If Rs Sample Booklet

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British library cataloguing-in-publication dataA catalogue record or this book is available rom the British Library.Published by:Kaplan Publishing Foulks Lynch

Unit 2 The Business CentreMolly Millars LaneWokinghamBerkshireRG41 2QZ

ISBN 978 1 84710 476 2

Clare Finch

Printed and bound in Great Britain.

All rights reserved. No part o this publication may be reproduced, stored in a retrieval system,or transmitted, in any orm or by any means, electronic, mechanical, photocopying, recording orotherwise, without the prior written permission o Kaplan Publishing Foulks Lynch.


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ContentsChapter PageAbout this book iii

1. Accounting standards- where we are and why? 1

2. IAS 1 Presentation o inancial statements 10

3. IAS 2 Inventories 21

4. IAS 7 Cash low statements 33

5. IAS 8 Accounting policies, changes in accounting

estimates and errors 43

6. IAS 10 Events ater the balance sheet date 55

7. IAS 16 Property, plant and equipment 69

8. IAS 18 Revenue 80

9. IAS 37 Provisions, contingent liabilities

and contingent assets 94

10. IAS 38 Intangible assets 102

Starting out The orange standards1

11. IAS 11 Construction contracts 105

12. IAS 12 Income taxes 112

13. IAS 17 Leases 124

14. IAS 20 Accounting or government grants

and disclosure o government assistance 142

15. IAS 23 Borrowing costs 16516. IAS 32 Financial instruments: presentation 180

17. IAS 33 Earnings per share 198

18. IAS 36 Impairment o assets 218

19. IAS 39 Financial instruments:

Recognition and measurement 226

20. IAS 40 Investment property 238

21. IFRS 5 Non current assets held or sale

and discontinued operations 249

22. IFRS 7 Financial instruments: disclosures 262

For the more advanced studentThegreenstandards2

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23. IAS 27 Consolidated and separate inancial statements 265

24. IFRS 3 Business combinations 281

25. IAS 28 Investments in associates 295

26. IAS 31 Interests in joint ventures 316

27. IAS 19 Employee beneits 319

28. IAS 21 The eects o changes in oreign exchange rates 328

29. IAS 24 Related party disclosures 342

30. IAS 29 Financial reporting in hyper-inlationary economies 354

31. IAS 34 Interim inancial reporting 372

32. IAS 41 Agriculture 386

33. IFRS 1 Firsttime adoption o international

inancial reporting standards 400

34. IFRS 2 Share-based payment 412

35. IFRS 4 Insurance contracts 42636. IFRS 6 Exploration or and evaluation o mineral resources 438

37. IFRS 8 Operating segments 452

AppendicesThe Key Cards orange standards 455

The Key Cards green standards 457

The Key Cards blue standards 459

The Key Cards red standards 461

Index

2

For those interested in group accountsThebluestandards23

2 For the seriously advanced!Theredstandards4

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About this book

Why do you need this book?

The most common reason or accountancy students ailing exams is that they tryto pass without learning their accounting standards WHY? They are sooooboring!!...... BUT it doesnt have to be like that..

This book is essential or all students sitting accountancy exams to internationalnancial reporting standards. Yes its a techie subject but this book is dierentbecause it:

makes IFRS/IAS accessible or you, the student

is the rst book to colour code and group the standards on a need toknow basis

tells the story behind the standards not just where we are but why ocuses on what the key need to learn essential points are or exam room

success uses memory techniques is written in a chatty, down to earth, understandable, style includes key cards excellent or testing yoursel.

This book is a companion guide to the accounting standards. It aims to make a

technical subject more digestible.

How to use this book

One o the problems with studying accounting standards is the size o the task. Thereare so many accounting standards that it can be dicult or a student to know whereto begin.

This book, uniquely, breaks the standards down, by diculty o topic. The standardsare then colour coded on a need to know basis.

The orange standards

The rst ten chapters are what we will reer to as the orange standards. These areessential reading or a student who is just starting out they cover the key basic areasthat will be met in most exam situations.

The green standards

As you progress through your studies you will meet more complex, less commontransactions. These standards will not eature on every exam and we will reer to themas the green standards.

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The blue standards

As well as being examined on individual company accounts, many exam papers, butnot all, ask or a consolidated set o accounts (reerred to as group accounts). I thatis the case you will need the blue standards.

The red standards

Finally we come to the red standards, these are the seriously advanced topics thatyou will need to get to grips with when you are say doing a nal level proessionalaccountancy exam.

Which onesdo youneed toknow?

