Advanced Accounting and Financial Reporting - Assignment Example

Advanced Accounting Name: Course Professor’s name University name City, State Date of submission Part A Having received and reading through the extracts to the financial statements, congratulations are in order for a job well done. However, some areas need corrections, and these are noted below. Numerical errors. There seems to be a numerical error in calculating profit before tax. You have indicated $610,000 while the books read $820,000. Interest revenue The figure has been correctly deducted as the company is yet to receive any cash for its investments. Tax will become due when cash is received as the end of the calendar year. From the extract, the deduction from accounting profit is correct. However, its addition later on is not correct aas tax authorities treat interest revenue only after it has been received in cash. Therefore, the addition of $14,000 should not have occurred as the company is yet to be paid for its investments. Depreciation For accounting purposes, the applicable depreciation is $15,000, which is the result of depreciating a vehicle that cost $60,000 over a four-year period. The motor vehicle depreciation rate is 20%. Therefore, the annual depreciation for tax purposes for a car that cost $60,000 is $12,000 ($60,000*20%). Instead of depreciating the machinery on a straight-line basis over a ten-year period with a residual value of $10,000, tax authorities depreciate machinery on a straight-line basis without residual value. Therefore, it would take five years to depreciate a machine that cost $210,000 at the annual rate of $42,000. These differences have an impact on the gross taxable income. The machine was bought at the beginning of 2007. Its cost of $210,000 had been exhausted by the end of 2012. Its depreciation does not qualify for any tax deductions. The right procedure for depreciation is as follows. 1. Add back the entire motor vehicle depreciation of $15,000 to accounting profit before tax to remove the expense that had been earlier recognized in arriving at the accounting profit of $820,000. 2. Now that the depreciation for motor vehicle has been removed, deduct the correct depreciation for tax purposes of $12,000. 3. Regarding depreciation on machinery, add back the accounting figure of $20,000 to accounting profit before tax. However, unlike motor vehicle depreciation, there is nothing to deduct as machinery depreciation in calculating tax due as the value of machinery had been exhausted in 2012 meaning that the applicable depreciation is now zero. Goodwill Goodwill is not deductible for tax purposes. Therefore, the only treatment necessary is to add back goodwill impairment to accounting profit before tax. Entertainment expense In a step similar to goodwill, add back the accounting amount of entertainment expense. This is an amount of $12,000. Insurance There is an error in arriving at the deducted figure of $14,000 because the opening debit balance in the prepaid insurance account was $18,000 at the beginning of the current year. At the end of 2013, the account had a prepayment of $24,000. The company expensed a total of $20,000 to its profit and loss statement. Therefore, to arrive at the amount of cash paid for insurance over the year the correct calculation ought to be: guise $24,000+$20,000-$18,000=$26,000. Therefore, the right insurance amount to deduct from accounting profit is $26,000. Annual leave costs Annual leave is only accounted for tax when it has been paid. Therefore, the correct step is to add back the profit and loss figure of $12,000. The next step is to deduct what has actually been paid as annual leave costs, and this amounts to $14,000. Provision for warrantees Tax treatment for warrantees’ expense is on a cash basis. In arriving at this figure, correct the following. First, add the profit and loss amount to the balance carried forward from the previous period. From this sum, deduct the amount carried forward to the next accounting period. Numerically, this is done as shown below: $20,000+$15,000-$22,000=$13,000. Now that you have the cash paid in warranties, proceed as follows. Add back the warranties expense as reported in the company’s profit and loss statement. Thereafter, deduct the cash amount paid for warranties expense. The statement below is illustrative of the above comments and corrections. Profit before tax 820,000.00 For reverse accounting treatment Deduct: Interest revenue (14,000.00) (14,000.00) Add: Depreciation expense-vehicle 15,000.00 Depreciation expense-machinery 20,000.00 Insurance 20,000.00 Annual leave expense 12,000.00 Warrantte expense 15,000.00 Impairment loss for goodwill 10,000.00 Entertainment expense 12,000.00 104,000.00 For taxation treatment Deduct: Depreciation-machine - Depreciation-vehicle (12,000.00) Insurance (26,000.00) Annual leave (14,000.00) Warrantee expense (13,000.00) (65,000.00) Taxable income 845,000.00 Income tax 253,500.00 Income after tax 591,500.00 To journalise the income tax derived above, the following entries should be made: Dr. Income tax expense $253,500 Cr. Current tax liability $253,850 Worksheet corrections From the worksheet, it is clear you have in the mind that temporal differences do arise out of the differences in how tax authorities treat income items and how accountants treat the same expenses. However, some errors have been observed and explained below. For