MICPA EXAMINATION

NOVEMBER 2002

Questions,
Unofficial Suggested
Answers and
Examiners’ Reports

PROFESSIONAL
EXAMINATION II
Module 5

Financial Accounting
& Reporting II

Advanced Taxation

Published by MACPA STUDENTS SOCIETY

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This booklet contains the questions, unofficial suggested answers and examiners’ reports for
MODULE 5 of PROFESSIONAL EXAMINATION II for the NOVEMBER 2002
examination session.

The unofficial suggested answers were prepared by the MACPA Students Society and are not
purported to be the official positions of The Malaysian Institute of Certified Public Accountants
(MICPA).

While every care has been taken to anticipate and satisfy the examiners’ requirements in the
preparation of the suggested answers, these should not be regarded as the only solutions.

Some of the answers set out are considerably more substantial than even the best candidate could
achieve in the time available in and examination. It is felt, however, that longer, more detailed
answers can be great help for study purposes and that shorter answers would not always be as
helpful.

ALL RIGHTS RESERVED : NO PART OF THIS PUBLICATION MAY BE

TRANSMITTED IN ANY FORM OR BY ANY MEANS, ELECTRONIC,
MECHANICAL PHOTOCOPYING, RECORDING OR OTHERWISE,
WITHOUT THE PRIOR PERMISSION OF THE MACPA STUDENTS
SOCIETY.

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 THE MALAYSIAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
(INSTITUT AKAUNTAN AWAM BERTAULIAH MALAYSIA)

NOVEMBER 2002

Professional Examination II - Module 5

FINANCIAL ACCOUNTING & REPORTING II

1. Time allowed: 3 hours

2. This paper consists of FIVE questions totalling 100 marks.

3. Answer ALL questions.

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 FINANCIAL ACCOUNTING & REPORTING II
(Answer ALL Questions)

Question 1

The draft balance sheets of Cee Holdings Bhd (Cee Holdings), Pea Sdn Bhd (Pea) and Air Sdn
Bhd (Air) as at June 30, 2002 are as follows:
Cee Holdings Pea Air
RM’000 RM’000 RM’000

Property, Plant and Equipment 6,000 4,000 14,200

Investments
Pea Sdn Bhd – 6,000,000 ordinary shares 8,000 - -
– 3,000,000 preference shares 3,000 - -
Air Sdn Bhd – 9,000,000 ordinary shares 13,000 - -

Current Assets
Inventories 3,250 3,000 4,200
Receivables 4,500 1,500 2,300
Related companies 5,100 900 3,000
Cash and bank balances 4,500 300 5,200

17,350 5,700 14,700

Current Liabilities
Payables 6,750 9,400 4,500
Related companies 3,000 5,300 900
Taxation 1,000 - 600

10,750 14,700 6,000

Net Current Assets / (Liabilities) 6,600 (9,000) 8,700

---------- ---------- ----------
36,600 (5,000) 22,900
====== ====== ======
Share Capital
Ordinary shares 20,000 10,000 9,000
Preference shares - 6,000 -
----------- ----------- ----------
20,000 16,000 9,000
Share premium - - 4,000
Revaluation surplus - - 2,200
Retained profit / (Accumulated loss) 16,600 (21,000) 7,700
----------- ----------- -----------
36,600 (5,000) 22,900
====== ====== ======

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The summarised income statements of the companies for the year ended June 30, 2002 are as
follows:
Cee Holdings Pea Air
RM’000 RM’000 RM’000
Sales 23,000 5,000 12,000
Cost of sales (15,000) (4,500) (2,000)
---------- ---------- ----------
Gross profit 8,000 500 10,000
Dividend income (gross) 900 - -
Operating and other expenditure (3,500) (17,000) (4,800)
Finance cost - (500) -
---------- ------------ ---------
5,400 (17,000) 5,200
Taxation (800) - (1,400)
---------- ----------- ---------
4,600 (17,000) 3,800
Dividend - - (648)
---------- ----------- ---------
4,600 (17,000) 3,152
Retained profit / (accumulated loss) b/f 12,000 (4,000) 4,548
---------- ---------- ---------
Retained profit / (accumulated loss) c/f 16,600 (21,000) 7,700
====== ====== =====

Other relevant information:

(1) Details of investments acquired were as follows:

Date of acquisition Net Assets

RM’000
Pea Sdn Bhd July 1, 2001 12,000
Air Sdn Bhd July 1, 2000 5,000

(2) Cee Holdings’ remittance of RM300,000 to Pea on June 30, 2002 was received by Pea on
July 2, 2002.

(3) Air purchased property with net book value of RM5 million from Cee Holdings on July 1,
2001 at a consideration of RM8 million, which was satisfied by the issue of 4 million
ordinary shares of RM1.00 each at RM2.00 per share in Air.

The property with estimated useful life of 40 years at July 1, 2001 was valued at RM10
million on June 30, 2002 and the revaluation surplus was recorded in Air’s books. Ignore tax
effects.

(4) Pea’s finance cost is in respect of the amount due to Cee Holdings. No interest income has
been recorded by Cee Holdings.

(5) Goodwill is amortised over a period of 20 years.

Required:

Prepare the consolidated balance sheet of Cee Holdings Bhd as at June 30, 2002 and the income
statement for the year ended June 30, 2002.
(20 marks)

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Question 2

(a) Under MASB 28: Discontinuing Operations, the initial disclosure event is the occurrence
of one of two events whichever occurs earlier.

Required:

(i) Describe each of these TWO events.

(2 marks)

(ii) The initial disclosure information that an enterprise should include relating to a
discontinuing operation in its financial statements in which the initial event occurs
is prescribed in the Standard.

Describe the minimum disclosure requirements.

(4 marks)

(b) The bookkeeper of Bina Bandar Sdn Bhd, a property developer, has asked you to advise
on how the following items should be dealt with in finalising the accounts for the
financial year just ended:

(1) The company is required to provide a reservoir and a community hall at its own
cost for its housing project, which is to be developed over five phases. The
reservoir and community hall are estimated to cost a total of about RM15 million.
The company intends to commence construction on these two items under Phase
3. As at the end of the financial year, only Phase 1 of the housing project is being
developed and no contracts have been awarded for these two items.

(2) Just before the financial year end, the company contracted to buy a crane for
RM1.2 million, which will be used for construction. Delivery is expected to be in
3 months’ time.

(3) As a result of the repatriation of foreign construction workers, construction of the

houses sold under Phase I has fallen behind schedule and it is likely that
compensation for late delivery will be incurred. The houses are contractually due
for handing over to purchasers in 6 months’ time.

Required:

Advise Bina Bander Sdn Bhd on how the above items should be dealt with under
MASB 20, Provisions, Contingent Liabilities and Contingent Assets. Support your
answer with reasons.
(7 marks)

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(c) The time table for the completion of the financial statements of Curious Bhd for the year
to December 31, 2001 was as follows:

Completion of audit March 28, 2002

Approval of the issue of the financial statements

by board of directors April 22, 2002

Announcement of results April 23, 2002

Audited financial statements sent to shareholders June 3, 2002

Financial statement adopted by the shareholders

at annual general meeting June 18, 2002

Filing with authorities June 21, 2002

Required:

Discuss the recognition and measurement of the impact of the following events in the
financial statements of Curious Bhd for the year ended December 31, 2001 in accordance
with MASB 19, Events After The Balance Sheet Date.

(i) On April 2, 2002, property with a net book value of RM30 million was revalued
at RM10 million when it was discovered that chemical waste from a nearby
factory has polluted the land and affected the foundation of the building.

(ii) The market value of quoted investments declined by RM10 million at March 30,
2002 and by another RM15 million at May 31, 2002.

(iii) The company provided an amount of RM25 million in the financial statements for
the year ended December 31, 2001 for compensation payable to a customer under
some warranty arrangements pending a court hearing. On April 18, 2002, the
court ruled in favour of the customer and ordered the company to pay RM29
million. The company intends to appeal against the judgement.

(7 marks)
(Total: 20 marks)

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Question 3

On January 1, 2002, Alpha Bhd issued 20 million bonds with 5 million detachable warrants for
total proceeds of RM20 million. Further details of the issue are as follows:

(1) The issue price of the bonds is at its nominal value of RM1.00 each and is to be redeemed
at its nominal value on maturity date, which is December 31, 2006.

(2) Interest on the bonds is payable annually in arrears, at a nominal rate of 3% per annum.

(3) The detachable warrants entitle a holder to subscribe for new shares of RM1.00 each in
Alpha Bhd, on the basis of one warrant for one new share, at an exercise price of RM4.00
per share at any time during the five-year option period, which will expire on December
31, 2006.

(4) Warrant holders may either pay for the exercise price in cash or tender bonds as part or
full consideration towards the exercise price. Bonds so tendered shall be given credit
towards the exercise price at its nominal value and be subsequently retired.

(5) The warrants were traded at a price of 25 sen on listing. A price of RM0.90 per bond
would give the same market yield to maturity as bonds issued by other companies in the
same industry and with the same credit rating as Alpha Bhd.

