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FAC4861/102/0/2013 ZFA4861/102/0/2013 NFA4861/102/0/2013

Tutorial Letter 102/0/2013


ADVANCED FINANCIAL ACCOUNTING I

FAC4861/ZFA4861/NFA4861 Year module


Department of Financial Accounting

This tutorial letter contains important information about your module.

Bar code

MJM

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Dear Student

INDEX
Due date Prescribed method of study Suggested working programme Study unit 1 2 3 4 5 6 General The Conceptual Framework for financial reporting Presentation of financial statements Income taxes Accounting policies, changes in accounting estimates and errors Revenue

Page
1 2 2 3 11 20 31 81 95 106

Self assessment question and solutions

DUE DATE FOR THIS TUTORIAL LETTER: TEST 1 ON TUTORIAL 102:

28 JANUARY 2012 10 MARCH 2012

Personnel Lecturers Prof ZR Koppeschaar (CTA coordinator) Ms C Wright (Primary lecturer) Ms M de Villiers Ms FF Gaie-Booysen Ms K Mohajane Ms A Oosthuizen Secretary Ms MJ Marais Please send all e-mail queries to: fac1postgrad@unisa.ac.za

Office number 2-62 2-65 2-64 2-70 2-64 2-54

Telephone number 012 429-4717 012 429-2004 012 429-3232 012 429-3560 012 429-4779 012 429-8971

2-59

012 429-4720

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PRESCRIBED METHOD OF STUDY 1. 2. 3. 4. 5. Firstly study the relevant chapter(s) in your prescribed textbook so that you master the basic principles and supplement this with the additional information (section A) in the study unit (where applicable). Now read the standard(s) and interpretation(s) covered by the study unit. Do the multiple choice (section B) and/or other questions (section C) in the study material and make sure you understand the principles contained in the questions. Consider whether you have achieved the specific outcomes (section D) of the study unit. After completion of all the study units - attempt the questions in the assignment (open book, but within the time constraint) to test whether you have mastered the contents of this tutorial letter.

SUGGESTED WORKING PROGRAMME JANUARY / FEBRUARY 2012 TUESDAY WEDNESDAY THURSDAY 24 25 26 Revenue Accounting Income Presentation policies, taxes of financial change in statements accounting estimates and errors

MONDAY 23 General Conceptual Framework

FRIDAY 27 Income taxes

WEEKEND 28 + 29 Do assignment 1

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STUDY UNIT 1 GENERAL A. EXAM TECHNIQUE COMMENTS


1. The comments presented below are comments made about the SAICA Qualifying Exam Part 1 2009 which were presented in the Accountancy SA magazine. They should be read carefully as these are common mistakes made by students in the SAICA Qualifying Exam as well as in the final UNISA exams. Objective In view of the primary objective of Part I of the Qualifying Examination, namely to test the integrated application of cognitive knowledge, candidates are tested on their ability to 2. apply the knowledge specified in the subject areas set out in the prescribed syllabus; identify, define and rank problems and issues; analyse information; address problems in an integrative manner; exercise professional judgement; evaluate alternatives and propose practical solutions that respond to the users needs; and communicate clearly and effectively.

Overall comments on the papers Overall comments received from universities indicated that the papers were of an appropriate standard for Part I of the Qualifying Examination. The accounting questions were of a good standard, as can be expected for this part of the Qualifying Examination. The accounting questions were adequately integrated between accounting topics and also incorporated knowledge relating to taxation and auditing. The questions required candidates to have a good knowledge of and solid foundation regarding the basic principles underlying the topics. Topics examined were relevant and of importance both in practice and in the academic syllabus. The questions tested the candidates abilities to intra-integrate their knowledge across topics and to plan their answers within the time allocated to each section of the question. However, a few areas relating to general exam technique need to be highlighted, and may be of use to candidates for purposes of future examinations: Discursive sections many candidates failed to identify the issues and to address all considerations before arriving at a conclusion; Journal entries many candidates failed to properly describe the specific accounts affected (e.g. did not commit themselves to specific accounts but rather described accounts as liability or equity) and/or failed to convey the type of account (e.g. profit or loss versus OCI); Statement of cash flows candidates did not do well with indicating the direction of cash flow (e.g. by using brackets or minus signs).

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3.

Specific comments From a review of candidates answers to the seven examination questions for the January 2012 examination, the general deficiencies set out below were identified. These problems affected the overall performance of candidates, and it is a matter of concern that candidates make the same mistakes year after year. Although these aspects seem like common sense, candidates who pay attention to them are likely to obtain better marks, and it may even turn a low mark into a pass. 3.1 Application of knowledge A serious problem experienced throughout the examination was that candidates were unable to apply their knowledge to the scenarios described in the questions. Many responses by candidates were a shopping list of items this being a pure regurgitation of what candidates may have learnt about the theory at university, but of no real relevance to the question in hand. Candidates also do not appear to be able to identify the correct issues in the scenario provided. This is a major concern, because by the time candidates qualify for entry to these examinations, one would expect them to have assimilated the knowledge, at least to the extent of being able to apply it to simplified facts as set out in an examination question. Obviously, candidates who are unable to identify the correct issues did not do well in the examination. 3.2 Workings It is essential that candidates show their workings and supply detailed computations to support the figures in their answers. Marks are reserved for methodology, but can only be awarded for what is shown. Workings should, like the rest of the paper, be done in blue or black ink to ensure legibility. In many instances workings were performed by candidates but not cross-referenced to the final solution. Once again, markers could not award marks as they were unable to follow which working related to which part of the final solution. Candidates must ensure they show their workings and that these are properly and neatly cross-referenced to the final solution. 3.3 Communication Candidates fared better in questions requiring calculations than in discursive questions. It is important that candidates bear in mind that written answers are a large component of the Qualifying Examination, because written communication is a key competency required in the workplace. Candidates should learn to answer discursive questions properly. This can be done by practicing exam-type answers under exam conditions in preparation for the examination. In addition markers found that candidates used their own abbreviations (sms messaging style) in their answers. Marks could not be awarded here as it is not up to the markers to interpret abbreviations that are not commonly used. The increased use of an sms style of writing in a professional examination it is a major concern. Candidates should pay specific attention to the way in which they write their answers, and bear in mind that this is a professional examination for which presentation marks are awarded.

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3.4

Journal entries A fundamental part of financial accounting is an understanding of debits and credits. A means of assessing whether a candidate understands the fundamental principles is to require the candidate to prepare the relevant journal entries. Candidates increasingly do not understand what journal entries they need to process. In many instances basic journal entries were processed the wrong way around. In addition, account descriptions were poor and abbreviations were used. This is inexcusable and candidates must ensure that they understand what impact transactions would have on specific account balances, by showing that they know which account in the statement of profit or loss, other comprehensive income or statement of financial position has to be debited or credited. It is not sufficient for a candidate with a postgraduate qualification to be a technocrat understanding of the fundamental principles of accounting is critical to the success of a candidate at a Part I level.

3.5

Time management Candidates are advised to use their time wisely and budget time for each question. The marks allocated to each question are an indication of the relevant importance the examiners attach to that question and thus the time that should be spent on it. Candidates should beware of the tendency to spend too much time on the first question attempted and too little time on the last. They should never overrun on time on any question, but rather return to it after attempting all other questions.

3.6

Layout and presentation Candidates should allocate time to planning the layout and presentation of their answers before committing thought to paper. Very often, candidates start to write without having read the question properly, which invariably leads to, for example, parts of the same question being answered in several places or restatement of facts in different parts. Marks are awarded for appropriate presentation and candidates should answer questions in the required format, that is, in the form of a letter, memorandum or a report, if this is what is required. The quality of handwriting is also an ongoing problem and was of particular concern in this years examination. The onus is on the candidate to produce legible answers. Separate books are used to answer each question of the Qualifying Examination. Each book is clearly marked and colour coded. Candidates are given explicit instructions to write the correct answer in the correct book. Despite this some candidates did not write the correct answer in the correct book, the secretariat did ensure that candidates who wrote answers in the incorrect book were marked by the correct mark team.

3.7

Irrelevancy Marks are awarded for quality, not quantity. Verbosity is no substitute for clear, concise, logical thinking and good presentation. Candidates should bear in mind that a display of irrelevant knowledge, however sound, will gain no marks.

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3.8

Recommendations / interpretations Responses to these requirements are generally poor, either because candidates are unable to explain principles that they can apply numerically or because they are reluctant to commit themselves to one course of action. It is essential to make a recommendation when a question calls for it, and to support it with reasons. Not only the direction of the recommendation (i.e. to do or not to do something) is important, but particularly the quality of the arguments in other words, whether they are relevant to the actual case and whether the final recommendation is consistent with those arguments. Unnecessary time is wasted by stating all the alternatives.

3.9

Examination technique Examination technique remains the key distinguishing feature between candidates who pass and those that fail. Many candidates did not address what was required by the questions and, for example, provided a discussion where calculations were required or presented financial statements where a discussion of the appropriate disclosure was required.

3.10 Open-book examination Candidates are reminded that they MUST familiarise themselves with SAICAs open book policy and be aware that this may differ from that of their CTA university. Candidates are also reminded that only SAICA has the authority to interpret its own open book policy. To this end candidates are advised of the following: No loose pages (of any kind) may be brought into the exam. This includes index pages which were seen by some candidates in this years exam not to supplement texts and therefore considered acceptable; and Writing on flags As per section 4.4 of the SAICA examination regulations: Candidates are only be allowed to highlight, underline, sideline and flag in the permitted texts. Writing on flags is permitted for reference and cross-referencing purposes only, that is, writing may only refer to the name or number of the relevant discipline, standard, statement or section in the legislation. Any contravention of regulation 4 will be considered to be misconduct. Candidates are advised to familiarise themselves with SAICAs exam rules prior to writing the examination.

Another problem relating to the open-book examination was that candidates did not state the relevant theory and/or definitions in their answers. One cannot build a logical argument without using the theory as a base and starting point. Reference to theory and definitions is essential to create the perspective from which the question is answered and is required to enable markers to follow the argument. However, since candidates have this information at hand, marks are not awarded for stating detailed definitions only. This type of examination does affect the answer that is expected and application and demonstration of insight into the use of the definition have gained in importance.

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Candidates should also remember that one has to be very well prepared for an open-book examination. There is not enough time in the examination to look up all information from the texts. With regard to certain aspects one would be expected to offer an immediate response based on embedded knowledge. Complex information needs to be fully understood before the examination. Candidates who enter the examination hoping to look up data that they have not processed in advance will be at a disadvantage as they are unlikely to finish the papers. In conclusion, a message to those who were unfortunately not successful in the examination: Please start preparing for next years examination in good time. Dont give up sufficient preparation and a review of the basics will stand you in good stead for next years exam!

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B. SCHOOL OF ACCOUNTING SCIENCES EXCELS IN QE1 EXAM


Unisas School of Accounting Sciences made another major contribution to the accounting profession with 585 of its students passing part 1 of the South African Institute of Chartered Accountants (SAICA) qualifying examination to become chartered accountants. The cherry on the top was a Unisa student, Mr Wiid Rossouw, obtaining the fourth highest marks in the examination. He works at GB&G Registered Auditors/Chartered Accountants in Cradock in the Eastern Cape. The principle purpose of SAICA is to uphold the standards of the CA designation and provide a professional home body for qualified CAs. The maintenance of standards is particularly important in light of the role performed by CAs in society and the immense trust that is placed in CAs by virtue of their qualification. One of the ways in which SAICA performs this important function is through the setting and administration of a test of core competence, the QE1. In order to gain admission to the QE1, a candidate must have completed a three year B Com Accounting degree and a postgraduate qualification at a SAICA accredited university. These requirements are met by Unisa. A total of 1 987 students from 14 universities passed the examination, which means Unisa students constituted more than 29% of the total number of students that passed the examination. The Part 1 Qualifying Examination (QE) results of the SAICA were released on Friday 30 March 2012. The following three factors played a significant role in the sustained throughput rate of 2012: The high standard of the Unisa CTA examinations, distinguishing between students with the necessary competencies and those without; The thorough assessment process where borderline cases were again reviewed accompanied by a quality marking process; The quality teaching in the Unisa CTA programme.

Prof Karin Barac (Director: School of Accounting Sciences) expressed her gratitude to staff members within the School of Accounting Sciences for their hard work by saying that such encouraging results could not have been achieved without the hard work and dedication of each and every staff member in the School. I am proud of the undergraduate and postgraduate academic staff providing quality study material, adequate student support and appropriate assessments. I am equally proud of the administrative staff in the School who provides valued assistance to academics, management, students and all other relevant parties. With such staff, the wheels of success could turn!

According to Prof Elmarie Sadler, Deputy Executive Dean of the College of Economic and Management Sciences (CEMS), the college is really excited about the large number of students from previously disadvantaged groups that passed the exam. This group represents 50,5% of the total number of Unisa students that passed. Of the total number of African students that passed, 31% (151) were from Unisa. Unisa students also represented 30% of all Coloured students that passed. This is the highest number of students from the designated groups that passed from all 14 universities that participated in the examination. Unisas target is to achieve a 70% pass rate for first time students by 2016. This requirement forms part of the SAICA accreditation criteria for the Unisa CA directed postgraduate programmes of the School of Accounting Sciences.

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C. UNISA TOP STUDENT IN SAICA EXAMINATION PAPER 2012


Dear Students We all know that studying for CTA is not the easiest thing to do, and doing it part-time through distance learning adds a whole new dimension to the challenge. I completed both my BCompt and BCompt Honours through UNISA while doing my SAICA articles. I hope that after you have read this you will realise that although the challenge in completing your CTA is great, the rewards are just so much greater. I was asked to give you some guidance from my own experience. Unfortunately I never had a study manual and just did what I have always done. So here goes: Working from 8-5 and being away on work, I am all too familiar with the time constraints when it comes to studies. A day just never has enough hours in it. The only way to get through the large volumes of work expected from you at post grad level is to do your bit day by day, even weekends, and try to stick to the study program as much as possible. In all honesty, I cant see that anyone can master the course content if they do not do their part every day. Yes, it is a tight schedule, but with discipline and dedication it is possible to manage. If you happen to be a day ahead, dont take it off just yet, chances are that you will need it during the year. My advice: stay within the study program as far as possible, doing so makes your life a lot easier, especially at the end of the year. Study Methods I am sure that everyone expects me to have used the perfect study methods timed mock exams, making summaries, etc. Unfortunately that is not the case. Every persons brain functions differently. I hope most of you have figured out what your preferred study method is by now. If you have been achieving 80%90% constantly, why change your method? If you have averaged 40%60% in the past, maybe it is time to change your method. Be honest with yourself: Post grad is a huge change from under grad. I have never had the problem of not being able to finish an exam paper on time, therefore I did not spend time doing timed mock exams. If you always wish you had 15 minutes more after an exam, do yourself a favour and do timed questions and exams. Be honest with yourself; focus on your own problem areas. Do an honest evaluation of your own study methods. If you need to make changes, do it as soon as possible - do not wait until right before the exams to deal with these things, it will be too late. I have been asked a couple of times what material I used while studying. In all honesty - ALL of it. The study guides, text books, standards and legislation. It is my personal opinion that no single source is complete and that all information is not always relevant. Use the study guides to guide your studies and pay attention to the notes they provide. They provide you with this information for a reason. The study guides alone do not provide all the information you require, so use your text books to obtain the necessary detail. Use your SAICA handbook to your advantage. Do not simply ignore them, but do not abuse them either. For example, use them to quickly check if you have complied with all the disclosure requirements of a particular standard, not to see what the requirements are.

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I found the auditing standards particularly helpful. Do yourself a favour and familiarise yourself with it. I found large amounts of information contained in the auditing text books, conveniently listed within the ISAs. This means that if you know where to find it, you do not need to memorise the entire list by heart. Instead, a decent working knowledge will be sufficient if you know where to find more detail if required. Always keep in mind that it does not help you if you know where to find all the information, but do not know the information you are looking for. Exams, Tests and Exam Technique For me one of the biggest changes from under grad to post grad was the way in which questions were structured. For one, this meant spending much of my time on analysing questions. As a rule I would compare my test answers with those in the memo for each test. While doing this, I noted especially the layout of the answers and how it differs from my own. I also took the time to learn what was being asked in each question. Often I found that I knew the answer but when reading the question, I did not think about what really was being asked. Misreading a word or two in the question often had a significant impact on my marks. This is also applicable to the contents of a question. Missing a date or skipping a word while reading the information was a big reason for many of my earlier mistakes. So when you attempt questions always ensure that your read the scenario accurately and note the details provided, be sure that you comprehend what is being required of you and compare the layout and contents of the answers provided, to your own answers. Do not simply note that you made a mistake, but rather try to understand why you made the mistake. Another technique that helped me a lot was to ensure to stay within the allotted time for each question. Knowing how much time you have left, help you to focus your efforts during the exam. Another lesson one has to learn is that there is no shame in asking if you do not know. If you have a problem, ask your lecturers or a friend who does understand. Remember that your lectures were where you are now at the same point in their lives as well. They are there to help you, so use it!! In the end achieving your CTA is a result of constant hard work during the year, a devotion to your studies and a willingness to learn. While the challenge is great, the achievement is so much more rewarding. After all, it is the difficult things in life that are worth achieving. So stay focused during the year, do your part daily and be confident in your abilities and you will be amazed at what you can achieve. I wish all of you the best of luck in all your endeavours and may each of you reap the fruits of your efforts.

Regards

Wiid Rossouw

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STUDY UNIT 2 THE CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING


KEY ISSUE The Conceptual Framework serves as a basic point of reference for policy making on specific issues. The Conceptual Framework sets out agreed concepts that underlie IFRS financial reporting. KEY CONCEPTS The following key concepts are underlying to this study unit: 1. 2. 3. 4. 5. 6. 7. The objective of general purpose financial reporting. Qualitative characteristics of useful financial information. Definitions of all the elements in financial statements. Recognition criteria to indicate when an item should be incorporated in the financial statements. Measurement bases for the elements in the financial statements Concepts of capital and capital maintenance. The role of the Conceptual Framework in setting standards.

PRESCRIBED STUDY MATERIAL The following must be studied before you attempt the questions in this study unit: 1. Chapter on the Conceptual Framework in either: Descriptive Accounting, 17 edition or GAAP Handbook 2013. 2. Conceptual Framework for Financial Reporting (2010).
th

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NOTE: THE REST OF STUDY UNIT 2 IS BASED ON THE ASSUMPTION THAT YOU HAVE ALREADY STUDIED THE PRESCRIBED STUDY MATERIAL.

SECTION A - ADDITIONAL INFORMATION


Overview of the Conceptual Framework
Conceptual

The International Accounting Standards Board (IASB) has undertaken a project to develop an improved Conceptual Framework for IFRS. Phase A (Objective and qualitative characteristics) of the project was completed and replaced the relevant sections of the Framework for the Preparation and Presentation of Financial Statements (1989). Phases B, C and D of the project is currently in progress. These remaining sections of the Framework (definitions of elements, recognition, derecognition measurement and reporting entity) have so far remained unchanged.