The rst thing you need to know, thereore, is which ones are you expected to knowor your exam. You need to ask your tutor or a list or check your syllabus/guideto examinable documents to nd out exactly what is relevant to you. I you are juststarting your studies you may nd many o the more dicult ones are not examineduntil later stages you can pick up the book again and study these ones when theybecome relevant.

About the chapers

Books on accounting standards normally start each chapter with the aims, keydenitions etc. This book deliberately doesnt do that. Each chapter starts with thebackground o what the issue is that gave rise to the need or a standard. In this waythe scene is set or a better understanding o what the standard is about.The chapteronly then introduces the aims and SOWHATSITTRYINGTOACHIEVE? will become a amiliar line.

Transactional example

To ensure the understanding o what the issue is, each chapter then includes atransactional example (excluding those couple o standards which are ormat ratherthan transactional based). This allows the explanation and application o the standardto the issue.

The pitfalls

We all actually learn a lot rom making mistakes getting something wrong is usuallya sure way o making sure we get it right the next time we see it. We can shortcut

this process, however, by learning rom the mistakes o others. There are some errorsthat are very common student ater student will trip up at the same point. Beingorewarned o the issue helps you to learn rom students who have gone beore you.

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The definitions

We cant avoid it orever, however and once the understanding o the issue isanchored with a transaction, the denitions rom the standard are given. Note peopledo have variable learning styles and those o you who already have some comort with

the standard may like to turn rst to the denitions box rearm those and then readthe chapter.

Key need to learn bit

I you are acing a closed book exam, it will not be enough to just be comortable withthe subject matter and to eel you understand the issue there are some key needto learn bits or each standard. You will, thereore, have to commit some issues tomemory. These are highlighted or you as you go through the topic.

The memory devices

Each chapter contains a suggested memory device. It could be an acronym,mnemonic, cloud diagram or image-story technique. Remember however manylearners will benet rom constructing their own diagrams and creating their ownmnemonics

More about memory devicesThe human brain has evolved to code and interpret very complex stimuli, we all do thiseveryday. Limiting your learning to just reading words is not using your ull potential.While language, i.e. words on a page, refects one o the most important aspects ohuman evolution, it is only one o the many skills available to the human mind.

Most books, however, present the inormation to be remembered in only one way aswords. Memory devices seek to use a broader range o these resources. By codinglanguage and using images many people nd the inormation much easier to recall.The book gives you plenty o examples so you should easily nd yoursel preparing

ones that are personal to you.

Key points when preparing your own devices:

many people remember a diagram better than a list (this plays to the righthand side o the brain)

colour enhances memory invest in coloured pens smell is very evocative it triggers memory. Have you tried using the

scented pens that are available? try drawing your own cloud diagrams when listening to a lecture

when doing your own mnemonics, you can use risqu ones generallythe easiest to remember!

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This book gives you illustrations throughout o memory devices including mnemonicsand cloud diagrams or remembering key points rom accounting standards. Dontorget, however, learner generated devices are always the most eective.

(I do appreciate some people have no problem with words on a page a list does it

or them but hey we are all dierent.)

Summary guide to the symbols

Transactional Example

Pitfalls

Definitions

Key Need to Learn Bit

Memory Device

Key cards

Included, as an appendix, is a key card or each standard. These can be cut outrom the book on a as need basis. (Some students even laminate them!!) These arewritten in a question-driven style so you can take them on the train/take them to work/study in your lunch break. The question based approach means you can pass themto a riend who can then test you on the inormation, even i they dont know anythingthemselves. This is in the style o the classic revision technique o preparing the crib

card.

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Starting out

Knowledge is of two kinds. We know asubject ourselves or we know where we

can find information on it.Samuel Johnson (1709 1784)

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Introduction

IntroductionThere are nine accounting standards which orm the baseline position or anyonewho is starting out studying nancial accounting, preparing their nancial statements

to the standards o the international accounting standards board (IASB).

- IAS 1 Presentation o Financial Statements- IAS 2 Inventories- IAS 7 Cash Flow Statements- IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors- IAS 10 Events Ater the Balance Sheet Date- IAS 16 Property, Plant and Equipment- IAS 18 Revenue- IAS 37 Provisions, Contingent Liabilities and Contingent Assets

- IAS 38 Intangible Assets

However, underpinning the accounting standards is The Framework Document. Thisis arguably the most important examinable document or any accounting studentto be amiliar with. This is covered in chapter 1 AccountingStandardsWhereweareandwhy? Do not be tempted to miss this chapter, the concepts and buzzwords you are introduced to or reminded o here are key to success in many nancialaccounting exam questions. Do not be tempted to skip this one!