the purposes of this worksheet, it is important to keep in mind the following formulas: Asset Tax base (TB) =carrying amount (CA)-future deductible tax amount (FB) + future deductible amount (FD). Liability tax base = carrying amount – future deductible amount Advance revenue tax base = carrying amount – revenues received in advance not liable for tax in future. When the carrying amount is greater than the tax base, a tax liability arises because the difference means that in future the company will have to pay tax as the tax base is yet to be exhausted. On the other hand, if the tax base is lower than the carrying amount, a tax asset arises because the tax authorities already owe the company some cash and this fits the proper description of a liability. That said, my corrections are observed below. There are numerical errors on the worksheet. For instance, the carrying amount for inventory has been entered as $110,000 but the tax base is $11,000 leading to the recognition of a deductible temporary difference where none exists. The correct figures should be $110,000 for the carrying amount, future taxable amount and future deductible amount to give rise to a tax base of the same amount. Prepaid insurance has been recognized with a future deductible amount of $14,000, which is wrong. The right figure should be $24,000 in recognition of prepaid insurance at the end of the period. As this amount is taxed on a cash basis, it has been recognized in the current year’s tax amount. It will not be subject to further deductions in the future. Thus, the tax base is zero, giving rise to a taxable temporary difference of $24,000. Accrued interest figure is incorrect as the tax base cannot be equal to the carrying amount. Interest is taxed on a cash basis, and the company is yet to receive interest for another six months. Therefore, the carrying amount and future taxable amount is $14,000. The future deductible amount is $28,000, thus a taxable temporal difference of $14,000. The motor vehicle carrying net carrying amount is $30,000. However, the tax balance sheet recognizes the item as having a net carrying amount of $36,000. The difference between the two results in a deductible temporal difference of $6,000. The motor vehicle has been fully depreciated for tax purposes. Thus, the tax base is zero. However, its carrying amount is $90,000. The taxable temporal difference amounts to $90,000. The building item recognized in the worksheet is supposed to be goodwill. It carrying amount is $50,000. The tax balance sheet does not recognize goodwill, and the corresponding tax base is zero[The148]. Consequently, the taxable temporal difference of $50,000 should be recognized in the worksheet. The recognition of accounts payable is accurate. Entertainment expenses are not allowable to tax[The148]. Therefore, future deductible amounts are zero. The carrying amount being $6,000, the tax base is $6,000. Thus zero temporal tax difference. Annual leave is allowed on a cash basis. As it is expected that the company will incur the expense at some point in the future, the appropriate tax deductible amount is $27,000. The amount is identical to what provided for annual leave. The tax base is zero, thus a deductible temporal difference of $27,000. Warrantees should be treated in a similar fashion to annual leave as they are only allowed on a cash basis. The resulting tax base is zero with a taxable temporal difference of $22,000. The corrected worksheet is as shown below: Carrying amount Future taxable amount Future deductible amount Tax base Taxable temporary differences Deductible temporary differences Assets Cash 40,000.00 40,000.00 40,000.00 40,000.00 - Inventory 110,000.00 110,000.00 110,000.00 110,000.00 - Prepaid insurance 24,000.00 24,000.00 - - - 24,000.00 Accrued interest revenue 14,000.00 14,000.00 28,000.00 28,000.00 14,000.00 Vehicle (net) 30,000.00 30,000.00 36,000.00 36,000.00 - 6,000.00 Machinery (net) 90,000.00 90,000.00 - - 90,000.00 - Investment 250,000.00 250,000.00 250,000.00 250,000.00 - - Goodwill 50,000.00 50,000.00 - - 50,000.00 Liabilities Accounts payable 40,000.00 - 40,000.00 - - Accrued Entertainment expenses 6,000.00 - 6,000.00 - - Provision for annual leave 27,000.00 27,000.00 - - Provision for product warrantees 22,000.00 22,000.00 - 22,000.00 Temporary differences 140,000.00 66,000.00 Exempt differences Deferred tax liability 19,800.00 Deferred tax asset 42,000.00 beginning balances 12,000.00 25,000.00 Movement during the year - - Adjustment 30,000.00 (5,200.00) Guide to AASB 116 Property, Plant and Equipment AASB 116 (Property, Plant and Equipment) requires that an asset be carried in the reporting entity’s books at cost less accumulated depreciation and impairment losses[Aus091]. If the company uses the revaluation approach in valuing its assets, AASB 116 requires that it carries is property, plant and equipment at the revalued amount net of any accumulated depreciation and impairment losses[Dav111]. The firm under study uses the cost model in valuing its assets. However, the use of fair value in the first question implies a change to the use of revaluation approach. When implementing the revolution approach to revaluing an item of property, it is mandated that the entire class of assets to which the asset belongs be revalued as well[Rob091]. AASB 116 defines a class of property, plant and equipment to be those assets that are used for a similar