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Hello Sir,
I don’t understand why in the following question they accounted twice for the deferred tax arisen from the revaluation of property .In the first time they correctly added to the deferred tax and the second time the substracted for the same event.
You will find it in their W3 working
please clarify this situation ,
Thanks,
_______________________________________________________________________________
QTRIAGE
After preparing a draftstatement of profit or loss(before interest and tax) for the year ended
31 March 20X6 (before any adjustments which may be required by notes (i) to (iv) below),
the summarised trial balance of Triage Co as at 31 March 20X6 is:
$000 $000
Equity shares of $1 each 50,000
Retained earnings as at 1 April 20X5 3,500
Draft profit before interest and tax for year ended 31 March 20X6 30,000
6% convertible loan notes (note (i)) 40,000
Property (original life 25 years) – at cost (note (ii)) 75,000
Plant and equipment – at cost (note (ii)) 72,100
Accumulated amortisation/depreciation at 1 April 20X5:
leased property15,000
plant and equipment 28,100
Trade receivables (note (iii)) 28,000
Other current assets 9,300
Current liabilities 17,700
Deferred tax (note (iv)) 3,200
Interest payment (note (i)) 2,400
Current tax (note (iv) 700
––––––– –––––––
187,500 187,500
––––––– –––––––The following notes are relevant:
(i) Triage Co issued 400,000 $100 6% convertible loan notes on 1 April 20X5. Interest is
payable annually in arrears on 31 March each year. The loans can be converted to
equity shares on the basis of 20 shares for each $100 loan note on 31 March 20X8 or
redeemed at par for cash on the same date. An equivalent loan without the conversion
rights would have required an interest rate of 8%.
The present value of $1 receivable at the end of each year, based on discount rates of
6% and 8%, are:
6% 8%
End of year 1 0.94 0.93
2 0.89 0.86
3 0.84 0.79(ii) Non?current assets:
The directors decided to revalue the property at $66.3m on 1 October 20X5. Triage Co
does not make an annual transfer from the revaluation surplus to retained earnings to
reflect the realisation of the revaluation gain However, the revaluation will give rise to
a deferred tax liability at a tax rate of 20%.
The property is depreciated on a straight?line basis and plant and equipment at 15%
per annum using the reducing balance method.
No depreciation has yet been charged on any non?current assets for the year ended
31 March 20X6.(iii) In September 20X5, the directors of Triage Co discovered a fraud. In total, $700,000
which had been included as receivables in the above trial balance had been stolen by
an employee. $450,000 of this related to the year ended 31 March 20X5, the rest to
the current year. The directors are hopeful that 50% of the losses can be recovered
from their insurers.(iv) A provision of $2.7m is required for current income tax on the profit of the year to
31 March 20X6. The balance on current tax in the trial balance is the under/over
provision of tax for the previous year. In addition to the temporary differences relating
to the information in note (ii), at 31 March 20X6 the carrying amounts of Triage Co’s
net assets are $12m more than their tax base.Required:
(a) Prepare a schedule of adjustments required to the draft profit before interest and
tax (in the above trial balance) to give the profit or loss of Triage Co for the year
ended 31 March 20X6 as a result of the information in notes (i) to (iv) above.
(5 marks)
(b) Prepare the statement of financial position of Triage Co as at 31 March 20X6.
(12 marks)
(c) The issue of convertible loan notes can potentially dilute the basic earnings per share
(EPS).
Calculate the diluted earnings per share for Triage Co for the year ended 31 March
20X6 (there is no need to calculate the basic EPS). (3 marks)
Note: A statement of changes in equity and the notes to the statement of financial position
are not required.
(Total: 20 marks)_____________________________________________________________________________
Answer
TRIAGE
(a) Triage – schedule of adjustments to profit for the year ended 31 March 20X6
$000
Draft profit before interest and tax per trial balance 30,000
Adjustments re:
Note (i)
Convertible loan note finance costs (W1) (3,023)
Note (ii)
Depreciation of property (1,500 + 1,700 (W2) (3,200)
Depreciation of plant and equipment (W2) (6,600)
Note (iii)
Current year loss on fraud (700 – 450 see below) (250)
Note (iv)
Income tax expense (2,700 + 700 – 800 (W3)) (2,600)
–––––––
Profit for the year 14,327
––––––(b) Triage– Statement of financial position as at 31 March 20X6
$000 $000
Assets
Non?current assets
Property, plant and equipment (64,600 + 37,400 (W2)) 102,000
Current assets
Trade receivables (28,000 – 700 fraud) 27,300
Other current assets per trial balance 9,300
––––––– 36,600
–––––––
Total assets 138,600
–––––––
Equity and liabilities
Equity
Equity shares of $1 each 50,000
Other component of equity (W1) 2,208
Revaluation surplus (7,800 – 1,560 (W2)) 6,240
Retained earnings (W4) 17,377
––––––– 25,825
–––––––
75,825
Non?current liabilities
Deferred tax (W3) 3,960
6% convertible loan notes (W1) 38,415
––––––– 42,375
Current liabilities
Per trial balance 17,700
Current tax payable 2,700
––––––– 20,400
–––––––
Total equity and liabilities 138,600
–––––––
(c) Diluted earnings per share (W5) 28.9 cents
Workings (monetary figures in brackets in $000)
Note: The $450,000 fraud loss in the previous year is a prior period adjustment
(reported in the statement of changes in equity). The possible insurance claim is a
contingent asset and should be ignored.(W1) 6% convertible loan notes
The convertible loan notes are a compound financial instrument having a debt
and an equity component which must both be quantified and accounted for
separately:
Year ended 31 March Outflow
8%
factor
Present
value
$000 $000
20X6 Interest – $4m × 6% 2,400 0.93 2,232
20X7 Interest 2,400 0.86 2,064
20X8 Capital + interest 42,400 0.79 33,496
–––––––
Debt component 37,792
Equity component (= balance) 2,208
–––––––
Proceeds of issue 40,000
–––––––
The finance cost will be $3,023,000 (37,792 × 8%) and the carrying amount of
the loan notes at 31 March 20X6 will be $38,415,000 (37,792 + 3,023 – 2,400).