Framework 2010 Foreword

Background

Framework

The Conceptual Framework sets out agreed concepts that underlie IFRS. The Conceptual Framework is like a constitution. A constitution is a general set of rules that provide guidance and structure for making more specific rules. The IASB uses the Conceptual Framework to set standards. Understanding the Conceptual Framework is important because it helps you understand how the Board thinks about accounting issues. The Conceptual Framework is not an IFRS, and cannot override any specific IFRS.

What is the role of the Conceptual

To provide financial information about the reporting entity to users (investors, lenders and creditors) that is useful in making decisions about providing resources to the entity. Financial reporting provides information about the financial position of an entity and the effects of transactions that change the entitys resources and claims. Users may have different, and possibly conflicting, information needs. Accrual accounting. The fundamental qualitative characteristics are: - Relevance - Faithful representation The enhancing qualitative characteristics are: - Comparability - Verifiability - Timeliness - Understandability The enhancing characteristics are desirable but less critical. Cost is a pervasive constraint on the information that can be provided by financial reporting.

Objective of financial

Chapter 1 OB1-21

reporting

Qualitative characteristics of useful

financial information

Chapter 3 QC1-39

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Conceptual

Assets Definition: A resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow. Recognition: When it is probable that economic benefits will flow to the entity and the cost/value can be measured reliably. Liabilities Definition: A present obligation of the entity arising from past events, the settlement of which is expected to result in the outflow of economic benefits. Recognition: When it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and the amount can be measured reliably. Equity Definition: The residual interest in the assets of the entity after deducting all its liabilities. Income Definition: Income includes gains and revenue. Revenue arises from ordinary activities of an entity. Gains may or may not arise from ordinary activities of any entity. Recognition: When an increase in future economic benefits related to an increase in an asset or decrease of a liability has arisen that can be measured reliably Expenses Definitions: Expenses include losses and expenses. Expenses arise in the ordinary activities of the entity. Losses may or may not arise from ordinary activities of an entity. Recognition: When a decrease in future economic benefits related to a decrease in an asset or increase of a liability has arisen that can be measured reliably. Measurem ent Measurement basis: Historical cost Current cost Realisable value Present value

Framework 2010 Chapter 4 4.2-4.53

Elements of the financial statements

Chapter 4 4.54-4.56

Underlying

assumption

Financial statements are normally prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future. If not, the financial statements must be prepared on a different basis, and, if so, the basis used is disclosed.

Chapter 4 4.1

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SECTION B - QUESTION ON CONCEPTUAL FRAMEWORK


QUESTION 2.1 (14 marks) Mr L Smith, the financial director of one of your clients, enquired whether the following items can be recognised as assets or liabilities in their year-end financial statements: (a) (b) (c) (d) (e) A large advertising cost item, the benefits of which is expected to flow to the company in the following year. Costs of researching the market for a new product the company wishes to produce. Goodwill that has been built up by the company as a result of good quality products. Revenue received in advance relating to the rendering of certain services. A provision for warranties given in respect of one of their products sold with a two year warranty.

REQUIRED Marks Discuss the recognition of the above items as assets or liabilities with reference to the Conceptual Framework and any other relevant accounting standards. 14

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QUESTION 2.1 - Suggested solution To be recognised as an asset, the item must meet the definition of an asset or liability as defined by the Conceptual Framework. Furthermore, an item can only be recognised as an asset or liability if it satisfies the following two criteria: 1. 2. (a) It is probable that a future economic benefit associated with the item will flow to or from the entity. The item has a cost or value that can be measured with reliability. (1) Advertising costs It is not possible to predict the benefits which will flow to the entity from the cost incurred with any degree of certainty. The probability that future economic benefits will flow to the entity, can therefore not be determined. Consequently, these costs may not be capitalised. (IAS 38.69(c) furthermore prohibits the capitalisation of advertising/promotional activities). (2) (b) Research costs It is not possible to predict, with any degree of reliability, the benefits which will flow to the entity from the costs incurred. These costs may thus not be capitalised. Furthermore, IAS 38.54 specifically states that research costs should be regarded as expenses. (c) Internally generated goodwill This item meets the definition of an asset. However, as the costs incurred and the prediction of the possible benefits cannot be made with any degree of reliability, the recognition criteria are not met and thus no asset can be recognised in the financial statements of the company. Furthermore, IAS 38.48 specifically states that internally generated goodwill should not be recognised as an asset. (2) (d) Revenue received in advance There are two possibilities here: 1. The amount received in advance is refunded if the service is not rendered Here, the amount should be treated as a liability as it meets the definition of a liability and the recognition criteria. (1) 2. The amount received in advance is not refundable If one strictly adheres to the Conceptual Framework, revenue received in advance which is not refundable should be treated as income in the year that it arose as it does not meet the definition of a liability as there is no obligation to the entity. However, the standard setters realised that this would not result in the fair presentation of the performance of the entity and as a result IAS 18.20 states that this amount should be deferred and recognised when the service is provided. (2)

(2)

(e)

Provision for warranties The costs of repairing or replacing all items that manifest manufacturing defects cannot be avoided. This represents a constructive obligation (IAS 37). As long as a reasonable estimate of the obligation can be made, a provision shall be recognised. The estimate may for example be based on past experience. In respect of this years sales, the obligation provided for at the reporting date is the cost of making good items for which defects have been notified but not yet processed, plus an estimate of costs in respect of the other items sold for which there is sufficient evidence that manufacturing defects will manifest themselves during their remaining periods of warranty cover. (4)

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QUESTION 2.2 (16 marks) Strive-to-be-green Ltd (Strive-to-be-green) is a manufacturing group listed on the JSE Limited. The chief financial officer of the group recently contacted you, a specialist on IFRS, requesting you to accept the appointment as technical partner of Strive-to-be-green. Strive-to-be-green has always expressed explicit and unreserved compliance with International Financial Reporting Standards (IFRS) in its separate and consolidated annual financial statements. The following unresolved accounting matter has been identified during a preliminary meeting with the accountant of Strive-to-be-green: Strive-to-be-greens carbon footprint The Kyoto Protocol is an international agreement linked to the United Nations Framework Convention on Climate Change. The major feature of the Kyoto Protocol is that it sets binding targets for 37 industrialised countries and the European community for reducing greenhouse gas (GHG) emissions. Companies in countries subject to the Kyoto Protocol aim to achieve their GHG emission reduction targets by acquiring certified emission reduction (CER) certificates from companies based in developing countries such as South Africa. Strive-to-be-green recently underwent a GHG assessment as part of its carbon offsetting strategy. Strive-to-be-green has always been very conscious of its contributions to a greener environment through the development of alternative projects such as solar and wind energy. Strive-to-be-green wants to take advantage of the Kyoto Protocols potential economic and environmental benefits relating to its environmentally-friendly projects, and especially the trade in CER certificates. The Strive-to-be-green Sandton factory converted from coal-based energy supplies to a fully solar based power plant in 20.5, which resulted in an average annual reduction of 15 000 tonnes of carbon dioxide emissions. The company as a result received CERs from the United Nations on 31 December 20.11. The CERs awarded to Strive-to-be-green are reliably estimated to have a total fair R5 million. REQUIRED Marks Prepare a memorandum to the chief financial officer in which you discuss and make recommendations on the initial recognition of the certified emissions reduction certificates in the financial statements of Strive-to-be-green for the financial reporting period ended 28 February 20.12. Please Note: Include, but do not limit your answer to, references to the Conceptual Framework for Financial Reporting 2010. Consideration must be provided for each class of asset for which the certified emissions reduction certificate may meet the definition. No journal entries are required. Ignore current and deferred taxation. 16 value of

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NFA4861/102 ZFA4861/102 QUESTION 2.2 Suggested solution An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity (Conceptual Framework chapter 4.4(a)) Resource: the Certified Emissions Reductions (CER) Certificates appear to be a resource, as these certificates provide Strive-to-be-green with access to future economic benefits in the form of income from the sale of the CER Certificates to companies in developed countries that regulate carbon emissions very stringently. An entity controls an asset if the entity has the power to obtain the future economic benefits flowing from the underlying resource and to restrict the access of others to those benefits (IAS 38.13) Control: Strive-to-be-green controls the resource, as it is able to restrict other parties from accessing the future economic benefits that can be earned from the sale of the CER Certificates these certificates have been awarded to Strive-to-be-green by the United Nations and the CER Certificates therefore legally belong to Strive-to-be-green. Control: should any benefits arise from the sale of the CER Certificates, these future economic benefits legally belong to Strive-to-be-green in terms of the sales agreement and the benefits are therefore legally protected. The past event leading to Strive-to-be-green controlling the resource is the awarding of the CER Certificates to Strive-to-be-green by the United Nations on 31 December 20.11. Economic benefits will arise through cash flows from the sale of the CER Certificates. The CER Certificates will be recognised as an asset in the financial statements of Strive-to-be-green if they satisfy the recognition criteria of probable future economic benefits and reliable measurement at the date of the recognition (Conceptual Framework chapter 4.44). The future economic benefits are probable as companies in developed countries are in direct need of these CER Certificates to meet their carbon emission targets and the CER Certificates have been reliably estimated to have a fair value or R5 million. Conclusion: It therefore appears that the CER Certificates will be recognised as an asset in terms of the Conceptual Framework for Financial Reporting. Class: Intangible assets An intangible asset is an identifiable, non-monetary asset without physical substance (IAS 38.8). The CER Certificates appear to be: Identifiable (they are separable as they can be divided from the entity and sold, transferred etc. and they arise in terms of legal rights as they were granted by the United Nations to Strive-to-be-green), Non-monetary (they are not rights to receive cash or cash equivalents) and Without physical substance (they are not physical assets, but are a commodity without physical substance).

(1)

(1)

(1)

(1)

(1)

(1) (1)

(1)

(2) (1)

(1)

(1) (1) (1)

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The CER certificates appear to meet the definition of an intangible asset in terms of IAS 38. Class: Inventories Inventories are assets held for sale in the ordinary course of business, in the process of production for such sale, or in the form of materials or supplies to be consumed in the production process or rendering of services (IAS 2.6). As Strive-to-be-green wishes to trade in CER Certificates, regular sales thereof could result in sales in the ordinary course of business, meaning that the CER Certificates could be classified as inventory. Class: Property, plant and equipment and Investment Property Property, plant and equipment and Investment property are tangible assets. It is clear from the discussion on intangible assets that CER Certificates are of an intangible nature and therefore cannot be classified as property, plant and equipment of investment property. Class: Financial Assets A financial asset is defined in IAS 32.11 as either cash, an equity instrument of another entity or a contractual right to receive cash or another financial asset from another entity. IAS 32 AG 10 states that physical assets (inventory, PPE etc) and intangible assets are not financial assets. Control of such physical or intangible assets creates an opportunity to generate an inflow of cash or another financial asset, but it does not give rise to a present right to receive cash or another financial asset. It is clear from the above, that the CER Certificates will fall in the class of intangible assets or inventories, in which case IAS 32 AG 10 would rule out the possibility of this being a financial asset. Further, although the CER Certificate creates the opportunity to generate an inflow if Strive-to-be-green elects to sell the CERs, the CER itself does not upon creation give rise to a present right to receive cash or another financial asset. Total Maximum

(1)

(2)

(1)

(1)

(1)

(1)

(1)

(1) (25) (16)

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SECTION C - SPECIFIC OUTCOMES


After you have studied this study unit, you should be able to do the following: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. Identify the purpose, scope and status of the Conceptual Framework. Specify the users and their need for information. Define the objective of general purpose financial reporting. Define and discuss the qualitative characteristics and the enhancing qualitative characteristics of useful financial information. Define the underlying assumption of financial statements. Discuss the characteristics of the elements of financial statements. Identify items as elements of financial statements and explain why the element comply with the characteristics. Describe the recognition criteria of an element of financial statements. Determine whether an item could be recognised in the financial statements. Specify the four different measurement bases. Determine in accordance with the measurement bases the value at which an element should be included in the financial statements. Describe the capital maintenance concepts and determination of profit concepts.

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STUDY UNIT 3 PRESENTATION OF FINANCIAL STATEMENTS


KEY ISSUE The objective of this standard is to provide guidelines for the structure and content of general purpose financial statements, as well as to explain certain underlying principles. IAS 1 is supplementary to the Conceptual Framework but in certain aspects there is overlapping. KEY CONCEPTS The following key concepts are underlying to this study unit: 1. 2. 3. 4. Purpose and components of financial statements. Overall considerations, including fair presentation, going concern, accrual, materiality and aggregation, offsetting, consistency and comparative information. Deviation from IFRS. Structure and content of the components of financial statements.

PRESCRIBED STUDY MATERIAL The following must be studied by you before you attempt the questions in this study unit: 1. Chapter on presentation of financial statements in either: Descriptive Accounting, 17 edition or GAAP Handbook 2013. 2. IAS 1. Presentation of financial statements.
th

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NOTE: THE REST OF STUDY UNIT 4 IS BASED ON THE ASSUMPTION THAT YOU HAVE ALREADY STUDIED THE PRESCRIBED STUDY MATERIAL.

SECTION A - ADDITIONAL INFORMATION


1. Overview of IAS 1
IAS
IAS 1 changesJune2011

The statement of comprehensive income is now referred to as the statement of profit or loss and other comprehensive income (OCI). An entity is now required to group items presented in OCI on the basis of whether they can be subsequently reclassified to profit or loss.
If the items in OCI are presented before tax then the tax related to each

of the two groups of OCI items (those that might be reclassified and those that will not be reclassified) must be shown separately. General purpose financial statements International Financial Reporting Standards Material omissions or misstatements Other comprehensive income Profit or loss Total comprehensive income Reclassification adjustments

1.7

Financi al statements structur e and content

Definitions

Purpose of financial statements A complete set of financial statements comprises of: - Statement of financial position -Statement of profit or loss and other comprehensive income - Statement of changes in equity - Statement of cash flows - Notes, comprising a summary of significant accounting policies and other explanatory information

1.9 1.54-80 1.81-105 1.106-110 1.111 1.112-138

statements of financial General features

Fair presentation and compliance with IFRS

Going concern Accrual basis of accounting Materiality and aggregation Offsetting Frequency of reporting Comparative information Consistency of presentation

1.15-24 1.25-26 1.27-28 1.29-31 1.32-35 1.36-37 1.38-44 1.45-46

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2.

Components of other comprehensive income (IAS 1.7) include IAS/ IFRS revaluation IAS 16 Paragraph

Component 1. Changes surplus. in the

Description Property, plant and equipment

2. Remeasurements benefit plans.

of

defined

IAS 19

Employee benefits

3. Gains and losses arising from translating the financial statements of a foreign operation.

IAS 21

The effects of changes in foreign exchange rates

32 37 38-49 5.7.5

4. Gains and losses from investIFRS 9 ments in equity instruments measured at fair value through other comprehensive income in accordance with paragraph 5.7.5. 5. The effective portion of gains and losses on hedging instruments in a cash flow hedge. 6. For particular liabilities designnated as at fair value through profit or loss, the amount of the change in fair value that is attributable to changes in the liabilitys credit risk. IAS 39

Financial instruments

Financial instruments: Recognition and measurement

95 - 102

IFRS 9

Financial instruments

5.7.7

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SECTION B - QUESTION ON THE PRESENTATION OF FINANCIAL STATEMENTS


QUESTION 4.1 (33 marks) The following information relates to the Rock Ltd Group for the year ended 31 December 20.11: 1. 2. Consolidated revenue amounted to R2 311 200 for the year. The costs to deliver these goods to clients amounted to R22 100. Inventories consisted of the following at 31 December 20.11 and 31 December 20.10: 31 December 20.11 R Raw materials Consumables Work-in-progress Finished goods 23 000 5 000 35 600 31 200 94 800 31 December 20.10 R 21 500 4 200 28 900 25 600 80 200

3.

Raw materials amounting to R920 200 and consumables amounting to R18 900 were purchased during the year. R 67 800 84 200 93 800

4. The following salaries were paid during the year: Factory workers Sales agents Administrative personnel 5.

Stationery amounting to R11 000 were used by the administrative personnel during the year, while advertising costs amounted to R14 800. R 54 300 26 700 8 200

6. Depreciation provided for the year is as follows: Plant Delivery vehicles Office buildings 7. 8. 9.

During the year dividends amounting to R7 000 were received on unlisted investments, while share of profit from associates amounted to R150 000. Interest paid on the bank overdraft amounted to R33 300. Rock Ltd was paid for the use of their trademark for six months during the year at R500 per month.

10. Donations (not deductible for tax purposes) amounting to R6 000 were made to various charity organisations during the year.

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11. The non-controlling shareholders interests in the subsidiaries profit for the year amounted to R45 100. 12. The tax rate is 28% and there are no temporary differences. The only non-taxable and nondeductible differences are those evident from the question. REQUIRED Marks (a) Prepare the consolidated statement of profit or loss and other comprehensive income of the Rock Ltd Group for the year ended 31 December 20.11. Expenses should be classified according to their function. All notes to the statement of profit or loss and other comprehensive income, excluding accounting policy notes, should be supplied. (b) Prepare the consolidated statement of profit or loss and other comprehensive income of the Rock Ltd Group for the year ended 31 December 20.11. Expenses should the classified by their nature. Only the note relating to profit before tax should be supplied. Please note: Your answer should comply with International Financial Reporting Standards (IFRS). Comparatives are not required. IAS 33 disclosure is not required.

19

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QUESTION 4.1 - Suggested solution (a) Classification of expenses by function ROCK LTD GROUP CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20.11 Note R Revenue Cost of sales [C1] Gross profit Other income [(500 x 6) + 7 000] Distribution costs [C2] Administrative expenses [C3] Other expenses Finance costs Share of profit of associates Profit before tax Income tax expense PROFIT FOR THE YEAR Profit attributable to: - Owners of the parent (balancing figure) - Non-controlling interests (given) 2 311 200 (1 046 600) 1 264 600 10 000 (147 800) (113 000) (6 000) (33 300) 150 000 1 124 500 (274 876) 849 624 () (3) (1)) (2) (1) () () () ()

2 3

804 524 45 100 849 624

() ()

COMMENT 1. Note that the allocation of costs between the different functions is very subjective. (It could, for instance, be debated that advertisement costs represents administrative or other costs rather than distribution costs.) Consequently IAS 1.103 states that cost of sales should be disclosed separately from other costs as a minimum requirement. In this question it would therefore be acceptable to combine distribution costs, administrative expenses and other expenses in one line-item (i.e. other expenses). Cost of sales must however be shown separately. 2. Also note that the line-item other income, includes both operating income and investment income.