You do not really understandsomething unless you can explain it to

your grandmother

Albert Einstein

NoteManybooksonaccountingstandardsstartbygivingyoutheaimsanddefinitionsfromthestandard.Thisbookdeliberatelydoesnotstructurethechaptersinthatstyle.Insteadtheissueisgenerallyexplained,withthesortoftransactionsthatthestandardrelatestobeingintroduced.Wedogettotheaimsanddefinitionandforthoseofyouwhoalreadyhavesomecomfortwiththestandard,youmayliketoturnfirsttothedefinitionsboxre-affirmthoseandthenreadthechapter.


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Accounting

standards wherewe are and why?

Introduction

ONCE UPON A TIMEaccounting students only had to get to grips with themechanics o double-entry bookkeeping and they could produce a set o accountsor any organisation. Deinitions were simple Abalancesheetisasummaryofassetsandliabilities we were told assetsarethingsweownandliabilitiesarethingsweowe. This was the staple diet o accounting lecture number 1 orthose o us who trained beore the late 1980s. Unortunately we didnt get to livehappilyeverafter and we constantly have to learn new tricks and keep up withchange. The modern accountancy student has a huge list o accounting standards toget to grips with as well as the mechanics o double-entry bookkeeping. Deinition oan asset well its not as simple as somethingyouown anymore!

The fairy tales or creative accounting

Unortunately the accountancy proession has shown itsel to be very able in thepractices o earnings management/ o balance sheet inance/window dressing whatever we call it, it involves deliberately structuring a series o transactions andexploitation o loopholes in rules - creative accounting, thinking about presentationrom what the company wants to show rather than the needs o the reader o theinancial statements. Two key hotspots exist; manipulation o proit and o liabilities.Firstly, showing proit as a steady upward movement can give the impression o

quality earnings. This makes it easier or the company to present its results to themarket. The second hotspot is under-reporting o liabilities i.e. o balance sheetinance. This is why modern day accounting students have so many accountingstandards to learn we really should blame ourselves (or other accountantsanyways!!)

Needs of users

Accounting standards have always been about the needs o users. The International

Accounting Standards Board (IASB) who produce the International FinancialReporting Standards (IFRS) are actually not interested in what companies wanttheir annual reports to show. Their job is to ensure that accounting standards helpproduce high quality, transparent and comparable inormation. In this way inancialstatements should help users make economic decisions.

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Accountingstandardswhereareweandwhy?

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Traditional approach to accounting

standards fire-fighting

Traditionally standard setters in many countries waited or there to be a corporate

collapse or other orm o bad publicity beore issuing an accounting standard tochange accounting practice waiting as it were, or the horse to bolt beore closingthe stable door. A classic example rom the UK was the collapse o the packageholiday business, Court Line Ltd. This company collapsed ater receiving a clean auditreport or a balance sheet showing shareholders unds o 18m. The shareholdersquite correctly asked what was the value in these inancial statements. As modernday accountants we would ind this balance sheet interesting and hopeully wouldhave raised questions.

The Court Line Ltd balance sheet

As Court Line were generating revenue by transporting people rom the UK to thecontinent (or their package holidays) we would have expected to see the aircratinvolved in their transport on the balance sheet. However the aircrat were not onthe balance sheet as Court Line had not bought the planes but had entered into alease agreement and thereore Court Line was not the legal owner. Under GenerallyAccepted Accounting Practice (GAAP) o the time, the aircrat and more importantlythe obligation to make payments to the leasing company which stood at 40m werenot required to be on the balance sheet. Court Line was ollowing the legal orm o

the transaction i.e. the leasing company were the owners o the aircrat, notCourt Line.

Needs of users?

Neither the shareholders nor the creditors ound it believable that accountants couldconsider that non-disclosure o a liability o 40m which dwared the shareholdersunds igure o 18m could be classed as giving a true and air view. Clearly therewas a need or an accounting standard. International Accounting Standard 17 (IAS17) would now require these aircrat and the associated obligation be brought on

balance sheet. The substance o the transaction was that the directors had boughtaircrat or their exclusive use with the inance being provided by the leasing company- in commercial reality terms no dierent to buying the asset on credit a inancedeal. These assets would now be dealt with as Finance leases which are required tobe capitalised shown on balance sheet along with the associated debt.

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Rules v principles

The problem with a ire-ighting approach to producing accounting standards is thatit tends to close one loophole with some rules as to how a transaction must nowbe accounted or, but doesnt stop the underlying problem. i.e. Having rules about

inance leases did not stop o balance sheet inance it just stopped one particularscheme companies simply came up with other methods. Modern accountingstandards, thereore, are based on principles rather than rules.

