involved, which of the following situations will give
rise to reporting a deferred tax liability on the balance sheet?
I. A revenue is deferred for financial reporting purposes but not for tax purposes.
II. A revenue is deferred for tax purposes but not for financial reporting purposes.
III. An expense is deferred for financial reporting purposes but not for tax purposes.
IV. An expense is deferred for tax purposes but not for financial reporting purposes.
a. item II only b. items I and II only c. items II and III only d. items I and IV only

3. Statement 1: If the depreciation expense recognized in tax is more that the depreciation expense recognized
in the book, the difference is a future deductible amount.
Statement 2: Impairment loss recognized on goodwill shall be treated as a nondeductible expense in
reconciliation of financial income to taxable income.
a. Only statement 1 is true c. Both statements are true.
b. Only statement 2 is true d. Both statements are false.

4. Mary Company’s financial reporting basis of its plant assets exceeded the tax basis because it uses a different
method of reporting depreciation for financial reporting purposes and tax purposes. If there is no other
temporary differences, Mary Company should report a:
a. current tax asset. b. deferred tax asset. c. current tax payable. d. deferred tax liability

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INCOME TAXES

5. The deferred tax consequence attributable to a deductible temporary difference and operating loss carry
forward is known as
a. current tax b. total tax expense c. deferred tax asset d. deferred tax liability

6. Statement 1: Total income tax expense is the sum of current income tax expense and deferred tax expense.
Statement 2: An increase in balance of deferred tax liability at the end of reporting period will also increase
the total income tax expense.
a. Only statement 1 is true c. Both statements are true.
b. Only statement 2 is true d. Both statements are false.

7. Statement 1: Deferred tax liability shall always be reported as current in the statement of financial position
at the end of reporting period if it is expected to reverse the following year.
Statement 2: Current income tax expense is equals to taxable income multiplied by the current year tax rate
even if the future enacted tax rate is different from the current period tax rate.
a. Only statement 1 is true c. Both statements are true.
b. Only statement 2 is true d. Both statements are false.

8. According to PAS 1, deferred tax assets and liabilities should be reported in the financial statement:
a. as noncurrent asset and noncurrent liability.
b. always net in current asset or net current liability.
c. as current and noncurrent depending on the order of liquidity or maturity.
d. as current and noncurrent assets and liabilities depending on the balance sheet classification of the related
tax basis of the temporary difference.

9. Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of:
a. deductible temporary differences; the carryforward of unused tax losses; and the carryforward of unused
tax credits.
b. deductible permanent differences; the carryforward of unused tax losses; and the carryforward of unused
tax credits.
c. deductible temporary differences; the carryforward of used tax losses; and the carryforward of unused tax
credits.
d. deductible temporary differences; the carryforward of unused tax losses; and the carryforward of used tax
credits.

10. Which of the following is a temporary difference classified as a revenue or gain that is taxable after it is
recognized in financial income?
a. Subscriptions received in advance.
b. Prepaid royalty received in advance.
c. Sales accounted for on the accrual basis for financial reporting purposes and on the installment (cash)
basis for tax purposes.
d. Interest received on government obligations.

11. Which of the following differences would result in future taxable amounts?
a. Expenses or losses that are tax deductible after they are recognized in financial income.
b. Revenues or gains that are taxable before they are recognized in financial income.
c. Revenues or gains that are recognized in financial income but are never included in taxable income.
d. Expenses or losses that are tax deductible before they are recognized in financial income.

12. The total income tax expense (Total ITE) is the:

a. the sum of current income tax expense and deferred tax liability
b. the difference of current income tax expense and deferred tax expense.
c. the difference of deferred tax liability and deferred tax asset
d. the current income tax expense plus increase in deferred tax liability less increase in deferred tax asset

13. When a change in the tax rate is enacted into law, its effect on existing deferred income tax accounts should?
a. be handled retroactively in accordance with the guidance related to changes in accounting standards.
b. be considered, but it should only be recorded in the accounts if it reduces a deferred tax liability or
increases a deferred tax asset.
c. be reported as an adjustment to tax expense in the period of change.
d. be applied to all temporary or permanent differences that arise prior to the date of the enactment of the
tax rate change, but not subsequent to the date of the change.

14. Tax rates other than the current tax rate may be used to calculate the deferred income tax amount on the
statement of financial position if
a. it is probable that a future tax rate change will occur.
b. it appears likely that a future tax rate will be greater than the current tax rate.
c. the future tax rates have been enacted or substantially enacted.
d. it appears likely that a future tax rate will be less than the current tax rate.

