The Difference between Carrying Values and Tax Values - Case Study Example

Financial Accounting Name Course Date Tutor Finаnсiаl Ассоunting Issue 1 Income taxation implement a balance sheet methodology for accounting for income taxation that would recognize the current tax effects of the events and connections for the future tax consequences of the recovery or settling of the carrying amount for the assets and liabilities of the firm. The difference between the tax base for assets and liabilities as well as, the carrying amount and the carried forward tax losses and credits are considered with limited exceptions as the deferred liabilities or deferred tax assets. The current taxation is viewed as a liability to the point it has not yet been settled and as an asset to the extent the amounts paid already exceed the amounts which are due. The current tax assets and liability is measured at the amount which is expected to be paid from the taxation authorities using the rates which have been substantively enacted by the balance sheet date. Deferred tax liabilities or the assets are representative of an increase or decrease in the taxation which is payable or refundable in the future years because of temporary differences. These come up when the events are seen in one period within the financial statement but they are recognized in another period on taxation returns. The deductible temporary differences reduce the taxable income for the future periods and they create deferred taxation assets (Raine, 2014). According to the international accounting standards stipulated by the International financial reporting standards the deferred taxation assets and liabilities are to be measured as based according to the taxation rates which are expected to apply when the asset or the liability is going to be realized or rather, settled. Normally, the current rates for taxation are utilized for the calculation of deferred taxation upon the basis they are a reasonable approximation for the future taxation ratings and that it would be quite unreliable for the estimation of the future taxation ratings. Deferred tax assets and liabilities are a representation of the future taxes which would be recovered or are payable. It can therefore be expected they would be discounted in order to reflect upon the time value of money which is consistent with the way that other liabilities are evaluated (Raine, 2014). The international accounting standards however, do not permit or allow for discounting of the deferred taxation assets or liabilities for practical reasons. Therefore, this answers the question on whether it is okay to utilize current tax liability other than DTL’s or DTA’s. The main reason here is it would be needed for entities to determine if the future tax would be paid or recovered. In practice this is usually complex and subjective. Requiring discounting of the deferred tax liabilities would result in a lot of unreliable results. The other thing is to allow but not need discounting would result in inconsistency and thus a lack of comparability between the entities. As seen the international accounting standards amendment considers the deferred taxation through taking a balance sheet approach to the accounting problem which is done by considering the temporary differences in the terms of the difference between carrying values and tax values for the assets and liabilities. Issue 2 When an enterprise makes sales to the clients it usually does this on the understanding if the product is defective then it is going to undertake or replace the product free of charge which is known as giving warranty to the product. If the product does not need replacement, the business is going to incur warranty costs in this process. The potential for the warranty costs to be incurred at a future date would thus create contingent liabilities for the enterprise. In order to be recorded for the accounting records and allowed within the financial statements, the contingent liability (Averkamp, 2016). If there is a history concerning minimal warranty expenditures, there is no need for recording contingent liabilities within the advance of actual warranty expenses considering the expectation is the ongoing expense would be immaterial. If there is history concerning minimal warranty expenditures, there is no need to record contingent liability in advance for the actual warranty expenses, as the expectation is the ongoing expense would not be relevant. The warranty liabilities would be utilized significantly less within service firms as they have a harder time in determining what a warranty liability is and since services are customized and thus less amenable to warranty liability analysis (Accounting tools, 2016). As such, the accrual is to take place in the same period for reporting as the related product sales are being recorded. In doing this, the financial statements would represent the costs that are linked with the product sales and indicate true figures pertaining to profitability which are linked to the sales. If the duration which is covered through the warranty is altered by the management, this is going to change the warranty expense figures and this is part of the reason why the expense seems to differ with the costs actuated which throws the budget of balance within the firm. This is not only for the sales in the current fiscal period, but also for the sales done within the previous durations whose warranties have been extended into the current time (Accounting tools, 2016). If the cost of warranty claims were to be known only when the firm starts to process claims from the clients, then the costs might not be known until after some months after the linked sales have been transacted. This financial reporting method would come up with ordinate high initial profits followed by a low in the later periods for as long as the warranty period would be there. If there exists no information which where one can derive estimates of warranty which would be used in an accrual, then it would be advisable to consider the use of industry information about the warranty claims. If the amount of the expense is high, then the auditors would be sure to investigate (Averkamp, 2016). If so, they can develop a history of the actual cost for the warranty claims and come up with calculations as to the link between the costs incurred and the relative amount or the units which are sold. Issue 3 Yes, the firm is going to become a shareholder in the Canadian company’s shares. On the other hand, it does not matter the amount of shares that we as a firm have in their company, the Canadian company will always have some vested control over the company. They will also have all decisive rights considering we do not have a single seat in their board. As the shareholders, we will get returns as divided. At the time of acquisition the value of the net assets of the subsidiary is measured at fair value. These fair value adjustments may not change the tax base for the net assets and so a temporary difference could come up. Deferred tax liabilities or assets that come up because of this are included as the fair value for the net assets at the transaction