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Dear sir,
I was practicing a past exam question and i got stuck in one part. I need your help.
The question mentions that “Fubuki Co’s directors expect to develop the project for a period of
four years and then sell it for $16 million to a private equity firm.”It is anticipated that the value attributable to the plant
and machinery after four years is $400,000 of the price at which the project is sold. No tax
allowable depreciation is available on the premises.Initial cost of acquiring suitable premises will be $11 million, and plant and machinery
used in the manufacture will cost $3 million.Tax allowable depreciation is available on straight line basis.
In solution they have subtracted 400,000 from 3 million and then calculated TAD.
My confusion:
I don’t understand this that why they have subtracted this 400,000.
This 400,000 is what they have sold the asset for. I think they should have calculated either balancing allowance or charge. But here they have initially subtracted this 400,000 which I don’t understand.
Thanks for your assistance.The examiners answer has given two alternatives.
What the main answer has done is simply calculated the TAD in the way we calculate straight line depreciation in financial accounts. This results in TAD each year of (3000-400)/4 = 650.
At the end of the four years the tax written down value is then 400 which is the same as the proceeds of sale and so there is no balancing allowance or charge.However strictly this is not how tax rules work. The TAD should be based on the initial cost and should therefore be 3000/4 = 750 for each of the first three years. This results after three years with a tax written down value of 750, and therefore a balancing allowance of 350 in the 4th year.
The examiner has written this in bold below workings (1) and said that doing this would have got full credit.
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