Business

Friday June 26, 2009

Revenue recognition and cost of sales

By Dr Choong Kwan Fatt


Starting today, we are running a 3-part series by the Association of Certified Chartered Accountants on tax filing for sole proprietorship for which the deadline is June 30

ACCORDING to the Companies Commission of Malaysia, the majority of the 810,150 registered companies in Malaysia are owned by sole proprietors or business enterprises.

These entrepreneurs are probably paying too much in taxes, since professional tax advice would be too costly for sole proprietors with a typical annual turnover of RM300,000 to RM500,000.

Via this three-part series on effective tax planning, you as the sole proprietor can optimise your taxes by understanding and applying the tax deductions available, hopefully in time for Form B submission by June 30.

This first part highlights how you can optimise taxes and avoid penalties by implementing permitted accounting standards, segregating trading stock from items for personal use and applying stock write-down and obsolescence policies.

·Sales/Revenue: Revenue is recognised once trading goods are sold to customers. In practice, the issuance of sales invoices are demarcation points for sales to be recorded in the accounts. For service industries, revenue is recognised at the point when services are rendered and completed.

Sales revenue at all times must be recorded at market price, which is the arm’s length or actual sales price between the trader and his customer.

For example, Hun provides auditing services. On June 30, 2008, he was appointed to carry out a due diligence audit for a fee of RM30,000 with a deadline of August 2009. He collected a mobilisation fee of RM5,000.

The fee of RM5,000 is not an income as it is very much subject to the completion of the special audit assignment. The full income of RM30,000 is only recorded for the financial year ending Dec 31, 2009.

On certain projects of long duration such as contracts and litigation works which are spread over two or more years, work in progress through interim billing will be treated as revenue for services provided.

·Sales recorded on accrual basis: Accounting standards in Malaysia require revenue to be recorded on an accrual basis. This means sales must be recorded notwithstanding whether it takes place on credit or cash terms; whether cash is received or not is irrelevant.

·Cash accounting: This is not a permitted accounting standard in Malaysia. Under the cash accounting basis, revenue is recognised solely based on cash received and there is no reference to the sale of goods or completion of services.

Sole proprietors computing income tax on this basis are considered as submitting an incorrect return and will be liable to a tax penalty of 100% and/or a fine up to RM10,000.

·Deemed sales for use of own stocks: Traders who wish to use their trading items (stocks) for donation, personal use or as gifts must record these items at market value, since Section 24(2) of the Act deems these as sales revenue. These transactions are treated as sales and the “profit” which was never earned is subject to income tax.

To avoid this situation, the sole proprietor has to request that the supplier invoice him separately on his personal account for the item that he intends to give away or keep for his own use. Do not bill the item to the business enterprise.

For example, Ken imports reconditioned luxury cars. In 2008, he imported eight Mercedes E200K cars into Malaysia and contemplated giving one to his wife for their wedding anniversary.

As the cars would be treated as stock-in-trade once imported into Malaysia, an amount equal to the market value of the stock at the time of withdrawal must be included in the gross income of Ken’s business when the car is withdrawn as a gift, although profit was not actually earned.

However, if this particular car was never recorded as trading stock, the profit element would not be taxed. Ken should thus request the supplier to bill a car in Ken’s own name and finance the purchase and importation costs from his own resources.

·Cost of sales: Trading stocks are assets to the sole proprietor and reflected in the balance sheet. The cost of trading stock is only allowed as a deduction against sales revenue when the stock is sold.

Excess unsold stock is an asset and not deductible. Sales quantity and the cost of sales must be identical.

For example, Wai Ling runs a computer business. On Dec 31, 2008, she sold 60 units of computers at RM3,000 each. She acquired 90 units in 2008 at the average cost of RM2,200. The 30 unsold units are not tax deductible and gross profit will be calculated as in table.

The closing stocks of 30 units at RM2,200 will be stated in the balance sheet and carried forward to the next financial year.

The sole proprietor should develop a stock write-down policy to evaluate the quantity or quality of unsold stocks as the Act allows tax deductions for stock written down or stock write-offs due to obsolescence.

The stock policy has to be applied consistently for at least three years. Tax authorities may review such a stock policy during the tax audit.

The write-offs of the stocks or write down in the value of trading stock must reflect actual market conditions. Sole proprietors must record the details of such stocks and provide the specific reason why certain stocks are written off or written down as part of the documentary evidence for tax audit inspection.

Tomorrow: Minimise legal tax payable by capitalising on deductible business expenses as well as deductions for bad trade debts, which tend to rise in troubled business conditions.

  • Dr Choong Kwai Fatt is a tax consultant and associate professor at Universiti Malaya’s Faculty of Business and Accountancy. For further enquiries or feedback, please email to
    info@accaglobal.com

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