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Dear Sir,
“In arriving at the fair value of net assets acquired at 1 December 20X3, Largo has not accounted for the deferred tax arising on the increase in the value of the property of both Fusion and Spine. The deferred tax arising on the fair valuation of the property was Fusion $15m and Spine $9M……”
FV adjustment : How come the answer compared the depreciation expense within the year with the (deferred tax liability * depreciation rate)? Why do we need to multiply the depreciation rate with deferred tax liability?
Answer given :
Fusion Property at Acq : $64 (1.12.X3)
Deferred tax liability : ($15)
= $49Movement (5%) (which is the depreciation rate of property given as per qns)
Property : ($3.2)
Deferred tax liability : 0.75Deferred tax liability and Deferred tax asset arises due to timing difference. Deferred tax liability occurs temporary differences between capital allowance vs depreciation and thus we have deducted a huge amount of expenses now but it is for future purpose. Therefore, we have to pay tax in future giving rise to DTL. Deferred tax asset arises when we recognized prepayment from customers, giving rise to paying less tax in future. Is my understanding correct?
Many thanks !
Your understanding is perfect – deferred tax liability is where the taxman’s capital allowances exceed the accountant’s depreciation so the taxman is allowing us a greater element of capital asset cost against profits earlier than the financial accountant is depreciating those assets
That’s the principle and deferred tax asset (rare) is effectively the other side of the same coin
Hi Mike,
Why the deferred tax must multiply with depreciation rate in order to compare the accounting depreciation? I thought the qns mentioned that the fair valuation of deferred tax is $15m for Fusion?
A little confused of that working.
Thanks
“Why the deferred tax must multiply with depreciation rate in ……”
The answer appears to be spreading the build up of the deferred tax provision over the life of the asset.
That calculation is normally done by comparing the carrying value (cost less accumulated depreciation) with the tax written down value (normally given in a question) and multiplying the difference by the tax rate
What appears to be being done in the Fusion answer is calculating the movement on the deferred tax account to spread that build up over the same period. Maybe better not to consider 5% as the depreciation rate. Rather consider 20 years as the appropriate time period
Does that make it any easier?
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