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INCOME TAXES

15. Which of the following statements is correct regarding deferred taxes under IFRS?
a. Current tax expense plus or minus the change in deferred income taxes equals income tax expense.
b. The current portion of income tax expense is the amount of change in deferred taxes related to the
current period.
c. In computing income tax expense, a company deducts an increase in a deferred tax liability to income
tax payable.
d. All of the choices are correct.

FINANCIAL ACCOUNTING & REPORTING - PROBLEMS

Problem 1
Alden Company reported pretax income of P5,500,000 for the year ended December 31, 2024. The company
record shows the following differences:
Tax depreciation in excess of book depreciation (expected reversal in 2026 and onwards) P1,500,000
Installment sales recognized in the book to be collected 70% in 2025 and 30% in 2026 1,200,000
Proceeds from life insurance policy upon death of an officer* 2,500,000
Interest revenue on bank deposits 200,000
Impairment loss on goodwill 150,000
Fines and penalties 1,150,000
Provision for litigation expected to settle in 2025, 2026 and 2027 in equal amounts 1,350,000
Warranty expense in 2024 expected to be settled in 2025 (40%) and 2026 (60%) 940,000
*The beneficiary of the life insurance policy is Alden Company.

Tax rate is 25% in 2024 and in the future. Payments in previous quarters totaled P750,000.

Answer the following questions:

1. Statement 1: The taxable income for year 2024 is P3,690,000.
Statement 2: The income tax payable in its December 31, 2024, statement of financial position is P172,500.
Statement 3: The excess of tax depreciation of P1,500,000 is a future taxable amount and shall be deducted
from pretax income in reconciling pretax income to taxable income.
a. Only 1 statement is incorrect. c. Only statements 1 and 3 are incorrect.
b. Only statements 1 and 2 are correct. d. All statements are correct.

2. Statement 1: The total future deductible amount in 2024 reconciliation that should be added to pretax income
is P2,290,000.
Statement 2: The current income tax expense for year 2024 is P922,500.
Statement 3: The total income tax expense in its Income statement for year 2024 is P1,125,000.
a. Only 1 statement is incorrect. c. Only statements 1 and 3 are incorrect.
b. Only statements 2 and 3 are correct. d. Only 2 statements are incorrect.

3. Statement 1: The resulting net deferred income tax expense of P102,500.

Statement 2: The net income after tax is P4,475,000.
Statement 3: The P750,000 payment of taxes in the previous quarters shall be included in the years total
income tax expense.
a. Only statement 3 is incorrect. c. Only statements 1 and 2 are correct.
b. Only statements 2 and 3 are correct. d. All statements are correct.

Use the following assumptions for the next three questions: If tax rate for year 2024 is 25%, but the congress
has enacted the tax rates for year 2025 at 27% and years 2026 and onwards at 30%:
4. How much is the balance of deferred tax asset and deferred tax liability as of December 31, 2024,
respectively?
a. P655,875 and P785,820 c. P788,820 and P660,645
b. P662,220 and P784,800 d. P647,880 and P785,600

5. Statement 1: The total income tax expense for year 2024 is P1,045,080.
Statement 2: The net income after tax in its Income Statement for year 2024 is P4,454,920.
a. Only statement 1 is true. c. Both statements are true.
b. Only statement 2 is true. d. Both statements are false.

6. What is the effective tax rate in this situation?

a. 19.00% b. 20.12% c. 21.18% d. 22.62%

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INCOME TAXES

Problem 2
Benson Corporation’s income statement for the year ended December 31, 2024, shows pretax income of
P4,500,000. The following are treated differently on the tax return and in the accounting records:
Tax Return Book records
Rent income P500,000 P300,000
Depreciation expense (reversal in 2026) 600,000 480,000
Unrealized loss – PL -- 100,000
Accrued interest income -- 60,000
Royalties received -- 200,000
Entertainment and recreational expense 760,000 860,000
Dividend received from a domestic corporation -- 140,000
Premiums paid on officer’s life insurance* -- 170,000
*Benson Corporation is the beneficiary of the life insurance policy of the officer.

Answer the following questions:

1. How much is the taxable income in its tax return for year 2024?
a. P4,370,000 b. P4,420,000 c. P4,480,000 d. P4,550,000

2. Assume that Benson Corporation’s tax rate for year 2024 and in the future years is 25%, how much is the
current income tax expense (CITE) for year 2024?
b. P1,337,500 b. P1,229,000 c. P1,137,500 d. P1,017,500

3. Assume that Benson Corporation’s tax rate for 2024 and in the future years is 25%, how much is the net
deferred income tax expense (benefit) for year 2024?
a. (P30,000) b. (P45,000) c. P35,000 d. P37,500

Use the following assumptions for the next three questions: Assume that Benson Corporation’s tax rate for year
2024 is 25%, and the congress has enacted tax rate of 30% for years 2025 and onwards.
4. Statement 1: The current income tax expense remains the same even if the tax rate will change in the future.
Statement 2: The total income tax expense will decrease by P6,000 because of change in future tax rates.
Statement 3: The net income after tax in 2024 is P3,398,500.
a. Only statement 3 is incorrect. c. Only statements 1 and 2 are correct.
b. Only statements 2 and 3 are correct. d. All statements are correct.

