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Hi Sir,
To my knowledge, in investment appraisal, if the initial investment is paid at the start of the first year and the tax is paid one year in arrears then the initial investment is to be in year zero and the tax in year two along with tax allowance both are in the same year. i.e if the tax is due to be paid in the year it arises then to my understanding both tax and tax allowance would be in year one and if one year in arrears then both are in year 2.
But in December 2014 past exam question stated that the tax would be paid in one year in arrears and placed the tax in year two. and tax allowance in year one not entirely sure why the examiner did that.
But the question has stated that the company would be able to claim a balance charge or allowance in year four which might be the reason as to why the examiner did that.
can you please advice me on this matter?
Thank you for your time in advance
What you have written about the tax timing is correct, but I think you have misread the examiners answer to the question.
There are two ways of showing the tax (both obviously resulting in the same answer) and the examiner has shown both ways in his answer.
Here, the tax is payable 1 year in arrears, and so the first tax affect is (as you state) at time 2.
In the first method, the examiner has calculated the taxable profit for the first year (the first years profit less the first years capital allowance) and then shown the tax on the taxable profit as payable at time 2 – which is correct.
However, because the capital allowances in the first year are not themselves a cash flow, they have been added back at time 1 (because they were subtracted at time 1 to get the taxable profit).In the alternative calculation shown in the answer (which is the method I prefer), the examiner has calculated the tax on the first years operating cash flow (the profit before allowances), and has it as payable 1 year later at time 2. Separately he has calculated the tax saving on the first years capital allowances, and shown this as a cash inflow 1 year later at time 2.
I hope that makes sense (and I assume that you have watched my free lectures on investment appraisal with tax), but if not then do ask again 🙂
Thank you very much, Sir, for the concise answer, Indeed I have watched your lectures and could not fault it at all. your time and effort are very much appreciated.
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