The Framework document

The Framework document was issued in 1989. Instead o producing standardsin a ire-ighting way, the Framework provides assistance that the IASB will use inthe development o accounting standards. It is based on the ocus that inancial

statements are prepared or the purpose o providing inormation that is useul inmaking economic decisions.

Aspects o the Framework document are vital or any accountancy student to learn.I you understand the key parts o the ramework document, it acts as a get outo jail ree card in many written questions on accounting standards. You will earngood marks by deaulting to the principles contained in the ramework document,especially when asked to explain why in reerence to any accounting standard.

Objective of financial statements

You must learn the objective o inancial statements, the qualitative characteristics oinancial statements and the underlying assumptions. These are a 'need to learn'.

At the user

The objective o inancial statements is to provide inormation about theinancial position, perormance and changes in inancial position o an entitythat is useul to a wide range o users in making economic decisions.

Sowhat's it trying to achieve?

The Frameworkdoes not have the orce o a Standard. Instead, its purposesinclude, irstly, to guide and assist the International Accounting Standards Board(IASB) as it develops new or revised standards and, secondly to assist preparers

o inancial statements in applying Standards and in dealing with topics thatare not addressed by an accounting standard. I, thereore, there is a conlictbetween the Frameworkand a speciic standard, the standard prevails over theFramework.


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The ramework does note that inancial statements principally convey theinancial eects o historic events, but they should allow users to makeeconomic decisions, such as whether to buy, sell or hold an investment inthe entity.

Qualitative characteristics of financial statements

ComparabilityComparability is a key qualitative characteristic o inancial statements.Inormation provided or one period must be comparable with that providedor the previous period.

ConsistencyIn order to achieve comparability, inormation must be given consistently rom

one period to another and accounting policies must be ully disclosed

UnderstandabilityUnderstandability is also a key qualitative characteristic o inancialstatements. Inormation should be comprehensible by users equipped with areasonable knowledge o business and economic activities and accounting.However the ramework notes that inormation should not be excluded romthe statements on the grounds that it may too complex or some usersto understand.

Relevant and ReliableThe inal two qualitative characteristics are providing inormation that isrelevant to the needs o the user whilst being reliable as in ree rom bias andmaterial error. The Framework recognises that there is a trade o betweenthese two which needs careul management.

Reliability includes the ollowing qualities: aithul representation, substanceover orm and neutrality. A key concept or students is that o substance overorm. For inancial statements to be reliable the economic substance o atransaction must be relected not the legal orm. By economic substance wemean 'commercial reality'.

Underlying assumptions concern

Accruals and going concernAccruals and Going Concern are two principal underlying assumptionsadopted whenever we are preparing inancial statements. You will havelearnt about these rom your irst introduction to double- entry bookkeeping.Although many modern accounting standards ocus on the balance sheetprimarily, the going concern and accruals concept are still bedrock to thepreparation o inancial statements.



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Even i you didnt know any accounting standards you could answer this questionrom the principles o the Framework document. See below:

The frameworkThe Framework describes the elements o inancial statements as broad classes oinancial eects o transactions and other events.

Definition of an assetAn asset is a 'resource controlled by the entity as a result o past events and romwhich uture economic beneits are expected to low'.

Payment of a fineThe payment o a ine does not meet this deinition. Future economic beneits will notlow to the entity as a result o paying this ine. It is not a resource controlled by thecompany.

Inappropriate treatmentIt is inappropriate to treat this transaction as an asset, the payment o the ine isactually a cost to the company and needs to be treated as such.

Definition of an expenseExpenses are decreases in economic beneits during the accounting period in theorm o outlows or depletions in assets or incurrences o liabilities that result indecreases in equity, other than those relating to distributions to equity participants.

The fine should be charged against profitClearly the payment o this ine decreases economic beneit and incurs a liabilityor the company that will result in a decrease in equity (shareholders unds)- it is anexpense to be charged against current year proit.

SummaryBylearningthedefinitionsoftheelementsoffinancialstatementsyoucan

applytheframeworktotransactionsevenifyoudontknowthespecific

standardyouwillbedoingaverygoodanswer.

Transactional exampleJamieIncwasfinedforthereceiptofillegalstatesubsidiesof$600millionthatwereusedtooffsettradelossesinpreviousyears.JamieInchastorepaythegovernmentthe$600millionplusinterestof$320million.Theyhavedecidedtotreattherepaymentasanintangibleassetwhichisbeingamortisedovertwentyyearswithatwentiethbeingchargedinthecurrentyearaccounts.Youneedtodiscusswhethertheaccountingtreatmentisacceptable.