Required:

(a) Compute the respective carrying values at which the bonds and the detachable warrants
ought to be taken up in the books of Alpha Bhd as at January 1, 2002 using:

(i) the residual valuation of equity component method, and

(ii) the relative market value approach method

(4 marks)

(b) Using the values you have worked out above by applying the residual valuation of equity
component method, show the journal entries required in the books of Alpha Bhd for the
bond issue with detachable warrants:

(i) as at January 1, 2002, the date of issue.;

(ii) for the interest expense for the first year;
(iii) as at January 1, 2003, assuming 500,000 warrants are exercised on this date by the
tender of bonds of nominal value RM2 million as consideration for the exercise
price;
(iv) as at December 31, 2006, assuming that another 4,200,000 warrants are exercised
on this date with the exercise price wholly paid by cash. The balance of 300,000
warrants not exercised, lapses on this date.

(13 marks)

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(c) Assuming that the aforesaid bonds with detachable warrants issue was fully underwritten
by a bank which took up the entire issue as the primary subscriber for RM20 million; the
bank sold off the 5 million warrants shortly after for RM2.5 million but held on to the
bond to maturity for the interest income.

Show the journal entries required in the books of the bank to reflect :

(i) the bond with detachable warrant investment;

(ii) the yearly bond interest income; and
(iii) the warrant sales.

(5 marks)
(Total: 22 marks)

Question 4

(a) Abe Berhad (Abe) is a company principally engaged in the hotel business. Abe has up to
June 30, 2001 adopted the following policy for its hotel properties:

“Hotel properties, which comprise freehold and leasehold land and the buildings thereon,
are stated at cost which include properties with unexpired lease periods of 50 years or
more. All hotel properties are appraised by independent valuers at least once in every
three years on the existing use basis and any reduction in the value of hotel properties
below their original cost is recognised in the income statement.”

The directors, having considered all the factors affecting the industry they operate in,
have now, in 2002 decided to adopt an accounting policy to state their hotel properties at
cost less accumulated depreciation and impairment losses. The relevant depreciation
policy proposed is as follows:

“Freehold land is not subject to depreciation. Leasehold land is depreciated over its lease
period of 60 years and buildings at 2% per annum on a straight-line basis. A full year’s
depreciation is charged in the year of acquisition.”

The directors have provided you with the following additional information.

(1) Information on depreciation

Amount
Year of Acquisition Description RM’000
2002 Buildings 150,000
Freehold land 30,000
2000 Buildings 130,000
Leasehold land 60,000
1998 Buildings 50,000
Leasehold land 6,000

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 (2) During the financial year ended June 30, 2001, Abe wrote down its hotel
properties acquired in 1998 to their revalued amount as follows:

RM’000
Buildings 20,000
Leasehold land 3,000
----------
23,000
---------

Abe’s accounting records for the year ended June 30, 2002 show a profit before taxation
of RM33,290,000 and taxation expense of RM9,038,000 (before adjustment for
depreciation). For the year ended June 30, 2001, Abe reported the following:

RM’000
Profit before taxation 20,947
Taxation (4,185)
----------
Profit after taxation 16,762
---------

As at July 1, 2000, retained earnings amounted to RM10,000,000 and the issued and paid
up capital was RM50,000,000.

Required:

(i) Prepare the statement of changes in equity incorporating the adjustments arising
from the change in accounting policy as required by MASB 3, Net Profit or Loss
for the Period, Fundamental Errors and Changes in Accounting Policies.

(12 marks)

(ii) Draft an appropriate accounting policy note for inclusion in the published
financial statements.
(4 marks)

(b) Abro Sdn Bhd (Abro) is a company trading in computers. In 2002, Abro discovered that
sales of goods amounting to RM5,000,000 for the year ended June 30, 2001 by the
Penang branch to customers in Thailand were inevitably omitted from the sales due to a
breakdown in the accounting systems. Abro generally derives a gross profit margin of
30% on selling price.

The Penang branch has recognised the above sales in the year ended June 30, 2002
instead.

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 For the year ended June 30, 2002, Abro’s accounting records show a profit before
taxation of RM3,000,000 and a tax expense of RM840,000. In the year ended June 30,
2001, Abro reported the following:

RM’000
Profit before taxation 300
Taxation (84)
-------
Profit after taxation 216
------

Required:

Prepare appropriate journal entries to correct the above (effective tax rate is 28%) for the
year ended June 30, 2002 and explain, with reasons, how the above should be treated by
Abro in the context of MASB 3.
(4 marks)
(Total: 20 marks)

Question 5

(a) MASB 25, which prescribes the accounting treatment for income taxes, defines
temporary differences as the differences between the carrying amount of an asset or
liability in the balance sheet and its tax bases.

Required:

What are the TWO types of temporary differences and what is the definition of tax base?

(4 marks)

(b) A qualifying asset with a cost of RM130,000 and a carrying amount of RM88,000 is
revalued to RM162,000. No equivalent adjustment is made for tax purposes and the
cumulative capital allowance is RM42,000. The company is subject to tax at 28%.

Required:

(i) Calculate the deferred tax liability of the company.

(3 marks)

(ii) How should the additional deferred tax arising from revaluation be dealt with?

(2 marks)

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(c) The following items relate to the financial statements of Cemplita Sdn Bhd (Cemplita)
for the financial years ended December 31, 2000 and 2001:

(1) Cemplita capitalises product development expenditure and amortises them over
their expected useful lives. As at December 31, 2000 and 2001, the deferred
expenditure reflected in the financial statements was RM42,000 and RM56,000
respectively.

(2) Details of the fixed assets are as follows:

31.12.2000 31.12.2001
RM’000 RM’000
Net book value of fixed assets 742 976
Residual expenditure of qualifying fixed assets 288 320
Net book value of land and building
included in fixed assets 168 272

The building does not qualify for industrial building allowance.

(3) The company guarantees its products and therefore maintains a warranty
provision in its financial statements. The balances in the warranty provision as at
December 31, 2000 and 2001 were RM15,000 and RM22,000 respectively.

Warranty costs are deductible for income tax purposes when paid.

(4) Other details include:

31.12.2000 31.12.2001
RM RM

Accrued interest expense 17,800 24,600

Accrued interest income 84,000 62,000
Donations 10,000 20,000
Retirement benefits paid 36,000 -

Required:

Compute the deferred tax liability for both years and the tax expense for 2001.

Assume that the company’s tax rate is at 28%.

(9 marks)
(Total: 18 marks)

12
 NOVEMBER 2002 EXAMINATION
SUGGESTED ANSWERS

FINANCIAL ACCOUNTING & REPORTING II

Question 1

CEE HOLDINGS BHD

CONSOLIDATED BALANCE SHEET AS AT JUNE 30, 2002
RM’000
Non-current assets
Property, plant and equipment
[6,000 + 4,000 + 14,200 – (URP3,000 + Depreciation 75)(W5)
+ Revaluation adj 2,925 (W3)] 24,200

Goodwill 4,180
---------
28,380

Current assets
Inventories (3,250 + 3,000 + 4,200) 10,450
Receivables (4,500 + 1,500 + 2,300) 8,300
Cash and bank balances [4,500 + 300 + 5,200 + Transit 300] (W6) 10,300
--------------
29,050
Current liabilities
Payables (6,750 + 9,400 + 4,500) 20,650
Taxation (1,000 + 0 + 600) 1,600
--------------
22,250

Net current assets 6,800

--------------
35,180
========
Share capital
Ordinary shares 20,000
Revaluation reserve [2,200 (W4) + 2,925 (W3)] 5,125
Retained profits (W5) 10,055
----------
35,180
Minority interests (W2) -
----------
35,180
======

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CONSOLIDATED INCOME STATEMENT FOR THE YEAR ENDED JUNE 30, 2002

RM’000
Sales (23,000 + 5,000 + 12,000) 40,000
Cost of sales (15,000 + 4,500 + 2,000) (21,500)
-----------
Gross profit 18,500
Operating and other expenditure
(3,500 + 17,000 + 4,800 + URP 3,000 – Depreciation 75 + GW 220) (28,445)

-----------
Loss before tax 9,945
Taxation (800 + 0 + 1,400 – 28% x 900) (1,948)
-----------
Loss after tax 11,893
Minority interests (W7) 5,400
---------
Loss for the year 6,493
=====

Workings:

1. Group structure
Cee Holdings

Pea Air
1/7/01 Ord. shares 6,000/10,000 = 60% 1/7/00 5,000 = 100%
Pref. shares 3,000/6,000 = 50% 1/7/01 4,000
--------
9,000 = 100%

2. Analysis of equity of Pea/Goodwill

Pre-acqn Post-acqn MI
RM’000 RM’000 RM’000 RM’000
Share capital
Ordinary shares 10,000 6,000 4,000
Pref shares 6,000 3,000 3,000

Retained profits
At acquisition (4,000) (2,400)
Since acquisition (17,000) (10,200)
At balance sheet date (21,000) (8,400)
----------- ---------- ---------- ----------
(5,000) 6,600 (10,200) (1,400)
======
Excess loss absorbed by Cee Holdings (1,400) 1,400
----------- ---------
11,600 NIL
====== =====
Cost of investment 11,000
---------
Goodwill 4,400
Amortisation (1/20) (220)
14
 ----------
4,180
======
Note: in view of the increasing losses, Cee Holdings should carry out an impairment
review of Pea and determine Pea’s recoverable amount. This may result in a recognition of
an impairment loss against the goodwill.

