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Hello sir,
sometimes at the question ask that tax will be given when it arises or following year. My question is if the assets in shown at year 0 (start of the project) then what will be impact of this 2 way, how we will show in our NPV calculation.
thanks in advanceTime 0 is the start of the first year.
The first capital allowances will be calculated at the end of the first year (time 1).
If there is no delay in the tax then the first tax effect will therefore be at time 1.
If, on the other hand, there is a 1 year delay in paying tax, then the first tax effect will be at time 2.
There are two ways of showing it in the actual cash flows (and both ways give the same answer, and are both equally acceptable).
You either subtract the allowances from the operating cash flow, then calculate the tax, then add back the allowances (because they are not a cash flow).
Or alternatively, you calculate the tax on the operating cash flow, and then separately calculate the tax saving on the allowances.
If you are not sure about any of the above then do watch our free lectures. (For this, best would first be to watch the Paper F9 lecture on investment appraisal with tax, because it is revision from Paper F9)
Sir, i have a confusion here. If the asset purchased on last day of previous year. So we write asset amount at year 0 . Okay. Then if the rule is mentioned that the tax will be in arrears. Means 1 year delay. So then we will take first tax saving on capital allowance in year 1 but the tax payment will be written in year 2 cause of 1 year delay rule is mentioned. So inshort, tax payment will not come in year 1 but the tax savings will be taken.
Am i right?There is no such thing as year 0.
0, 1, 2 etc are not years but points in time that are 1 year apart (so that we can discount in whole years).
Time 0 is the start of the first year.
Time 1 is the end of the first year and start of the second year
Time 2 is the end of the second year and start of the third year, and so on.
Unless (obviously) told differently, operating flows (revenue, expenses) occur at the ends of years, so the first years revenue is a time 1, the second years revenue is at time 2 and so on.
Capital allowances are always calculated at the end of the accounting period in which the asset was purchased.
If the asset was purchased on the last day of the previous year (time 0), then the capital allowances would be calculated immediately (even though they were only bought on the last day). Therefore if there is no delay in tax then the first tax saving would be at time 0. With a 1 year delay in tax, the first saving will be at time 1.
However, this is very very unlikely in the exam. Unless specifically told differently we assume that assets are bought on the first day of an accounting period.This problem is only ever likely to be relevant in a lease/buy question (because there aren’t really any other problems the examiner can bring in on those questions 🙂 )
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