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ROCK LTD GROUP NOTES FOR THE YEAR ENDED 31 DECEMBER 20.11 2. Profit before tax The following items are included in profit before tax: Income Dividends received unlisted (IAS 18.35(b)(v)) Expenses Depreciation on property, plant and equipment (54 300 + 26 700 + 8 200) (IAS 16.75(a)) Donations (IAS 1.112(c)) Employee benefit expense (67 800 + 84 200 + 93 800) COMMENT Note that IAS 1.104 requires that when expenses are classified by function, total depreciation, amortisation and employee benefits expenses should be disclosed in a note. 3.Income tax expense Major components of tax expense SA normal taxation Current taxation [C4] Tax rate reconciliation Accounting profit Tax at 28% Tax effect of non-deductible/non-taxable items: - Depreciation on office buildings (8 200 x 28%) - Donations (6 000 x 28%) - Dividends received (7 000 x 28%) - Share of profit of associates (150 000 x 28%) Income tax expense 1 124 500 314 860 2 296 1 680 (1 960) (42 000) 274 876 Total R R

7 000

()

89 200 6 000 245 800

() () ()

274 876

(3)

() () () () () (19)

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(b)

Classification of expenses by nature ROCK LTD GROUP CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20.11 Note R Revenue Other income [(500 x 6) + 7 000] Changes in inventories of finished goods and work in progress [C5] Raw materials and consumables used [C6] Employee benefits expense (67 800 + 84 200 + 93 800) Depreciation (54 300 + 26 700 + 8 200) Other expenses [C7] Finance costs Share of profit of associates Profit before tax Income tax expense [C4] PROFIT FOR THE YEAR Profit attributable to: - Owners of the parent (balancing figure) - Non-controlling interests (given) NOTES FOR THE YEAR ENDED 31 DECEMBER 20.11 2. Profit before tax The following items are included in profit before tax: Income Dividends received unlisted (IAS 18.35(b)(v)) 7 000 Total () (14) 2 311 200 10 000 12 300 (936 800) (245 800) (89 200) (53 900) (33 300) 150 000 1 124 500 (274 876) 849 624 () (1) (1) (3) (1) (1) (2) () () ()

2 3

804 524 45 100 849 624

() ()

CALCULATIONS C1. Cost of sales Opening inventories Production costs Salaries: factory workers Raw materials purchased Consumables purchased Depreciation: plant Closing inventories 80 200 67 800 920 200 18 900 54 300 (94 800) 1 046 600 [] [] [] [] [] [] [3]

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C2. Distribution costs Salaries: sales agents Depreciation: delivery vehicles Delivery costs Advertising costs 84 200 26 700 22 100 14 800 147 800 [] [] [] [] [2] C3. Administrative expenses Salaries: administrative personnel Depreciation: office buildings Stationery 93 800 8 200 11 000 113 000 [] [] [] [1] C4. Taxation Profit before tax Non-taxable/non-deductible differences: - Depreciation on office building - Donations - Dividends received - Share of profit of associates Taxable profit Current tax at 28% C5. Change in inventory levels Opening inventories (28 900 + 25 600) Closing inventories (35 600 + 31 200) Increase in inventories results in an increase in profit C6. Raw materials and consumables Opening inventories (21 500 + 4 200) Purchased (920 200 + 18 900) Closing inventories (23 000 + 5 000) Consumed during the year 25 700 939 100 (28 000) 936 800 [1] [1] [1] [3] C7. Other operating expenses Stationery utilised Delivery costs Advertising costs Donations 11 000 22 100 14 800 6 000 53 900 [] [] [] [] [2] (54 500) 66 800 12 300 [] [] [] [1] 1 124 500 8 200 6 000 (7 000) (150 000) 981 700 274 876 [] [] [] [] [] [] [3]

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SECTION C - SPECIFIC OUTCOMES


After you have studied this study unit, you should be able to do the following: 1. 2. 3. 4. 5. 6. 7. Identify the purpose and scope of IAS 1 Presentation of financial statements. Identify under which circumstances the standard should be applied. Discuss the objective of financial statements. Specify the components of financial statements. Specify and discuss the overall considerations with the preparation of financial statements. Prepare financial statements in accordance with the requirements in IAS 1. Disclose relevant information as required by IAS 1.

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STUDY UNIT 4 INCOME TAXES


KEY ISSUE Taxation represents an unavoidable expense for most entities. Apart from various income taxes that include all domestic and foreign taxes, it is also necessary to account for deferred taxation. Deferred taxation represents taxation that will be paid/saved in future periods when the carrying amount of assets/liabilities is recovered/settled. KEY CONCEPTS The following key concepts are underlying to this study unit: 1. 2. 3. 4. The determination of the tax base of assets and liabilities. The measurement of deferred tax liabilities and assets. The recognition of current and deferred tax. The presentation and disclosure of tax in financial statements.

PRESCRIBED STUDY MATERIAL The following must be studied before you attempt the questions in this study unit: 1. 2. Chapter on income taxes in Descriptive Accounting, 17 edition. IAS 12. Income taxes. 3. 4. IAS 12.38-.45 relating to investments in subsidiaries, branches, associates and interests in joint arrangements is not examinable. IAS 12.68A-.68C relating to deferred tax for equity settled share-based payments is only examinable on level 1 (knowledge and awareness only).
th

AC 502. Substantively enacted tax rates and tax laws. Circular 3/2011 Impact of the Dividends Tax on deferred tax assets arising from unutilised Secondary Tax on Companies (STC) credits TO CHECK IF EXAMINABLE IN 2013.

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NOTE:

THE REST OF STUDY UNIT 4 IS BASED ON THE ASSUMPTION THAT YOU HAVE ALREADY STUDIED THE PRESCRIBED STUDY MATERIAL.

SECTION A - ADDITIONAL INFORMATION

1.

Circulars and interpretations relating to tax Circular 3/2011 Impact of the Dividends Tax on deferred tax assets arising from unutilised Secondary Tax on Companies (STC) credits TO CHECK IF EXAMINABLE IN 2013. AC 502 Substantively enacted tax rates and tax laws is examinable and provide guidance on when changes in tax rates and tax laws should be regarded as substantively enacted. Useful illustrative examples accompany the standard.

The following documents are not examinable: SIC 25 Income taxes Changes in the tax status of an entity or its shareholders. AC 501 Accounting for Secondary Tax on Companies (STC).

The following documents have been incorporated into IAS 12 Income taxes and have subsequently been withdrawn: SIC 21 Income taxes Recovery of revalued non-depreciable. Circular 1/2006 Disclosure in relation to deferred tax.

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2.
General

Overview of IAS 12
Difference between temporary differences and timing differences Use of the balance sheet method as opposed to the income statement method Fundamental principle of IAS12 IAS 12.IN2 12.IN2 12.10

Taxable profit (tax loss) Tax expense (tax income) Current tax Deferred tax liabilities Deferred tax assets Taxable temporary differences Deductible temporary differences Tax base of an asset Tax base of a liability Tax base of revenue received in advance Current tax liabilities and current tax assets Unpaid tax expense is a liability If amount paid exceeds amount due, excess is an asset

12.5 12.5 12.5 12.5 12.5 12.5 12.5 12.7 12.8 12.8 12.12

Definitions

Deferred tax liabilities Taxable temporary differences (IAS 12.15-23)

Deferred tax assets Deductible temporary differences (IAS 12.24-32) 12.33 12.34-36 12.37 12.38-45

Recognition

Deferred tax asset that arises on initial recognition Unused tax losses and unused tax credits Reassessment of unrecognised deferred tax assets Investments in subsidiaries, branches, associates and interest in joint arrangements (not examinable)

Recognition of current and deferred tax Recognised in profit or loss Recognised outside profit or loss Business combination Share-based payment transactions (examinable on level 1 only) Tax rates to be used for deferred tax Manner of recovery of non-depreciable asset measured using the revaluation model in IAS 16 Manner of recovery of investment property measured using the fair value model in IAS 40 Investment property at fair value in a business combination Deferred tax assets and liabilities shall not be discounted Review of deferred tax assets at end of each reporting period Offsetting of current tax assets and current tax liabilities Offsetting of deferred tax assets and deferred tax liabilities Tax expense or tax income related to profit or loss from ordinary activities

12.58 12.61A 12.66-68 12.68A-C IAS 12.47 12.51B 12.51C 12.51D 12.53 12.56 12.71 12.74 12.77-77A

Presentation Measurement

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12.79-80 12.81 12.82

Disclosur e

Major components of tax expense (income) shall be disclosed separately List of separate disclosures Disclosure required for a deferred tax asset

Conceptual Framework for Financial Reporting

Definition of asset: Conceptual Framework par 4.4(a) Definition of liability: Conceptual Framework par 4.4(b) Recognition of an asset: Conceptual Framework par 4.44 - 4.45 and IAS 12.16 Recognition of a liability: Conceptual Frameworkpar4.46and IAS 12.25 The limitation of a deferred tax asset is in line with the Conceptual Framework as the asset is limited when all the recognition criteria are not met

12.16 12.25 12.34

3.

DIVIDENDS TAX Secondary Tax on Companies (STC) was replaced by Dividends Tax on 1 April 2012. Dividends Tax is a withholding tax on the shareholders of the company and not a tax on the company declaring the dividend. If however the dividend consists of a dividend in specie, the company declaring the dividend will be liable for the Dividends Tax. The shareholder (any person holding a share in that company) must be the beneficial owner of the dividend attaching to a share (as defined in section 64D of the Income Tax Act). If the shareholder is a resident company or a dual-listed company, no Dividends Tax will arise on dividends declared to that company. The company or the regulated intermediary (as defined in section 64D of the Income Tax Act) will withhold the Dividends Tax and pay it to SARS on behalf of the shareholders.

Circular 3/2011 Impact of the Dividends Tax on deferred tax assets arising from unutilised STC credits was issued in November 2011 regarding the impact that the new Dividends Tax legislation will have on deferred tax assets raised as a result of unutilised STC credits. Paragraph 14 of Circular 3/2011 states that Dividends Tax will have the effect that STC credits no longer serve to reduce a companys tax obligation and therefore will be held solely for the benefit of the companys shareholders. In light of this, a deferred tax asset will not be recognised in respect of the carry-forward of STC credits as it ceases to reflect future tax benefits available to the company. This should be considered in assessing the recoverability of deferred tax assets recognised in respect of these STC credits. The following two examples are provided to illustrate how Dividends Tax will be accounted for: EXAMPLE 1 The new Dividends Tax became effective in South Africa on 1 April 20.12. Pioneers Ltd has a 31 March 20.12 year-end. Pioneers Ltd has 1 000 000 ordinary shares in issue and declared a cash dividend of R0,50 per share on 30 April 20.12 that was paid on 15 May 20.12. All the shareholders of Pioneers Ltd are natural persons and according to the new legislation relating to Dividends Tax, Pioneers Ltd is required to withhold Dividends Tax of

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10% from all shareholders and pay it to the SARS on behalf of the shareholders. The Dividends Tax must be paid to the SARS at the end of the month following the month in which the dividend was declared. As at 1 April 20.12, Pioneers Ltd recognised a deferred tax asset for accumulated unutilised STC credits that arose from the net dividends accrued to Pioneers Ltd in the dividend cycle that ended on 31 March 20.12. On 1 April 20.12, due to the new legislation on Dividends Tax, these STC credits are no longer an asset of Pioneers Ltd, but an asset belonging to the shareholders. Pioneers Ltd correctly derecognised the deferred tax asset arising from STC credits of R200 000. The journals are as follows: Dr R 1 April 20.12 Income tax expense (P/L) Deferred tax asset (SFP) (R200 000 x 10%) Derecognise STC credits of R200 000 30 April 20.12 Dividends declared (SCE) (R500 000 x R0,50) Dividends payable (SFP) Dividend declared Dividends payable (SFP) ((R500 000 R200 000) x 10%) Other payables: SARS (Dividends Tax) Recognise Dividends Tax payable to SARS net of STC credits 15 May 20.12 Dividends payable (SFP) (R500 000 - R30 000) Bank (SFP) Payment of dividends to shareholders 31 May 20.12 Other payables: SARS (Dividends Tax) Bank (SFP) Pay Dividends Tax to the SARS DISCLOSURE PIONEERS LTD EXTRACT FROM THE STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 MARCH 20.12 Retained earnings R Dividends paid (R0,50 per share) 500 000 20 000 20 000 Cr R

500 000 500 000 30 000 30 000

470 000 470 000

30 000 30 000

EXAMPLE 2 The same information as IN Example 1 applies except that 30% of the shares are held by shareholders who are natural persons and 70% of the shares are held by the holding company of Pioneers Ltd which is a South African resident company. Pioneers Limited only needs to pay Dividends Tax to the SARS for the shareholders that are natural persons as the holding company is exempt from Dividends Tax.

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The journals are as follows:

1 April 20.12 Income tax expense (P/L) Deferred tax asset (SFP) (R200 000 x 10%) Derecognise STC credits of R200 000 30 April 20.12 Dividends declared (SCE) (1 000 000 x R0,50) Dividends payable (SFP) Dividend declared Dividends payable (SFP) ((R500 000 R200 000) x 30% x 10%) Other payables: SARS (Dividends Tax) Recognise Dividends Tax payable to SARS net of STC credits 15 May 20.12 Dividends payable (SFP) (R500 000 - R30 000) Bank (SFP) Payment of dividends to shareholders 31 May 20.12 Other payables: SARS (Dividends Tax) Bank (SFP) Pay Dividends Tax to the SARS DISCLOSURE

20 000 20 000

500 000 500 000 9 000 9 000

491 000 491 000

9 000 9 000

PIONEERS LTD EXTRACT FROM THE STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 MARCH 20.12 Retained earnings R Dividends paid (R0,50 per share) 500 000

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DEFERRED TAX AND INCOME TAX EXAMPLES The purpose of this series of examples is to assist you in understanding deferred tax and how it fits together with income tax. Examples 1 - 5 relate to Deasy Ltd which has a 31 December financial year-end. The income tax rate is 28% and the inclusion rate for capital gains tax (CGT) is 66,6%. EXAMPLE 1A Income tax The accounting profit for the financial year ended 31 December 20.12 is R500 000. Included in the accounting profit are dividends received of R10 000 that are not taxable and a penalty of R15 000 that is not deductible for tax purposes. CALCULATIONS 20.12 R 500 000 (10 000) 15 000 505 000 1 141 400

C1. Current tax Profit before tax Non-taxable/non-deductible items: Dividends not taxable Penalty not deductible Taxable profit Tax at 28% (505 000 x 28%)
1

The current tax of R141 400 is income tax payable to the SARS in respect of the taxable profit for the year ended 31 December 20.12.

DISCLOSURE The income tax note to the financial statements of Deasy Ltd for the year ended 31 December 20.12 will be as follows: DEASY LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12 3. Income tax expense Major components of tax expense SA normal tax Current tax -Current year [C1] 20.12 R

141 400 141 400

Tax reconciliation Accounting profit Tax @ 28% Tax effect of non-taxable/non-deductible items: - Dividends not taxable (10 000 x 28%) - Penalty not deductible (15 000 x 28%) Income tax expense

500 000 140 000 (2 800) 4 200 141 400

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THE PURPOSE OF A TAX RECONCILIATION Profit before tax of R500 000 in the statement of profit or loss and other comprehensive income multiplied with 28% is R140 000. Why is the income tax expense R141 400 and not R140 000? The reasons are as follows: Included in profit before tax is dividends received that were not taxable for tax purposes, and Included in profit before tax is a penalty paid that was not deductible for tax purposes. The dividends received and penalty paid will be the reconciling items in the tax rate reconciliation. EXAMPLE 1B Income tax and prior year underprovision The same information as in Example 1A applies. Deasy Ltd provided for current tax of R121 000 for the financial year ended 31 December 20.11. The final assessment relating to the financial year ended 31 December 20.11, that was issued by the SARS on 30 April 20.12, reflected income tax payable of R126 000. Deasy Ltd accepted the assessment issued by the SARS as correct. UNDERPROVISION RELATING TO THE PRIOR YEAR The current tax that was calculated by Deasy Ltd for the financial year ended 31 December 20.11 was R121 000. The final assessment issued by the SARS reflected income tax payable of R126 000. As a result, the income tax expense in the prior year financial statements was underprovided for with R5 000 (R126 000 R121 000). This additional R5 000 will increase the income tax payable. The underprovision will be accounted for as follows: Dr Cr R R Income tax expense (P/L) 5 000 Other creditors: SARS (SFP) 5 000 The underprovision will be disclosed in the income tax expense note as current tax relating to the prior year.

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Taking into account the underprovision, the income tax note to the financial statements of Deasy Ltd for the year ended 31 December 20.12 will be as follows: DEASY LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12

3.

Income tax expense Major components of tax expense SA normal tax Current tax Current year [C1] -Underprovision for prior year (126 000 - 121 000) Tax reconciliation Accounting profit Tax @ 28% Tax effect of non-taxable items/non-deductible items: - Dividends not taxable (10 000 x 28%) - Penalty not deductible (15 000 x 28%) Underprovision for current tax for prior year (126 000 - 121 000) Income tax expense

20.12 R

141 400 5 000 146 400 500 000 140 000


(2 800) 4 200 1 5 000 146 400

Note that the amount of the underprovision in the tax rate reconciliation is not multiplied with 28% as it already represents 28%. UNDERPROVISION AND THE TAX RECONCILIATION Profit before tax of R500 000 in the statement of profit or loss and other comprehensive income multiplied with 28% is R140 000. Why is the income tax expense R146 400 and not R140 000? The reason is that in addition to the reconciling items of Example 1A, Deasy Ltd has an increase in income tax expense of R5 000 that relates to the prior years taxable profit. As the taxable profit that gave rise to the R5 000 income tax is not included in the accounting profit of R500 000, it will be a reconciling item in the tax reconciliation.

EXAMPLE 1C Income tax and prior year overprovision The same information as in Example 1A applies. Deasy Ltd provided for current tax of R128 000 for the financial year ended 31 December 20.11. The final assessment relating to the financial year ended 31 December 20.11, that was issued by the SARS on 30 April 20.12, reflected income tax payable of R122 000. Deasy Ltd accepted the assessment issued by the SARS as correct.

