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Hi again, Mike,
Sorry to be such a pain, but I have 2 more questions, and this time is re: Deferred Tax, I don’t have the answers to them, I calculated them, but just want to make sure that the way I am thinking is correct and Deferred Tax is soooooooooo confusing 🙁 So, in the 1st post and 2nd (if it doesn’t fit, I’ll write the question) and then in the following ones, the way I solved it, if you could take a quick look at them 🙂
1st QUESTION:
The finance director of Alpha plc is preparing its 2012 annual financial statements and has collected the following information with respect to the accounting for income taxes.
Pre-tax financial statement income: £900,000
Tax rate (for all years): 30%The finance director of the company needs to consider a number of issues relating to the calculation of deferred tax.
i) Property, plant and equipment include an asset that cost £250,000 when it was purchased on 1 January 2009 and was estimated at that time to have a useful life of 5 years. The asset has been depreciated using the straight line method of depreciation. On 1 January 2012, the asset was revalued to £140,000 which was used as a basis for straight line depreciation for the remaining 2 years of the life of the asset. At the end of 2011 and 2012 the company claimed total tax allowances on the asset of £180,000 and £210,000 respectively.
ii) The financial statements include a £200,000 expense which related to a fine for violating environmental laws. Fines are not tax deductible.
iii) Beta plc announced a formal plan to restructure one of its reportable segments which is located in South America. Relating to this restructuring, Beta plc wants to make a PROVISION to include the following costs:
– redundancies: £440,000
– legal/accounting costs relating to staff redundancies: £90,000
– re-training of remaining staff: £100,000
– written-off research and development costs (capitalized in 2011): £120,000
– expected loss on inventory: £80,000The research and development costs were deducted for tax purposes in 2011, the year in which they were INCURRED and PAID.
iv) The company estimated and recognized in its financial statements a bad-debt expense of £60,000 relating to its trade debtors (accounts receivable). For tax purposes bad debts are deductible when they become uncollectible.
v) The company collected in advance £50,000 rent. For tax purposes revenue is recognised when cash is received.
a) Calculate the DEFERRED TAX BALANCE as at 31 December 2012.
b) Calculate for 2013 the DEFERRED TAX CHARGE that Beta plc will report on its income statement in relation to its property, plant and equipment referred to in i) above.
The way I solved it (and is probably wrong as it’s sooooo confusing) is:
a) for the DEFERRED TAX BALANCE => here, from what I’ve read (and please confirm whether it is correct or not) I need to go through every item and, if it gives rise to a temporary difference, I compare the carrying amount and the tax base (I ignore items which give rise to a permanent difference such as the fine in ii)) and in the case of an ASSET, if the carrying amount > tax base => deferred tax liability, if carrying amount < tax base => deferred tax asset; in the CASE of a LIABILITY, if the carrying amount > tax base => deferred tax asset, if the carrying amount < tax base => deferred tax liability.
SO,
i) PPE the carrying value of that ASSET: £140,000 – £70,000 = £70,000 which is greater than its tax base: £250,000 (cost) – £210,000 (total tax allowances until that date)= £40,000. Temporary difference: £70,000 – £40,000 = £30,000, which * 0.30 (tax rate) = – £9,000 (deferred tax liability)
ii) PROVISION (this also tests my knowledge about provisions), and from what I know, only the first two items should be included in the provision, i.e. redundancies and legal/accounting costs relating to staff redundancies. I’ve read on IAS+ that you cannot make a provision for re-training the remaining staff and neither for future operating losses, which in this case would be the expected loss on inventory, right? And since it states that “The research and development costs were deducted for tax purposes in 2011, the year in which they were INCURRED and PAID” => the R&D would not give rise to a temporary difference. So, the provision which must have been included in arriving at the pre-tax financial statement income must be comprised of 440,000 (redundancies) + 90,000 (legal/accounting costs relating to staff redundancies) = 530,000
the carrying amount of this provision (which is a liability, of course) is £530,000 and the tax base is 0 => temporary difference of £530,000 * 0.30 = + 159,000 (deferred tax asset).
iv) BAD DEBT EXPENSE: carrying value of bad debt expense is £60,000 which is greater than its tax base of 0 => temporary difference of £60,000* 0.30 (tax rate) = 18,000 which is a deferred tax asset, right?
v) deferred revenue (Liability): carrying amount: £50,000 > its tax base of 0 => temporary difference of £50,000*0.30= 15,000 which is a deferred tax asset
SO now the deferred tax balance is: -9,000 (deferred tax liability PPE)+ 159,000 (deferred tax asset Provision) + 18,000 (deferred tax asset Bad Debt Expense) + 15,000 (deferred tax asset Deferred Revenue) = 183,000 DEFERRED TAX ASSET, right?
b) DEFFERED TAX CHARGE – from what I know,and please correct me if this is not true, I take the difference between the TAX DEPRECIATION and ACCOUNTING DEPRECIATION and multiply it by the tax rate
SO,
TAX DEPRECIATION for 2013 must be: £250,000 – £210,000 (total tax allowances until end of 2012)= £40,000
ACCOUNTING DEPRECIATION: £140,000 / 2 = £70,000
(£40,000 – £70,000)* 0.30 = – £ 9,000 must be the TAX CHARGE for 2013
Apologies for such a looooong post 🙁 and hopefully, you won’t hate me too much for making you go through such a horrible question 🙁
Where on earth have you found this? The hardest deferred tax question I have ever seen at F7 was re PPE where tax base and book value were given as also was the tax rate!
I wake up on a Thursday morning and the first thing I see is this post. I’ve a good mind to go back to bed!
Checking through your answer, it seems that you’re correct (I can’t see any errors or mistakes in logic)
I presume that you have a printed solution for this – what does the solution say?
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