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6

Cloud diagrams

Sorry but you need to know... DEFINITIONS

The elements of financial statements

The Framework also gives deinitions or the elements o inancialstatements- clearly all accounting students need to be able to deine anasset and a liability when answering questions.

Assets an asset is deined as a resource controlled by the entityas a result o past events and rom which uture economic beneitsare expected to low to the entity.

Liabilities a liability is deined as a present obligation o the entityarising rom past events, the settlement o which is expected

to result in an outlow rom the entity o resources embodyingeconomic beneits.

Equity the residual interest in the assets o the entity aterdeducting all o its liabilities.

Income increases in economic beneit during the accountingperiod in the orm o inlows or enhancements o assets orincurrences o liabilities that result in increases in equity, other thanthose relating to distributions to equity participants.

Expenses decreases in economic beneits during the accountingperiod in the orm o outlows or depletions in assets or incurrences

o liabilities that result in decreases in equity, other than thoserelating to distributions to equity participants.

These deinitions are ABSOLUTELYMUSTLEARNS or allaccountancy students.

As explained in the 'About this book' section, dierent students have dierent learningneeds. When aced with a 'need to learn' area you have to decide what works bestor you. For some learners the words on the page are adequate but or many there arebetter ways to aid recall.

Remember the human brain can code and interpret rom a variety o stimuli, justreading the words is only one way available. Some when aced with the task OKso I need to remember the ive elements o inancial statements will beneit romdrawing a diagram see the ollowing cloud diagram as an example.

This plays to the strengths o the right hand side o the brain, which has been provento recall colour and diagram better than black and white writing.



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The

elements

of financialstatements

Assets

7

Pitfalls

When using mnemonics students need to be careul to apply it to the particularquestion dont try to get all 8 parts o ACCURATE into every explain why. In thesolution here we have used

- At the user- Understandability- Relevance- Elements o inancial statements (deinitions o assets/liabilities)

Remember each answer is dierent apply/apply/apply

The Framework document does not say inancial statements must beACCURATE but students may ind it useul as a mnemonic:

Attheuser

Comparability

Consistency

Understandability

Relevance&Reliability

Accruals&GoingConcern

Timely

ElementsofFinancialStatements

Key to the success o students is the use o such words whenattempting written questions, particularly ones asking them toExplain why

Liabilities

EquityIncome

Expenses



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8

Conclusion

Key to the success o students is the use o such words as ACCURATE whenattempting written questions, particularly ones asking them to Explain why. TheFramework document will be central to the success o accounting students at all

levels. It may appear to be painul to learn deinitions o the elements, but hey youhave chosen to study accountancy, so it hardly seems unreasonable. The sooner youdo so, the easier it will be to get to grips with the standards as they are based out othese deinitions.



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The green standards

not everything that can be countedcounts and everything that counts can

be counted.Albert Einstein (1879 1955)

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IAS

12-IncomeTaxes

IAS 12 - Income taxes

Introduction

In this world nothing can be said to be certain, except death and taxesBenjamin Franklin (1706 1790)

An old quote maybe, but as true today as it was then. Dierent countries will havedierent tax rules and the tax requested may get called by dierent names such ascorporation tax or income tax, but at the end o the day i a company makes proit,they will certainly have to pay tax on that proit.

Well, you may ask, companies pay lots o expenses rent, electricity, telephone, Whyis tax so dierent that it needs an accounting standard? It is true that accounting orthe tax o companies could be so easy (maybe it is in a parallel universe!). Imagine aworld where the tax rules simply said take your calculation o proit rom the income

statement and multiply it by say 30% hey presto we have a tax expense and thecompany has a liability to the tax authorities. That, however, is not our world (and itkeeps accountants in work!!)

Why can life never be that simple?

Well it couldnt be could it! Unortunately or most countries the way proit iscalculated or accounting purposes is not the same as the way proit is calculated ortax purposes. In addition to preparing the income statement down to proit beoretax, companies will then need to do a working o their taxable proit. It is this taxable

proit that orms the basis o the tax computation commonly known as the taxcomp. As accounting proit is dierent to taxable proit, accounting or tax becomesa subject o two parts: current tax and deerred tax.

Current tax

Current tax is not a problem. Once tax is estimated based on taxable proit (i.e. thetax comp is done) it becomes a current tax liability. It will be debited to the incomestatement and credited to current liabilities.

Tax rates used to calculate current tax should be those that have been enacted bythe balance sheet date. This will include those substantially enacted by the balancesheet date.

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IAS12IncomeTaxes

Deferred tax

This then is the problem child recognising and dealing with the act that becausethe accounting proit is not the same as taxable proit there may be uture taxconsequences based on current period transactions. This is what we call

deerred tax.