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OVERPROVISION RELATING TO THE PRIOR YEAR The current tax that was calculated by Deasy Ltd for the financial year ended 31 December 20.11 was R128 000. The final assessment issued by the SARS reflected income tax payable of R122 000. As a result, the income tax expense in the prior year financial statements was overprovided for with R6 000 (R128 000 R122 000). The SARS will use this R6 000 overprovision to reduce income tax payable in the current year. This overprovision will be accounted for as follows: Dr Cr R R Other creditors: SARS (SFP) 6 000 Income tax expense (P/L) 6 000 The overprovision will be disclosed in the income tax expense note as a reduction of current tax relating to the prior year. Taking into account the overprovision, the income tax note to the financial statements of Deasy Ltd for the year ended 31 December 20.12 will be as follows: DEASY LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12 3. Income tax expense Major components of tax expense SA normal tax Current tax Current year [C1] -Overprovision for prior year (122 000 - 128 000) 20.12 R

141 400 (6 000) 135 400

Tax reconciliation Accounting profit Tax @ 28% Tax effect of non-taxable/non-deductible items: - Dividends not taxable (10 000 x 28%) - Penalty not deductible (15 000 x 28%) Overprovision for current tax for prior year (122 000 - 128 000) Income tax expense

500 000 140 000 (2 800) 4 200 (6 000) 135 400

INTRODUCTION TO EXAMPLES 2 - 5 Now that we have covered the basic principles of the calculation and disclosure of income tax we can introduce the concept of deferred tax. Deferred tax arises due to different treatments of items from an accounting and income tax perspective. Deferred tax is an accounting entry to account for future tax payments or tax savings that arise due to these different treatments. Deferred tax is thus tax that Deasy Ltd will pay in future to the SARS or a future tax saving due to these differing treatments. The future tax consequences are provided for by recognising a deferred tax liability (for future tax payable) or an asset (for a future tax saving).

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EXAMPLE 2 Temporary differences The accounting profit was R500 000 for each of the financial years ended 31 December 20.12, 20.13, 20.14 and 20.15. Included in the accounting profit for each year are dividends received of R10 000 that are not taxable and a penalty of R15 000 that is not deductible for tax purposes. Deasy Ltd acquired a machine on 1 January 20.12 for R300 000 which is depreciated over four years on the straight line basis (the residual value is Rnil). The SARS allows a S12C deduction of 40% in the first year and 20% per year for the subsequent three years. The deferred tax balance on 31 December 20.11 was Rnil. ACCOUNTING POLICY VERSUS THE INCOME TAX ACT The total cost of the machine of R300 000 is going to be deducted over time for accounting purposes and for tax purposes. For the year ended 31 December 20.12, for accounting purposes, depreciation will be R75 000 (R300 000 / 4 years) while the SARS will allow R120 000 (R300 000 x 40%) as a deduction for tax purposes. Even though the amounts of the deductions differ for accounting and tax purposes, by 31 December 20.15, the full cost of the machine of R300 000 will be written off for both accounting and tax purposes. INCOME STATEMENT METHOD VERSUS BALANCE SHEET METHOD (IAS 12.IN2) The original IAS 12 Income Taxes issued in July 1979 required an entity to account for deferred tax using the income statement method. The revised IAS 12 that was issued in October 1996 prohibited the income statement method and required another method which is known as the balance sheet method. The IAS 12 we use today is an updated version of IAS 12 issued in October 1996 which requires the use of the balance sheet method. The income statement method focuses on timing differences and the balance sheet method focuses on temporary differences: Timing differences are differences between taxable profit and accounting profit that originate in one period and reverse in one or more subsequent periods as can be seen in calculation C1 below. The term timing differences does not exist in the IAS 12 we use today and should not be used. Temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base. The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. The current tax calculation C1 below is firstly performed using the income statement method that is prohibited in terms of IAS 12 and then reperformed using the balance sheet method. The income statement method was only performed for explanatory purposes and students should NOT make use of this method when calculating deferred tax.

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CALCULATIONS C1. Current tax (when deferred tax is calculated using the "income statement method") 20.12 R Profit before tax (given) Non-taxable/non-deductible items: Dividends not taxable Fine not deductible Taxable profit before temporary differences Timing differences: Add back depreciation on machine (300 000 / 4 years) Deduct S12C tax deduction on machine (20.12: 300 000 x 40%) (20.13-20.15: 300 000 x 20%) Taxable profit Tax at 28%
1

20.13 R 500 000

20.14 R 500 000

20.15 R 500 000 (10 000) 15 000 505 000 2 15 000 75 000

500 000 (10 000) 15 000 505 000 1 (45 000) 75 000

(10 000) (10 000) 15 000 15 000 505 000 505 000 2 2 15 000 15 000 75 000 75 000

(120 000) 460 000 128 800

(60 000) 520 000 145 600

(60 000) 520 000 145 600

(60 000) 520 000 145 600

This R45 000 is the difference between the depreciation amount of R75 000 that is added back and the S12C deduction of R120 000 that is deducted. From an income tax perspective, this R45 000 has the effect of decreasing the taxable profit from R505 000 to R460 000 for the year ended 31 December 20.12. From a deferred tax perspective, the tax deduction is R45 000 larger than the accounting deduction for the year ended 31 December 20.12. The future tax deductions available against the machine will be R45 000 less in future than the future accounting deductions which will cause an increase in the taxable profit in future. This increase in future taxable profit and future income tax expense is provided for on 31 December 20.12 by raising a deferred tax liability of R12 600 (45 000 x 28%). The difference of R15 000 for the financial years ended 31 December 20.13, 20.14 and 20.15 is the difference between the depreciation amount of R75 000 that is added back and the S12C deduction of R60 000 is deducted. From an income tax perspective, the R15 000 has the effect of increasing the taxable profit from R505 000 to R520 000. From a deferred tax perspective, as the difference of R15 000 increases the taxable profit from 31 December 20.13 20.15, the deferred tax liability of R12 600 that was raised for the R45 000 on 31 December 20.12 is now reversing with R4 200 (15 000 x 28%) on 31 December 20.13, 20.14 and 20.15.

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The deferred tax is recalculated below using the balance sheet method: C1. Current tax (when deferred tax is calculated using the "balance sheet method") 20.12 R 500 000 (10 000) 15 000 505 000 (45 000) 460 000 128 800 20.13 R 500 000 20.14 R 500 000 20.15 R 500 000 (10 000) 15 000 505 000 15 000 520 000 145 600

Profit before tax (given) Non-taxable/non-deductible items: Dividends not taxable Fine not deductible 1 Taxable profit before temporary differences Movement in temporary differences [C2] Taxable profit Tax at 28%
1

(10 000) (10 000) 15 000 15 000 505 000 505 000 15 000 15 000 520 000 520 000 145 600 145 600

The current tax calculation above can be performed to the line Taxable profit before temporary differences. It is then necessary to first complete the deferred tax calculation below [C2] in order to calculate the movement in temporary differences. COMPARISON OF THE INCOME TAX METHOD TO THE BALANCE SHEET METHOD As can be seen above, the movement in temporary differences calculated using the balance sheet method as below in C2, is equal to the timing differences calculated using the income statement method. The current tax calculation in terms of the income statement method and the balance sheet method gives exactly the same answer. C2. Deferred tax Carrying amount R 31 December 20.11 (given) Tax base R Temporary difference R 45 000 180 000
5 10

Deferred tax at 28% (Dr)/Cr R 12 600 12 600

Movement in temporary difference (taxable) (45 000 - 0) 31 December 20.12 Machinery 225 000
1

45 000

Movement in temporary difference (reversal of taxable) (30 000 - 45 000) 31 December 20.13 Machinery 150 000
2

(15 000) 120 000


6

11

(4 200) 8 400

30 000

Movement in temporary difference (reversal of taxable) (15 000 - 30 000)

(15 000)

(4 200)

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3

Carrying amount R 31 December 20.14 Machinery 75 000

Temporary difference R
7

Deferred tax at 28% (Dr)/Cr R 4 200

60 000

15 000

Movement in temporary difference (reversal of taxable) (0 - 15 000) 31 December 20.15 Machinery


1 2 3 4 5 6 7 8 9 4 8

(15 000)

(4 200)

10

11

20.12: 300 000 (300 000 / 4) = 225 000 20.13: 225 000 (300 000 / 4) = 150 000 20.14: 150 000 (300 000 / 4) = 75 000 20.15: 75 000 (300 000 /4) = 0 Tax base of an asset is the amount that will be deductible for tax purposes in future (IAS 12.7). 20.12: 300 000 (300 000 x 40%) = 180 000 20.13: 180 000 (300 000 x 20%) = 120 000 20.14: 120 000 (300 000 x 20%) = 60 000 20.15: 60 000 (300 000 x 20%) = 0 On 31 December 20.12, the carrying amount of R225 000 is greater than the tax base of R180 000 which gives rise to a taxable temporary difference of R45 000. Why is it taxable? It is taxable because for tax purposes R45 000 more have been deducted than for accounting purposes. In future, for tax purposes, there will be R45 000 less to deduct than for accounting purposes and this will cause in increase in taxable profit and income tax expense in future. This movement in temporary differences from Rnil to R45 000 is taxable as it will increase taxable profit in future. The impact of the R45 000 is as follows: Income tax: This movment must be deducted from taxable profit in the current year as it is only taxable in future. Deferred tax: It gives rise to an increase in the deferred tax balance from Rnil (as at 31 December 20.11) to a deferred tax liability of R12 600 (as at 31 December 20.12). The movement in the temporary differences of R15 000 (R30 000 R45 000) is a partial reversal of the taxable temporary difference of R45 000 that arose on 31 December 20.12. This reversal of a taxable temporary difference has the same effect as a deductible temporary difference. The impact of the R15 000 is as follows: Income tax: This movement must be added to the taxable profit in the current year as it is taxable in the current year. Deferred tax: It gives rise to a decrease in the deferred tax liability from R12 600 (as at 31 December 20.12) to a deferred tax liability of R8 400 (as at 31 December 20.13).

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The T-accounts below illustrate the effect of the deferred tax liability on P/L from 20.12 until 20.15: Dr Deferred tax (SFP) 20.11 Opening balance 12 600 20.12 Income tax expense (P/L) 12 600 20.13 Balance b/f 4 200 8 400 12 600 20.14 Balance b/f 4 200 4 200 8 400 20.15 Balance b/f 4 200 4 200 20.16 Balance b/f Cr 12 600 12 600 12 600

20.12 Balance c/f

20.13 Income tax expense (P/L) 20.13 Balance c/f

12 600 8 400

20.14 Income tax expense (P/L) 20.14 Balance c/f

8 400 4 200

20.14 Income tax expense (P/L) 20.14 Balance c/f

4 200 -

Dr 20.12 Deferred tax (SFP) Income tax expense (P/L) 12 600 20.13 Deferred tax (SFP) 20.14 Deferred tax (SFP) 20.15 Deferred tax (SFP)

Cr

4 200 4 200 4 200

It is clear from the T-accounts above that in 20.12 the increase in the deferred tax liability increases the income tax expense in P/L (which will together with the current tax, will increase the total income tax expense). From 20.13 to 20.15, the decrease in the deferred tax liability results in a credit to P/L which will decrease the income tax expense in P/L.

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DISCLOSURE The income tax note and deferred tax note in the financial statements of Deasy Ltd for the financial years ended 31 December 20.12, 20.13, 20.14 and 20.15 will be as follows: DEASY LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12 TO 31 DECEMBER 20.15 3.Income tax expense Major components of tax expense 31-Dec-12 31-Dec-13 R R SA normal tax Current tax -Current year [C1] Deferred tax -Movement in temporary differences [C2] Tax reconciliation Accounting profit Tax @ 28% Tax effect of non-taxable/non-deductible 1 items: - Dividends not taxable (10 000 x 28%) - Penalty not deductible (15 000 x 28%) Income tax expense 10. Deferred tax Analysis of temporary differences: Property, plant and equipment -Accelerated deductions for tax purposes [C2] Deferred tax liability
1

31-Dec-14 31-Dec-15 R R

128 800

145 600

145 600

145 600

12 600 141 400 500 000 140 000

(4 200) 141 400 500 000 140 000

(4,200) 141 400 500 000 140 000

(4 200) 141 400 500 000 140 000

(2 800) 4 200 141 400

(2 800) 4 200 141 400

(2 800) 4 200 141 400

(2 800) 4 200 141 400

12 600 12 600

8 400 8 400

4 200 4 200

Note that the temporary differences are NOT reconciling items in the tax reconciliation as the temporary differences are accounted for when deferred tax is raised. THE TWO FUNCTIONS OF THE MOVEMENT IN TEMPORARY DIFFERENCES With reference to the financial year ended 31 December 20.12, the R45 000 taxable temporary difference has two functions: 1. It is deducted from the taxable profit on 31 December 20.12 in the current tax calculation, AND 2. It gives rise to a deferred tax liability of R12 600 on 31 December 20.12 (R45 000 x 28%) which increases the income tax expense (debit P/L). The deferred tax expense of R12 600 has the effect of increasing the total income tax expense (income and deferred tax combined) from R128 800 to R141 400 which is the same as the income tax expense in example 1A where no temporary differences existed (refer to the income tax note in Example 1A above).

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DEFERRED TAX CALCULATIONS When doing a deferred tax calculation using the balance sheet method, it is very important to correctly apply the definitions of a tax base in IAS 12.7 11. It is suggested that you memorise these definitions so that you can apply them without constantly referring to IAS 12. You can also memorise the following for purposes of determining whether a temporary difference on an item is taxable or deductible: ASSET (for example Machinery):
Carrying amount > tax base Carrying amount < tax base taxable temporary difference deferred tax liability deductible temporary difference deferred tax asset

LIABILITY (for example Revenue received in advance): Carrying amount > tax base Carrying amount < tax base deductible temporary difference deferred tax asset taxable temporary difference deferred tax liability

CALCULATING THE MOVEMENT IN TEMPORARY DIFFERENCES You should understand the following in order to determine whether the total movement in temporary differences (from one year to the next year) is taxable or deducible: Deferred tax liability: Increase in deferred tax liability is an increase in taxable temporary differences deduct movement in temporary differences in current tax calculation, and increase income tax expense (debit P/L) and increase deferred tax liability (credit SFP) Decrease in deferred tax liability is a decrease in taxable temporary differences add movement in temporary differences to current tax calculation, and decrease income tax expense (credit P/L) and decrease deferred tax liability (debit SFP) Deferred tax asset: Increase in deferred tax asset is an increase in deductible temporary differences add movement in temporary differences to current tax calculation, and decrease income tax expense (credit P/L) and increase deferred tax asset (debit SFP) Decrease in deferred tax asset is a decrease in deductible temporary differences deduct movement in temporary differences in current tax calculation, and increase income tax expense (debit P/L) and decrease deferred tax asset (credit SFP)

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EXAMPLE 3A Unused tax loss when future taxable profits are probable The accounting profit for the year ended 31 December 20.12 is R500 000. Included in the accounting profit are dividends received of R10 000 that are not taxable and a penalty of R15 000 that is not deductible for tax purposes. On 31 December 20.11 there were no temporary differences except for an unused tax loss of R550 000 for the year ended 31 December 20.11. The SARS assessment also reflects an assessed tax loss of R550 000. Deasy Ltd acquired machinery on 1 January 20.12 for R300 000 which is depreciated over four years on the straight line basis. The SARS allows a S12C deduction of 40% in the first year and 20% per year for the subsequent three years. Future taxable profits are probable for both financial years ending 31 December 20.11 and 20.12. ASSESSED TAX LOSS VERSUS UNUSED TAX LOSS Please note that an unused tax loss that has been assessed by the SARS for the prior year is referred to as an assessed tax loss. The tax loss calculated as part of the current tax calculation has not yet been assessed by the SARS and will be referred to as an unused tax loss. The difference between the assessed tax loss calculated by the SARS and the unused tax loss calculated by the company will result in an overprovision or underprovision of income tax that will be corrected in the following financial year. CALCULATIONS C1. Current tax Profit before tax Non-taxable/non-deductible items: Dividends received not taxable Fine not deductible Taxable profit before temporary differences Movement in temporary differences (taxable) [C2] Taxable profit before unused tax loss Unused tax loss of prior year (given) Cumulative unused tax loss as at 31 December 20.12 Tax at 28% 20.12 R 500 000 (10 000) 15 000 505 000 1 (45 000) 460 000 2 (550 000) 2 (90 000)
-2

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3

C2. Deferred tax 31 December 20.11 Unused tax loss Deferred tax asset 31 December 20.12 Machinery Unused tax loss Net deferred tax asset

Carrying amount R -

Tax base R 550 000

Deferred tax at 28% (Dr)/Cr R (154 000) (154 000)


4

225 000 -

180 000 90 000

45 000 3 (90 000) (45 000) 45 000


1

12 600 4 (25 200) 4 (12 600) 12 600


5 5 5

Movement in temporary differences (excluding tax loss) (taxable) (45 000 - 0) Movement in unused tax loss (reversal of deductible) ((90 000) - (550 000)) Total movement in temporary differences ((45 000) - (550 000))

460 000 505 000

128 800 141 400

4 5

The movement in the temporary differences of R45 000 that is used in the current tax calculation excludes the movement in the unused tax loss. The R45 000 is a taxable temporary difference and must be deducted from taxable profit. The unused tax loss of R550 000 as at 31 December 20.11 is used to reduce the taxable profit of R460 000. No income tax is payable to the SARS for the year ended 31 December 20.12 as following the set off of the unused tax loss, Deasy Ltd still has a taxable loss of R90 000, which will be set off against taxable profit in the 20.13 financial year. As future taxable profits are probable against which the unused tax loss can be utilised, the unused tax loss can be seen as an asset as it will reduce future taxable profit and income tax expense. The tax base is greater than the carrying amount which gives rise to a deductible temporary difference and a deferred tax asset. Note that these deferred tax balances will be used to prepare the deferred tax note below. Note that these movements in deferred tax balance will be used to prepare the income tax expense note below.

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DISCLOSURE The income tax note and deferred tax note to the financial 31 December 20.12 of Deasy Ltd will be as follows:
DEASY LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12 3. Income tax expense Major components of tax expense SA normal tax Current tax -Current year [C1] Deferred tax -Movement in temporary differences [C2] (45 000 x 28%) -Unused tax loss utilised [C2] (460 000 x 28%) 20.12 R

statements for the year ended

12 600 128 800 141 400

Tax reconciliation Accounting profit Tax @ 28% Tax effect of non-taxable/non-deductible items: -Dividends received not taxable (10 000 x 28%) -Penalty not deductible (15 000 x 28%) Income tax expense 10 Deferred tax Analysis of temporary differences: Property, plant and equipment -Accelerated deductions for tax purposes Unused tax loss for normal tax Net deferred tax asset

500 000 140 000 (2 800) 4 200 141 400

12 600 (25 200) (12 600)

EXAMPLE 3B Unused tax loss when future profits are not probable as at 31 December 20.12 The accounting profit for the year ended 31 December 20.12 is R500 000. Included in the accounting profit are dividends received of R10 000 that are not taxable and a penalty of R15 000 that is not deductible for tax purposes. On 31 December 20.11 there were no temporary differences except for the unused tax loss of R550 000 for the year ended 31 December 20.11. The SARS assessment also reflects an assessed tax loss of R550 000. Deasy Ltd acquired machinery on 1 January 20.12 for R300 000 which is depreciated over four years on the straight line basis. The SARS allows a S12C deduction of 40% in the first year and 20% per year for the subsequent three years. Assume that future taxable profits were probable as at 31 December 20.11 but when reevaluated as at 31 December 20.12, that they are not.