3. Revaluation of property
Air Group Adjustment
RM’000 RM’000 RM’000
1/7/01 Carrying amount 8,000 5,000
Amortisation (1/40) (200) (125)
--------- ----------
7,800 4,875
30/6/02 Revalued amount 10,000 10,000
---------- ----------
Surplus 2,200 5,125 2,925
====== ====== =====

4. Analysis of equity of Air/Goodwill

Pre-acquisition Post-acquisition
1/7/00 1/7/01 Rev. R Ret profits
RM’000 RM’000 RM’000 RM’000 RM’000
Share capital 9,000 5,000 4,000
Share premium 4,000 - 4,000
Rev. reserve 2,200 2,200
Retained profits 7,700 7,700
-------- --------- -------- --------- --------
5,000 8,000 2,200 7,700
===== =====
Cost of investment 5,000 8,000
-------- --------
Goodwill NIL NIL
===== ====

5. Consolidated retained profits

RM’000
Cee Holdings (16,600 + Interest 500) 17,100
Pea (W2) (11,600)
Air (W4) 7,700
Goodwill amortisation (220)
Unrealised profit on property (3,000)
Depreciation adjustment (3,000/40) 75

------------
10,055
=======
Check:
Balance brought forward
Cee Holdings 12,000
Pea NIL
Air 4,548

-----------
16,548
Loss for the year (6,493)
15
-----------
10,055
======

16
6. Intra-group balances
RM’000
Debtor balances
Cee Holdings 5,100
Interest receivable 500
--------
Adjusted balance 5,600
Pea 900
Air 3,000
--------
9,500
--------
Creditor balances
Cee Holdings 3,000
Pea 5,300
Air 900
--------
9,200
--------
Cash in transit 300
====

7. Minority interests
RM’000
Share of loss after tax (40% x 17,000) 6,800
Excess absorbed by group (W2) (1,400)
----------
5,400
======

Question 2

(a) (i) The two events are :

 the enterprise has entered into a binding sale agreement for substantially all of
the assets attributable to the discontinuing operation
 the enterprise’s board of directors has both approved a detailed, formal plan for
the discontinuance and made an announcement of the plan.

(ii) The minimum disclosure requirements include :

(a) a description of the discontinuing operation;
(b) the business or geographical segment(s) in which it is reported in accordance
with MASB 22, Segment Reporting;
(c) the date and nature of the initial disclosure event;
(d) the date or period in which the discontinuance is expected to be completed if
known or determinable;
(e) the carrying amounts, as of the balance sheet date, of the total assets and the
total liabilities to be disposed of;
(f) the amounts of revenue, expenses, and pre-tax profit or loss from ordinary
activities attributable to the discontinuing operation during the current financial

17
 reporting period, and the income tax expense relating thereto as required by
MASB 25, Income Taxes; and
(g) the amounts of net cash flows attributable to the operating, investing, and
financing activities of the discontinuing operation during the current financial
reporting period.
(b) (1) It has been assumed that one of the terms for obtaining approval for the housing project
is that the company is required to provide a reservoir and a community hall at its own
expense. The company should provide for the cost of building the reservoir and
community hall since
(a) it has a present legal obligation as a result of a past event: the commencement of
Phase 1 of the housing project is the obligating event;
(b) it is probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; and
(c) a reliable estimate can be made of the amount of the obligation.

A provision is required notwithstanding the fact that contracts have not yet been
awarded for these two items. As these items will benefit the entire housing project, a
fair and appropriate basis would be to provide for their cost and allocate that cost over
the 5 phases, for example in proportion to projected sales revenue.

(2) The contract to buy a crane which is expected to be delivered in 3 months time is an
executory contract under which neither party has performed any of its obligations. The
company’s obligation to pay for the crane only arises when it has been delivered. No
provision should be made for the cost of the crane, instead it should be disclosed as a
capital commitment.

(3) The obligation to pay late delivery charges only arises when the houses are
contractually due for handing over to purchasers. Since the company still has 6 months
before due date, no provision should be made for the estimated late delivery charges.

However, if the total contract costs, including the late delivery charges expected to be
more than total contract revenue, the foreseeable loss should be immediately provided
for in accordance with MAS 7, Accounting for Property Development.

(c) (i) Decline in value of property

The following should be considered :
 Did the decline in property value take place prior to the balance sheet date? Based
on the information given, it is more likely that the damage to the land and
foundation of the building from chemical waste did not occur overnight but is a
process that has taken place over an extended period of time. It this were the case,
then the decline in value should be charged to the income statement (subject to a
charge against any existing revaluation reserve on the same asset).

 Is there sufficient evidence to indicate that the decline in value only arose after
balance sheet date? If this were the case, then no adjustment is necessary.
Disclosure of the decline in value would only be necessary if non-disclosure
would affect the ability of the users of financial statements to make proper
evaluations and decisions.

(ii) Decline in value of investments

18
 The decline in the market value of investments does not relate to the condition of the
investments at balance sheet date but rather to circumstances that have arisen after
balance sheet date. Thus, the company should make no adjustment for the decline in
value. Again as in (i) above, the company should consider disclosure.

(iii) Litigation
The company confirms that it has a present obligation for the compensation under a
warranty arrangement by making a provision of RM25 million at balance sheet date.
The resolution of a court case after the balance sheet date and before the date the
financial statements are authorised for issue provides further evidence of a condition
existing at balance sheet date. The company should adjust the provision already made
by increasing it to RM29 million.

Question 3

(a) (i) Residual valuation of equity component method

Under this method, the fair value of the liability component should be first established
and the residual value is then ascribed to the equity component. The question does not
provide sufficient information to independently compute the fair value of the bond.
However, it states that a price of RM0.90 would give the same market yield to maturity
as bonds issued by other companies in the same industry and with same credit rating as
the company. Thus, RM0.90 should be taken as the fair value per RM1.00 nominal
value of the bond at the date of issue.

RM
Total proceeds 20,000,000
Fair value of bond
20 million at RM0.90 18,000,000
---------------
Residual value attributable to the
5,000,000 warrants 2,000,000
=========
(ii) Relative market value approach
RM
Market value of
Bonds (per above) 18,000,000
Warrants (5 million at RM0.25) 1,250,000
--------------
19,250,000
Deficit 750,000
--------------
Total proceeds 20,000,000
========

The deficit should be proportionately allocated, as follows:

Bond = 18,000,000 + 18,000,000 x 750,000 = 701,299

19,250,000

= RM18,701,299

19
 Warrants = 1,250,000 + 1,250,000 x 750,000 = 48,701
19,250,00

= RM1,298,701

(b) Journal entries

RM RM
(i) Date of issue – Jan 1, 2002
DEBIT Bank account 20,000,000
Discount on bond account 2,000,000
CREDIT Bond account 20,000,000
Capital reserve 2,000,000

To record issue of RM20 million bond with detachable warrants and to allocate proceeds
between liability and equity components using the residual valuation of equity
component method.

DEBIT Capital reserve 560,000

CREDIT Deferred tax account 560,000

To record the deferred tax effect on the resulting taxable temporary difference caused by
the equity component.

(ii) Interest expense for the first year

DEBIT Interest expense 1,000,000
CREDIT Bank account 600,000
Discount on bond account 400,000

To recognise interest expense for 2002 comprising cash interest paid of RM600,000
(RM20 million x 3%) plus amortisation of bond discount (using straight-line over 5
years)

DEBIT Deferred tax account 112,000

CREDIT Deferred tax expense 112,000

To recognise reversed of the deferred tax liability

(iii) Jan 1, 2003, on exercise of 500,000 warrants

DEBIT Bond account 2,000,000
Capital reserve (W1) 144,000
CREDIT Share capital account 500,000
Share premium account 1,484,000
Discount on bond account (W2) 160,000

To record issue of share at RM4.00 each on exercise of 500,000 warrants and retirement
of 2,000,000 bonds tendered in satisfaction of exercise price

W1 500,000 x (2,000,000 – 560,000 = 1,440,000) = 144,000

5,000,000
W2 2,000,000 x (2,000,000 – 400,000 = 1,600,000) = 160,000
20,000,000
20
 (iv) Dec 31,2006
DEBIT Bank account 16,800,000
Capital reserve (W3) 1,209,600
CREDIT Share capital 4,200,000
Share premium 13,809,600

To record issue of shares at RM4.00 each on exercise of 4.2 million warrants and
receipt of cash tendered in satisfaction of exercise price.

W3 4,200,000 x 1,440,000 = 1,209,600

5,000,000

DEBIT Bonds account 18,000,000

CREDIT Bank account 18,000,000

To record redemption of outstanding bonds on maturity date

DEBIT Capital reserve 86,400

CREDIT Retained profits 86,400

To transfer balance of capital reserve as remaining warrants have lapsed.