Temporary differences

In order to make any sense o IAS 12 we need to look at what happens when weprepare accounts, using the simple approach - only accounting or current tax andignoring uture (deerred) tax consequences.

A company could possibly report an accounting proit o say $200,000 and yet berequired to pay no current tax.

This is because o temporary dierences, which distort the timing o when tax is paid.The normal eect o temporary dierences is to delay when tax is paid (i.e deer) and,as result there will be a need to provide or a deerred tax liability to ensure that thetax eects o transactions are reported in the same period when they are recognised.This is simply an application o the matching/ accruals concept to tax.

It is possible or temporary dierences to accelerate the timing o when tax is paid, inwhich case, although not as commonly, this will reduce the amount o the deerredtax liability or maybe create a deerred tax asset. It is impossible to understanddeerred tax until we understand timing dierences. This concept is best understoodwith an example as ollows.

So...What's it trying to achieve?IAS 12 aims to provide guidance on accounting or the current and uture taxconsequences o the uture recovery or settlement o assets and liabilities, andtransactions and other events that have occurred in the same period.

Transactional exampleLetusassumethatTyrrellmakesupfinancialstatementsto31Decembereachyear.On1January20X1thecompanypurchasedapieceofequipmentfor$40,000thathadananticipatedusefuleconomiclifeoffouryearsbutqualifiedforimmediatetaxreliefof100%ofthecostoftheasset.Fortheyearending31December20X1thedraftaccountsofthecompanyshowedaprofitbeforetaxof$100,000.Thedirectorsanticipatethatthislevelofprofitwillbemaintainedfortheforeseeable

future.Tyrrellpaystaxatarateof30%.Apartfromthedifferencescausedbythepurchaseofthenon-currentassetin20X0therearenootherdifferencesbetweenaccountingprofitandtaxableprofitorbetweenthetaxbaseandnetbookvalueofnetassets.


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This illustrates the key issue irstly the common major dierence betweenaccounting proit and taxable proit relates to the dierence in treatment o non-current assets. We, as accountants, will spread the cost o the asset over 4 yearsincome statements. This is an application o the matching concept the equipmenthas a useul economic lie o 4 years and we will depreciate the asset over that

period. Most tax jurisdictions, however, do not accept the depreciation expense aspart o the calculation o taxable proit. Instead the tax authorities allow companies atax allowance when they purchase non-current assets.

The tax comp will usually involve taking accounting proit and adding back thedepreciation expense. We can then deduct the tax allowance to get taxable proit.This orms the basis o the tax calculation. I we account or current tax based onthis calculation but ignore the deerred tax we will seriously misstate the accounts,particularly in the year we purchase a non current asset.

BasedontheexampleofTyrrellaboveassumeyouaretheaccountantpreparingtheincomestatementfortheyearended31stDecember20X1,andthatyouhavenoknowledgeorunderstandingofdeferredtax.

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Tyrrell

Income Statement (extract) or the year ended 31st December20X1(ignoringdeferredtax)

20X1$000

Proit beore tax 100Current tax at 30% ( see tax comp at working 1) (21)

Proit ater tax 79

To estimate the current years tax you would need to have on ile a tax computation

(as below). This would involve taking current year accounting proit and irst o alladding back depreciation. You would then deduct the tax allowance to get taxableproit. This is multiplied by the tax rate (here 30%) to get the current tax liability-

DR Income Statement tax expense

CR Balance sheet current tax liability

Income

Statement


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The can you sleep at night? test

By ignoring deerred tax you are presenting the accounts o Tyrrell as showing proitater tax o $79,000 (100,000- 21,000). You prepared them the test is can yousleep that night?

Paul Browne now wishes to buy this company and he speaks to the owner who isconident this trading outcome o $100,000 proit beore tax can be delivered or thethree ollowing years using this one piece o equipment. Paul is delighted, he is not anaccountant but buys the company believing next years accounts will show proit atertax o $79,000 just like the 20X1 accounts.

The director was true to his word, trading proit o $100,000 was indeed delivered you again do the accounts.

Workings

W1 Tax computation

20X1$000

Accounting proit 100Add back depreciation(40/4years) 10less capital allowances (40)

Taxable proits 70

Current tax at 30% 21

Tyrrell

Income statement (extract) or the year ended 31st December 20X2 withcomparators (stillignoringdeferredtax)

Income 20X1 20X2$000 $000

Proit beore tax 100 100Current tax at 30% (W1) (21) (33)

Proit ater tax 79 67

IncomeStateme

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Oh dear! Paul, the new owner is now grumpy!

