In the last 5 parts, i Capital has looked at [1]. Is Tax a Distribution of Earnings or a Business Expense? [2]. Accounting Profit versus Taxable Profit, Tax Paid versus Tax Expense and [3]. What is Deferred Tax? [4]. Deferred Tax Under International Accounting Standards (IAS) 12 and [5]. IAS 12 (1979) : Timing Difference Method based on [a]. Permanent differences, [b]. Timing differences, [c]. Deferred tax asset and [d]. Deferred tax liability.

[6]. IAS 12 (1996): Temporary Difference Method
In last week’s issue, i Capital looked at “Tax Bases in Temporary Differences Method” under [6]. IAS 12 (1996): Temporary Difference Method. This issue will continue with item [6]. IAS 12 (1996): Temporary Difference Method.

Taxable Temporary Differences & Deductible Temporary Differences
Simply put, Taxable Temporary Differences are temporary differences that give rise to Deferred Tax Liabilities (increase the current tax expense) whereas Deductible Temporary Differences are temporary differences that give rise to Deferred Tax Assets (reduce the current year's tax expense).

Deferred Tax Calculation Based on Timing Differences & Temporary Differences
The example below will show the difference between deferred tax calculation based on the timing difference method (Income Statement Liability method) and temporary difference method (Balance Sheet Liability method).

Company ABC (ABC) started operations in 2004 with a machine worth RM100,000. ABC depreciated the machine at 10% per annum. In 2004, ABC recognized a provision for warranty expense of RM3,000 attributable to a sale. Warranty expenses are only tax-deductible when the actual claim is incurred. In 2005 and 2008, RM1,000 and RM2,000 respectively were claimed for warranties by customers. Assuming that ABC’s taxable income maintains at RM20,000 from 2004 to 2008. Initial and annual allowances for the machine are 20% and the tax rate stays at 28% throughout the years.

[a]. Deferred Tax calculation Based on Timing Differences Method
Table 1 shows the deferred tax calculation worksheet, Table 2 and 3 shows the Deferred Tax Liability and Deferred Tax Asset account in the balance sheet respectively, and Table 4 shows the calculation of the total tax expense incurred by ABC from 2004 to 2008, although the actual deferred tax timing will be until 2014 (due to the 10% depreciation policy).

Table 1: Deferred Tax Calculation (RM)

Table 2: Deferred Tax Liability (DTL) account (RM)

Table 3: Deferred Tax Asset (DTA) account (RM)

Table 4: Calculation of Total Tax Expense (RM)

[b]. Deferred Tax calculation Based on Temporary Differences Method
The carrying amount of the machine is equal to its net book value (cost less accumulated depreciation), for that is the value shown in the balance sheet. As for its tax base, it is represented by its amount allowed for tax deduction (which is known as Qualifying Expenditure and equals to the whole RM100,000 in this instance) less initial and annual allowances claimed. This is based on the definition of a tax base for an asset : The machine is allowed for tax deductible up to RM10,000. As at the balance sheet date, ABC had already claimed RM40,000 worth of capital allowances. Therefore, the company still can claim RM60,000 for tax-deduction in future periods, thus forming the tax base. The calculation of the assets carrying amount and tax base is shown in the following table.

Table 5: Calculation of Tax Base for ABC’s Machine (RM)

As for the provision for warranty expense, the carrying amount in the balance sheet will reduce with the actual claim incurred. Table 6 shows the calculation of tax base for the provision for warranty expense.

Table 6: Calculation of Tax Base for Provision of Warranty Expense (RM)

Table 7 will show the deferred tax calculation based on the temporary differences method.

Table 7: Deferred Tax Calculation (RM)

Unlike the timing difference method, the deferred tax calculated based on the temporary difference method represents the ending balance of the deferred tax as at the balance sheet date. The deferred tax to be charged to the tax expense account in the profit and loss statement is the difference between the ending balance of the deferred tax account and the opening balance of the deferred tax account. Tables 8 and 9 shows the calculation of deferred tax to be charged to the tax expense account.

Table 8: Deferred Tax Liability Calculation (RM)

Table 9: Deferred Tax Asset Calculation (RM)

The DTL and DTA account based on this temporary difference method is exactly the same as the DTL and DTA account using the timing difference method, which are shown in tables 2 and 3. Table 10 shows the calculation of the total tax expense for each respective year. As can be noticed, it is the same as table 4, which calculates the deferred tax using the timing difference method.

Table 10: Calculation of Total Tax Expense (RM)

From the example above, it can be seen that both the timing difference and temporary difference methods show the same result. However, this may not be always true. As stated earlier, the definition of temporary differences cover a wider scope than timing differences. The main difference between these 2 methods is that the timing difference approach calculates the amount of deferred tax to be recognized in the current year and the deferred tax account in the balance sheet is the accumulation deferred tax recognized over the years. On the other hand, the temporary difference method calculates the ending balance of deferred taxes in each year. The amount of deferred tax to be recognized in the profit and loss is the difference between the opening deferred tax and the closing deferred tax amount. This clearly illustrates why the timing difference method is known as the Income Statement Liability method whereas temporary difference method is known as the Balance Sheet Liability method.d