(c) Bank’s journal entries

RM RM
(i) Investments taken up
DEBIT Investment in bond account 18,000,000
Investment in warrants account 2,000,000
CREDIT Bank account 20,000,000

To take up investment in Alpha Bhd’s bond with detachable warrant

(ii) Yearly interest income

DEBIT Bank account 600,000
Investment in bond account 400,000
CREDIT Interest income 1,000,000

To take up the year’s annual bond interest income received plus accretion of bond
discount on straight-line basis over 5 years.

(iii) Warrant sales

DEBIT Bank account 2,500,000
CREDIT Investments in warrants account 2,000,000
Gain on sale of warrants 500,000

21
Question 4

(a) (i) ABE BERHAD

STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED JUNE 30, 2002
Share Retained
Capital Earnings Total
RM’000 RM'000 RM’000
As at June 30, 2000
As previously reported 50,000 10,000 60,000
Prior year adjustment* - (4,968) (4,968)
--------- ---------- -----------
As restated 50,000 5,032 55,032

Net profit for the year - 16,546 16,546

--------- ----------
----------
As at June 30, 2001 50,000 21,578 71,578
===== ====== ======

As at June 30, 2001

As previously reported 50,000 26,762 76,762
Prior year adjustment ** - (5,184) (5,184)
--------- ----------- -----------
As restated 50,000 21,578 71,578

Net profit for the year - 18,708 18,708

--------- ---------- ---------

As at June 30, 2002 50,000 40,286 90,286
===== ====== =====

(ii) Change in Accounting Policy

In prior years, hotel properties, which comprise freehold and leasehold land and the
buildings thereon, were stated at cost which includes properties with unexpired lease
periods of 50 years or more. All hotel properties were appraised by independent valuers
at least once in every three years on the existing use basis and any reduction in the
value of hotel properties below their original cost was recognised in the income
statement.

The directors, having considered all the factors affecting the industry they operate in,
have now, in 2002, decided to state hotel properties at cost less accumulated
depreciation and accumulated impairment losses. Freehold land is not depreciated.
Leasehold land is depreciated over its lease period of 60 years and buildings are
depreciated at 2% per annum on a straight line basis.

This change in accounting policy has been accounted for retrospectively. The
comparative statements for 2001 have been restated to conform to the changed policy.
The effect of the change is an increase in depreciation expense of RM7,700,000 in 2002
and RM300,000 in 2001. Opening retained earnings for 2001 have been reduced by
RM6,900,000 which is the amount of the adjustment relating to periods prior to 2001.

* (Net of income tax of RM1,932,000)

** (Net of income tax of RM2,016,000)
22
23
Workings:
1. Calculation of accumulated depreciation and impairment losses
1998 2000 2002
LL Bldgs LL Bldgs LL Bldgs Amortisation

RM’000 RM’000 RM’000 RM’000 RM’000 RM’000 RM’000

Acquisition 6,000 50,000
Amortisation (100) (1,000) 1,100
--------- ----------
31/12/98 5,900 49,000
Amortisation (100) (1,000) 1,100
--------- ----------
31/12/99 5,800 48,000
Acquisition 60,000 13,000
Amortisation (100) (1,000) (1,000) (2,600) 4,700
--------- ---------- ---------- -----------
31/12/00 5,700 47,000 59,000 127,400 6,900
====
Amortisation (100) (1,000) (1,000) (2,600) 4,700
--------- --------- ---------- -----------
5,600 46,000 58,000 124,800
Impairment 2,600 26,000 - - 28,600
--------- ---------- ---------- -----------
31/12/01 3,000 20,000 58,000 124,800 33,300
=====
Acquisition 30,000 150,000
Amortisation (100) (1,000) (1,000) (2,600) - (3,000) 7,700
--------- ---------- ---------- ----------- --------- ----------- =====

31/12/02 2,944 19,565 57,000 122,200 30,000 147,000

===== ====== ====== ====== ===== =======

2. Effect of change in accounting policy

Impairment loss recognized prior to 2001:

LL Bldgs Total
RM’000 RM’000 RM’000
Cost 6,000 50,000 56,000
Impairment (3,000) (30,000) (33,000)
----------- ---------- ------------
6,000 20,000 23,000
======= ====== =======

Year ended June 30, 2001

RM’000
Prior year adjustment 6,900
Less : Tax at 28% (1,932)
----------
4,968
======

24
 RM’000 RM’000 RM’000

Before After
adjustment Adjustment adjustment
Profit before tax 20,947 # (300) 20,647
Taxation (4,185) 84 (4,101)
---------- ----------- -----------
Profit after tax 16,762 (216) 16,546
====== ====== ======

# Adjustment
Depreciation (4,700)
Impairment (28,600)
Add back
Impairment recognized prior to 2001 33,000
-----------
(300)
======

Year ended June 30, 2002

RM’000 RM’000 RM’000

Prior year adjustment (6,900 + 300) 7,200

Less: Tax at 28% (2,016)
-----------
5,184
======

Before After
adjustment Adjustment adjustment
Profit before tax 33,290 (7,700) 25,590
Taxation (9,038) 2,156 (6,882)
----------- --------- -----------
Profit after tax 24,252 (5,544) 18,708
====== ===== ======

(b) RM,000 RM’000

DEBIT Sales 5,000
CREDIT Cost of sales 3,500
Taxation expense 420
Retained earnings 1,080

To correct the error arising from the omission of sales in 2001 which was wrongly taken
up in 2002.

The adjustment to rectify the omission of sales in 2001 has been regarded as a correction
of a fundamental error. Fundamental errors are errors discovered in the current period
that are of such significance that the financial statements of one or more prior periods can
no longer be considered to have been reliable at the date of their issue.
25
 The adjustment to profit before tax, taxation expense and profit after tax is 500% more
than the results which were previously reported.

The amount of the fundamental error, i.e. RM1,080,000 should be reported by adjusting
the opening balance of retained earnings. Comparative information should be restated.

Question 5

(a) The two types of temporary differences are:

(1) taxable temporary differences, which are temporary differences that will result in
taxable amounts in determining taxable profit (tax loss) of future periods when the
carrying amount of the asset or liability is recovered or settled; or
(2) deductible temporary differences, which are temporary differences that will result
in amounts that are deductible in determining taxable profit (tax loss) of future
periods when the carrying amount of the asset or liability is recovered or settled.

The tax base of an asset or liability is the amount attributed to that asset or liability for tax
purposes.

(b) (i) Deferred tax liability

Carrying Tax Temporary
amount base difference
RM RM RM
Cost of asset 130,000 130,000
Depreciation/capital allowances 42,000 42,000
---------- ----------
88,000 88,000
Revaluation surplus 74,000 -
---------- ---------
Revaluation surplus 162,000 88,000 74,000
====== ===== =====

The amount of deferred tax liability will depend on the manner in which the company
expects, at the balance sheet date, to recover the carrying amount of the asset.

If the company expects to recover the carrying amount by using the asset, the deferred tax
liability is RM20,720 (74,000 x 28%).

However, if the company expects to recover the carrying amount by selling the asset
immediately for RM162,000, the deferred tax liability is computed as follows

Taxable Deferred
temporary Tax tax
difference rate liability
RM RM
Cumulative capital allowance 42,000 28% 11,760
Proceeds in excess of cost 32,000 0% -
--------- ---------
Total 74,000 11,760
26
 ===== =====

(ii) The additional deferred tax liability arising from the revaluation should be charged
directly to equity, i.e. the revaluation surplus.

(c) Deferred tax liability

December 31, 2000 RM106,176
December 31, 2001 RM127,512

Deferred tax expense for 2001 RM21,336

Workings:
2000 2001
RM RM
Temporary Differences
Taxable temporary differences
Product development expenditure 42,000 56,000
Fixed assets
Carrying amount 742,000 976,000
Land and building (168,000) (272,000)
---------------- ----------------
574,000 704,000
Tax base (288,000) (320,000)

286,000 384,000
Interest income 84,000 62,000
------------ ------------
412,000 502,000
------------ ------------
Deductible temporary differences
Warranty provision 15,000 22,000
Accrued interest expense 17,800 24,600
----------- ----------
32,800 46,600
====== ======

Deferred tax liability

(412,000/502,000 x 28%) 115,360 140,560
Deferred tax asset
(32,800/46,600 x 28%) (9,184) (13,048)
------------ ------------
106,176 127,512
======= =======

27
 THE MALAYSIAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
(INSTITUT AKAUNTAN AWAM BERTAULIAH MALAYSIA)

EXAMINERS’ REPORT
NOVEMBER 2002 EXAMINATION

FINANCIAL ACCOUNTING & REPORTING II

Question 1

Subject matters examined: Preparation of consolidated financial statements.

This is a relatively straightforward question on consolidated financial statements. However, the

overall performance of candidates was unsatisfactory, reflecting a lack of preparation and practice.

The following common weaknesses were observed from candidates’ answers:

(i) Minority interest adjustments were not shown clearly.