You now have to break the news that this year the tax estimate or current tax is notthe $21,000 it was last year but an unpleasant $33,000!! See the tax comp workingbelow. Paul, not surprisingly, is not happy with you:

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Workings W1 Tax computation

20X1 20X2$000 $000

Accounting proit 100 100Add back depreciation 10 10less capital allowances (40) -

Taxable proits 70 110

Current tax at 30% 21 33

In the year you bought the equipment you beneited rom a temporary dierencewhich artiicially reduced your tax bill. This was not a permanent reduction in taxbut simply a postponement a deerral. In act i you look at the X1/X2/X3 and X4

accounts, you will ind that in act i Tyrrell does make a constant trading proit o$100,000 a year or the our years i.e $400,000 total, they will over the our years pay$400,000 x 30% tax= $120,000.

Year ended 31 December Total20X1 20X2 20X3 20X4$000 $000 $000 $000 $000

Accounting proit 100 100 100 100 400Add back depreciation 10 10 10 10 40less capital allowances (40) - - - (40)

Taxable proits 70 110 110 110 400

Current tax at 30% 21 33 33 33 120

The dierences between the accounting proit and the taxable proit thatoccur rom one year to another, cancel out over the our years as a whole.


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Ignoring deerred tax produces a perormance proile that appears to suggest adeclining perormance between 20X1 and 20X2. In act the decline in proits iscaused by the timing o the current tax charge on them. Yes, in the year they boughtthe asset, their tax bill was pushed down to $21,000 but in the next three years it hasgone up to $33,000. This is not a surprise, we know that these temporary dierencesarise, we know they cause a temporary deerment o tax and we should haveaccounted or the deerred tax i the accounts are to present airly.

The original income statement we prepared did not present airly because we haveignored the deerred tax. We have misled Paul Browne, he is right to be crossandno we shouldnt have slept that night.

What should we have done to sleep soundly? Well,

recognised the deferred tax of course:

I we have a temporary dierence we should have had a working 2 on our ile. It is notenough just to calculate the current tax, we have also to calculate the amount o taxwe have deerred and to make a provision in the balance sheet. To get the provision

on the balance sheet we charge the income statement.

So what does this Working 2 look like?

We calculate a deerred tax provision based on a temporary dierence. We havea temporary dierence i the igure on the balance sheet the Net Book Value isdierent to its tax base i.e its tax written down value the amount that can be setagainst uture tax bills.

I we ignore deerred tax we get the ollowing income statements or eachperiod and or the our years as a whole:

Yearended31December Total

20X1 20X2 20X3 20X4$000 $000 $000 $000 $000

Proit beore tax 100 100 100 100 400Current tax at 30% (21) (33) (33) (33) (120)

Proit ater tax 79 67 67 67 280

IncomeSta

tement


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I you want a memory device or remembering this working an image storymethod might work or you

Imagine a CD on top o a TV with a teddy (TD) under the TV

Decode it:

C-D (Cost Depreciation)TV (Tax Value)TD (Temporary Dierence)

Where we have a temporary dierence, i.e. when the cost - depreciation (carryingvalue o the asset) is dierent to the cost tax allowances taken (tax base or taxwritten down value) we have a deerred tax issue. Here the temporary dierence is is

$30, we multiply it by the current rate o tax. This tells us the amount to provide onthe balance sheet $30 x 30% = $9 provision or deerred tax is required.

To achieve this we:Dr Income statement Tax charge Transer to deerred tax

Cr Balance Sheet Provision or deerred tax

I we had done this our income statement in the year we purchased the equipmentwould have looked like this:

This is the key working for all deferred tax

questions - learn it

Working2Deferredtaxprovisionrequiredforbalancesheet

20X1$000

Cost Depreciation (NBV) (40 10) (Carrying Value) 30Tax Value (WDV) (40 40) (Tax Base) Nil

Temporary dierence at year end 30

Closing deerred tax liability [30%] 9


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Tyrrell

Income statement or the year ended 31st December 20X1 (afteraccountingfordeferredtax)

20X1

$000Proit beore tax 100Current tax (W1) (21)Deerred tax(W2) (9)

Proit ater tax 70

IncomeStatement

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This has eectively accounted or all tax on current year transactions, whether currentor deerred. This what we mean by provide in ull or all temporary dierences or

use ull provision method or deerred tax.The accruals concept is being applied totax and the tax charge is shown as 30% o accounting proit we can once againsleep at night!!