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RECOGNITION OF A DEFERRED TAX ASSET (IAS 12.34-35) In order to recognise a deferred tax asset for an unused tax loss which can be used to decrease future taxable profit, the normal recognition criteria must be considered. If it is not probable that future taxable profits will be available against which the unused tax loss can be utilised, the deferred tax asset recognised must be limited to the extent that future taxable profits are probable. CALCULATIONS C1. Current tax Profit before tax Non-taxable/nondeductible items: Dividends received not taxable Fine not deductible Taxable profit before temporary differences Movement in temporary differences (taxable) [C2] Taxable profit before unused tax loss Unused tax loss of prior year (given) Cumulative unused tax loss as at 31 December 20.12 Tax at 28% Carrying amount R Temporary difference R (550 000) 1 (550 000) 45 000 2 (45 000) 1

20.12 R 500 000 (10 000) 15 000 505 000 (45 000) 460 000 (550 000) (90 000) Deferred tax at 28% (Dr)/Cr R (154 000) (154 000) 12 600 (12 600) -

C2Deferred tax 31 December 20.11 1 Unused tax loss Deferred tax asset 31 December 20.12 Machinery 2 Unused tax loss

Tax base R 550 000

225 000 -

180 000 90 000

Movement in temporary differences (excluding tax loss) (taxable) (45 000 - 0) Movement in unused tax loss (reversal of deductible) ((45 000) (550 000)) Total movement in temporary differences (0 - (550 000))

45 000 505 000 550 000

12 600 141 400 154 000

The full unused tax loss of R550 000 on 31 December 20.11 can be recognised as a deferred tax asset of R154 000 as future taxable profits are probable against which the unused tax loss can be utilised. As at 31 December 20.12, future taxable profits are not probable which means that the future utilisation of the unused tax loss must be limited. The taxable temporary difference of R45 000 relating to the machinery represents future taxable profits. In terms of IAS 12.35, the deferred tax asset on the unused tax loss of R90 000 must be limited to the extent that Deasy Ltd expects future taxable profits. Deasy Ltd has taxable temporary differences which will be taxable in future, and as a result, the unused tax loss that can be recognised is limited to R45 000. The net deferred tax balance is therefore Rnil.

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DISCLOSURE The income tax note and deferred tax note to the financial statements of Deasy Ltd for the year ended 31 December 20.12 will be as follows: DEASY LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12 3. Income tax expense Major components of tax expense SA normal tax Current tax -Current year [C1] Deferred tax -Movement in temporary differences [C2] (45 000 x 28%) -Unused tax loss utilised [C2] (505 000 x 28%)

20.12 R

12 600 141 400 154 000

Tax reconciliation Accounting profit Tax @ 28% Tax effect of non-taxable/non-deductible items: - Dividends received not taxable (10 000 x 28%) - Penalty not deductible (15 000 x 28%) Unused tax loss not recognised [C2] (90 000 - 45 000 = 45 000 x 28%) Income tax expense 10. Deferred tax Analysis of temporary differences: Property, plant and equipment -Accelerated deductions for tax purposes Unused tax loss for normal tax Net deferred tax balance

500 000 140 000 (2 800) 4 200 1 12 600 154 000

12 600 (12 600) -

The company has an unused tax loss in the current year for which no deferred tax asset has been recognised due to uncertainty regarding the probability of future taxable profits. The unrecognised unused tax loss is as follows: Unused tax loss for which no deferred tax asset has been recognised (90 000 - 45 000)
1 2

45 000

As at 31 December 20.12, a deferred tax asset is raised for only R45 000 of the R90 000 unused tax loss. The remaining balance of R45 000 is not recognised at all and as a result the total income tax expense of R154 000 includes deferred tax on only R45 000 of the unused tax loss. The remaining R45 000 that is not recognised due to future taxable profits not being probable and will give rise to a reconciling item in the tax reconciliation. Please note the additional disclosure required for the unrecognised unused tax loss in the deferred tax note.

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COMMENT ON THE TAX RECONCILIATION Compare the income tax note of Example 3A to the income tax note of Example 3B. Take special note of the differences between the two notes as the differences relate solely to the unrecognised unused tax loss of R45 000. EXAMPLE 3C Unused tax loss when future profits were not probable as at 31 December 20.11 The accounting profit for the year ended 31 December 20.12 is R500 000. Included in the accounting profit is dividends received of R10 000 that are not taxable and a penalty of R15 000 that is not deductible for tax purposes. On 31 December 20.11 prepaid expenses amounted to R40 000 and the unused tax loss was R 550 000. The SARS assessment also reflects an assessed tax loss of R550 000. Deasy Ltd acquired machinery on 1 January 20.12 for R300 000 which is depreciated over four years on the straight line basis. The SARS allows a S12C deduction of 40% in the first year and 20% per year for the subsequent three years. Future taxable profits were not probable as at 31 December 20.11 but are probable as at 31 December 20.12. CALCULATIONS C1. Current tax Profit before tax Non-taxable/non-deductible items: Dividends received not taxable Fine not deductible Taxable profit before temporary differences Movement in temporary differences (taxable)[C2] Taxable profit before unused tax loss Unused tax loss of prior year (given) Cumulative unused tax loss as at 31 December 20.12 Tax at 28% C2 Deferred tax 31 December 20.11 Prepaid expenses Unused tax loss 31 December 20.12 Machinery Unused tax loss Net deferred tax asset Carrying amount R 40 000 225 000 Tax base R Temporary difference R 40 000 5 (40 000) 45 000 6 (50 000) (5 000)
1

20.12 R 500 000 (10 000) 15 000 505 000 1 (5 000) 500 000 2 (550 000)
(50 000)
3

Deferred tax at 28% (Dr)/Cr R 11 200 (11 200) 12 600 (14 000) (1 400)

-4
550 000 180 000 50 000

Movement in temporary differences (excluding tax loss) (taxable) (45 000 - 40 000) Movement in unused tax loss (deductible) ((50 000) - (40 000)) Total movement in temporary differences ((5 000) - 0)

5 000 (10 000) (5 000)

1 400 (2 800) (1 400)

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1 2

3 4

The movement in the temporary differences of R5 000 that is used in the income tax calculation excludes the movement in the unused tax loss. It is important to note that for purposes of the current tax calculation, the SARS does not consider if future profits are probable or not, thus even though the entire unused tax loss was not recognised for accounting purposes, the SARS will allow Deasy Ltds full unused tax loss as a deduction against taxable profits in the current tax calculation. As at 31 December 20.12, R500 000 of the R550 000 was utilised to reduce the income tax expense and an unused tax loss balance of R50 000 remains. Prepaid expenses are an asset. The tax base of prepaid expenses is the amount deductible in future. The tax base is Rnil as the expense is deducted for tax purposes in the current year. For accounting purposes, this prepaid expense will only be recognised in P/L as an expense in the 20.13 financial year but no amount will be deductible for tax purposes in the 20.13 financial year as it was deducted in the 20.12 year.

As at 31 December 20.11, future taxable profits are not probable. The taxable temporary difference of R40 000 relating to the prepaid expenses represents future taxable profits. In terms of IAS 12.35, the deferred tax asset on the unused tax loss of R550 000 must be limited to the extent that future taxable profits are probable, and as a result, the unused tax loss that can be recognised is limited to R40 000. The net deferred tax balance is therefore Rnil. The unused tax loss of R50 000 is not limited as future taxable profits are probable as at 31 December 20.12. The R510 000 (550 000 40 000) unused tax loss that was previously not recognised has now been utilised to reduce the taxable profit even though it was never been recognised.

DISCLOSURE The income tax note and deferred tax note to the financial statements of Deasy Ltd for the year ended 31 December 20.12 will be as follows: DEASY LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12 3. Income tax expense Major components of tax expense SA normal tax Current tax -Current year [C1] Deferred tax -Movement in temporary differences [C2] (5 000 x 28%) -Recognition of unused tax loss not previously recognised (550 000 - 40 000 = 510 000 x 28%) -Unused tax loss utilised (550 000 - 50 000 = 500 000 x 28%) 20.12 R

1 400 (142 800) 2 140 000 (1 400)


1

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Tax reconciliation Accounting profit Tax @ 28% Tax effect of non-taxable/non-deductible items: - Dividends received not taxable (10 000 x 28%) - Penalty not deductible (15 000 x 28%) Unused tax loss utilised that was not previously recognised (510 000 x 28%) Income tax expense A previously unrecognised unused tax loss gave rise to a benefit of R142 800 that 3 was used to reduce the current tax expense in the current year. 10. Deferred tax Analysis of temporary differences: Property, plant and equipment -Accelerated deductions for tax purposes Unused tax loss for normal tax Net deferred tax asset

500 000 140 000 (2 800) 4 200 1 (142 800) (1 400)

12 600 (14 000) (1 400)

2 3

Only R40 000 of the unused tax loss of R550 000 has been recognised as at 31 December 20.11. As the balance of the unused tax loss of R510 000 (R550 000 R40 000) was not recognised at all as at 31 December 20.11 and as there is no limitation as at 31 December 20.12, this unrecognised unused tax loss of R510 000 must now be recgonised and will affect both the income tax expense and tax rate reconciliation in the current year. The unused tax loss utilised is the unused tax loss that was used in C1 above to reduce the taxable profit of R500 000 for the year ended 31 December 20.12. Please note the additional disclosure in the income tax note for the previously unrecognised unused tax loss that is utilised in the current year to reduce the income tax expense (IAS 12.80(f)).

EXAMPLE 4A Land measured using the revaluation model in IAS 16 The accounting profit for the year ended 31 December 20.12 is R500 000. Included in the accounting profit are dividends received of R10 000 that are not taxable and a penalty of R15 000 that is not deductible for tax purposes. Prepaid expenses on 31 December 20.11 amounted to R40 000 and R30 000 on 31 December 20.12. There were no other temporary differences on 31 December 20.11. Deasy Ltd acquired land in Midrand for R1 000 000 on 1 January 20.12 and plans to construct a factory thereon. The land is measured using the revaluation model in IAS 16. The land was revalued to R1 200 000 on 31 December 20.12.

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CALCULATIONS C1. Current tax Profit before tax Non-taxable/nondeductible items: Dividends received not taxable Fine not deductible Taxable profit before temporary differences Movement in temporary differences (reversal of taxable) [C2] Taxable profit Tax at 28% Carrying amount R 40 000 Temporary difference R 40 000 40 000 30 000 200 000 230 000 200 000 (10 000) 190 000
1

20.12 R 500 000 (10 000) 15 000 505 000 10 000 515 000 144 200 Deferred tax at 28% (Dr)/Cr R 11 200 11 200 8 400 3 37 296 45 696 37 296 (2 800) 34 496
1

C2Deferred tax 31 December 20.11 Prepaid expenses Deferred tax liability 31 December 20.12 Prepaid expenses Land in Midrand (through OCI) Net deferred tax liability

Tax base R -

30 000 2 1 200 000 1 000 000

Movement in temporary differences (through OCI) (taxable) (200 000 - 0) Movement in temporary differences (through P/L) (reversal of taxable) (30 000 - 40 000) Total movement in temporary differences (230 000 40 000)

The movement in temporary differences excludes items that do not affect P/L. As a result, the revaluation of the land (which affects OCI) is not included from the movement in temporary differences. Note that the movement in temporary differences of R10 000 is a reversal in the taxable temporary difference from R40 000 to R30 000 which is added to the taxable profit. It has the same effect as a deductible temporary difference. The carrying amount of land will be recovered through sale and not through use. Land measured using the revaluation model in IAS 16 or IAS 40 will always be recovered through sale (IAS 12.51B). The tax base of land will therefore be the CGT base cost which is the amount deductible in future against the proceeds of the land when it is sold. The deferred tax on the temporary difference on land is raised at the CGT inclusion rate of 66,6% which is tehn taxed at 28%.

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DISCLOSURE The income tax note and deferred tax note to the financial statements of Deasy Ltd for the year ended 31 December 20.12 will be as follows: DEASY LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12 3. Income tax expense Major components of tax expense SA normal tax Current tax -Current year [C1] Deferred tax -Movement in temporary differences [C2] (10 000 x 28%) Tax reconciliation Accounting profit Tax @ 28% Tax effect of non-taxable/non-deductible items: - Dividends received not taxable (10 000 x 28%) - Penalty not deductible (15 000 x 28%) Income tax expense 10. Deferred tax Analysis of temporary differences: Property, plant and equipment -Revaluation, net of related depreciation Prepaid expenses Deferred tax liability 20.12 R

144 200 (2 800) 141 400 500 000 140 000 (2 800) 4 200 141 400

37 296 8 400 45 696

COMMENT ON THE INCOME TAX NOTE AND TAX RECONCILIATION Note that the revaluation of the land does not affect the income tax expense note and tax reconciliation. The tax reconciliation relates only to items that affect P/L. The revaluation of land affects OCI and the revaluation of the land, together with its tax effect, will be disclosed in OCI. EXAMPLE 4B Land sold for a capital gain The accounting profit for the year ended 31 December 20.12 is R500 000. Included in the accounting profit are dividends received of R10 000 that are not taxable and a penalty of R15 000 that is not deductible for tax purposes. Prepaid expenses on 31 December 20.11 amounted to R40 000 and R30 000 on 31 December 20.12. Deasy Ltd acquired land in Midrand for R1 000 000 on 1 January 20.11 and plans to construct a factory thereon. The land is carried at historical cost in terms of IAS 16. There were no other temporary differences on 31 December 20.11.

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The land in Midrand was sold on 31 December 20.12 due to a decision by the board to rather rent a factory than to build one. The land was sold for R1 400 000 and the profit on the sale of the land is included in the accounting profit. Assume that the SARS treats the gain as a capital gain and that the capital gain for CGT purposes is equal to the accounting profit on the sale of land. CALCULATIONS C1. Current tax Profit before tax Non-taxable/non-deductible items: Dividends received not taxable Fine not deductible Add back entire capital gain as not taxable (400 000 x 100%) Capital gain on sale of land that is taxable (400 000 x 66,6%) Taxable profit before temporary differences Movement in temporary differences (reversal of taxable) [C2] Taxable profit Tax at 28% Carrying amount R 40 000 1 000 000 Temporary difference R 40 000 40 000 30 000 30 000 (10 000) 20.12 R 500 000 (10 000) 15 000 1 (400 000) 1 266 400 371 400 10 000 381 400 106 792 Deferred tax at 28% (Dr)/Cr R 11 200 11 200 8 400 8 400 (2 800)

C2

Deferred tax 31 December 20.11 Prepaid expenses Land in Midrand Net deferred tax liability 31 December 20.12 Prepaid expenses Deferred tax liability

Tax base R
2

1 000 000

30 000

Movement in temporary differences (reversal of taxable) (30 000 -40 000)

The land was sold for a capital gain of R400 000 (R1 400 000 - R1 000 000). The entire capital gain of R400 000 is deducted from the taxable profit and only the taxable portion of 66,6% of the capital gain is then included in the taxable profit. The balance of 33,4% will never be taxable and is a non-taxable item in the tax rate reconciliation. On 31 December 20.11 the land is carried at cost. IAS 12 requires that carrying amount of land measured using the revaluation model in IAS 16 or IAS 40 be recovered through sale (IAS 12.51B). It is therefore theoretically possible to recover the carrying amount of land measured at historical cost through use. Practically however, the use of the land will not decrease the value of the land (as is the case with machinery) as it cannot be depleted in use. This also confirms why no depreciation and tax deductions are allowed for on land. UNISAs approach is that the carrying amount of land will always be recovered through sale, regardless if it is measured at historical cost or using the revaluation model. The tax base of the land will therefore be the CGT base cost which is the amount that will be deductible in future against the proceeds of the land when it is sold.

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DISCLOSURE The income tax note and deferred tax note to the financial statements of Deasy Ltd for the year ended 31 December 20.12 will be as follows: DEASY LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12 3. Income tax expense Major components of tax expense SA normal tax Current tax -Current year [C1] Deferred tax -Movement in temporary differences [C2] (10 000 x 28%) Tax reconciliation Accounting profit Tax @ 28% Tax effect of non-taxable/non-deductible items: - Dividends received not taxable (10 000 x 28%) - Penalty not deductible (15 000 x 28%) - Capital gain on sale of land (400 000 x 33,4% x 28%) Income tax expense 10. Deferred tax Analysis of temporary differences: Prepaid expenses Deferred tax liability 20.12 R

106 792 (2 800) 103 992 500 000 140 000 (2 800) 4 200 1 (37 408) 103 992

8 400 8 400

Note that the non-taxable portion of the capital gain on the sale of land is a reconciling item in the tax reconciliation together with the other non-taxable and non-deductible items.

EXAMPLE 4C Land sold for capital gain (Assessed capital loss from the prior year when future capital profits were probable) The accounting profit for the year ended 31 December 20.12 is R500 000. Included in the accounting profit are dividends received of R10 000 that are not taxable and a penalty of R15 000 that is not deductible for tax purposes. Prepaid expenses on 31 December 20.11 amounted to R40 000 and R30 000 on 31 December 20.12. Deasy Ltd acquired land in Midrand for R1 000 000 on 1 January 20.11 and plans to construct a factory thereon. The land is carried at historical cost in terms of IAS 16. Deasy Ltd had an assessed capital loss of R300 000 on 31 December 20.11 and future capital profits were probable at that date. There were no other temporary differences on 31 December 20.11.

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The land in Midrand was sold on 31 December 20.12 due to a decision by the board to rather rent a factory than to build one. The land was sold for R1 400 000 and the profit on the sale of the land is included in the accounting profit. Assume that the SARS treats the gain as a capital gain and that the capital gain for CGT purposes is equal to the accounting profit on the sale of land. CALCULATIONS C1. Current tax Profit before tax Non-taxable/non-deductible items: Dividends received not taxable Fine not deductible Deduct entire capital gain as not taxable Net capital gain that is taxable [C3] Taxable profit before temporary differences Movement in temporary differences (reversal of taxable) [C2] Taxable profit Tax at 28%
1

20.12 R 500 000 (10 000) 15 000 1 (400 000) 1 66 600 171 600 10 000 181 600 50 848

The entire capital gain of R400 000 is added back. The assessed capital loss that existed on 31 December 20.11 must first be set off against the capital gain in order to determine how much of the net capital gain will be taxable. Refer to calculation C3 below. Carrying amount R 40 000 1 000 000 Temporary Tax base difference R R 1 000 000 199 800 40 000 40 000 (199 800) (159 800) 30 000 30 000 (10 000) 199 800 189 800 Deferred tax at 28% (Dr)/Cr R 11 200 11 200 (55 944) (44 744) 8 400 8 400 (2 800) 55 944 53 144

C2.

