1. avatar says

    Hi..I have a doubt.. In one of the examples pertaining to the comparison of lease vs buy,it was written that”purchase of machinery would be financed through a four year loan paying interest at an annual rate of 8.6%” why didn’t we take this and its tax implication into consideration??

  2. Profile photo of jay0v says

    Hello Sir,
    I have a confusion with the statement in the question
    “Buying it will involve borrowing money at an after tax interest cost of 7% p.a”
    It only says buying it so why do we use the interest rate of 7% for leasing, or is it that we assume that the money is always borrowed?

  3. avatar says

    Hello Jon,

    Example 3 purchase VS lease,when you calculate the CA tax savings for the machine, you applied 5 years savings but the machine only last for 4 years, why? Because it was bought at last day of accounting year?

    • Profile photo of John Moffat says

      Yes. Because it was bought on the last day of the year, you would get CA’s for that year. Then you use it for 4 years and you get CA’s for those 4 years as well.

      (It is something that really only happens in the exam in a lease/buy question. Normally in other questions we assume the machine is bought on the first day of a year and so it if lasts 4 years there are 4 CA calculations)

  4. avatar says

    I got few confusions John:

    The corporation tax was as a tax payable, but in lease you didn’t assume it as subtraction like rather than ($10500), you simply indicated as +$10500.

    In ch#8 ex3 and onwards, we continued to assume that taxation 1 year in arreas and put on the profit’s figure year later, like $1000 profit in year2 and 25% tax = $250 in year 3. BUT why we moved to another forward year, althought you told us that its rule…ahh but why this?

    The purchase was made at year0 and hence 0,1,2,3years become 4years, with the fact that we purchased on year 0, regardless of its date( dec 31), but why it happened as year forward?

    I know its all about dates problems but I think I need your bit help, although major part of help is being conducted through your lectures :)

    Many Thanks

    • Profile photo of John Moffat says

      1 The tax is not payable. We are making lease payments, these will be allowable for tax, so it will reduce our existing tax liability – we will save tax.

      2 We usually assume that operating flows are at the ends of year. So it will affect the profit immediately, and the tax effect will be one year later.
      The lease payments are made at the start of the year, so it will affect the profit calculated at the end of the year (i.e. one year later), and the tax effect will be one year after that.

      (The cash flows are points in time – they are not whole years. Time 0 is now, time 1 is one year from now, time 2 is 2 years from now, etc..)

      3 We usually assume that machine are bought at the start of a year. In which case, then capital allowances are calculated at the end of the year (i.e. time 1) and the tax effect is one year later (time 2).
      This question says that the machine is bought on the last day of the current year. So (from Paper F6) the first capital allowances will be calculated immediately (cos we are at the end of the year) and the tax effect will be one year later – i.e. time 1.

      It is only with lease and buy that you have these tax timing problems (because otherwise it would be too easy :-) )
      To be honest I will be surprised if it is asked this time because it was asked last time.

      • avatar says

        Thanks for the help. Its clear now. “To be honest I will be surprised if it is asked this time because it was…”: my habit is I never see guess before exams as it ruins my psychology and I feel that I am bad at other topics. Its also recommended by you and examiner. Why we guess for some topics if you teach us everything here :)

        Many Thanks

      • avatar says

        ah one more thing as you explained, so we assume generally preculded from leasing that the cash outflows at year start( costs ) and it cash inflows at year end ( profits), hence we put scrap value that likely. But now here we are assumed at 31st Dec, so this way it also extends the scrap figure to year forward.

        Many Thanks

  5. avatar says

    Hi John, firstly, thanks for your great lectures! You make it very easy to understand the concepts. I need one clarification on the tax rule you mentioned at the end of this lecture: “Payment at the end of accounting year – tax effect is 1 yr later.” Is the “end of accounting year” referred to here is the “current” accounting year? Is it the day before time 0? Also, when the term “current” is mentioned in the exam, is it usually the period before time 0, like for example, the inflation of costs referred to in example 4, chapter 8?

    Thanks much!

  6. avatar says

    Hello John, I’m a bit confused with this example, you assume the year end is December, so 1.1.2011 is beginning of the year, 31.12.2011 is the year end, corporation tax is payable one year after the year end, so should be 31.12.2012. If 2011 is year 0, then 2012 should be year 1, the tax savings should be the end of year -31.12.2012, why do you say it is in year 2 2013 which is 2 years after the year end of initial payment?