(ii) Majority of the candidates did not disclose the elimination of inter-company balance
(RM8,700,000) in the related companies’ accounts.

(iii) Workings were not shown clearly.

Question 2

Subject matters examined: MASB 28 – Discontinuing operations; MASB 20 – Provisions, contingent

liabilities and contingent assets; MASB 19 – Events after the balance sheet date.

Part (a) : This is a theoretical question on discontinuing operations, which was quite well
answered by most candidates.

Part (b) : Candidates were unable to differentiate between provision, disclosure and recognition.
In addition, they were ignorant of what is an obligation.

Part (c) : Candidates were unable to determine whether the post balance events given in the
question required adjustments to the financial statements.

Question 3

Subject matters examined: MASB 25, Financial instruments, specifically on bonds with detachable
warrants.

This question tests candidates on the computation of the carrying value of bonds with detachable
warrants and the related journal entries. Most of the candidates did not even attempt this question.
For those who did, they displayed poor knowledge of the topic. It was apparent candidates were not
prepared for the topic.

28
Question 4

Subject matters examined: MASB 3 – Net profit or loss for the period, fundamental errors and
changes in accounting policies.

Candidates displayed poor understanding of MASB 3. The following weaknesses were observed
from candidates’ answers:

(i) unsure of how prior year adjustments were to be disclosed;

(ii) unable to draft appropriate policy note;

(iii) incorrect treatment of impairment loss – some candidates wrongly set off against cost and in
certain cases, it was even treated as a revenue;

(iv) unable to explain why and how fundamental errors are to be treated;

(v) unable to treat the imputed taxation adjustments as a result of the depreciation charge;

(vi) misunderstanding of the treatment of leasehold property in the previous policy.

(vii) failure to approach the question in a systematic manner;

Question 5

Subject matters examined: MASB 25 - Income taxes.

Candidates demonstrated the following weaknesses:

(i) inability to explain the different types of temporary differences and tax base.

(ii) lack of understanding of the computation of deferred tax liability.

29
 THE MALAYSIAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
(INSTITUT AKAUNTAN AWAM BERTAULIAH MALAYSIA)

NOVEMBER 2002

Professional Examination II - Module 5

ADVANCED TAXATION

1. Time allowed: 3 hours

2. This paper consists of SIX questions totalling 100 marks.

3. Answer ALL questions.

4. Any reference to "the Act" means the Income Tax Act, 1967 (as amended).

5. Workings are to be submitted.

30
 ADVANCED TAXATION
(Answer ALL questions)

Question 1

Furniture World Sdn Bhd has been in the business of manufacturing rubberwood furniture for
which it has registered its brand name in Malaysia. The company operates its manufacturing
activities out of its factory building located in Batu Pahat, Johor. The company is 25% foreign
owned.

The company prepares its accounts to December 31 annually. During the year ended December
31, 2001, the company embarked on a 5-year expansion programme with the view to increasing
its production of furniture for export.

The company’s profit and loss account for the year ended December 31, 2001 is as follows:

Note RM’000 RM’000

Sales 1 60,000
Less: Cost of sales
Opening stock 5,000
Cost of goods manufactured 2 38,000
---------
43,000
Closing stock 3,000
--------- 40,000
----------
Gross profit 20,000
Less: Selling and distribution expenses
Remuneration 3,500
Training 3 400
Travelling expenses 4 4,500
Advertising, publicity and entertainment 5 2,000
---------
10,400
---------
Administration expenses
Salaries and allowances 6 2,000
Depreciation 500
Legal and professional expenses 7 200
Insurance, maintenance and utilities 8 250
Miscellaneous expenses (all allowable) 120
---------
3,070
---------
Financial expenses
Interest cost 9 600
Foreign exchange loss 10 700
--------
1,300
-------- 14,770
---------

31
 Note RM’000 RM’000

Add: Other income

Foreign sourced royalties 50
Interest income 11 80
Dividend income 12 100
Profit on disposal of fixed asset 13 70
-------- 300
--------
Profit before taxation 5,530
=====

Notes

1. Exports constitute 50% of total sales.

2. Cost of goods manufactured includes:

RM’000
(i) Depreciation
Factory building 150
Plant and machinery 400
-----
550
-----

(ii) Insurance premium of RM22,000 paid to Bumiputra Insurance Berhad, a

company incorporated in Malaysia, for insuring raw materials imported from
United Kingdom.

(iii) Provision for stock obsolescence amounting to RM150,000.

(iv) Research and development expenses

RM’000

Market research on customers’ preference in Malaysia 100

Quality control testing 125
Cash contribution to approved research institute 200
Payment for the use of services of an approved research institute 175
-----
600
-----

RM’000
(v) Freight charges incurred on exporting rubberwood furniture. 20

3. Training includes:
RM’000

Payments for an approved training programme. 200

32
4. Travelling expenses include:

Travelling, accommodation and sustenance allowance provided to the managing director

and the marketing manager amounting to RM2,500 and RM1,800 respectively during
their 5-day business trips to Thailand and Singapore to negotiate sales contracts.

5. Advertising, publicity and entertainment include:

RM’000

Entertainment of clients 220

Costs incurred in providing samples of the company’s
products to prospective customers overseas 80
Participation in approved trade fairs overseas 60
Cash donations to approved institutions 50
Advertisements to promote brand name in
magazines and newspapers 70
Participation in domestic trade fairs 50
Cost of maintaining sales office in Singapore 20

6. Salaries and allowances include:

RM’000

Directors’ entertainment allowances 100

Directors’ remuneration and fees 200
Provision for retirement gratuity 80
Remuneration of disabled employee 20

7. Legal and professional expenses comprise:

RM’000

Audit and taxation fees 20

Legal fees incurred in obtaining bank facilities 40
Fees paid to Search Ltd., a company in Singapore for
conducting export market research 80
Legal fees incurred in trade debt recovery 40
Registration of trademark 20
--------
200
--------

8. Insurance, maintenance and utilities include a provision for maintenance of the plant and
machinery equivalent to 1.5% of local sales.

33
9. Interest cost comprises:
RM’000
Bank loan interest (outstanding loan at end of the
year was RM3,000,000) 250
Interest payment to a supplier for late settlement of
trade debts 30
Bank overdraft interest (assume all trade related) 270
Interest on a finance lease* on equipment (the
principal element of the lease payment for the year
is RM500,000) 50
-------
600
-------
* The lease is not regarded as a deemed sale under the
Income Tax Leasing Regulations, 1986.

10. Foreign exchange loss comprises:

RM’000

Foreign exchange gain on trade debts (100)

Foreign exchange loss arising from translation of
debts owing to foreign suppliers at year-end 800
-------
700
-------

11. Interest income comprises:

RM’000

Interest charged on late payment of trade debts 80

RM’000
12. Gross dividend income (investment at end of year was RM400,000) 100

13. Profit on disposal of fixed asset is arrived at as follows:

RM’000

Motor car for use of sales manager (licensed for

commercial use, acquired on March 30, 1999)

Original cost 200

Accumulated depreciation 120
------
Net book value 80
Sale proceeds (disposed of on May 7, 2001) 150
------
Profit on disposal 70
------

34
14. Other information

(i) Balances in provision accounts

31.12.2001 31.12.2000
RM’000 RM’000
Provision for stock obsolescence 250 150
Provision for retirement gratuity 200 150

Note: Obsolete stock was written off against the provision in the year. In
addition, gratuity payments were made from the provision account.

(ii) Fixed assets

Qualifying Residual Capital
cost expenditure allowance
as at 1.1.2001 as at 1.1.2001 rate
RM’000 RM’000 %

Factory building 6,000 4,500 3

Plant and machinery 3,000 1,800 20
Motor vehicle – cars 400 160 20
Office equipment & furniture 250 150 10

Fixed assets additions :

Factory building extension costing RM200,000 was completed and in use by

November 7, 2001. 20% of the additional floor space of the factory building
extension is used for warehousing the finished goods.

The company also acquired plant and machinery on hire-purchase as follows:

Acquired on September 1, 2001 RM’000

Cash price 3,500

Down payment 350
Hire-purchase loan 3,150
Monthly instalment (36 instalments
commencing September 1, 2001)

(iii) The company has unabsorbed reinvestment allowance of RM420,000 brought

forward from the year of assessment 2000.

Required:

Compute the chargeable income of Furniture World Sdn Bhd for the year of assessment 2001,
showing all relevant tax adjustments.

(20 marks)

35
Question 2

(a) Land Sdn Bhd acquired:

 Real property of RM500,000 on June 1, 1999 (at that date, the value of other
tangible assets in Land Sdn Bhd was RM200,000).

 Real property of RM1,200,000 on January 31, 2000 (at that date, the value of real
property and other tangible assets in Land Sdn Bhd were RM700,000 and
RM300,000 respectively).

Invest Sdn Bhd acquired:

 Real property of RM800,000 on May 30, 1998 (at that date, the value of other
tangible assets in Invest Sdn Bhd was RM300,000).

