Wednesday 26 December 2012

Simple Explanation on Taxation and Deferred Taxation

Recently, depreciation, capital allowance and deferred taxation have become one of the hottest issues among my investment friends. My friends asked me to blog about it.

Okay, it’s time to utilize my experience of working in audit firm. I think I shall explain what’s that to my investment friend through my blog.

First of all, let me explain what is depreciation.

When a company purchases an asset, such as a machine, it would be recorded as an asset in account and then being depreciated when time passes. There are several method of depreciation such as straight line method, reducing balance and sum of digit. Commonly, straight line method is being used. Straight line method means, the asset will be depreciated equally throughout the useful life. Thus, useful life has to be determined. Useful life will be determined basically base on how long can the equipment being used.

Example: Company XYZ bought twenty computers that cost RM60,000 with estimated useful life of 5 years. By using straight line method, the computer will be depreciated RM 12,000 a year.


Year 1
Year 2
Year 3
Year 4
Revenue
200,000
220,000
250,000
280,000
Cost of sales
100,000
120,000
130,000
135,000
Gross profit
100,000
100,000
120,000
145,000
Marketing expenses
10,000
20,000
25,000
40,000
Depreciation
12,000
12,000
12,000
12,000
Other expenses
13,000
10,000
15,000
17,000
Profit before tax
65,000
58,000
68,000
76,000

After the profit before tax is computed, tax computation is required to compute the taxation.


Year 1
Year 2
Year 3
Year 4
Profit before tax
65,000
58,000
68,000
76,000
Add: non allowable expenses
            - Depreciation
            - Greeting and gift


12,000
2,000


12,000
3,000


12,000
2,000


12,000
3,000
Adjusted income
79,000
73,000
82,000
91,000

In computation of tax, we need to add back all the non-allowable income, such as depreciation to derive to adjusted income. Depreciation is not applicable for deduction for tax. However, there is application of capital allowance for tax. Capital allowance is similar to depreciation. The asset purchased will be deducted portion by portion year after years.

There are two common types of capital allowance, which are initial allowance and annual allowance. Initial allowance are tax deductible for the first year of purchase (20%), while annual allowance is deducted annually until the value is fully claimed. The rate for annual allowance for each type of asset is different.


Year 1
Year 2
Year 3
Year 4
Adjusted income
79,000
73,000
82,000
91,000
Capital allowance
36,000
24,000
-
-
Statutory income
43,000
49,000
82,000
91,000
Tax payable (25%)
10,750
12,250
20,500
22,750
* initial allowance and annual allowance for computer are 20% and 40% respectively

Tax payable is tax that needs to be paid for the year by the company.

However, as there is capital allowance method doesn’t fulfill the concept of matching principle by accounting standard. Deferred tax exists to reconcile the taxation part.


Year 1
Year 2
Year 3
Year 4
Year 5
Net book value
48,000
36,000
24,000
12,000
-
Residual expenditure
24,000
-
-
-
-
Difference
X 25% (tax rate) =
24,000
6,000
36,000
9,000
24,000
6,000
12,000
3,000
-
-
Changes from last year
6,000
3,000
(3,000)
(3,000)
(3,000)
Net book value = Cost of asset – accumulated depreciation
Residual expenditure = Qualified expenditure (value asset that qualified for tax deduction) – accumulated capital allowance

The difference will be the figure appear as balance in statement of financial position (formerly known as balance sheet) while the changes will be appear in income statement.

Thus the final part of income statement and notes to the account will be look like this:-

 Note to the account (to see the real report, you may refer page 77 of Power Root Berhad’s 2012 annual report)


Year 1
Year 2
Year 3
Year 4
Major components of income tax expense :
Current tax expense
Deferred tax (income)/expenses
-          Origination and reversal of temporary difference

10,750

6,000

12,250

3,000

20,500

(3,000)

22,750

(3,000)

16,750
15,250
17,500
19,750


Year 1
Year 2
Year 3
Year 4
Reconciliation of effective tax expense
Profit before tax
Income tax using Malaysian tax rate
Non-deductible expenses


65,000
16,250

500


58,000
14,500

750


68,000
17,000

500


76,000
19,000

750

16,750
15,250
17,500
19,750

Income statement:


Year 1
Year 2
Year 3
Year 4
Profit before tax
65,000
58,000
68,000
76,000
Taxation
16,750
15,250
17,500
19,750
Profit after tax
48,250
42,750
50,500
56,250

10 comments:

  1. the “car” will be depreciated RM 12,000 a year.

    I think "car" need to change to computers。

    ReplyDelete
    Replies
    1. Thank you very much!! Edited.

      Delete
    2. I think readers will be much appreciated if you could mention the initial allowance and annual allowance for computers are 20% & 40% respectively.

      Delete
    3. Thanks for your comment. Thank you, I appreciate. I added it.

      Delete
    4. I hope you don't mind for me to borrow your table.

      Delete
    5. Sure no problem. You can use it.

      Delete
  2. This information is priceless. When can I find out more?


    Feel free to surf to my homepage - way to make money online

    ReplyDelete
  3. Thank a lot for the information.Its help me a lot.

    ReplyDelete