- This topic has 5 replies, 2 voices, and was last updated 4 years ago by
.
- Posts
Hello Sir,
In answer sheet: audit risks
Deferred tax liability
The finance director states that the change in the deferred tax liability relates to the changes in estimated useful lives of assets and associated accelerated tax depreciation (capital allowances). However, the impact on profit of the change to estimated useful lives amounts to $5 million, so the $8 million increase in deferred tax seems inappropriate and it is likely that the liability is overstated.
The deferred tax liability has increased by five times, and the $10 million recognised in the year-end projection is material at 2·8% of total assets. The changes in deferred tax and the related property, plant and equipment therefore does not appear to be proportionate and the amount recognised could be incorrect.
I am unable to understand how come the liability might be overstated?
Suppose the deferred tax difference $2m in PY was entirely attributable to difference between carrying amount and tax WDV – I’m just making this up to explain what’s happening. Suppose the actual tax rate is 20%, then the difference between carrying amount and tax WDV is $10m – so when last year’s PPE was $78m, the tax WDV was $68m.
If this year depreciation is $5m less than PY, you’d expect that to increase the gap (relatively) that gives rise to DT – but by only $1m (i.e. 20% x $5m). So the $8m increase in DT seems unaccounted for.
Even if the $20m additions in the year got 100% tax deduction, the DT effect would be an increase of $4m (assuming 20% tax rate), so something is very wrong.
Lets say:
Cost: 2000, Depreciation: 500
Capital allowance y1: 800, y2: 600
Tax rate: 25%Carrying value in y1: 2000-500= 1500
Tax base: 2000- 800= 1200
Temporary difference= 300
Deferred tax liability: 25% × 300= 75Now lets says that depreciation has reduced to 400
Cv in y1: 2000-400=1600
Tax base: 1200
Temp.diff: 400
Defer tax liabilty: 25% ×400= 100Deferred tax liabilty has increased to 100= equivalent decrease in depreciation.
Is my understanding correct?
*So based on the scenario in the past exam it will increase but not significantly, may indicate overstatement of liability.
Correct – I have revised the calculation in previous reply – the difference in depreciation can account for only a small amount of the increase in DT liability.
- The topic ‘March/ June 2017 q1 a) laurel Group’ is closed to new replies.