    • Profile photo of John Moffat says

      Time 0, time 1 etc are not years, but points in time.

      The first payment is on 1.1.2011, time 0. The tax is calculated at the end of the year and payable one year later I.e 31.12.2012.

      From 1.1.2011 to 31.12.2012 is two years (we are not bothered about one day) and therefore is time 2 because it needs discounting for two years interest.

  7. Profile photo of iluvgorgeous says

    Dear John
    I just want to say thank you sooooooooooooo much for the brilliant lectures. I have been living with your lecturers in the last couple of months and I have done to paper today and I feel pretty positive, thanks to your brilliant style of teaching. If you ever decided to teach in London I will be your front line student. thank you.

  8. avatar says

    Could you please explain me which DF for leasing should I use for such questinons? Namely for questinon ASOP Co. I can not match DF @6% 3.673 shown in answers with annuity table.

    Sorry if the qustion sounds stupid.


    • Profile photo of John Moffat says

      For the lease buy decision you should discount the flows at the after-tax cost of borrowing.

      In ASOP the before tax cost is 8.6%, and so the after tax cost (with tax at 30%) is 8.6 x 0.7 = 6.02% – so discount at 6%

      With regard to the discount factor itself, because the payments are made in advance, the first payment is at time 0, and then there are payments at times 1, 2 & 3.

      The discount factor for a payment at time 0 is 1.
      The discount factor for an annuity at times 1 to 3 is the 3 year annuity factor at 6% = 2.673

      So….either discount the two bits separately and then add up, or multiply the figure by the total of 1 + 2.673 = 3.673

      (PS If you ask about specific questions, please say where the question is from. I can’t remember the name of every exam question that there has ever been, and it takes ages for me to find it :-) )

  9. avatar says

    Good evening, John!
    Could you, please, help on the following question: i tried to do question from December 2009 Exam # 1 regarding lease or buy the new technology, and I’ve got the following question:
    why when trying to find option 1 – bank loan license fees are included? nothing told about interest payable on loan, but license fees are calculated, and what is more, tax saving on license fee is given.
    And just would like to clarify general approach:
    1) when we use option bank loan – we have non-current asset, and as result we have tax saving on WDA, which should be included into calculation of CFs, besides we should include interest payable on the loan + tax relief. Is this all regarding taxation?
    2) when we use option leasing – we only have lease payments and tax relief on the lease payments?
    Thank you in advance!

    • Profile photo of John Moffat says

      As far as the lease or buy decision is concerned, if we lease the machine then the only payments are the lease payments (they include the license fee) and we get tax relief on the lease payment.

      If we buy the machine, then we get the tax saving on the capital allowances. In addition there are the license fees an we get tax relief on these. We do not bring in the interest payments (or the tax relief on them) because these are taken account of by the discounting.

  10. avatar says

    hi sir i have a question if the question does not state when the asset is bought but says it has a year end of 31 december and that the 1st payment is made in january when do i claim WDA year 9 or year 1

  11. avatar says

    hi sir im doing a question and it says the accounting year ends on 31december,if the machine is purchased,payment will be made in january of the first year of operation,if leased annual lease rentals will be paid in january of each year of operation…my question is when will i claim WDA in year 0 or year 1

  12. avatar says

    Sir, before making the decision for whether to borrow to buy of to lease the asset through the finance or operating lease , is it mandatory that we must compute the NPV for investment (acquisition) decision even when it is not required ? eg saying no cashflow was given but cost savings was given

  13. avatar says

    @johnmoffat: I am doing a question in the revision kit where the machine will be used for 4 years and at the end of that time it will generate scrap proceeds of 20,000. The question states that “a full year’s allowance is given in the year of acquisition but no writing down allowance is available in the year of disposal. The difference between the sale proceeds and the tax written down value in the year of disposal is allowable or chargeable for tax as appropriate.” In the answer tax is not calculated on the sale proceeds of 20,000. Also the capital allowance tax saving is claimed on the written down value in the 4th year and claimed again in the 5th year after sale proceeds is deducted. You taught that sale proceeds should be deducted in the year the asset is disposed of and tax calculated on the sale proceeds.. This is somewhat confusing to me. Can you please explain? Thank you.