Deferred tax 31 December 20.11 Prepaid expenses Land in Midrand Unused capital loss (300 000 x 66,6%) Net deferred tax asset 31 December 20.12 Prepaid expenses Deferred tax liability

30 000

Movement in temporary differences (excluding capital loss) (reversal of taxable) (30 000 - 40 000) Movement in unused capital loss (reversal of deductible) (0 (199 800)) Total movement In temporary differences (30 000 (159 800)) C3. Capital gains tax Capital gain on sale of land Assessed capital loss on 31 December 20.11 Net capital gain Portion of capital gain that must be included in taxable income (100 000 x 66,6%)

400 000 (300 000) 100 000 66 600

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DISCLOSURE The income tax note and deferred tax note to the financial statements of Deasy Ltd for the year ended 31 December 20.12 will be as follows: DEASY LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12 3. Income tax expense Major components of tax expense SA normal tax Current tax -Current year [C1] Deferred tax -Movement in temporary differences [C2] (10 000 x 28%) -Unused capital loss utilised [C2] (199 800 x 28%)

20.12 R

50 848 (2 800) 55 944 103 992

Tax reconciliation Accounting profit Tax @ 28% Tax effect of non-taxable/non-deductible items: - Dividends received not taxable (10 000 x 28%) - Penalty not deductible (15 000 x 28%) - Capital gain on sale of land (400 000 x 33,4% x 28%) Income tax expense 10. Deferred tax Analysis of temporary differences: Prepaid expenses Net deferred tax liability

500 000 140 000 (2 800) 4 200 1 (37 408) 103 992

8 400 8 400

Note that the non-taxable portion of the capital gain of R400 000 is a reconciling item in the tax reconciliation together with the other non-taxable and non-deductible items. The entire R400 000 capital gain is included in the accounting profit and therefore 33,4% of R400 000 is a reconciling item regardless of the fact that only R66 600 of the capital gain is included in the taxable profit.

EXAMPLE 4D Land sold for capital gain (Assessed capital loss from the prior year when future capital profits were not probable) The accounting profit for the year ended 31 December 20.12 is R500 000. Included in the accounting profit are dividends received of R10 000 that are not taxable and a penalty of R15 000 that is not deductible for tax purposes. Prepaid expenses on 31 December 20.11 amounted to R40 000 and R30 000 on 31 December 20.12.

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Deasy Ltd acquired land in Midrand for R1 000 000 on 1 January 20.11 and plans to construct a factory thereon. The land is carried at historical cost in terms of IAS 16. Deasy Ltd had an assessed capital loss of R300 000 on 31 December 20.11 and future capital profits were NOT probable at that date. There were no other temporary differences on 31 December 20.11. The land in Midrand was sold on 31 December 20.12 due to a decision by the board to rather rent a factory than to build one. The land was sold for R1 400 000 and the profit on the sale of the land is included in the accounting profit. Assume that the SARS treats the gain as a capital gain and that the capital gain for CGT purposes is equal to the accounting profit on the sale of land. CALCULATIONS C1. Current tax Profit before tax Non-taxable/non-deductible items: Dividends received not taxable Fine not deductible Deduct entire capital gain as not taxable Net capital gain that is taxable [C3] Taxable profit before temporary differences Movement in temporary differences (reversal of taxable) [C2] Taxable profit Tax at 28% Carrying amount R 40 000 1 000 000 Temporary difference R 40 000 40 000 40 000 30 000 30 000 (10 000) (10 000)
1

20.12 R 500 000 (10 000) 15 000 (400 000) 66 600 171 600 10 000 181 600 50 848 Deferred tax at 28% (Dr)/Cr R 11 200 11 200 11 200 8 400 8 400 (2 800) (2 800)

C2.

Deferred tax 31 December 20.11 Prepaid expenses Land in Midrand

Tax base R 1 000 000

Unused capital loss (300 000 x 66,6%) 199 800 Net deferred tax liability 31 December 20.12 Prepaid expenses 30 000 Deferred tax liability Movement in temporary differences (excluding capital loss) (reversal of taxable) (30 000 - 40 000) Movement in unused capital loss Total movement in temporary differences (30 000 (159 800))

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C3

Capital gains tax Capital gain on sale of land Assessed capital loss on 31 December 20.11 Net capital gain Portion of capital gain that must be included in taxable income (100 000 x 66,6%) 400 000 2 (300 000) 100 000

66 600

Future capital gains were not probable as at 31 December 20.11. As the unused capital loss can only be used to reduce future capital gains, and future capital gains were not probable, the entire unused capital loss could not be recognised. Please note that it is not limited to the taxable temporary difference of R40 000 as the R40 000 does not represent future capital gains. It is important to note that for purposes of the income tax calculation, the SARS does not consider whether future capital gains are probable or not and the SARS allows Deasy Ltds full unused capital loss as a deduction against capital gains in determining the net capital gain that is taxable.

DISCLOSURE The income tax note and deferred tax note to the financial statements of Deasy Ltd for the year ended 31 December 20.12 will be as follows: DEASY LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12 3. Income tax expense Major components of tax expense SA normal tax Current tax -Current year [C1] Deferred tax -Movement in temporary differences [C2] (10 000 x 28%) -Recognition of unused capital loss not previously recognised [C2] (300 000 x 66,6% x 28%) -Unused capital loss utilised [C2] (300 000 x 66,6% x 28%) 20.12 R

50 848 (2 800) (55 944) 55 944 48 048


1

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FAC4861/102 NFA4861/102 ZFA4861/102 20.12 R

Tax reconciliation Accounting profit Tax @ 28% Tax effect of non-taxable/non-deductible items: - Dividends received not taxable (10 000 x 28%) - Penalty not deductible (15 000 x 28%) - Capital gain on sale of land (400 000 x 33,4% x 28%) Unused capital loss utilised that was not previously recognised (300 000 x 66,6% x 28%) Income tax expense A previously unrecognised unused capital loss gave rise to a benefit of R55 944 2 that was used to reduce the current tax expense in the current year. 10. Deferred tax Analysis of temporary differences: Prepaid expenses Net deferred tax liability

500 000 140 000 (2 800) 4 200 (37 408) (55 944) 48 048

8 400 8 400

The full R300 000 unused capital loss has not been recognised as at 31 December 20.11 and as the full unused capital loss is utilised as at 31 December 20.12, this unrecognised unused capital loss of R300 000 must now be recognised and will affect both the income tax expense and tax rate reconciliation in the current year. Please note the additional disclosure in the income tax note for the previously unrecognised unused capital loss that is utilised in the current year to reduce the income tax expense (IAS 12.80(f)).

EXAMPLE 4E Land sold for a capital loss when future capital gains are probable The accounting profit for the year ended 31 December 20.12 is R500 000. Included in the accounting profit are dividends received of R10 000 that are not taxable and a penalty of R15 000 that is not deductible for tax purposes. Prepaid expenses on 31 December 20.11 amounted to R40 000 and R30 000 on 31 December 20.12. Deasy Ltd acquired land in Midrand for R1 000 000 on 1 January 20.11 and plans to construct a factory thereon. The land is carried at historical cost in terms of IAS 16. There were no other temporary differences on 31 December 20.11. The land in Midrand was sold on 31 December 20.12 due to a decision by the board to rather rent a factory than to build one. The land was sold for R920 000 and the loss on the sale of land is included in the accounting profit. Assume that the SARS treats the loss as a capital loss and that the capital loss for CGT purposes is equal to the accounting loss on the sale of land. Assume that future capital gains are probable.

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CALCULATIONS C1. Current tax Profit before tax Non-taxable/non-deductible items: Dividends received not taxable Fine not deductible Add back entire capital loss on sale of land not deductible Capital loss that is deductible (80 000 x 66,6%) Taxable profit before temporary differences Movement in temporary differences (reversal of taxable) [C2] Movement in unused capital loss (deductible) [C2] Taxable profit Tax at 28% 20.12 R 500 000 (10 000) 15 000 1 80 000 (53 280) 531 720 10 000
2 3

53 280 595 000 166 600 Deferred tax at 28% (Dr)/Cr R

C2.

Deferred tax 31 December 20.11 Prepaid expenses Land in Midrand Deferred tax liability 31 December 20.12 Prepaid expenses Unused capital loss (80 000 x 66,6%) Net deferred tax asset

Carrying amount R 40 000 1 000 000

Tax base R 1 000 000

Temporary difference R 40 000 40 000

11 200 11 200 8 400 8 400 (14 918) (6 518) (2 800) (14 918) (17 718)

30 000 -

53 280

30 000 30 000 3 (53 280) (23 280) (10 000) 3 (53 280) (63 280)
3

Movement in temporary differences (excluding capital loss) (reversal of taxable) (30 000 - 40 000) Movement in unused capital loss (deductible) ((53 280) - 0) Total movement in temporary differences ((23 280) - 40 000)

The entire capital loss of R80 000 is added back to the taxable profit and 66,6% of the capital loss that is deductible is then deducted from the taxable profit. The balance of 33,4% will never be deductible and is a non-deductible item in the tax rate reconciliation. The movement in the temporary differences is split between the normal temporary differences and the temporary differences that relate to the unused capital loss. This split is done in order to disclose the capital loss separately in the income tax note. The unused capital loss at 66,6% can be seen as an asset as it will reduce future capital gains that will give rise to CGT. This asset may only be recognised if future capital gains are probable. The tax base of this asset is greater than the carrying amount which gives rise to a deductible temporary difference and a deferred tax asset. For income tax purposes this deductible temporary difference is added to the taxable profit. For deferred tax purposes the deductible temporary difference gives rise to a deferred tax asset of R53 280 which causes a net deferred tax asset of R23 280.

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DISCLOSURE The income tax note and deferred tax note to the financial statements of Deasy Ltd for the year ended 31 December 20.12 will be as follows: DEASY LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12 3. Income tax expense Major components of tax expense SA normal tax Current tax -Current year [C1] Deferred tax -Movement in temporary differences [C2] (10 000 x 28%) -Unused capital loss created [C2] (53 280 x 28%) Tax reconciliation Accounting profit Tax @ 28% Tax effect of non-taxable/non-deductible items: - Dividends received not taxable (10 000 x 28%) - Penalty not deductible (15 000 x 28%) - Capital loss on sale of land (80 000 x 33,4% x 28%) Income tax expense 10. Deferred tax Analysis of temporary differences: Prepaid expenses Unused capital loss for capital gains tax Net deferred tax asset 20.12 R

166 600 (2 800) (14 918) 148 882 500 000 140 000 (2 800) 4 200 1 7 482 148 882

8 400 2 (14 918) (6 518)

1 2

Note that the non-deductible portion of the capital loss is a reconciling item in the tax reconciliation. Note that deferred tax on the unused capital loss is disclosed in the deferred tax note.

EXAMPLE 4F Land sold for a capital loss when future capital gains are not probable The accounting profit for the year ended 31 December 20.12 is R500 000. Included in the accounting profit is dividends received of R10 000 that is not taxable and a penalty of R15 000 that is not deductible for tax purposes. Prepaid expenses on 31 December 20.11 amounted to R40 000 and R30 000 on 31 December 20.12. Deasy Ltd acquired land in Midrand for R1 000 000 on 1 January 20.11 and plans to construct a factory thereon. The land is carried at historical cost in terms of IAS 16. There were no other temporary differences on 31 December 20.11.

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The land in Midrand was sold on 31 December 20.12 due to a decision by the board to rather rent a factory than to build one. The land was sold for R920 000 and the loss on the sale of the land is included in the accounting profit of R500 000. Assume that the SARS treats the loss as a capital loss and that the capital loss for CGT purposes is equal to the loss on the sale of land Assume that future capital gains are NOT probable as at 31 December 20.12. CALCULATIONS C1. Current tax Profit before tax Non-taxable/non-deductible items: Dividends received not taxable Fine not deductible Add back entire capital loss not deductible Capital loss that is deductible (80 000 x 66,6%) Taxable profit before temporary differences Movement in temporary differences (reversal of taxable) [C2] Unused capital loss added back because deferred tax will not be recognised (80 000 x 66,6%) [C2] Taxable profit Tax at 28% Carrying amount R 40 000 1 000 000 Temporary Tax base difference R R 1 000 000 40 000 40 000 30 000 30 000
-1

20.12 R 500 000 (10 000) 15 000 80 000 (53 280) 531 720 10 000 53 280 595 000 166 600 Deferred tax at 28% (Dr)/Cr R 11 200 11 200 8 400 8 400 8 400 (2 800) (2 800)
1

C2.

Deferred tax 31 December 20.11 Prepaid expenses Land in Midrand Deferred tax liability 31 December 20.12 Prepaid expenses Unused capital loss (80 000 x 66.6%) Deferred tax liability

30 000 -

53 280

30 000 (10 000) (10 000)

Movement in temporary differences (excluding capital loss) (reversal of taxable) (30 000 - 40 000) Movement in unused capital loss Total movement in temporary differences
1

Due to future capital gains not being probable, no deferred tax asset will be raised for the unused capital loss of 66,6% that will be deductible against future capital gains. As a result, 100% of the capital loss is non-deductible for income tax purposes: 33,4% of the capital loss will never be deductible and qualifies as a non-deductible item. 66,6% of the capital loss is also treated as a non-deductible item but only because future capital gains are not probable as at 31 December 20.12 against which this unused capital loss can be deducted. This unused capital loss may be recognised in future when future capital gains become probable again. However, until future capital gains become probable, this 66,6% of the capital loss will be treated similarly to a nondeductible item and must be added back from the taxable profit and it will be a reconciling item in the tax reconciliation.

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DISCLOSURE The income tax note and deferred tax note to the financial statements of Deasy Ltd for the year ended 31 December 20.12 will be as follows: DEASY LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12 3. Income tax expense Major components of tax expense SA normal tax Current tax -Current year [C1] Deferred tax -Movement in temporary differences [C2] (10 000 x 28%) -Unused capital loss created [C2] Tax reconciliation Accounting profit Tax @ 28% Tax effect of non-taxable/non-deductible items: - Dividends received not taxable (10 000 x 28%) - Penalty not deductible (15 000 x 28%) - Capital loss on sale of land (80 000 x 33,4% x 28%) Unused capital loss not recognised (80 000 x 66,6% x 28%) Income tax expense 10. Deferred tax Analysis of temporary differences: Prepaid expenses Unused capital loss for capital gains tax Net deferred tax asset 20.12 R

166 600 (2 800)


-1

163 800 500 000 140 000 (2 800) 4 200 7 482 1 14 918 163 800

8 400 8 400

The company has an unused capital loss for which no deferred tax asset has been recognised due to uncertainty regarding the probability of future capital gains. The unrecognised unused

capital loss is as follows: Unused capital loss for which no deferred tax asset has been recognised
1

53 280

No deferred tax is raised on the unused capital loss. As a result, the unrecognised unused capital loss at 66,6% is treated as a non-deductible item in the tax rate reconciliation. Please note that 33,4% of the capital loss is already a non-deductible item. 66.6% of the capital loss is not disclosed as part of the list of non-deductible and non-taxable items. It is a separate line item in the tax rate reconciliation because it arose as a result of not being recognised for deferred tax purposes. Please take note of the additional disclosure required in the deferred tax note relating to the unused capital loss for which no deferred tax has been recognised (IAS 12.82).

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EXAMPLE 5A Deferred tax on items that do not affect profit or loss The accounting profit for the year ended 31 December 20.11 is R500 000. Included in the accounting profit are dividends received of R10 000 that are not taxable and a penalty of R15 000 that is not deductible for tax purposes. On 1 January 20.11 Deasy Ltd acquired shares in Cappy Ltd for strategic reasons and elected to present the changes in fair value of the shares in OCI in terms of IFRS 9. The fair value adjustments must be allocated to the mark-to-market reserve in OCI. The shares were acquired for R800 000 and transaction costs were R20 000. In terms of IFRS 9, the transaction costs must be capitalised against the cost of the investment in shares. The fair value of the shares was R920 000 on 31 December 20.11 and R990 000 on 31 December 20.12. The shares are held for long term purposes and will be subject to CGT. Assume that transaction costs are included in the base cost of the shares for CGT purposes. No other temporary differences existed on 31 December 20.11. Deasy Ltd acquired machinery on 1 January 20.12 for R300 000 which is depreciated over four years on the straight line basis. The SARS allows a S12C deduction of 40% in the first year and 20% per year for the subsequent three years. CALCULATIONS C1. Current tax Profit before tax Non-taxable/non-deductible items: Dividends received not taxable Fine not deductible Taxable profit before temporary differences Movement in temporary differences (taxable) [C2] Taxable profit Tax at 28% Carrying amount R 920 000 Temporary difference R 100 000 100 000 170 000 45 000 215 000 45 000 70 000 115 000 20.12 R 500 000 (10 000) 15 000 505 000 (45 000) 460 000 128 800 Deferred tax at 28% (Dr)/Cr R 18 648 18 648 31 702 12 600 44 302 12 600 13 054 25 654
2 2

C2.

Deferred tax 31 December 20.11 Investment in shares (through OCI) Deferred tax liability 31 December 20.12 Investment in shares (through OCI) Machinery Deferred tax liability

Tax base R 820 000


1

990 000 225 000

820 000 180 000

Movement in temporary differences (through P/L) (taxable) (45 000 - 0) Movement in temporary differences (through OCI) (taxable) (170 000 - 100 000) Total movement in temporary differences (215 000 - 100 000)

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The tax base of the investment in shares for 20.11 and 20.12 is the CGT base cost that will be deductible from the proceeds when the investment will be sold in future (800 000 + 20 000 = 820 000). Deferred tax on the temporary differences on the shares is raised at the CGT inclusion rate of 66,6% which is then taxed at 28%.

DISCLOSURE The income tax note and deferred tax note to the financial statements of Deasy Ltd for the year ended 31 December 20.12 will be as follows: DEASY LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12 3 Income tax expense Major components of tax expense SA normal tax Current tax -Current year [C1] Deferred tax -Movement in temporary differences [C2] (45 000 x 28%) Tax reconciliation Accounting profit Tax @ 28% Tax effect of non-taxable/non-deductible items: - Dividends received not taxable (10 000 x 28%) - Penalty not deductible (15 000 x 28%) Income tax expense The aggregate tax relating to items that are charged or credited directly to equity (IAS 12.81(a)) (see comment below) - Current tax - Deferred tax 10 Deferred tax Analysis of temporary differences: Property, plant and equipment -Accelerated deductions for tax purposes Investment in equity shares 20.12 R

128 800 12 600 141 400 500 000 140 000 (2 800) 4 200 141 400

xxx xxx xxx

12 600 1 31 702 44 302

The total deferred tax (regardless if it is recognised in P/L, OCI or directly in equity) must be disclosed in the deferred tax note. The deferred tax note includes the total deferred tax liability and therefore includes the deferred tax that relates to the investment in equity shares.