in order to calculate the good will (Alexander & Britton, 2014). In this scenario, the Canadian company was willing to pay an additional sum of about 1.5 million dollars above the fair value for the net assets as identifiable which means the deferred assets came to this figure after some calculation was done. Now goodwill only comes on consolidation as it is not seen as an asset within the general financial statements. In theory, one can say goodwill provides a temporary difference which would then result in a deferred tax liability because it is an asset that has a carrying value within the group accounts through it has a zero taxation base. Though the international accounting standards stipulate the exclusion of a deferred tax liability being recognized because of goodwill. Going forward we can see that the international accounting standards which are being utilized in this scenario deal with intangible assets and thus goodwill (Alexander & Britton, 2014). The accounting requirements for goodwill show the perspective that goodwill that comes from an acquisition is not an asset like the other assets or an immediate loss in value. On the contrast, it forms a bridge between the cost of the investment as an asset in the financial statements of the buyer, as the values which are characterized to the acquired assets and liabilities within the financial statements as consolidated. However, purchased goodwill is not an asset as well and the inclusion among the assets within the reporting entity rather than a deduction from the seller considers the fact that goodwill is part of a larger asset or investment. This was a scenario where the goodwill of 1.5 million was purchased for deferred assets. Here, it is safe to say that in the event that the transaction does not occur it would mean that the goodwill will not be provided and not recorded within the financial statements of the would be buyer. An intangible item may meet the definition of an asset when access to the future economy is of benefit in that it represents or becomes controlled by the reporting entity. Letter Junior Accountant McKenzie and Associates 777 South Terrace Adelaide, SA 5000 Con Pewter Managing Director, Pewter Ltd Level 6, 510 King William Street, Adelaide SA 5000 Dear Sir, I am writing this letter to you concerning the questions that you raised about the company on a number of issues, most of them pertaining to tax exemptions and the actions that would be required of the company in certain scenarios. the first thing I would like to tell you is after an assessment of the financial activities and the areas of concern that you posed, there are a few areas that your firm would incur liabilities but not as severe. The first issue that you raised had to do with the deferred tax assets and liabilities and their comparison with the current taxation liabilities. The financial system being utilized in this scenario is the IFRS or the international financial reporting standards. Under the IAS 12, there is a categorical statement which denounces discounting of the deferred tax assets and liabilities which means they have to be recorded. As stated in the technical section the reason is to determine when the future taxation would be paid or recovered. That means that needing discounting of DTL or DTA would result in a lot of unreliability or inconsistency. The scenario with your company is a number of the board members claim that people are spending too much man hours and revenue trying to account for the future taxation effects which would include the DTA and the DTL. They would like to do away with these means of tax reporting as long as it is within the requirements of financial reporting and it does not lead to illegal activity. This is pragmatic from the end that it would save money in the short term but it would result in chaos with unreliable statements being produced and it would not be feasible to have comparisons with other corporations. This is a cutback that the board does not want to take because those seemingly wasteful procedures are the unseen glue holding things up, albeit in an indirect manner. The board also seemed to be concerned with the variances that came from the warranty expenses which were recognized compared to the actual cost of warranty. The decision apparently was to stop recognizing the warranty expense before the warranty cost is incurred. This was a good decision to depend upon the incurred warranty costs as opposed to the warranty expenses. If the warranty claims are estimated but not exactly known until after some time after the related products have been transacted it could lead to significant discrepancies in the original estimation versus the actual value. an increase would means that there would be initial high profits because the initial estimates may be lower than the actual and then a decrease in revenue as the costs become known which unnecessarily weighs down the firm. Warranty estimates should therefore be utilized within an accrual setting. Last but not least, there is the issue of the division which was sold to the Canadian firm. The negotiations done between both companies seemed to have yielded a goodwill transaction of 1.5 million dollars on top of the fair value. Now, this seems to be a purchased goodwill on the side of the seller company which means that it is going to be showcased within the asset groups after being issued the payment. However, if this deal does not go through, then it does not have reason to put the asset clause on considering no transaction took place. When it comes to the unrecorded patent, the only amount that the purchasing company would make an entry for would be the costs that they incurred during the purchase of it from the original owner which would be your firm. Your firm would also note this within the intangible assets section. The fair value of the patent does not play any part in the journal entry or putting the patent on the financial statements. As such the transaction also included shares being given to the seller of the Canadian company which would mean a piece of the firm however, they would control most vested interest and the major decisions. Apart from the problem with the deferred tax assets and liabilities, other decisions seem to be in order and there should be no major problems from the accounting scope. In any case I trust that you will consider this information in future transactions and operations. Yours Sincerely, References Averkamp, H. (2016). When should a product warranty liability be recorded? Retrieved from http://www.accountingcoach.com/blog/warranty-liability-warranty-expense Accounting tools. (2016). Warranty Accounting. Retrieved from http://www.accountingtools.com/warranty-accounting Raine, M. Tax Accounting: Current and Deferred Tax. Deloitte. Retrieved from https://www2.deloitte.com/content/dam/Deloitte/ie/Documents/Tax/delooitte_ireland_tax_accounting_current_deferred_tax_2014.pdf Alexander, D., Britton, A. (2004). Financial Reporting. Cengage Learning EMEA, Baker, S., Clendon, T. Deferred Tax. Retrieved from http://www.accaglobal.com/content/dam/acca/global/PDF-students/2012s/sa-aug09-bake- clendon.pdf Read More