    • Profile photo of John Moffat says

      I would have to see the question to give a firm answer.
      From what you have written, it would seem that the full 20,000 should be taxable. I can only assume that it is at time 5 because there is a one year delay in the tax.

      • avatar says

        Tax is payable 1 year after the end of the accounting year. The 20,000 was not taxed. The question is from a dec 2002 past paper. Leaminger. Thank you.

  14. avatar says

    I still don’t understand how the “last day of the current financial year” is year 0 when it comes to buying the machine. I would think this would be year 1 as the question did not say the machine is bought at the start of the year or now. Please help me understand. Thank you.

  15. avatar says

    thanks for the just to double confirm..can i say year 0 is the beginning of the 1st year,and lease payment are paid at the start of each year,thats why its computed in yr 0.As for the tax saving for lease payment..year 1 is like the end of 1st year so there will be tax saving in year 1,however tax is payable a year later,so thats y its computed in year 2?…….and as for capital allowances,asset is bought at the end of the accounting period 2010,so i agree that we claim it at year 0 however tax is payable one year later so again,tax saving only occurs starting from year 1.

    sir,i did some past year papers and the question did not say the asset is bought at the end of accounting period.and the answer claimed its capital allowances on year 1 and tax payable on year later,so tax saving from capital allowances is on year 2.why is it that the capital allowances are claimed in year 1?do we claim our capital allowances in year 1 as d default basis when the question did not say when the asset is bought?

    secondly,there is this question i did,it did not say when the asset is bought.however it does say that the company is able to fully utilise its allowances throughout the project and its capital allowances is claimed at year 0…

    ive talked to some students who passed their f9.and they told me capital allowances are always claimed on year 1 unless the question told me to claim it at year im really confused here :(

    • Profile photo of John Moffat says

      @flippy, Usually you are not told in the question the date on which the asset is bought. For the exam therefore you assume that the first capital allowance saving occurs at the same time as the first charge of tax on the profits. With a one year delay in tax this is at time 2.

      The only time that the timing of the capital allowance saving is likely to matter is in a lead and buy questions (watch the lecture on lease and buy).

      Otherwise questions never tell you whether allowances are claimed at time 1 or time 2 (what other students have told you is not true). Always assume that the first CA saving is at the same time as the first tax is payable on profits (unless the question actually gives dates, which these days is very unlikely indeed).

      • avatar says

        @johnmoffat, right,what about this question i did..its not about lease/buy decision but the answer given claimed its capital allowances at year 0,and tax payable one year later is at year 1.However it does state that the company is able to fully utilise its capital allowances throughout the project.does this sentence tell us that we need to claim our capital allowance at year 0?tax delay year1.

      • avatar says

        @johnmoffat, and i have another question,if lease payment are paid in advance,it is not the same meaning as lease payment paid at the beginning of the year right?.thus my tax saved on lease payment will be computed in year 0 and if there’s tax delay,then year 1.correct?again im sorry for being so annoying by asking so many questions :(

    • Profile photo of John Moffat says

      @andreivoinescu1987, Because it is bought on the last day of the current accounting period, it means that it gets capital allowances for that year and then for each of the four years it is used. So 5 in total.

  16. avatar says

    Not finished the lecture yet so maybe it gets corrected but it says “If the machine is bought, it is bought on the last day of the current financial year”. Wouldn’t that mean it is bought in time 1 and not time 0? Any help would be appreciated.

  17. avatar says

    I’m a bit unclear about the tax saving being a cashflow in year 2.

    As usually the operating cashflows are taken to be at the end of the year (say year 1) and the tax being payable an year later, which would be in year 2.

    However in this case, regarding the lease the cashflow is taken to be at the beginning of Year 0 but it says the tax cashflow happens in Year 2?

    It says in the Lecture, tax is calculated at the end of Year 0, and being paid an Year later being at the end of Year 1??

    Is it possible to explain this in line with how it works in the usual scenario where the tax is paid an in year 2 – i.e where the cashflow for which the tax is payable occurs at the end of Year 1 and where the tax cashflow occurs in Year 2?

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