Lecture 5

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Agenda
 Current Malaysian Taxation
 Taxable and Non-Taxable Income
 Deductible and Non-deductible Expenses
 Deferred Taxes
 Deferred Taxes- Temporary Differences
 Deferred Taxes- Permanent Differences
 Applicable Standard and Scope (IAS 12/ MFRS 112)
 The Balance Sheet Liability Method
 The Balance Sheet Liability Method- Taxable Temporary Differences
 The Balance Sheet Liability Method-Deductible Temporary Differences
 Measurement Principles
 Measurement of Taxes
 Disclosures
 Comprehensive Example on Deferred Taxes
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 Accounting for
Income Taxes

Income Deferred
Taxes Taxes

Income Tax Deferred

Expense Tax Liability

Income Tax Deferred

Payable Tax Asset

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Current Malaysian Taxation
 The requirements for income tax in Malaysia are specified in
the Income Tax Act 1967.

 The Malaysian tax system is based on the ‘pay as you earn

basis’.

 The amount of tax to be paid by a company is based on the

estimate or revised estimate of the income tax payable for
the immediately preceding year.

 Current tax for current and prior periods shall, to the extent
unpaid, be recognised as a liability- income tax payable.

 If the amount already paid in respect of current and prior

periods exceeds the amount due for those periods, the
excess shall be recognised as an asset.

 Current tax payable is computed based on rules established

by the IRB, which set out the basis for items of income
which are taxable or non-taxable, and items of expenses
which are deductible or non-deductible for tax purposes. 7
Taxable and Non-Taxable Income
 General rule is income or revenue receipts are taxable
whilst capital receipts are not taxable under the ITA
1967.

 Under S4 of the ITA, classes of income which are

taxable (unless specifically exempted) are:
(a) Gains or profits from a business
(b) Gains or profits from employment
(c) Dividends, interest or discounts
(d) Rents, royalties or premiums
(e) Pensions, annuities etc
(f) Gains or profits from other sources

 Items of income that are taxable give rise to temporary

differences if they are recognised in accounting profit in
periods that differ from their inclusion in taxable profits.

 Items of income that are not taxable give rise to

permanent differences.
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Deductible and Non-deductible
Expenses
 S33 of the ITA provides for the general rule of
deductibility of expenses.

 General rule is that revenue expenses are

deductible whilst expenses of a capital nature
are not.

 Items of expenses that are deductible for tax

purposes give rise to temporary differences if
they are recognised in accounting profits in
periods that differ from their deduction in
taxable profit.

 Items of expenses that are not deductible for

tax purposes give rise to permanent
differences.
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Deferred Taxes
Income Taxes

Financial
Accounting &
Income Tax Rules
Reporting
Standards (IFRS)

VS
Tax payable is Tax payable is
based in net based on its
income before tax taxable income
(Accounting Law) (Tax Law)

Deferred Taxes
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Deferred Taxes
 Deferred taxes arise from the differences
between the tax calculated for taxation
purposes and financial accounting and
reporting purposes.
 There are two types of differences:
 Temporary differences
 Permanent differences

 Due to the deferring impact of temporary

and permanent differences on deferred
taxes, care has to be taken in identifying
items that need to be considered in
accounting for deferred tax.

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 Deferred Taxes- Temporary Differences
 Temporary differences refer to items that are
treated differently for taxation and financial
accounting and reporting purposes.

• Arise from :
• timing differences, and
• circumstances that are not related to timing
differences (revaluation of assets, FV adjustment in
an acquisition, compound instruments, overseas
operations)

• Temporary differences have deferred tax

consequences:
• depend on whether the temporary differences are
taxable or deductible temporary differences.
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 Deferred Taxes- Permanent Differences
 Permanent differences relate to items incurred by an entity that are not
allowable or deductible for taxation purpose.

 Created when an income item is included in taxable income or accounting

income but will never be included in the computation of the other.

 Permanent differences are not considered when determining both tax

payable currently and the deferred tax effect. Permanent differences have
no deferred tax consequences.

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 Deferred Taxes- Why important?
 The effect of these differences is that amount of a
current income tax payable may bear no similarity to
the current level of statutory income tax rate.

 In absence of appropriate tax effect consideration,

these differences may materially distort the tax
charge in P&L of a reporting entity.

 The differences between tax rules and accounting

rules may give rise to tax effects in one or more
future accounting periods.

 If tax effect accounting had been applied, the

effective tax charge rate = statutory income tax rate.

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 Deferred Taxes Example

 Desa Berhad reported profit before taxation of

RM18,000,000 for the current financial year ended 31
December 2019.

 Depreciation charged for the year amounted to

RM2,000,000.