 300,000 shares in Land Sdn Bhd for RM600,000 on March 1, 2000 (at that date, the
value of real property and other tangible assets in Invest Sdn Bhd were
RM1,200,000 and RM300,000 respectively. The total issued shares of Land Sdn
Bhd was 500,000 at that date).

A Sdn Bhd acquired the following shares in Invest Sdn Bhd:

 500,000 shares for RM500,000 on May 1, 1998. The total issued shares of Invest
Sdn Bhd on that date was 1,000,000.

 300,000 shares for RM450,000 on February 20, 2000. The total issued shares of
Invest Sdn Bhd on that date was 1,600,000.

Invest Sdn Bhd issued 160,000 bonus shares to A Sdn Bhd on March 1, 2001. The total
issued shares of Invest Sdn Bhd as at March 1, 2001 was increased to 1,920,000.

A Sdn Bhd subsequently sold the 960,000 shares in Invest Sdn Bhd at RM2 per share on
September 30, 2002.

Required:

Determine when Land Sdn Bhd and Invest Sdn Bhd became a real property company and
compute the real property gains tax payable by A Sdn Bhd.
(10 marks)

36
(b) Encik Ahmad operates a seafood restaurant and had exceeded the licensing threshold for
service tax on September 30, 2001. He obtained a service tax licence on June 30, 2002.

Required:

State:

(i) The service tax licensing threshold for restaurants as at September 30, 2001.
(ii) The number of months in a taxable period.
(iii) When the service tax for a taxable period has to be paid in order to avoid a late
payment penalty.
(iv) How the penalty for late payment would be computed and what is the maximum
rate of penalty.
(5 marks)
(Total: 15 marks)

Question 3

(a) Express Road Transport Sdn Bhd (ERTSB) is engaged in the transportation and freight
forwarding business. It owns a fleet of vehicles for distributing goods for its customers.
In the course of distributing the goods, its drivers often exceed the speed limit along the
highways, resulting in fines being imposed on them. Although the company policy is that
all its drivers must observe the law by complying with the speed limits, ERTSB was
imposed with substantial fines by the authorities each year due to the drivers exceeding
the speed limit in order to meet delivery times.

Required:

State your arguments for and against the deductibility of the fines paid by ERTSB.

(2 marks)

(b) DX Sdn Bhd (DXSB), a company engaged in the timber extraction and saw milling
business, paid RM3 million to the Sabah State Government for a concession to extract
timber for a period of 5 years. The sum of RM3 million is determined by reference to the
estimated volume of timber logs that can be extracted during that period. In addition,
there is an annual royalty payable to the State Government. As part of the agreement,
DXSB can only extract not more than 200 million cubic meters of timber logs from the
land during the period. The timber extracted was sold as timber logs or used in the saw
milling business.

Required:

State, with reasons, your arguments for and against the deductibility of the RM3 million
paid to the Sabah State Government.
(3 marks)

37
(c) RD Sdn Bhd (RDSB) was incorporated on January 2, 1999 with an issued and paid-up
capital of RM100,000 comprising 100,000 ordinary shares of RM1.00 each. It was
formed with the intention of acquiring and holding shares as long-term investment.
RDSB acquired the following shares in SP Sdn Bhd (SPSB) on the respective dates:

Date of No. of shares Cost price/ Manner of

acquisition of RM1.00 each subscription price acquisition
RM’000
October 20, 1999 1,000,000 6,000 Outright purchase from
third party
January 8, 2001 200,000 200 Subscription at par value
April 20, 2001 800,000 3,800 Subscription at premium

The acquisition of shares in SPSB, which was financed by shareholders’ advances, was
the first investment made by RDSB.
On February 14, 2002, RDSB disposed of its entire shareholding of 2,000,000 shares in
SPSB to LT Bhd (LTB), a public listed company, for RM100 million, satisfied by the
issuance of 40,000,000 ordinary shares of RM1.00 each at RM2.50 per LTB share. RDSB
realised a gain of RM90 million on the disposal of SPSB shares.
Between March 2002 and June 2002, RDSB disposed of 10,000,000 ordinary shares in
LTB in 3 tranches and realised a gain of RM50 million.
The shares in SPSB, which were subsequently exchanged for shares in LTB, were the
only investments held by RDSB. RDSB did not hold any other type of investments or
carry out any other activities. RDSB did not employ any staff in the company.
The proceeds received from the disposal of shares in LTB were utilised to repay the
shareholders’ advances. RDSB did not receive any dividend income from the investments
in SPSB and LTB. The investments in SPSB and LTB were reflected as long-term
investments in the balance sheet of RDSB for the relevant years prior to their sale.

Required:

State your arguments for and against the taxability of the gains arising from the disposal
of shares in SPSB and LTB.
(10 marks)
(Total: 15 marks)

38
Question 4

(a) Santan Malaysia Sdn Bhd (SMSB) is engaged in the business of manufacturing santan
powder. SMSB closes its accounts to December 31 annually. SMSB’s export
performance for the financial years 1999, 2000 and 2001 was as follows:

Year FOB value of export sales

RM’000
1999 3,000
2000 5,000
2001 15,000

The ex-factory price of santan powder for the year 2000 was RM2.00 per packet whilst
the cost of raw materials for each packet was RM1.20. For 2001, the ex-factory price of
santan powder increased to RM2.50 per packet whilst the cost of raw materials remained
unchanged.

In order to meet the increasing demand for its products, SMSB had incurred the
following capital expenditure in the year ended December 31, 2001 for the purpose of
increasing its production capacity:-
RM’000
Cost of land 500
Factory building 800
Plant and machinery transferred from SMSB’s
subsidiary 2,000
Generator purchased by SMSB’s subsidiary in
2001 at a cost of RM100,000 and transferred
to SMSB in the same year 200
Building used as child care centre for factory
workers 250
Motor vehicle provided to factory manager 280

The net book value of the plant and machinery transferred from SMSB’s subsidiary was
RM1,500,000 whilst its residual expenditure as at January 1, 2001 was RM1,000,000.
SMSB’s subsidiary also closes its annual accounts to December 31.

SMSB did not incur any capital expenditure in the year ended December 31, 2000.

SMSB’s statutory income for the years of assessment 2000 and 2001 was RM200,000
and RM2,500,000 respectively.

Required:

Advise SMSB of the most beneficial tax incentive which it is eligible to claim and
compute SMSB’s chargeable income based on the incentive selected for the years of
assessment 2000 and 2001.

(12 marks)

39
(b) Mrs Chan and her daughter, Miss Chan Yin Lai (CYL), are the beneficiaries of a trust
established by the late Mr Chan. The trust was a tax resident in Malaysia for the basis
year 2001 and it has the following income for the year ended December 31, 2001:

RM
Business income from Malaysian source
(statutory income) 100,000
Business income from non-Malaysian source
(remitted RM5,000 to Malaysia) 27,000
Rent from property located in Malaysia 8,000
Rent from property located outside Malaysia
(not remitted to Malaysia) 15,000
Interest from Malaysian banks 4,000

Under the terms of the trust, Mrs Chan and CYL are entitled to 3/4 and 1/4 share of the
distributable income of the trust respectively. In addition, CYL is entitled to an annuity of
RM5,000 from the trust. Mrs Chan was a resident in Malaysia whilst CYL was a non-
resident.

Mrs Chan received RM70,000 from the trust body during the year. In addition, she
received RM24,000 from the non-Malaysian source of the trust which she remitted to
Malaysia.

CYL received RM22,000 from the trust body. She also received RM8,000 from the non-
Malaysian source of the trust which she remitted to Malaysia.

Required:

(i) Compute the total income of the trust for the year of assessment 2001.

(3 marks)

(ii) Compute the statutory income of Mrs Chan and CYL for the year of assessment
2001 in respect of their ordinary and further source and also indicate whether or
not each of the sources of income received by them is taxable in Malaysia.

(5 marks)
(Total: 20 marks)

40
Question 5

Veri Maju Sdn Bhd (VMSB) is an investment holding company. Currently, VMSB only receives
dividends from its subsidiaries. Its group structure is diagrammatically shown below:

VMSB

100% 100% 100%

VM Manufacturing VM Trading VM Property
Sdn Bhd (VMM) Sdn Bhd (VMT) Sdn Bhd (VMP)

Information relating to the VMSB Group

(1) The management of the Group is undertaken through VMSB. No management fee was
charged for the services rendered by VMSB to its subsidiaries. Over the years, with the
growth in the activities of the Group, the level of management services has increased
substantially.

(2) VMM is involved in the manufacturing of consumer products such as toiletries, skin and
dental care and baby diapers. It sells to the Malaysian market through the Group’s
marketing arm, VMT, and undertakes directly all export sales. VMM is continuously
upgrading and modernising its plant and machinery and as such has not been in a taxable
position due to substantial unutilised reinvestment allowance and unutilised capital
allowances.

(3) VMT, on the other hand, has been very profitable as the Group’s products have a large
share of the Malaysian market. Unfortunately, due to high advertising and promotional
expenditure as well as freight costs, export sales by VMM are not profitable.

(4) VMP acquired a piece of land six years ago for development. It has recently constructed a
hotel on the land.

