Accounting for

Deferred Taxes
Lecture 5

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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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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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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 immediate preceding
year.

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

 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.
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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
 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

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 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
Profit before taxation
Add:
Less:
Taxable profit
Current income tax

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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

Deferred tax @ 25%

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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

Profit before taxation

Taxation:
Current income tax
Deferred tax

Profit after taxation

Effective tax charge rate

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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 Temporary differences

Taxable profit (loss)

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.
(e.g. Warranties, long- An expense when Recognised as a tax
service leave) accrued. deduction only when
paid.
Many prepaid expenses.
(e.g. Prepaid rent, Initially an asset- Typically a tax
prepaid insurance) expensed when deduction when paid.
economic benefits
used.
Entertainment & goodwill
impairment. Treated as an Not a tax deduction in
expense. current or subsequent
Doubtful debts. periods.
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-
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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 Workings
The Balance Sheet Liability Method-
Taxable Temporary Differences
Entity A has a plant which Plant Cost =
was bought at 2019, costing
RM50,000,000. Depreciation =
C.Allow =
The depreciation rate is 10% =
per year while the capital
allowances applicable is Tax Rate =
20% initial allowance and
14% annual allowance. Carrying Amount Tax Base

Assume an income tax rate

of 28%.

Required:
Calculate the deferred tax in TTD =
Year 2019.
DTL =
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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-
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 33
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. 34
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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 Workings
The Balance Sheet Liability Method-
Deductible Temporary Differences
At the end of year 1, Provision =
a provision for
warranty costs is Tax Base =
carried in the
Statement of financial
position at RM8,000.

The tax base of the

provision on this date Carrying Amount Tax Base
is zero as tax law
allows such costs to
be claimed only when
incurred.
DTD =
Assume at income
tax rate of 28%. DTA =

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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 2020.

 For SMC (paid-up capital of up to RM2.5 million and below), tax rate
of 17% on chargeable income of up to RM500,000. On subsequent
chargeable income, tax rate is 24%.

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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
RM RM RM
Machine
Deferred development
costs

Trade debtors (gross)

Allowance for bad debts
Trade debtors (net)
Provision for warranties

Net temporary
differences
Deferred tax liability
Deferred tax asset
Net deferred tax liability
Less: Opening deferred
tax liability
Deferred tax expense
related to the origination
of temporary differences
 Comprehensive Example on Deferred
Taxes Workings

 Current income tax expense is computed as follows:

RM • For the year ended

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

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 Comprehensive Example on Deferred
Taxes Workings

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

RM
Profit before tax
Less: Taxation expense
Current tax expense
Deferred tax expense

Profit after tax

Journal Entries

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