Every accounting period would require us to revisit and recalculate any temporarydierences. We calculate the required provision on the balance sheet and use theincome statement entry to either increase or reduce the balance. We can illustratethis with Tyrrell Ltds 20X2 accounts:

Firstly we need to recalculate the temporary dierence, noting the asset will now

have been depreciated by two years not one. This will be reducing the temporarydierence to 20;

(W2)Taxdeferred

20X2$000

Cost- Depreciation (40 10 10) (carrying value) 20Tax Value (40 40) (tax base) Nil

Temporary dierence at year end 20

Closing deerred tax liability [30%] 6Opening deerred tax liability (9)

So charge/(credit) to income (3)


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No shocks here or Paul Browne!!

At 31 December 20X4 the temporary dierence is gone and no deerred taxprovision is required see the our year eect below:

Tyrrell

Income statement or the year ended 31st December 20X2(includingdeferredtax)

20X1 20X2$000 $000

Proit beore tax 100 100Current tax (21) (33)Deerred tax (9) 3

Proit ater tax 70 70

IncomeStateme

nt

(W2)Taxdeferred

Yearended31December

20X1 20X2 20X3 20X4$000 $000 $000 $000

Cost Depreciation (carrying value) 30 20 10 NilTax Value Nil Nil Nil Nil

Temporary dierence at year end 30 20 10 Nil

Closing deerred tax liability [30%] 9 6 3 Nil

Opening deerred tax liability Nil (9) (6) (3)

So charge/(credit) to income 9 (3) (3) (3)

As the temporary dierence has reduced then so does our calculation o the deerredtax provision. We already have a provision o $9,000 and we now need to reduce it to$6,000. The entries required would be:

Dr Balance sheet $ 3,000(9,000 6,000)

- Provision or deerred tax

Cr Income statement $3,000- Transer rom deerred tax

For the 20X2 accounts the income statement would look like this:


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By accounting or deerred tax we are showing proits o $30,000 each year or theour trading periods. Total tax remains as $120,000 but the way it is being presentedrelects the accounting concept o accruals.

Deferred tax assets

Most companies experience temporary dierences like we have just seen in Tyrrell.This means that i they have an asset on the balance sheet whose tax base (amountthat can be charged against uture tax) is lower than the net book value o the asset.This means they have postponed tax and need a deerred tax liability on the balancesheet.

It is possible that the company will have a deerred tax asset, however. The mostcommon example o a temporary dierence which gives a potential asset is acompany with unused tax losses. This is not shown anywhere on the companiesbalance sheet it has a nil carrying value, but it does have a tax value (oten reerredto as a tax base) it may be utilised to oset a uture tax bill. We dont however just

automatically put a deerred tax asset on a balance sheet. We would have to beconvinced that the asset will be recoverable. This would mean that it was probablethe company will return to proit, only then will be able to take the beneit.

The income statement (extracts) or the our year period includingdeferredtax are shown below:

Yearended31December Total

20X1 20X2 20X3 20X4$000 $000 $000 $000 $000

Proit beore tax 100 100 100 100 400Current tax (21) (33) (33) (33) (120)Deerred tax (9) 3 3 3 Nil

Proit ater tax 30 30 30 30 280

IncomeS

tatement


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And the really important stuff... Accounting

practice

Recognition

Current tax should be recognised as a current asset or liability.

Deerred tax is provided infull on all temporary dierences (a balance sheetcalculation approach), except or any relating to non deductible goodwill and assetspurchased that are ineligible or tax allowances.

Deerred tax assets can be provided (mainly or tax losses) provided it is probable thatthe asset will be recovered.

Measurement

Deerred tax must not be discounted to present value

The tax rate used should be the one when the dierences reverse, however based onlegislation enacted or substantially enacted by the balance sheet date.

Presentation

Deerred tax is always presented as a non-current item on the balance sheet.

I the item giving rise to the deerred tax is in reserves (or example a revaluation o an

asset), then the deerred tax should be recognised in reserves.

Sorry but you need to know... DEFINITIONS

Currenttax is the amount o income taxes payable (recoverable) inrespect o the taxable proit (tax loss) or a period.

Temporarydifferences are dierences between the carrying amount oan asset or liability in the balance sheet and its tax base. Temporarydierences may be either taxable (giving rise to deerred tax liabilities) ordeductible (giving rise to deerred tax assets).

The taxbase o an asset or liability is the amount attributed to thatasset or liability or tax purposes i.e its tax value.


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Disclosure

There are extensive disclosure requirements or tax including a reconciliation o the

accounting proit to the total tax charge.

Conclusion

As you progress with your studies deerred tax will become an increasingly importanttopic. There are many dierent circumstances that could give rise to deerred tax.What is important is that you are clear on your understanding o what a temporarydierence is. I you get that you can apply it to any situation, with a bit o practice.


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Documents

If Rs Sample Booklet