Proposed plans of the VMSB Group

(1) VMM is proposing to extend its range of consumer products. The managing director of
VMM estimates the additional investment for this expansion project to be in the range of
RM10 million. He is proposing to establish a new company as a 100% subsidiary of
VMM to undertake this project and has met with officials from the Malaysian Industrial
Development Authority (MIDA). However, MIDA has confirmed that the project would
not qualify for tax incentives, i.e. pioneer status or investment tax allowance.

(2) VMM believes that its products have a huge export potential and intends to continue with
an aggressive advertising and promotion campaign. In addition, it intends to set up a sales
office in China to tap the market there.

41
(3) VMM intends to venture into a software development project. The Multimedia
Development Corporation has confirmed that the project will qualify for Multimedia
Super Corridor (MSC) status which enables the project to be eligible for pioneer status.
VMM intends to set up a wholly-owned subsidiary to undertake the software
development project.

(4) VMP has received an offer to purchase the hotel. It intends to accept the offer but has
been advised that the gain on the sale of the hotel may be subject to income tax. The
potential gain from the sale of the hotel would be significant.

(5) VMSB is considering charging a management fee to its subsidiaries.

Required:

You have been appointed by the VMSB Group to review their proposed plans with the objective
of advising the Group on how to achieve maximum tax efficiency. You are required to identify
the tax issues involved and set out your recommendations.
(15 marks)

Question 6

(a) Modern Switch Sdn Bhd (MSSB) intends to construct a power generation plant in Johor
Bahru.

MSSB proposes to appoint a German firm of architects as consultants for the design of
the plant. The German architects are not expected to perform any services in Malaysia.

MSSB has shortlisted the following parties for the supply and installation of the plant:

(i) Nippon Ltd, a company resident in Japan.

(ii) A partnership between a resident Malaysian company and a UK resident
company. (The UK company has a 40% share in the partnership.)

It is expected that all the plant and equipment will be fully imported.

MSSB is considering the following options for the financing of the project:

(i) A foreign currency loan from a Labuan offshore bank.

(ii) A loan from the Malaysian branch of Nippon Ltd.

MSSB will lease a warehouse, which is owned by a Hong Kong resident company, for
the storage of equipment required for the construction project.

Required:

Advise MSSB on the withholding tax implications, if any, in respect of all payments by
MSSB in connection with the project.
(7 marks)
(b) During the year ended December 31, 2001, Global Shipping Sdn Bhd (GSSB) operated
the following ships:
42
Ships owned by GSSB:

 Malaysian ship A
 Non-Malaysian ship P

Ships not owned by GSSB:

 Malaysian ship B
 Non-Malaysian ship Q

The adjusted income/losses and capital allowances for the year of assessment 2001
relating to the ships are as follows:-

A P B Q
RM’000 RM’000 RM’000 RM’000
Adjusted income/(loss) 500 -200 -100 -250
Capital allowances 20 10 Nil Nil

The balance of the tax exempt income account as at January 1, 2001 is RM650,000.
GSSB paid RM400,000 as exempt dividends during the year.

Required:

Determine the tax liability of GSSB for the year of assessment 2001 with the view of
maximising its tax exempt account. Determine also the balance of the tax exempt income
account as at December 31, 2001.
(8 marks)
(Total: 15 marks)

43
 NOVEMBER 2002 EXAMINATION
SUGGESTED ANSWERS

ADVANCED TAXATION
Question 1
Furniture World Sdn Bhd
RM’000 RM’000
Profit before taxation

5,530
Add/(Less)

Depreciation 550
Double deduction of insurance premium (22)
Double deduction of freight charges (20)
Provision for stock obsolescence 150
Obsolete stocks written off against provision account (150+150-250) (50)
Double deduction of R & D expenses
- Cash contribution (200)
- Payment for services of approved research institute (175)
Double deduction of export promotion expenses
- Travelling accommodation and sustenance allowance
(RM200 x 5 x 2) (2)
- Provision of samples (80)
- Participation in approved trade fairs (60)
- Cost of maintaining sales office (20)
- Fees for export market research (80)
- Double deduction for training (200)
Client entertainment 220
Advertisement on brand promotion (70)
Cash donations 50
Directors’ entertainment allowances 100
Remuneration of disabled employee (20)
Provision for retirement gratuity 80
Gratuity paid (150+80-200) (30)
Depreciation 500
Legal fees re: bank facilities 40
Legal fees re: registration of trademark 20
Provision for maintenance of plant & machinery
1.5% x RM60,000 x 50% 450
Lease rental principal (500)
Interest restriction (Note 1) 33
Foreign exchange loss on translation of trade debts 800
Dividend income (70)
Foreign sourced royalty (50)
Profit on disposal of fixed asset (100)
----------

1,244
---------
Adjusted Income 6,774
Less : Capital allowances (Note 2) (1,081)
---------

44
Statutory Business Income 5,693
Less: Reinvestment allowance utilized (Note 3) (960)
---------
4,733

45
Add : Dividend Income 70
Less : Interest expense attributable (33) 37
--------- ---------
Aggregate income 4,770
Less: Donations to approved institutions (50)
---------
Chargeable Income 4,720
=====

Notes

(1) Interest Restriction Calculation

Investment x interest
Borrowings

400 x 250 = 33
3,000 ==

(2) Capital allowance Qualifying Initial Annual Total

Cost Allowance Allowance
Existing Assets: RM’000 RM’000 RM’000
Factory building 6,000 - 180 180
Plant & Machinery 3,000 - 600 600
Motor vehicle – cars (400-200) 200 - 40 40
Office equipment & furniture 250 - 25 25

New Assets:
Factory building 200 20 6 26
Plant & Machinery
(principal repayment) 700 (see Note 3) 140 140 280
-------------------------------------
Total 1,151

Less: Balancing charge RM’000

Qualifying cost of car 200

Less: CA claimed [200x20%x3] 120
------
TWDV 80
Sale Proceeds 150
------
Balancing charge (70)
-------
CA available for set-off 1,081
====

(3) Reinvestment allowance (RA) claim RM’000

(i) factory extension 200

(ii) Capital repayment on plant and machinery

on hire purchase 3,150 x 4 + 350 (down payment) 700
36 -------
900
====
RA @ 60% 540
RA b/f from Y/A 1997 420
-------
RA available for set-off 960
====
46
Question 2

(a) Determine when Land Sdn Bhd became a RPC

 not a RPC on 1 June 1999 as the real property (RM 0.5 million)
<75% of total tangible assets (RM 0.7 million)
 Became a RPC on 31 January 2000, as the real property (RM 1.9 million)
>75% of total tangible assets (RM 2.2 million)

Determine when Invest Sdn Bhd became RPC

 Not a RPC on 30 May 1998, as the real property (RM 0.8 million)
<75% of tangible assets (RM 1.1 million)

 Became a RPC on 1 March 2000, as the real property assets > 75%
of total tangible assets

Computation as at 1 March 2000

Land 1,200,000
Investment in Land Sdn Bhd 600,000 (note: use price paid since Land
------------ Sdn Bhd is already a RPC)
Real Property Assets 1,800,000
Other Tangible Assets 300,000
------------
Total Tangible Assets (TTA) 2,100,000
------------
75% of TTA 1,575,000
=======
Computation of Acquisition price of shares in Invest Sdn. Bhd.

Since Invest Sdn Bhd only became a RPC on 1 March 2000, the acquisition cost of
the 800,000 shares owned by A Sdn Bhd as at 1 March 2000 is computed using the
formula of
800,000 x 1,800,000 = 900,000
1,600,000

The acquisition cost of the 160,000 bonus shares is Nil

Computation of Chargeable Gain and RPGT

First Next
800,000 shares 160,000 shares Total
(RM)
Disposal Price 1,600,000 320,000
(RM2 per share)
Acquisition Price 900,000 Nil
------------- -----------
Chargeable Gain 700,000 320,000
======== =======
RPGT Rate 20% 30%

RPGT Payable 140,000 96,000 236,000

======
47
(b) (i) RM500,000

(ii) 2 months

(iii) Within 28 days from the end of a taxable period

(iv) 10% for each month, subject to maximum of 50%.

Question 3

(a) Not deductible as the fines are due to the breach or contravention of the law
Deductible as the fines are incurred in the ordinary course of business, i.e. necessarily
incurred in order to meet delivery deadlines

(b) Not deductible as the amount represents a payment for a concession, i.e. for the right to
extract timber, and is not a purchase of the timber trees itself. Therefore, it is a capital
payment.
(Hood Barrs v. CIR)
Deductible as the amount represents a payment for the purchase of the timber logs, not a
payment for the right to extract timber. This is supported by the fact that the sum is
determined by reference to the estimated volume of timber logs that can be extracted
during the period.