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ITEMS RECOGNISED IN P/L, OCI AND DIRECTLY IN EQUITY Current tax calculations: A company can do three separate current tax calculations: 1. For items recognised in P/L, 2. For items recognised in OCI, and 3. For items recognised directly in equity. The aggregate of these three current tax calculations will be the amount that must be paid to the SARS for the current financial year. Deferred tax calculations: A company can do one deferred tax calculation, but need to split the movement in the temporary differences between P/L, OCI and directly in equity. The income tax expense (current tax and deferred tax) is disclosed as follows: 1. The income tax expense for items recognised in P/L is disclosed in the income tax note. 2. The income tax expense for items recognised in OCI is disclosed either on the face of the statement of OCI or in an income tax expense note for items recognised in OCI (IAS 1.91 and IAS 12.81(ab)). 3. The income tax expense for items recognised in directly in equity is disclosed as an aggregate amount (IAS 12.81(a)) which can be added as a disclosure at the end of the income tax note or a separate note for income tax expense for items recognised directly in equity. Refer to the disclosure above in Example 5A. EXAMPLE 5B Deferred tax on items carried at fair value through profit or loss The accounting profit for the year ended 31 December 20.12 is R500 000. Included in the accounting profit are dividends received of R10 000 that are not taxable and a penalty of R15 000 that is not deductible for tax purposes. On 1 January 20.11 Deasy Ltd acquired shares in Cappy Ltd as a long-term investment. The shares are carried in terms of IFRS 9 at fair value through profit or loss. The shares were acquired for R800 000 and transaction costs were R20 000. The fair value of the shares was R920 000 on 31 December 20.11 and R990 000 on 31 December 20.12. Assume that the investment in shares is subject to CGT and that transaction costs are included in base cost of the shares for CGT purposes. No other temporary differences existed on 31 December 20.11. Deasy Ltd acquired machinery on 1 January 20.12 for R300 000 which is depreciated over four years on the straight line basis. The SARS allows a S12C deduction of 40% in the first year and 20% per year for the subsequent 3 years.

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CALCULATIONS C1. Current tax Profit before tax Non-taxable/non-deductible items: Dividends received not taxable Fine not deductible Fair value adjustment on shares (70 000 x 33,4%) Taxable profit before temporary differences Movement in temporary differences (taxable in future) [C2] Taxable profit Tax at 28% Carrying amount R 920 000 Temporary difference R 100 000 100 000 170 000 45 000 215 000 20.12 R 500 000 (10 000) 15 000 1 (23 380) 481 620 (91 620) 390 000 109 200 Deferred tax at 28% (Dr)/Cr R 18 648 18 648 31 702 12 600 44 302

C2.

Deferred tax 31 December 20.11 Investment in shares Deferred tax liability 31 December 20.12 Investment in shares Machinery Deferred tax liability

Tax base R 820 000

990 000 225 000

820 000 180 000

Movement in temporary differences (through P/L) (taxable) (215 000 - 100 000) Adjust movement in temporary difference on investment in shares to reflect 66,6% and not 100% by deducting 33,4% (170 000 - 100 000) x 33,4% Total movement in temporary differences (taxable) Movement in deferred tax balance (44 302 - 18 648)

115 000
2

(23 380) 91 620

25 654

The fair value adjustment on the investment in shares on 31 December 20.12 is R70 000 (R990 000 R920 000) and is included in P/L. 66,6% of this fair value adjustment will be subject to CGT in future when the shares are sold. The balance of 33,4% will never be taxable and is a non-taxable item that must be added back. For purposes of calculating the movement in temporary differences that must be included in the current tax calculation, all temporary differences must be subject to the same tax rate, i.e. 28%. The temporary differences relating to the investment in shares are subject to an effective CGT tax rate of 18,6% (66,6% x 28%). In order to adjust the movement in temporary differences relating to the investment in shares so that it is subject to tax at 28%, the temporary differences that are subject to CGT must be decreased with 33,4% so that multiplying them with 28% will give the same deferred tax amount. This concept can be explained as follows:

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Deferred tax on investment in shares as at 31 December 20.11: R100 000 temporary difference x (66,6% x 28% = 18,6%) = R18 648 Adjust temporary difference to be subject to tax at 28%: (R100 000 R33 400 = R66 600 temporary difference x 28% = R18 648 The deduction of 33,4% from the temporary difference of R100 000 has the effect that the reduced temporary difference of R66 600 multiplied with 28% gives the same deferred tax answer of R18 648. As a result, 33,4% is deducted from the movement in temporary differences of R70 000 (R170 000 R100 000) above in order to only multiply it with 28%. DISCLOSURE The income tax note and deferred tax note to the financial statements of Deasy Ltd for the year ended 31 December 20.12 will be as follows: DEASY LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.12 3. Income tax expense Major components of tax expense SA normal tax Current tax -Current year [C1] Deferred tax -Movement in temporary differences [C2] (91 620 x 28%) Tax reconciliation Accounting profit Tax @ 28% Tax effect of non-taxable/non-deductible items: - Dividends received not taxable (10 000 x 28%) - Penalty not deductible (15 000 x 28%) - Fair value adjustment on shares (70 000 x 33,4% x 28%) Income tax expense 10. Deferred tax Analysis of temporary differences: Property, plant and equipment -Accelerated deductions for tax purposes Investment in equity shares Deferred tax liability

20.12 R

109 200 25 654 134 854 500 000 140 000 (2 800) 4 200 (6 546) 134 854

12 600 31 702 44 302

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SECTION B - QUESTIONS ON INCOME TAX


QUESTION 3.1 (26 marks) The following information was extracted from the books and records of April Ltd for the year ended 29 February 20.12: 1. The deferred tax liability as at 28 February 20.11 was made up as follows: R Property, plant and equipment (accelerated deductions for tax purposes) Revenue received in advance 271 150 (13 340) 257 810 Cr Dr Cr

2.

Profit before tax for the year ended 29 February 20.12 amounted to R735 000 and included, inter alia, the following items: R Foreign income (not taxable in South Africa as tax is payable on this income at 35% in the foreign country) Dividends received (not taxable) Profit on sale of land (capital gain for tax purposes) Fines and donations (not tax deductible) Legal fees - Not tax deductible - Tax deductible Depreciation on vehicles 132 000 175 000 210 000 700 900 1 100 150 000 February 20.12 was

3.

The carrying amount of property, plant and equipment as at 29 R2 550 000 and the tax base was R1 360 000.

4. 5.

The revenue received in advance account in the trial balance reflected a credit balance of R62 000 on 29 February 20.12. The creditor account for the SARS (relating to income tax) in the accounting records of April Ltd as at 29 February 20.12 was made up as follows: R dr (cr) (31 000) 29 500 38 000 36 500

Balance at 1 March 20.11 (provision in respect of 20.11 tax assessment) Payments actually made in final settlement of 20.11 tax assessment Provisional tax payments made in respect of 20.12

6.

The foreign tax payable account in the trial balance was a credit balance of R46 200 at yearend. This amount of tax relates to the foreign income received of R132 000 in the financial year ended 29 February 20.12. No foreign tax was paid over during the year.

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Additional information 1. 2. No objection was made by April Ltd in respect of the 20.11 tax assessment. The Minister of Finance announced in March 20.11 that the tax rate decreased from 29% to 28% for financial years starting on or after 1 March 20.11. The inclusion rate for capital gains is 66,6%.

REQUIRED Marks (a) Present the abovementioned information in the statement of profit or loss and other comprehensive income and the statement of financial position of April Ltd for the year ended 28 February 20.12. Disclose the notes of April Ltd for the year ended 28 February 20.12 as required by IAS 12 Income taxes. 4

(b)

22

Please note: Your answer should comply with International Financial Reporting Standards (IFRS). Comparatives are not required. Amounts must be rounded to the nearest Rand. COMMENTS ON INFORMATION GIVEN IN THE QUESTION The provision in respect of the 20.11 assessment of R31 000 in point 5 relates to the income tax calculation that has been done for the financial year ended 28 Feruary 20.11. The payments actually made in final settlement of the 20.11 assessment of R29 500 represent the amount reflected on the assessment issued by the SARS. Point 1 in the additional information states that April Ltd did not object to the 20.11 assessment that was issued by the SARS which means that the correct amount payable to the SARS was R29 500 and not R31 000. The current tax for 20.11 was overprovided for with R1 500 (31 000 29 500).

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QUESTION 3.1 - Suggested solution APRIL LTD STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 20.12 Notes Profit before tax Income tax expense PROFIT FOR THE YEAR TOTAL COMPREHENSIVE INCOME FOR THE YEAR APRIL LTD STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.12 Notes ASSETS Current assets Other receivables: SARS [C3] EQUITY AND LIABILITIES Non-current liabilities Deferred tax Current liabilities Other creditors: Tax payable in foreign country R 3 R 735 000 (136 459) 598 541 598 541 () () ()

4 721

(1)

10

315 840

()

46 200

() (4)

OFFSET OF CURRENT TAX ASSETS AND LIABILITIES The tax receivable and tax payable may only be set off against one another if there is a legal enforceable right to set off the recognised amounts (IAS 12.71-.72). The tax payable on the foreign income is payable to the tax authority of the foreign country and not to the SARS. As a result the assessment issued by the SARS is separate from the tax payable in the foreign country and these two amounts cannot be set off against each other.

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APRIL LTD NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.12 3.Income tax expense Major components of tax expense R SA normal taxation Current tax - Current year [C1] - Overprovision in prior year (31 000 - 29 500) Deferred tax - Movement in temporary differences [C2] - Change in tax rate [C2] SA normal tax Foreign tax Tax rate reconciliation Accounting profit Tax at 28% Tax effect of non-taxable/non-deductible items: - Dividends received not taxable (175 000 x 28%) - Capital gain on sale of land not taxable (210 000 x 33,4% x 28%) - Fines and donations not deductible (700 x 28%) - Legal fees not deductible (900 x 28%) Change in tax rate [C2] Effect of different tax rate on foreign income (46 200 - (132 000 x 28%)) Overprovision of current tax in prior year (31 000 29 500) Income tax expense 735 000 205 800 (49 000) (19 639) 196 252 (8 890) 9 240 (1 500) 136 459 () () (1) (1) (1) (1) (1) (1) () (32 229) 33 729 (1 500) 58 030 66 920 (8 890) 90 259 46 200 136 459

(5) (1) (4) (1)

()

The income tax rate has been decreased from 29% to 28% by the Minister on Finance in March 20.11 for financial years starting on or after 1 March 20.11. (IAS 12.81(d)) FOREIGN TAX IN THE TAX RECONCILIATION

()

The foreign income is taxed at 35% (46 200 /132 000) while tax is paid in South Africa at 28%. This additional 7% causes a reconciling item in the tax rate reconciliation. 3. Deferred tax Analysis of temporary differences: Property, plant and equipment - Accelerated deductions for tax purposes [C2] Revenue received in advance [C2] Net deferred tax liability

333 200 (17 360) 315 840

(1) (1) (22)

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CALCULATIONS C1. Current tax

Profit before tax (given) 1 Non-deductible/non-taxable items: Dividends received not taxable Gain on sale of land not taxable (210 000 x 33,4%) Fines and donations not deductible Legal fees not deductible Foreign income not taxable in SA Taxable profit before temporary differences Movement in temporary differences (taxable in future) Taxable profit for the year Tax at 28%
1

735 000 (175 000) (70 140) 700 900 2 (132 000) 359 460 (239 000) 120 460 33 729

[] [] [1] [] [] [] [1]

[] [5]

Note that no separate adjustment is necessary for depreciation, as the movement in temporary differences already includes the effect of adding back depreciation and deducting the S12C tax deduction. The foreign income should be deducted from profit before tax as it is not taxable in South Africa. The tax that was paid in the foreign country will be shown separately in the income tax expense note and because it was taxed at 35% and not 28%, it will cause a reconciling item in the tax reconciliation. COMMENT A taxable temporary difference will only be taxable in future and will result in a tax liability payable to the SARS in future. In the current year, this taxable temporary difference is not taxable and must be deducted from the taxable profit. A deductible temporary difference will only be deductible in future and will result in a tax saving in future. In the current year, this deductible temporary difference is not deductible and must be added to the taxable profit.

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1

FAC4861/102 NFA4861/102 ZFA4861/102 Temporary Tax base differences Deferred tax 29% 271 150 (13 340) 257 810 (8 890) 248 920 Deferred tax 28% [] []

[1]

29 February 20.12 Property, plant and equipment Revenue received in advance Net deferred tax liability 2 550 000 (62 000) 1 360 000 1 190 000 4 (62 000) 1 128 000
5

333 200 (17 360) 315 840

[1] [1]

Movement in temporary differences (taxable) (1 128 000 889 000)


1 2 3

239 000

66 920 [4]

4 5

271 150 / 29% = 935 000 13 340 / 29% = 46 000 The tax base of revenue received in advance is the carrying amount minus amounts NOT taxable in future (46 000 46 000 = 0). The revenue received in advance is taxed in the financial year ended 29 February 20.12 and will not be taxable again. 62 000 62 000 = 0 The deferred tax liability increases for the year ended 29 February 20.12 which means that the movement in temporary differences is taxable.

C3. Creditor account for the SARS The overprovision of R1500 is corrected by passing the following journal: Dr R Creditors account for SARS (SFP) Income tax expense (P/L) 1 500 1 500 Cr R

The income tax for the year is then accounted for by passing the following journal: Dr R 33 729 Cr R 33 729

Income tax expense (P/L) [C1] Creditors account for SARS (SFP)

Balance of creditor account for the SARS on 29 February 20.12 R36 500 (dr) (given) + 1 500 (dr) 337 129 (cr) = R 4 271 (dr). The R4 271 is a debit balance (amount receivable from the SARS) which means it is a current asset and not a current liability.

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SECTION C - SPECIFIC OUTCOMES


After you have studied this unit, you should be able to do the following: 1. 2. Identify the objective of IAS 12 and be able to apply IAS 12. Understand and apply the following definitions: (a) (b) (c) 3. 4. Tax base of assets and liabilities; Taxable and deductible temporary differences; and Deferred tax assets and liabilities.

Understand and calculate current tax. Understand and calculate deferred tax by: (a) (b) (c) Calculating the tax base of assets and liabilities, Calculating the temporary differences for each asset and liability (according to the balance sheet method), and Calculating the movements in temporary differences and deferred tax.

5.

Understand and calculate the implications of tax losses (recognised and unrecognised) on current and deferred tax. Calculate and recognise the income tax line in the statement of profit or loss and other comprehensive income. Disclose the income tax expense in the notes to the statement of profit or loss and other comprehensive income. Calculate and recognise all tax balances for the statement of financial position, for example the deferred tax balance and tax payable. Disclose income tax and deferred tax in the notes to the statement of financial position.

6.

7.

8. 9.

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STUDY UNIT 5 ACCOUNTING POLICY, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS


KEY ISSUE The purpose of this standard is to prescribe criteria for the selection of an accounting policy, as well as for the accounting treatment and disclosure of changes in accounting policies, changes in accounting estimates and correction of prior period errors, to ensure consistent preparation and presentation of financial statements. The standard enhances the comparability of the entitys financial statements with previous periods, as well as with financial statements of other entities. KEY CONCEPTS The following key concepts are underlying to this study unit: 1. 2. 3. 4. Selection of an accounting policy. Changes in accounting policy. Changes in accounting estimates. Errors.

PRESCRIBED STUDY MATERIAL The following must be studied by you before you attempt the questions in this study unit: 1. 2. Chapter on accounting policies, changes in accounting estimates and errors in th Descriptive Accounting, 17 edition. IAS 8. Accounting policies, changes in accounting estimates and errors.

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NOTE:

THE REST OF STUDY UNIT 5 IS BASED ON THE ASSUMPTION THAT YOU HAVE ALREADY STUDIED THE PRESCRIBED STUDY MATERIAL.

SECTION A - ADDITIONAL INFORMATION


1. Overview of IAS 8
Accounting policy Change in accounting estimate Material Prior period errors Retrospective application Retrospective restatement Impracticable Prospective application When an IFRS specifically applies to a transaction then use the policy of that IFRS In the absence of an IFRS that specifically apply to a transaction management will use judgement An entity shall apply its accounting policies consistently IAS 8.5

Definitions

8.7 8.10-12 10.13

accounting policies Selection of

Change in accounting policies

An entity shall change an accounting policy only if change is required by IFRS or if it provides reliable and more relevant information about the effects of transactions The following are not changes in accounting policy - the application of an accounting policy to transactions that differs in substance from previous transactions - the application of a new accounting policy to transactions that did not occur previously or was immaterial Initial application of a policy to revalue assets (IAS 16 or IAS 38) is a change in accounting policy to be dealt with as a revaluation in according to IAS 16 or IAS 38 Applying changes in accounting policies

8.14

8.16 8.17

8.19

Compulsory change Is required by an IFRS Apply specific transitional arrangementsof IFRSif applicable Otherwise apply retrospectively

Voluntary change Results in more relevant and reliable information Apply changes retrospectively to extent practicable

8.22 8.23

Impracticable apply to the beginning of the earliest period for which retrospective application is practicable

8.24-.25 8.50-.53

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IAS 8.30

Disclosure If an entity has not applied a new IFRS that has been issued, but it is not effective yet then disclose: - This fact; and - Information relevant to assess the possible impact of the application of the new IFRS Compulsory change Title of IFRS In accordance with transitional provisions plus description Nature of change Effect on future periods Amount of adjustment for current and each prior period presented Amount relating to periods before those presented if practicable If impracticable circumstances that led to that condition Voluntary change Nature of change Reasons why the new policy is more reliable and relevant Amount of adjustment of current and each prior period presented Amount relating to periods before those presented if practicable If impracticable, the circumstances that led to that condition

8.28 8.29

Many items cannot be measured with precision but can only be estimated for example bad debts, fair value of financial assets, useful lives of assets etc. Change in estimate Recognition Prospectively In period of the change OR In period of the change and future periods if change affects both If change give rise to changes in assets and liabilities or an item of equity then it will be recognised by adjusting the carrying amount of assets, liabilities or equity in period of the change Disclosure Nature and amount in current and future periods If impractical to estimate effect on future periods disclose the fact Can arise in respect of recognition, measurement, disclosure of elements of financial statements presentation or

8.32-35

8.36, 8.38 8.37

8.39 8.40 8.41

Prior period error

Recognition Retrospective restatement, if practicable Restating comparative amounts for prior period OR Restating opening balances of assets, liabilities and equity if error occurred before the earliest prior period If impracticable to determine period specific effect Restate opening balance of assets, liabilities and equity for earliest period that retrospective restatement is practicable Disclosure Nature of prior period error Amount of correction for each prior period Amount of correction at the beginning of earliest prior period Description if impracticable and the circumstances that led to the existence of that condition

8.42-43

8.44-45

8.49

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2.