 For income tax purposes, capital allowances claimed for

the year totaled RM8,000,000.

 The income tax rate was 25%.

Required:
Show the abridged profit or loss of Desa Berhad for the
2019 financial year if:
a) No tax effect accounting is applied &
b) Tax effect accounting is applied 15
 Deferred Taxes Workings

 No tax effect accounting is applied, tax charge in P/L would consist

of only the current income tax payable.

RM’000

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 Deferred Taxes Workings

 With tax effect accounting, an additional tax charge is required on the

difference between the capital allowance claimed and depreciation expense for
the year.
RM’000

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 Deferred Taxes Workings

 P/L of Desa Berhad without & with tax effect accounting:

Without With tax
tax effect effect
RM’000 RM’000

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Applicable Standard and Scope
 An entity is required to apply IAS 12/ MFRS 112 Income Taxes in
accounting for income taxes, which include both
 Current tax and
 Deferred tax

Income Tax
Current income tax Deferred income tax
Substance Payable to tax office Accounting measure

Basis Taxable profit (loss) Temporary differences

Timing Current period Future periods

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 Applicable Standard and Scope
 There are 3 methods that are applicable in accounting for
income taxes:
 Flow through method (not permitted)
 Full provision method
 Partial provision method

 IAS 12/ MFRS 112 requires entity to use the full provision
method.

 In the recognition and measurement of current and deferred

taxation, IAS 12 places more emphasis on the financial
position by focusing on the tax effect of assets and liabilities
that are recognised in the Statement of Financial Position.

 Under the full provision method, deferred taxes are

calculated based on the ‘balance sheet liability’ method.

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Applicable Standard and Scope
 Under the balance sheet liability method, the tax
effects at the end of each accounting period are
derived from temporary differences in the Statement
of Financial Position.

 Deferred tax assets and liabilities in the Statement of

Financial Position are first measured and the
consequential changes in the tax assets and tax
liabilities are accounted for as deferred tax expenses
or deferred tax income in the Profit or Loss.*

 Advantage: There is a match between revenue & tax

expenses.

 Disadvantage: May result in the amount of deferred

taxes to keep growing and possibly never become
payable.
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The Balance Sheet Liability
Method
IFRS/ IAS Tax Law

ASSETS
Carrying Tax
Amount
LIABILITIES Base

Deductible Taxable
Temporary Temporary
Difference Carrying Amount ≠ Tax Base Difference
(DTD) (Temporary Differences) (TTD)
Deferred Tax
Deferred Tax
Asset
Liability
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The Balance Sheet Liability
Method  Derived from temporary differences in the
balance sheet.

 Compare carrying amounts of assets and

liabilities and their corresponding tax bases.

 Carrying amount of an asset or a liability at a

particular point in time is the amount
recognised on the face of the balance sheet.

 Tax base of an asset or a liability is the amount

attributed to that asset or liability for tax
purposes.
 Temporary differences can be categorized into:
 Taxable temporary differences
 Deductible temporary differences
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The Balance Sheet Liability
Method
Item Accounting Standards- Tax rule
IFRS
Many accrued expenses. An expense when Recognised as a tax
(e.g. Warranties, long- accrued. deduction only when
service leave) paid.

Many prepaid expenses. Initially an asset- Typically a tax

(e.g. Prepaid rent, expensed when deduction when paid.
prepaid insurance) economic benefits
used.
Entertainment & goodwill Treated as an Not a tax deduction in
impairment. expense. current or subsequent
periods.
Doubtful debts Treated as a tax deduction
Treated as an expense
when debtor is actually written
when recognised. off in subsequent period.

Development expenditure Often capitalised and Typically a tax deduction

subsequently amortised. when paid for. 24
The Balance Sheet Liability
Method
IFRS/ IAS Tax Law

ASSETS
Carrying Tax
Amount
LIABILITIES Base

Deductible Taxable
Temporary Temporary
Difference Carrying Amount ≠ Tax Base Difference
(DTD) (Temporary Differences) (TTD)
Deferred Tax
Deferred Tax
Asset
Liability
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The Balance Sheet Liability Method-
Taxable Temporary Differences
 Taxable temporary differences are the
differences that cause accounting income >
taxable income.

 Arise in the situations where:

 CA of an asset > Tax Base.
 CA of liability < Tax Base.

 Taxable temporary differences cause a future

taxable amount and create deferred tax
liabilities for taxes to be paid on the future
taxable amounts.

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The Balance Sheet Liability Method-
Taxable Temporary Differences
 Taxable temporary differences give rise to Deferred Tax Liabilities.