(c) Arguments for taxability

1. Frequency of transactions, several purchases of SPSB shares. Although there was

one disposal of SPSB shares, there were several disposals of LTB shares.
2. Short holding period of SPSB (about 2 years) and LTB shares (less than 1 year).
3. Acquisition of SPSB shares financed by shareholders’ advances. Proceeds of
disposal of LTB shares were used to repay the shareholders’ advances. This
indicates the intention to hold the asset for a short period before its resale at a profit
so as to settle the advances from shareholders.
4. No dividends were derived during the holding period of the SPSB and LTB shares.
Indicates no intention to hold the shares as long-term investments to generate
dividend income.
5. LTB shares are readily marketable as LTB is a listed company.

Arguments against taxability

1. Disposal of SPSB shares to LTB in exchange for LTB shares represents a

replacement of one investment for another investment. No cash consideration was
involved.

2. Although RDSB did not derive dividend income as yet, it may derive dividend
income in future because it continues to own the remaining 30,000,000 shares in
LTB.

3. Original intention is to hold shares as long-term investment. RDSB does not hold
other investments or carry out other activities.

48
 4. The investment in shares is reflected as long-term investments in the Balance Sheet,
thus showing the intention to hold the shares as a long-term investment.

5. RDSB did not perform any active monitoring of stocks as it did not employ any
staff. Indicates no organised activity to promote the sale of the shares.

6. No external borrowings were obtained apart from shareholders’ advances.

Question 4

(a) Choice of incentive

 Allowance for increased exports

Rate of Increase in
allowance export sales Allowance
Year Value-added (a) (b) (c = b x a)
% % RM’000 RM’000

2000 40 2.0 – 1.2 x 100% 10 2,000 (5,000 – 3,000) 200

2.0

2001 52 2.5 – 1.2 x 100% 15 10,000 (15,000 – 5,000) 1,500

2.5

 Reinvestment Allowance (RIA)

Assets Qualifying expenditure RIA @ 60%

RM’000 RM’000

Land - -
Factory 800 480
Plant and machinery* 1,000 600
Generator* 100 60
Child care centre - -
Motor car - -
---------
Total 1,140
======
* Controlled transfer

 Allowance for increased exports is more beneficial as the allowance of

RM1.5 million granted is higher than the RIA of RM1.140 million.

49
 Computation of chargeable income

YA 2000 YA 2001
RM’000 RM’000 RM’000

Statutory income 200 2,500

Less: Allowance for Less: Allowance for
increased exports increased exports
(restricted to 70% b/f 60
of S.I) (140) current 1,500 (1,560)
--------- --------- -----------
Chargeable income 60 (compare to 70% of 940
====== 2,500 = 1,750) =======

Allowance for increased

exports c/f to YA 2001
(200,000 – 140,000) = 60
===

(b) (i) The total income of the trust for the YA 2001 is as follows:

RM
Business (Malaysian) 100,000
Business (non-Malaysian) 5,000
Rent (Malaysian) 8,000
Interest 4,000
------------
117,000
Less: Annuity (5,000)
------------
Total income 112,000
=======

(ii) Statutory income of Mrs Chan and CYL for YA 2001 in respect of each of the
sources are as follows:
Taxability in
RM Malaysia
 Mrs Chan
Ordinary source 84,000 Yes
Further source 10,000 Yes

 CYL
Ordinary source 28,000 Yes
Further source 2,000 No
Annuity 5,000 Yes

50
Question 5

ISSUES RECOMMENDATIONS
 Deductibility of group management  Currently, VMSB is only eligible to ¼
costs in VMSB. deduction of permitted expenses. Suggest
VMSB charges its group companies a
management fee which can be set off against
costs incurred. The management fee would
be deductible against the income of the
subsidiaries.
Management fee should be commensurate
 with services rendered. Basis of charge
should be consistently applied. Service tax
of 5% would apply to the fees.
 Subsidiary of VM Manufacturing to  As MIDA has informed that the new project
undertake new range of consumer will not qualify for tax incentives, the
products. project should be undertaken directly by
VM Manufacturing. This is because VM
Manufacturing will enjoy reinvestment
allowance on the new plant and machinery.
 In addition, VM Manufacturing also has
substantial unutilised RIA and CA which
can be used to set off any profits from the
new projects.
 Consider transferring VMT’s
distribution/marketing business into VMM.
Since both businesses relate to the same
products, VMM would be considered to
have only one business source. The
additional profits would be available to
absorb the excess RIA and CA that VMM
has.

 Export sales undertaken by VM  Currently, the export sales are not profitable.
Manufacturing. This only serves to increase the unutilised
RIA and CA in VM Manufacturing whilst
VM Trading is in a taxable position. Suggest
transferring the export sales to VM Trading.
Losses from export sales will serve to
reduce VM Trading’s tax liability.
 To claim double deduction for expenses for
promotion which will further reduce VM
Trading’s taxable income.

 Subsidiary of VM Manufacturing to  The company which is to apply for MSC

undertake software development. status should not be a subsidiary of VM
Manufacturing. This is because any exempt
dividends paid by the MSC company will
create a “dividend trap” in VMSB arising
from the 2-tier exemption.
· The MSC company should be held directly
by VMSB.

51
 · Sale of Hotel vs shares in VM Property. · The sale of the hotel by VM Property could
trigger a potential income tax liability if the
tax authorities view the sale of the hotel to
fall within the ambit of income tax as
opposed to RPGT.

· VMSB could sell the shares of VM Property

which will attract RPGT at the rate of 5%.

Question 6

(a)

ISSUES WITHHOLDING TAX (WHT)

IMPLICATIONS
1. Design of plant by German architects. No WHT – exemption under Article 21 of
Malaysia/German DTA.

2. Payment to Malaysian Branch of 20% WHT under Section 107A on onshore

Japanese company for supply and construction service portion.
construction works.

3. Payments to Malaysian/UK partnership 20% WHT under Section 107A on

for supply and construction works. construction service portion relation to the
UK company’s share.

4. Loan from a Labuan offshore bank No WHT.

5. Loan from Malaysian Branch of No WHT as it is attributable to Malaysian

Japanese construction company. Branch of Japanese company.

6. Rental payments to Hong Kong Section 109B (iii) does not apply to
company. immoveable equipment.

(b)
A B P&Q
RM’000 RM’000 RM’000

Adjusted income/(loss) 500 -100 -450

Less:
Capital allowances (not to claim) 0 0 0
-------- -------- --------
500 -100 (c/f) -450 (c/f)
Less:
Current year losses 0 0 0
---------- ---------- ----------
Chargeable income 500 NIL NIL
Less: exempt (Section 54A) 500 ===== =====
=====
NIL
52
Tax exempt account RM’000

Balance as at 1 Jan. 2001 650

Add: Exempt income 500
-----------
1,150
Less: dividends paid 400
-----------
750
=======

53
 THE MALAYSIAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
(INSTITUT AKAUNTAN AWAM BERTAULIAH MALAYSIA)

EXAMINERS’ REPORT
NOVEMBER 2002 EXAMINATION

ADVANCED TAXATION

Question 1

Subject matters examined: Corporate tax computation with relevant tax adjustments.

The overall performance in this question was satisfactory.

Question 2

Subject matters examined: (a) Determination of real property company and computation of real
property gains tax from disposal of RPC shares; (b) service tax.

Part (a): Most candidates were unable to determine the deemed acquisition date / acquisition
price of RPC shares. Some candidates did not even know what is a real property
company.

Part (b): Most candidates provided wrong answers as regards the service tax licensing
threshold as at September 30, 2001.

Question 3

Subject matters examined: Deductibility of expenses/payments; taxability of gains arising from

disposal of shares.

Part (a) & : The overall performance in these two parts of the question was satisfactory.
Part (b)

Part (c) : Most of the candidates did not understand the basic principles in determining
taxable and non-taxable income. Some candidates did not seem to understand the
question and therefore the answers given were irrelevant.

54
Question 4

Subject matters examined: Tax incentives; tax computation for a trust.

Candidates displayed the following weaknesses:

Part (a) : Majority of the candidates were not aware of the allowance for increased exports
incentive. Most of the candidates compared pioneer status and reinvestment
allowance / investment tax allowance. Those candidates who were aware of the
allowance for increased exports incentive did not know how to compute the incentive.

Part (b) : Most of the candidates were able to compute the total income of the Trust. However,
many candidates were unable to compute the statutory income from the ordinary and
further source. In addition, most of them were unable to provide answer on the
taxability of each source of income.

Question 5

Subject matters examined: Tax planning covering various aspects of tax incentives, RPGT vs
Income Tax issues and utilisation of tax attributes.

The following weaknesses of candidates were observed:

(i) Many candidates encountered difficulty in identifying the issue of RPGT vs income tax,
especially when tackling the issue of VMP wanting to sell the land with hotel.

(ii) Quite a few candidates did not seem to understand the fundamental concept that tax
attributes remain with the company. A number of candidates talked about transfer of the
business and also the tax attributes, e.g. moving across unutilised capital allowances.

Question 6

Subject matter examined: (a) Withholding tax; (b) taxation of shipping business.

Part (a) : A large proportion of the candidates could not identify the incidence of withholding
tax, especially consideration of section 107A vs section 109B.

Part (b) : Most of the candidates were unable to identify the ships subject to section 54(A).
They were also unable to treat the taxation of non-Malaysian ships.

55