(W2) Non?current assets
$000
Property carrying amount at 1 April 20X5 (75,000 – 15,000) 60,000
Depreciation to date of revaluation (1 October 20X5)
(75,000 × 6
/12) (1,500)
–––––––
Carrying amount at revaluation 58,500
Gain on revaluation = balance 7,800
–––––––
Revaluation at 1 October 20X5 66,300
Depreciation to year ended 31 March 20X6 (66,300/19.5 years
× 6
/12) (1,700)
–––––––
Carrying amount at 31 March 20X6 64,600
–––––––
Prior to the revaluation annual depreciation is $3m (75,000/25 years).
Therefore the accumulated depreciation at 1 April 20X5 of $15m represents
five years’ depreciation. At the date of revaluation (1 October 20X5), there will
be a remaining life of 19.5 years.
Of the revaluation gain, $6.24m (80%) is credited to the revaluation surplus and
$1.56m (20%) is credited to deferred tax.
Plant and equipment
$000
Carrying amount at 1 April 20X5 (72,100 – 28,100) 44,000
Depreciation for year ended 31 March 20X6 (15% reducing
balance) (6,600)
–––––––
Carrying amount at 31 March 20X6 37,400
––––––(W3) Deferred tax
Provision required at 31 March 20X6:
Revalued property and other assets (7,800 + 12,000) × 20%) 3,960
Provision at 1 April 20X5 (3,200)
–––––––
Increase in provision 760
Revaluation of land and buildings (7,800 × 20%) (1,560)
–––––––
Balance credited to profit or loss 800
–––––––
(W4) Retained earnings
Balance at 1 April 20X5 3,500
Prior period adjustment (fraud) (450)
Adjusted profit for year (from (a)) 14,327
–––––––
Balance at 31 March 20X6 17,377
–––––––
(W5) The maximum additional shares on conversion is 8 million (40,000 × 20/100),
giving total shares of 58 million. The notional saving in loan interest is $2.418m
(3,023 (from (W1) above × 80% (i.e. after tax)), giving adjusted earnings of
$16.745m (14,327 + 2,418).
Therefore diluted EPS is $16,745,000/58,000,000 = 28.9 centsHi,
It is a tricky one but the key factor is that the deferred tax on the revaluation goes through OCI and not through profit or loss.
To work out the movement in deferred tax that goes through profit or loss then we need to look at the total movement in deferred tax and then strip out the part that relates to the revaluation. What then remains is the amount that goes through profit or loss.
So, they have calculated the total deferred tax position as being the 3,960 liability, which would appear on the SFP. The opening deferred tax figure in the TB was the liability of 3,200 and hence a movement (increase) in the liability of 760. Under normal circumstances this would all go through profit or loss (DR SPL CR DT Liability) but it cannot as part of the closing figure of 3,960 is due to the revaluation gain in the year of 7,800.
There are several ways of looking at it next and what they have done in the answer is to say that the deferred tax balance at the year end that relates to the revaluation is 1,560. This figure will go through OCI so the journal entry to look at the movement would look like such:
CR DT Liability (total movement from earlier) 760
DR OCI (tax on revaluation gain) 1,560But this doesn’t balance as we’ve not included the movement through profit or loss. The additional entry required would be:
CR SPL (tax expense) 800
The other way to look at it would be to say that the opening liability is 3,200 and the closing is 2,400 (20% x 12,000) effectively ignoring the revaluation. The movement in the provision is a reduction to the liability of 800 and so:
DR DT Liability 800
CR SPL 800You could then look at the revaluation separately.
Thanks
The
Hello Sir,
Thanks for clarification. So it means that from the beginning we can ignore the deferred tax arisen from the revaluation and instead taking it to OCI.
But should this principle be applied to the tax base difference or that will be normally included in the P&L ,
Thanks,
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