 A deferred tax liability shall be recognised for all taxable temporary

differences, except to the extent that the deferred tax liability arises
from:
(a) the initial recognition of goodwill; or
(b) the initial recognition of an asset or a liability in a transaction
which:
i. is not a business combinations; and
ii. at the time of the transaction, affects neither accounting
profit nor taxable profit (tax loss)

 Deferred tax liability arises when a company is able to defer paying

tax on profit.

 Deferred Tax Liability = (CA – Tax Base) x Tax Rate %

Taxable Temporary
Differences
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The Balance Sheet Liability Method-
Taxable Temporary Differences
Depreciation on PPE
 For PPE that qualifies for capital allowances, its tax
base is the amount that will be deductible for tax
purposes against any taxable economic benefits
when it recovers the carrying amount of the asset.
 For qualifying items, if claims of capital allowances
are more than the corresponding depreciation to
date, the carrying amount of the asset will be more
than its tax base.

 Non-qualifying items like land and buildings (which

are not industrial buildings), its tax base is nil, are
items giving rise to permanent difference.

 The cumulative capital allowance > the accumulated

depreciation is equivalent to CA > Tax Base. Gives
rise to deferred tax liability.
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The Balance Sheet Liability Method-
Taxable Temporary Differences Example

 Entity A has a plant which was bought at 2019,

costing RM50,000,000.

 The depreciation rate is 10% per year while the

capital allowances applicable is 20% initial
allowance and 14% annual allowance.

 Assume an income tax rate of 28%.

Required:
Calculate the deferred tax in Year 2019.

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The Balance Sheet Liability Method-
Taxable Temporary Differences
Workings

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The Balance Sheet Liability Method-
Taxable Temporary Differences
Revaluation of PPE
 A surplus arising on revaluation increases the CA of
the asset for which there is no equivalent tax
adjustment.
 Give rise to an additional taxable temporary
difference. A deferred tax liability much be
recognised, regardless of management’s intention.
 As the gain is recognised in OCI, the related
deferred tax is also recognised as an expense in
OCI.*
 Tax will crystallize either through use, or on disposal
of the asset.
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The Balance Sheet Liability Method-
Taxable Temporary Differences
Deferred Expenditure Capitalised as an Asset

 Development expenditure capitalised as an intangible

asset and amortised over its useful life.

 For an asset in which its related costs have been

deducted for tax purposes in a current or prior periods,
the tax base of the asset is nil, as the entity will not be
able to claim a further tax deduction when the CA of the
asset is recovered in the future periods.

 Thus, the entire carrying amount at the reporting date is

the temporary difference that gives rise to a deferred tax
liability.

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The Balance Sheet Liability
Method
IFRS/ IAS Tax Law

ASSETS
Carrying Tax
Amount
LIABILITIES Base

Deductible Taxable
Temporary Temporary
Difference Carrying Amount ≠ Tax Base Difference
(DTD) (Temporary Differences) (TTD)
Deferred Tax
Deferred Tax
Asset
Liability
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The Balance Sheet Liability Method-
Deductible Temporary Differences
 Deductible temporary differences are the
differences that cause accounting income <
taxable income.

 Arise in the situations where:

 CA of an asset < Tax Base.
 CA of liability > Tax Base.

 Deductible temporary differences cause a

future deductible amount and create deferred
tax assets for taxes to be paid on the future
taxable amounts.
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The Balance Sheet Liability Method-
Deductible Temporary Differences
 Deductible temporary differences give rise to Deferred Tax Assets.

 A deferred tax asset shall be recognised 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 utilised, unless the
deferred tax asset arises from the initial recognition of an asset or liability
that:
(a) is not a business combination; and
(b) at the time of the transaction, affects neither accounting profit nor
taxable profit (tax loss).

 Deferred tax assets arise when a company has future tax benefit
originating from the reversal of temporary difference between the financial
statement carrying amount and its tax base.

 Deferred Tax Asset = (Tax Base – CA) x Tax Rate %

Deductible Temporary
Differences 35
The Balance Sheet Liability Method-
Deductible Temporary Differences
Accrued Expenses and Provision
 For a liability in which the related expense has been
recognised earlier, either in a current period or prior
periods, the tax base is its carrying amount, less
any amount that will be deductible for tax purposes
in respect of the liability in future periods.

 Recognised as expenses in accounting based on

the applicable IFRS/ MFRS.

 These are treated as general provisions for tax

purposes and hence not allowed for deductions until
they are paid in a future date. Tax base of nil at
reporting date.

 Carrying amount is the deductible temporary

difference that gives rise to a deferred tax asset.
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The Balance Sheet Liability Method-
Deductible Temporary Differences
Example
 At the end of year 1, a provision for
warranty costs is carried in the Statement
of financial position at RM8,000.