purpose within the reporting entity[Aus091]. For instance, a class of these assets in a production plant might be considered to be the machinery of production, the land it sits on and the goodwill associated with the products made by the assets. However, inventories are not to be included in valuing a class of assets unless the entity expects to use them for more than one period[Ros07]. For the purposes of the case, it is assumed that inventory is to be used over the next one year. Therefore, it has not been included in the class asset valuation of $510,000. The purpose of general financial statements is to enable their users determine whether the management is effectively using the scarce resources at their disposal[Aus10]. Consequently, it is vital that the financial statements reflect the true and fair value of assets as they are recorded in the accounting books[The148]. Towards establishing its assets’ true and fair value, a company is required to regularly conduct valuation assessments. AASB 116 recommends a revaluation every three to five years[Aus091]. With the above considerations in place, it is sufficient that the total value of the class of assets presented in the question is $500,000. AASB 116 states that revaluations are to be credited to the revolution surplus account under accumulated earnings[Aus091]. However, they are to be passed through profit or loss where they represent a devaluation passed through the same account. The essence of the requirement is to ensure that there is no mix-up between the firm’s capital and its earnings. Moreover, the company has to adhere to set policies that dictate how these items should be accounted for[Del144]. AASB 116 states that the items belonging to a class of assets must be revalued simultaneously to avoid a case where the value of one assets is far ahead of the entire class[Aus091]. With regard to deprecation, a firm is required to begin depreciating an asset as soon as it becomes available to start it in generating economic benefits[Bru14]. However, AASB 116 notes that such expectations might not always hold as an asset is subject to changes in technology that lead to obsolescence[Aus091]. As such, AASB 116 lays out four factors to be considered when estimating the useful life of an asset[The148]. One is the expected usage of the asset especially regarding physical output[Aus091]. An entity should consider the life cycle of the product that is going to be produced by the asset or class of assets[Kar09]. The second factor is how fast the asset depreciates as a result of wear and tear while the third factor is how fast the company expects the asset to become obsolete as a result of technology changes[Aus091]. The last factor is the legal limit to which the asset is subject[Aus091]. A valuation of $510,000 means that the entire class of assets has been revalued upwards. Before the revaluation took place, the value of land was $140,000, $10,000 lower than its cost. As such, the proper treatment would be to pass the devaluation of $10,000 through the revolution surplus account. As a capital account, a reduction in revolution amounts is debited while the same amount is credited to the respective asset account. The effect of these entries is that they reduce the net amount of the entire class of assets to $490,000. It is to be noted that equipment is already depreciated through the cost model to a net amount of $120,000. However, when adopting the revaluation approach equipment was revalued by a net of tax amount of $4,200. In line with the company policy of recording revaluations through the revaluations account, the revaluation was credited to the revaluation account and debited to the equipment account. After these adjustments, the net carrying amount before overall revolution was $494,200. The implication is that a revaluation to $510,000 was an increase of $15,800. The amount should be divided into two between the remaining assets that are yet to be revalued. Therefore, factory will have a revalued amount of $217,900 while goodwill will have a revalued amount of $27,900. The table below illustrates these points. Account Notes Dr. ($) Cr.($) Impairment loss(Income statement) Recognition of an impairment loss 10,000.00 Land 10,000.00 Equipment Purchase of equipment 150,000.00 Cash 150,000.00 Accumulated depreciation To record the amount of accumulated depreciation 30,000.00 Equipment 30,000.00 Equipment To record the revaluation of equipment 4,200.00 Tax expense 1,800.00 Revaluation surplus 6,000.00 References The148: , (The Institute of Chartered Accountants in Australia, 2014, p. 441), The148: , (The Institute of Chartered Accountants in Australia, 2014, p. 423), Aus091: , (Australian Accounting Standards Board, 2009, p. 13), Dav111: , (Parker, 2011, p. 678), Rob091: , (Pilcher, 2009, p. 165), Aus091: , (Australian Accounting Standards Board, 2009, p. 20), Ros07: , (Rosssouw, 2007, p. 72), Aus10: , (Board, Australian Accounting Standards, 2010, p. 7), The148: , (The Institute of Chartered Accountants in Australia, 2014), Aus091: , (Australian Accounting Standards Board, 2009), Del144: , (Deloitte Global Services Limited, 2014), Aus091: , (Australian Accounting Standards Board, 2009, p. 21), Bru14: , (Bruce, et al., 2014, p. 16), Aus091: , (Australian Accounting Standards Board, 2009, p. 24), Kar09: , (Conneely, 2009, p. 112), Aus091: , (Australian Accounting Standards Board, 2009, p. 25), Read More