Summary
Highlights
The video begins by differentiating permanent and temporary differences in accounting for income tax. Permanent differences, previously discussed, are items recorded by one but never by the other (accounting vs. taxation). Temporary differences, the focus of this lecture, involve items recorded in different periods but eventually reconcile.
Permanent differences involve revenues or expenses recorded by accounting but never by taxation (or vice versa), regardless of the period. Temporary differences, however, are recorded by one entity in one period and by the other in a subsequent period, eventually balancing out. It's a matter of timing.
Temporary differences are defined as discrepancies between the carrying amount of an asset or liability and its tax base. This definition also includes 'timing differences,' which refer to income and expenses included in both accounting and taxable income but in different periods. The speaker highlights that temporary differences are a broader concept than timing differences.
Based on the definitions, two methods for accounting for income tax are identified: the income statement approach (focusing on income and expenses, related to timing differences) and the statement of financial position approach (focusing on assets and liabilities). Both approaches are interconnected as income/expenses eventually affect assets/liabilities.
Temporary differences can result in either a 'deferred tax liability' (for taxable temporary differences arising from future taxable amounts) or a 'deferred tax asset' (for deductible temporary differences arising from future deductible amounts). A deferred tax liability means paying tax in the future, while a deferred tax asset means a future deduction from taxes.
A deferred tax liability typically arises when accounting income is higher than taxable income. This can happen if accounting revenue is higher than tax revenue, or if accounting expenses are lower than tax expenses. The carrying amount of an asset being higher than its tax base, or the carrying amount of a liability being lower than its tax base, also leads to a deferred tax liability.
Conversely, a deferred tax asset arises when accounting income is lower than taxable income. This occurs if accounting revenue is lower than tax revenue, or if accounting expenses are higher than tax expenses. Similarly, if the carrying amount of an asset is lower than its tax base, or the carrying amount of a liability is higher than its tax base, a deferred tax asset is created.
Using a numerical example with a 30% tax rate, the speaker demonstrates how a difference between accounting income (e.g., 1 million) and taxable income (e.g., 500,000) leads to a deferred tax liability. Accounting records a higher tax expense, but only the lower tax determined by the BIR is payable currently, with the remaining difference becoming a deferred tax liability.
The discussion provides real-world examples: installment sales (accounting recognizes full revenue upfront, BIR recognizes only collected portion, leading to deferred tax liability) and advanced rent (accounting recognizes as liability, BIR recognizes as income, leading to deferred tax asset).
Further examples for expense differences include development costs (accounting may capitalize, BIR expenses it, leading to deferred tax liability) and depreciation methods (different methods used by accounting and BIR creating differences). Warranties and doubtful accounts also serve as examples where accounting estimates expenses while BIR only recognizes actual costs, leading to deferred tax assets.
Beyond timing differences (income and expenses), 'other temporary differences' involve only real accounts (assets and liabilities). Examples include revaluation surplus (upward revaluation increases carrying amount of asset but not tax base, creating deferred tax liability, and vice versa for downward revaluation) and investments (e.g., equity method for associates leading to differences in carrying amount vs. tax base).
A special case related to deferred tax assets is the Net Operating Loss Carryover (NOLCO). If a business incurs losses in early years, it can carry over these losses to deduct from future profits, reducing future tax obligations. This ability to deduct past losses acts as a future deductible amount, thereby creating a deferred tax asset.
Deferred tax assets and liabilities are always presented as non-current items. For their calculation, if projected future tax rates are known and differ from the current rate, the future or projected tax rate should be used, reflecting the future nature of these deferred taxes.