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1. why losses were carried forward in third year instead of offseting against profit of the co. in other project in U.S. in answer?
2.why depreciation was not added back with cash flow ?(working 5)Please let me know what I am missing?
1 It is because the losses are in Gamala, so they cannot offset against US profits. They have no other projects in Gamala, but Gamala allows the losses to be carried forward.
2 In the cash flow table itself, there is no depreciation (because obviously depreciation is not a cash flow). However when they have worked out the tax, they have taken the profits before depreciation (the cash flows) and then subtracted tax-allowable depreciation (another word for capital allowances). However this is only for the calculation of the tax charge.
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Dont know if this chat is still active, anyway here is the question:
WHy is the tax allowable depreciation is not added back after tax was calculated? The way the answer is presented it seems logical that after calculating the tax (where capital allowance is deducted), it should be added back later? pls help!
There are two ways of dealing with tax.
Either calculate the taxable profit (after capital allowances) then calculate the tax, and then add back the capital allowances (because they are not a cash flow).
The alternative (which is what has happened in the answer to this question) is to calculate the tax on the operating cash flows (before any capital allowances), and separately calculate the tax saving on the capital allowances.
Both approaches give the same answer – the second one is usually quicker and safer.
(It might be worth watching my F9 lecture on this if you are still unclear).
@ACCA Tutor, I understand that there are 2 methods of dealing with Tax allowable depreciation and know how to apply them.
However, in Tramont, the depreciation was deducted before tax but not added back as it should have been done, after tax.
is there any reason why this was done?
I think you are mis-reading the examiners answer.
In the cash flow table he shows the ‘profits before tax’ and these are the cash flows before depreciation.
He then shows the tax flows, and when calculating the tax flows in workings 5, he bases them on the taxable profit, which is correct (i.e. his ‘profits before tax’ less depreciation.)There is no need to add the depreciation back in the main cash flow table, because it was never subtracted in the main cash flow table.
(I think what may be confusing you is that very often the tax is worked out in the main table instead of as separate workings – then in the main table we subtract depreciation, then calculate the tax, then add back the depreciation because it is not a cash flow. However here he has shown the workings completely separately.)
Okay. The examiner did a separate working (W5) and deducted TAD from PBT, he then claimed Losses in year 2 and part of year 3 before deducting taxes.
I still do not understand why he did not add back the depreciation even in his separate working. (I hope this is not frustrating but i still don’t get it).
Two methods- Add tax savings on Depreciation/TAD OR deduct TAD, deduct tax and add back depreciation to PAT (RE:Trosoft), but in the examiner’s workings (W5), he only deducted then claimed back tax on losses made. There is no statement which states that the investment required to maintain NCA is equivalent to the amount of TAD (this would have been a reason not to add back).
it’s a bit inconsistent to me, how will i know when this type of working done by the examiner is required in the exam?
Depreciation itself is not a cash flow, so the only purpose in deducting it is to actually calculate the tax.
Just suppose the net cash flow was 100, the depreciation 20, and the tax rate 30%.
What you could do in the cash flow table is take 100 – 20 = 80, then subtract the tax of 24 (30% x 80) and then add back the depreciation (20) because it is not a cash flow. That ends up with a net cash flow of 100 – 20 – 24 + 20 = 76.
What he has done is leave the cash flow at 100, then calculated tax separate in his workings ((100-20) x 30%= 24), then shown this as an outflow in the cash flow table. So you have 100 – 24 = 76. Same as before 🙂
1 more question, please- I tried using MMII to get the ungeared Ke but i think because of the clause which states that the Asset Beta applicable to the project is 0.4 more than current asset beta, my Ke,ungeared was not the same.
is it possible to use MMII and still get the same result as the ungearing method, with the 0.4 increase requirement? if yes, how?
MMII can be used and will give the same result (because the asset beta formula is actually derived from the MM formula). However it is a lot more messy and you should always use the asset beta formula.
(One problem is that the MM formula has in it Kd. However, MM assume that debt is risk free and so we need to use the risk free rate, but of course Kd is likely to be different and then messes things up 🙂 )- Topics: 0
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Good Day,
Could you please advise on the working 7, “additional tax, contribution and opportunity cost”. I could not quite understand where do the numbers calculated for additional tax, opportunity cost and additional contribution come from ? Formulas are given as an explanation but I do not understand what were the numbers used for calculation. Could you please clarify this for me ?
Since the tax rate in Gamala is 20% but the tax for Tramont is 30%, there is an extra 10% tax to be paid. From workings 5, you know the taxable profits in GR’s and so Tramont has to pay an extra 10% of this (converted into their own currency $’s)
The opportunity cost if the $20 per unit that the question says is currently being earned. With the new investment, this will be lost (and, of course, it needs inflating and it is only the after-tax amount that will be lost)
The additional contribution is the component that Tramont is selling to the Gamala project. The question says that Tramont makes $4 per unit contribution (but again, it needs inflating each year, and it is the amount net of tax that we need).
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Thank you very much for the answer.
Could you please explain why have the inflation rates been taken from year 2 and not year 1 for calculating the Variable cost?
The question specifically says that the revenues and costs given apply to the first year of operation. Therefore they will only inflate in the second year onwards.
Hello John,
In Tramont Co, for the first year of operation, there is a loss of GR 22,200 and tax is not computed on this amount (taxable amount is nil). However, in the question of Sleepon Hotels, though there is a loss, tax is calculated and the amount is added (instead of being deducted) to the taxable profit (should I say taxable loss).
Please clarify on the above.
In Tramont, the new ‘project’ is the only business they will have in Gamala. So they are not currently making any taxable profits in Gamala. Therefore if there is a loss then there is no tax payable in Gamala and the loss is carried forward to reduce future years profits (as the question says is the rule in Gamala).
In Sleepon, the new ‘project’ is in the same country (UK) as their existing operations. The question says in the first sentence that they are successful. Therefore we assume that they are currently paying tax and that therefore any ‘losses’ from the new operation will simply reduce their existing profits and therefore save them tax, rather than create a tax loss to be carried forward. (This is the assumption we normally make anyway whenever the investment is in the same country).
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