 The tax base of the provision on this date

is zero as tax law allows such costs to be
claimed only when incurred.

 Assume at income tax rate of 28%.

Required:
Calculate the deferred tax.
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The Balance Sheet Liability Method-
Deductible Temporary Differences
Workings

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The Balance Sheet Liability Method- No
Temporary Differences (Permanent
Differences)
 Where no temporary differences exist, CA = Tax Base.

 Arise in the situations where:

 No future taxable amount for an asset (no tax
consequences)
 No future deductible amount for a liability (no tax
consequences)
 Assets are related to income that is not taxable
 Liabilities are related to expenses that is not deductible

 Hence, amount that will be taxable (deductible) when income

is received (payment is made) is the entire balance. Example?

 No deferred tax consequences exist.

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The Balance Sheet Liability Method
Carrying Amount Carrying Amount
> Tax Base < Tax Base

Asset Items Taxable Deductible

Temporary Temporary
Difference Difference
Deferred Tax Deferred Tax
Liabilities Assets
Liability Items Deductible Taxable
Temporary Temporary
Difference Difference
Deferred Tax Deferred Tax
Assets Liabilities
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Measurement Principles
 Deferred tax assets and liabilities shall be measured at
the tax rates that are expected to apply to the period
when the asset is realised or the liability is settled based
on tax rates (and tax laws) that have been enacted or
substantially enacted by the end of the reporting period
[IAS12.47].

 In practice, the measurement is usually based on the

current income tax rate. Thus, if the tax rate changes
over time, there is a need to adjust the deferred taxes
brought forward.

 The measurement 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
[IAS12.51].
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 Measurement of Taxes
 For most resident companies, the current income tax rate is 24% in
year 2024.

 For SMC (paid-up capital of up to RM2.5 million and below), tax rate
of 20% on chargeable income of up to RM500,000. On subsequent
chargeable income, tax rate is 27%.

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Disclosures
 Components of tax
expense/ income.

 Components of
deferred taxes.

 Taxes related to
items recognised in
OCI or charged or
credited directly to
equity.

 Reconciliation of
effective tax rates.

 Other disclosures.

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Disclosures

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Disclosures

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Comprehensive Example on Deferred
Taxes Example
 Kola Bhd commenced operations on 1 Jan 2018. It purchased a machine for
RM20,000.

 The machine is being depreciated on the straight-line basis over 5 years. For income
tax purposes, the machine qualifies for initial and annual allowances of 20% each.

 The company capitalises product development expenditure in accordance with IAS

38/ MFRS 138 Intangible Assets. For income tax purposes, such expenditure is
claimed in the year it is incurred. For the year ended 31 Dec 2018, the amount
capitalised was RM12,000.

 For the year ended 31 Dec 2018, the company made a profit before tax of
RM50,000. This profit was after deducting general allowance for bad debts of
RM5,000 and provision for warranties of RM8,000.

 At year end, the balance in gross trade debtors account was RM30,000. For income
tax purposes, bad debts and warranty costs are claimed when incurred or paid.

 Income tax rate is 28%.

Required:
Compute the amount of deferred tax liability required as at 31 Dec 2018. Also
compute the amount of taxation expense and show the abridged profit or loss for
the year.

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 Carrying Tax Temporary
Workings Amount Base Differences • Kola Bhd commenced operations on 1 Jan
RM RM RM 2018. It purchased a machine for
RM20,000.

• The machine is being depreciated on the

straight-line basis over 5 years. For income
tax purposes, the machine qualifies for
initial and annual allowances of 20% each.

• The company capitalises product

development expenditure in accordance
with IAS 38/ MFRS 138 Intangible Assets.
For income tax purposes, such expenditure
is claimed in the year it is incurred. For the
year ended 31 Dec 2018, the amount
capitalised was RM12,000.

• For the year ended 31 Dec 2018, the

company made a profit before tax of
RM50,000. This profit was after deducting
general allowance for bad debts of
RM5,000 and provision for warranties of
RM8,000.

• At year end, the balance in gross trade

debtors account was RM30,000. For
income tax purposes, bad debts and
warranty costs are claimed when incurred
or paid.

• Income tax rate is 28%.

 Comprehensive Example on Deferred
Taxes Workings

 Current income tax expense is computed as follows:

RM • For the year ended

31 Dec 2018, the
company made a
profit before tax of
RM50,000. This
profit was after
deducting general
allowance for bad
debts of RM5,000
and provision for
warranties of
RM8,000.

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 Comprehensive Example on Deferred
Taxes Workings

 The P&L for the year would be as follows:

RM

Journal Entries?

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