5. Statement 1: The balance of deferred tax asset as of December 31, 2024, will increase by P15,000 because
of the change in tax rate.
Statement 2: The balance of deferred tax liability as of December 31, 2024, is P54,000.
a. Only statement 1 is true. c. Both statements are true.
b. Only statement 2 is true. d. Both statements are false.

6. What is the effective tax rate in this situation?

a. 22.07% b. 23.11% c. 24.21% d. 25.84%

Problem 3
Cadillac Incorporated’s partial income statement for year 2024 is as follows:
Income tax expense:
Current P1,050,000
Deferred 82,500
Total income tax expense P1,132,500

Cadillac Incorporated uses straight-line method of depreciation for financial reporting purposes and accelerated
depreciation method for tax purposes. The amount charged to depreciation expenses on its book this year was
P1,500,000. During the year, Cadillac Incorporated purchase a two-year fire insurance for P500,000 dated
January 1, 2024. The entire amount paid was debited to fire insurance expense on January 1, 2024. A provision
for litigation of P280,000 was recognized in the book for a probable loss in a case filed against Cadillac
Incorporated by a customer.

During the year, a total of P120,000 was received from Mercedes Company (a domestic corporation) as dividend
income and paid a total of P55,000 to BIR for penalties in late filing of tax returns.

Tax rate for year 2024 and in the future is 25% as enacted by the congress.

Answer the following questions:

1. How much is the taxable income for year 2024?
a. P4,500,000 b. P4,400,000 c. P4,300,000 d. P4,200,000

2. Statement 1: The amount deducted as depreciation expense in its tax return for year 2024 is P1,560,000.
Statement 2: The amount of pretax income is P4,595,000.
a. Only statement 1 is true. c. Both statements are true.
b. Only statement 2 is true. d. Both statements are false.

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3. How much is the net income after tax for year 2024?
a. P4,832,500 b. P4,712,500 c. P4,462,500 d. P4,582,500 e. no answer

4. What is the effective tax rate in this situation?

a. 25.52% b. 24.65% c. 23.37% d. 22.88% e. no answer

Problem 4
Drex Company at the end of 2024, its first year of operation, prepared reconciliation between pretax financial
income and taxable income as follows:
Pretax financial income P2,500,000
Estimated litigation expense 950,000
Installment sales (550,000)
Taxable income P2,900,000

The estimated litigation expenses of P950,000 will be deductible in 2025 and 2026 when it is expected to be paid
in equal amounts. The installment sales will be realized in the amount of P350,000 and P200,000 each of the
next two years. The income tax rate is 25% in current year and 30% in future years.

Answer the following questions:

1. How much is the current income tax expense (CITE)?
a. P840,000 b. P810,000 c. P750,000 d. P725,000

2. How much is the total income tax expense (Total ITE)?

a. P845,000 b. P710,000 c. P605,000 d. P590,000

3. How much is the deferred tax asset at year end?

a. P340,000 b. P320,000 c. P290,000 d. P285,000

4. How much is the deferred tax liability at year end?

a. P230,000 b. P190,000 c. P165,000 d. P150,000

Problem 5
Hanabishi Company has revalued its property and has recognized the increase in the revaluation reserve in its
financial statements. The carrying value of the property in Hanabishi’s book was P5,000,000, and the revalued
amount was P12,000,000. The tax base of the property was P8,000,000. The tax rate 25%.
1. What amount of deferred tax expense should be reported in other comprehensive income?
a. None b. P750,000 c. P1,000,000 d. P1,750,000

Problem 6
On January 2, 2024, Union Company acquired from the stock exchange 20,000 shares of Asahi Company at the
prevailing market price of P60 per share. Union Company has designated the shares as equity investment at fair
value to through other comprehensive income. On December 31, 2024, the shares of Asahi are selling at P68 per
share.

On July 1, 2024, Union Company paid P300,000 for one year insurance that will expire on June 30, 2025.

The current year income tax rate is 32% while the future tax rate is 30%.

1. What amount of deferred tax expense (savings) should the Union Company disclose in its 2024
Comprehensive Income?
a. P45,000 b. P51,200 c. P48,000 d. P93,000

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