IAS 1: Statements of financial position According to IAS 1.39 an entity shall present three statements of financial position if an accounting policy is applied retrospectively, or if the entity makes retrospective restatements or reclassifications. Examples when three statements of financial position are required: Retrospective change in accounting policy for valuation of inventory (e.g. weighted average to first-in-first-out); Errors in prior periods; Reclassification adjustments of amounts previously recognised in other comprehensive income to profit or loss; Reclassification adjustments on disposal of a foreign operation, derecognition of available-for-sale financial assets and when a hedged forecast transaction affects profit or loss (IAS 1.95); or Other retrospective changes in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

If financial statements are thus presented for the year ended 31 December 20.12 and the accounting policy for valuation of inventory was changed retrospectively, statements of financial position will have to be presented on 1 January 20.11, 31 December 20.11 and 31 December 20.12 (if the information is available). On 17 May 2012, the International Accounting Standards Board (IASB) issued Annual Improvements to IFRSs: 2009-2011 Cycle which included clarification of the requirements for comparative information in IAS 1 Presentation of Financial Statements: Additional comparative information is not necessary for periods beyond the minimum comparative financial statement requirements of IAS 1. If additional comparative information is provided, the information should be presented in accordance with IFRSs, including disclosure of comparative information for any additional statements included beyond the minimum comparative financial statement requirements. Presenting additional comparative information voluntarily would not trigger a requirement to provide a complete set of financial statements. An entity that changes accounting policies retrospectively, or makes a retrospective restatement or reclassification which has a material effect on the information in the statement of financial position at the beginning of the preceding period would present the statement of financial position at the end of the current period and the beginning and end of the preceding period. Other than disclosure of certain specified information, related notes are not required to accompany the opening statement of financial position as at the beginning of the preceding period. The amendments must be applied retrospectively and are effective for annual periods beginning on or after 1 January 2013, with earlier application permitted. Entities are permitted to early adopt any individual amendment within the Annual Improvements to IFRSs: 2009-2011 Cycle without early adopting all other amendments.

The amendment to IAS 1 reduces the amount of information from previous reporting periods which are required to be repeated in the event of a change in accounting policy, reclassification or restatement by limiting the requirement to present an additional statement of financial position to circumstances when the statement is materially affected. The amendment also clarifies that related notes to an additional statement of financial position are not required.

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SECTION B QUESTIONS ON ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS


QUESTION 5.1 (26 marks) The accounting profit of Trueblue Ltd for the financial year ended 28 February 20.11 was R600 000 (R500 000 for the financial year ended 28 February 20.10). The accounting profit for both years is fully taxable, in other words, no non-taxable or non-deductible items existed and the only temporary differences are those that are apparent from the information provided below. The following information relating to TrueBlue Ltd is presented to you for the year ended 28 February 20.11: b. Inventories amounting to R95 000 were destroyed and written off due to a flood during the year. An amount of R60 000 was received from the insurance company as compensation for the inventories that was destroyed. These two amounts are included in the accounting profit for the year ended 28 February 20.11. Assume that these amounts are material. 2. The directors of the company decided to change the accounting policy in respect of the valuation of inventories, as the new policy will ensure a more reliable value of inventories. Previously inventories were valued according to the weighted average method, but it should now be valued according to the first-in-first-out method. This change in accounting policy has not been accounted for as yet.
The value of inventories at 28 February, based on the two methods of valuation, was as follows:

3.

20.11 R First-in-first-out method Weighted average method 4. 460 000 420 000

20.10 R 420 000 395 000

20.9 R

20.8 R

395 000 380 000 382 000 375 000

The SARS will not re-open the previous years assessments, but will accept the new policy in respect of the current year for tax purposes. During the current year the bookkeeper established that a material error had been made in the published financial statements for the year ending 28 February 20.10. Equipment amounting to R25 000 that was acquired on 1 September 20.9 was incorrectly recorded as administration expenses. The company depreciates such equipment at 20% per annum according to the straight-line method, apportioned for a portion of a year. This error has not been accounted for as yet. The accountant immediately informed the SARS of the error and the SARS agreed to re-open the 20.10 assessment in order to correct this error. The SARS allows a S12C deduction of 40% in the first year and 20% in the second, third and fourth years, not apportioned for a portion of a year.

5.

6.

Trueblue Ltd acquired a fleet of delivery vehicles on 1 March 20.9 for R500 000. The fleet has been depreciated over three years on the straight line method, apportioned for a portion of a year. The fleet has a residual value of R140 000. On 28 February 20.11 management extended the maintenance contract of the fleet to 28 February 20.13 and management estimated the remaining useful life of the fleet on 28 February 20.11 to be two years. Management has decided to give effect to this change as from 1 March 20.10. This change has not been accounted for as yet.

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FAC4861/102 NFA4861/102 ZFA4861/102 The SARS allows a wear-and-tear allowance on the fleet over four years, apportioned for a portion of a year. 7. Assume a normal tax rate of 28% for all the years. There are no other temporary differences than those that are apparent from the question. The deferred tax balance on 28 February 20.9 was R3 500 (cr). All temporary differences included in the deferred tax blanace of R3 500 are subject to a tax rate of 28%. The retained earnings balance on 1 March 20.9 was R800 000. The company had 500 000 issued ordinary shares since incorporation.

85

8. 9.

REQUIRED Marks (a) Prepare an extract of the statement of profit or loss and other comprehensive income for the year ended 28 February 20.11 by starting with profit before tax. year ended 3 18

(b) Prepare extract from statement of changes in equity for the 28 February 20.11 (retained earnings colomn). (c)

Disclose the following notes in the financial statements of TrueBlue Ltd for the year ended 28 February 20.11: - Profit before tax - Change in accounting policy - Prior period error 7 11 9

Please note: Your answer should comply with International Financial Reporting Standards (IFRS). Round all amounts off to the nearest rand. COMMENTS ON INFORMATION GIVEN IN THE QUESTION The change in accounting policy must be applied retrospectively which means the information must be adjusted for: the current year ended 28 Fbruary 20.11, the previous year ended 28 February 20.10, and the opening balance for the previous year (1 February 20.9). The valuations of inventories provided for 20.8 should not be used. The change in the accounting policy will also effect the provision for obsolete inventories as the 5% percentage of the provision is applied to the inventories balance. The error regarding the equipment that was incorrectly expensed should be corrected in the financial year where the error occurred, being the previous financial year. The error will also affect the current year as depreciation on the equipment must still be recognised. The change in the useful life of the fleet is a change in accounting estimate. The change in accounting estimate must be applied prospectively to the current and future periods. The change in the accounting estimate in the current year must be done at the beginning of the current year, i.e. 1 March 20.10.

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QUESTION 5.1 - Suggested answer (b) TRUEBLUE LTD

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 28 FEBRUARY 20.11 20.11 R 650 000 (182 000) 468 000 468 000 20.10 R 534 500 (149 660) 384 840 384 840 Total marks (b) TRUEBLUE LTD STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 28 FEBRUARY 20.11 Retained earnings R Balance as at 1 March 20.9 Change in accounting policy [C1] Restated balance Total comprehensive income for the year - Profit for the year (restated) Balance at 28 February 20.10 Total comprehensive income for the year - Profit for the year Balance at 28 February 20.11 800 000 9 360 809 360 384 840 1 194 200 468 000 1 662 200 Total marks () (1) (18) (5) (12) (1)

Notes Profit before tax [C4] Income tax expense [C5] PROFIT FOR THE YEAR TOTAL COMPREHENSIVE INCOME FOR THE YEAR

() () () () (3)

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(c) TRUEBLUE LTD NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.11 1.Profit before tax The following items are included in profit before tax: 20.11 R Income Compensation received from insurance company for inventories damaged in flood (IAS 2.36 and IAS 1.98) Expenses Write -off of inventories as a result of flood (IAS 2.36 and 1.98) Depreciation on property, plant and equipment (IAS 1.104) - Equipment - Fleet of delivery vehicles [C3.1] 60 000 20.10 R (1)

95 000 5 000 80 000

2 500 120 000

(1) (1) (2)

Included in depreciation for 20.11 is a change in estimate (decrease in depreciation) of R40 000 arising from the remaining useful life of the fleet of delivery vehicles that was changed from one year to two years on 28 February 20.11. This change will result in an increase in depreciation in future periods amounting to R40 000. (IAS 8.39) [C3.2]. Total marks 2. Change in accounting policy

(2) (7)

The company changed its accounting policy during the year in respect of the valuation of inventories from the weighted average method to the first-in-first-out method. This change was effected to ensure fairer presentation of the valuation of of inventory. The opening balance of retained earnings at the beginning of 20.10 was adjusted while the comparative amounts were restated accordingly. The effect of the change in accounting policy on the results for 20.10 and 20.11 is as follows: (2) 20.11 R 15 0002 (4 200) 10 800 40 000 (11 200) 28 800 20.10 R 12 000 1 (3 360) 8 640 25 000 (7 000) 18 000 1 March 20.9 R (1) (1) 13 000 (3 640) 9 360 9 360 0,02 0,02 Total marks (1) (1) (11) (2) (1) (1)

Decrease in cost of sales [C1] Increase in income tax expense [C1] Increase in profit [C1] Increase in inventory [C1] Increase in deferred tax liability [C1] [C6] Increase in tax payable [C1] [C5] Increase in equity [C1] Adjustment against retained earnings on 1 March 20.9 (IAS 8.29(d)) Increase in earnings per share (IAS 8.29(c)) (10 800 / 500 000) (8 640 / 500 000)

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The R3 360 is a movement in the deferred tax balance relating to inventories from R3 640 to R7 000 [C6] as the SARS indicated that they will only accept the new accounting policy from the current year. The income tax expense line includes the current tax and movement in deferred tax relating to the change in accounting policy. The R4 200 (R15 000 x 28%) can also be proved as follows: Income tax on change in accounting policy 28 February 20.11: Increase in taxable profit Movement in temporary differences (reversal of taxable temporary difference) Taxable profit Current tax at 28% (R40 000 x 28%) Deferred tax expense (7 000 - 0) [C6] (debit deferred tax liability and credit P/L) Income tax expense (R11 200 - R7 000) for the year ended R15 000 R25 000 R40 000 R11 200 (R 7 000) R 4 200

3.

Prior period error The error relates to a correction in respect of equipment that was incorrectly recorded as administrative expenses in the 20.10 financial year.The comparative amounts were restated. The effect of the correction of the error on the 20.10 results is as follows: 20.10 R 22 500 1 (6 300) 16 200 22 500 (2 100) (4 200) 16 200 0,03 Total marks (1) 9 1 March 20.9 R (2) () () (1) () () ()

(2)

Decrease in other expenses [C3] (25 000 - 2 500) Increase in income tax expense (22 500 x 28%) Increase in profit for the year Increase in property, plant and equipment (25 000 - 2 500) [C3] Increase in deferred tax liability Increase in tax payable ((22 500 - 7 500) x 28%) Increase in equity Adjustment against retained earnings on 1 March 20.9 (IAS 8.49(c)) Increase in earnings per share (IAS 8.49(b)) (16 200 / 500 000)

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The income tax expense line includes the current tax and movement in deferred tax relating to the prior period error. The R6 300 (R22 500 x 28%) can also be proved as follows: Income tax on error for the year ended 28 February 20.10: Increase in taxable profit Movement in temporary differences (7 500 - 0) (taxable temporary difference) Taxable profit Current tax at 28% (R15 000 x 28%) Deferred tax expense (2 100 - 0) [C6] (debit P/L and credit deferred tax liability) Income tax expense (4 200 + R2 100) R22 500 (R 7 500) R15 000 R 4 200 R 2 100 R 6 300

COMMENT Note that the effect of the error in the current year is not disclosed as it is corrected in the current year before the financial statements are published. CALCULATIONS C1. Change in accounting policy (inventory) 20.9 First-in-first-out (New) Weighted average (Old) Tax at 28% 395 000 (382 000) 1 13 000 (3 640) 9 360 P/L 20.10 P/L 20.11 460 000 (420 000) 40 000 [2] (11 200) [2] 28 800

12 000 (3 360) 8 640

420 000 (395 000) 3 25 000 15 000 7 000 (4 200) 18 000 10 800

2 3

On 28 February 20.9, as a result of the change in accounting policy, the closing inventory increased with R13 000. As closing inventory is deducted from cost of sales, the R13 000 decreases costs of sales which increase gross profit and profit before tax. On 28 February 20.10, the closing inventory increased with R25 000. The P/L for the year ended 28 February 20.10 is affected by opening inventory that increased with R13 000 (which increases cost of sales) and closing inventory that increased with R25 000 (which decreases cost of sales). The net effect on P/L for the year ended 28 February 20.10 is a net decrease in cost of sales which is an increase in profit before tax of R12 000. [5]

C2. Prior period error Equipment Acquistion on 1 September 20.9 Depreciation for year ended 28 February 20.10 (25 000 x 20% x 6/12) Carrying amount of equipment on 28 February 20.10 Depreciation for year ended 28 February 20.11 (25 000 x 20%) Carrying amount of equipment on 28 February 20.11

25 000 (2 500) 22 500 (5 000) 17 500

[] [1] [1] [2]

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JOURNALS TO EXPLAIN PRIOR PERIOD ERROR Even if the journals are not required in a question, if you are unsure of the effects of an error, it can be of great assistance to do the journals as part of your calculations. Correcting journals on 28 February 20.10:
J1

Dr R 25 000

Cr R 25 000

J2

Equipment (SFP) Other expenses (P/L) Reclassification of equipment from other expenses Depreciation (P/L) Accumulated depreciation (SFP) Recognise depreciation on the equipment Correcting journal on 28 February 20.11: Depreciation (P/L) Accumulated depreciation (SFP)

2 500 2 500

J3

5 000 5 000

The correction in the current year (J3) is corrected before the finanical statements are published and therefore not disclosed in the note.

C3.1 Change in accounting estimate After change in estimate 500 000 (120 000) 380 000 (80 000) 300 000
1

Fleet of vehicles acquired on 1 March 20.9 Depreciation for year ended 28 February 20.10 (500 000 - 140 000)/3 Carrying amount on 28 February 20.10 (1 March 20.10) Depreciation for year ended 28 February 20.11 (380 000 - 140 000)/3 Carrying amount on 28 February 20.11 Depreciation for year ended 28 February 20.12 (380 000 - 140 000)/3 Carrying amount on 28 February 20.12 Depreciation for year ended 28 February 20.12 (380 000 - 140 000)/3 Carrying amount on 28 February 20.13
1

Before change in estimate 500 000 (120 000) 380 000 (120 000) 260 000 (120 000) 140 000 140 000 [1]

[1]

(80 000) 220 000 (80 000) 140 000

On 28 February 20.11 the remaining useful life was two years. That means that on 1 March 20.10 three years remained.

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C3.2 Effect of change in estimate on future depreciation Future depreciation on 28 February 20.11 (after change in estimate) (80 000 for 20.12 + 80 000 for 20.13) Future depreciation on 28 February 20.11 (before change in estimate) Increase in future depreciation

160 000 120 000 40 000

[] [] [3]

C4. Profit before tax 20.11 Accounting profit (given) Change in accounting policy (inventory) [C1] Prior period error: add back other expenses Prior eriod error: deduct depreciation Change in estimate: decrease in depreciation (R120 000 - R80 000) 600 000 15 000 (5 000) 40 000 650 000 20.10 500 000 12 000 25 000 (2 500) 534 500 [1] [1] [1] [1] [1] [5] C5. Current tax Profit before tax [C5] Movement in temporary differences (taxable) [C7] Taxable profit Current tax at 28% Deferred tax expense (debit P/L) Income tax expense 650 000 (25 000) 625 000 175 000 7 000 182 000 534 500 (7 000) 527 500 147 700 1 960 149 660 [3] [1]

[1] [1]

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C6. Deferred tax Deferred tax (dr)Cr 3 500 3 640 7 140 1 960 7 000 2 100 1 400 9 100 7 000 2 100 14 000 16 100

Carrying amount 28 February 20.9 Inventory 395 000 Deferred tax liability Movement in temporary differences (taxable) 28 February 20.10 Inventory 420 000 Equipment 22 500 Fleet of delivery vehicles 380 000 Deferred tax liability Movement in temporary differences (taxable) 28 February 20.11 Inventory 460 000 Equipment 17 500 Fleet of delivery vehicles 300 000 Deferred tax liability
1 2 3 4

Tax base 382 000

Temporary difference 12 500 13 000 25 500 7 000 25 000 7 500 5 000 32 500 25 000 7 500 50 000 57 500

[] [1] [1] [1] [1] [1] [1] [1] [1] [1] [9] [28]

395 000 1 15 000 2 375 000

460,000 3 10 000 4 250 000

25 000 - (25 000 x 40%) = 15 000 500 000 - (500 000 / 4) = 375 000 25 000 - (25 000 x 40%) - (25 000 x 20%) = 10 000 500 000 - (500 000 / 4)- (500 000 / 4) = 250 000

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SECTION C - SPECIFIC OUTCOMES


After you have studied this study unit, you should be able to do the following: 1. 2. 3. 4. 5. Identify the objective of IAS 8 and be able to apply IAS 8. Provide guidance on the choice of an accounting policy regarding specific transactions. Identify, account for and disclose a change in accounting policy. Identify, account for and disclose changes in accounting estimates. Identify, account for and disclose prior period errors.

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STUDY UNIT 6 REVENUE


KEY ISSUE The primary issue in accounting for revenue is to determine when to recognise revenue.

KEY CONCEPTS The following key concepts are underlying to this study unit: 1. 2. Understanding the definition of revenue. Identifying the different types of transactions or events from which revenue arises and understanding the recognition criteria applicable to each category of revenue arising from these transactions of events. Applying the revenue recognition criteria to revenue arising from different circumstances for the purpose of determining whether revenue should be recognised. Accounting for revenue that has satisfied the criteria for recognition.

3.

4.

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PRESCRIBED STUDY MATERIAL The following must be studied before you attempt the questions in this study unit: 1. Chapter on revenue in either: Descriptive Accounting, 17 edition or GAAP Handbook 2013. 2. 3. IAS 18. Revenue. Appendix to IAS 18 The appendix to IAS 18 serves to illustrate the application of the requirements of the standard to assist in clarifying its meaning in a number of commercial situations. It is critical to carefully study each of the situations illustrated in the Appendix as questions on revenue often address the issues illustrated in the Appendix. Please note that the examples in the appendix generally assume that the amount of revenue can be measured reliably, it is probable that the economic benefits will flow to the entity and that costs incurred can be measured reliably. These aspects should generally also be addressed when answering a question on revenue. Therefore the examples in the Appendix only focus on addressing the other criteria: 4. 5. 6. Sale of goods; Rendering of services; (Par 14: Financial service fees examinable on level 1: Knowledge and awareness only). Interest, Royalties and Dividends; and Agent relationship.
th

Circular 09/2006. Transactions giving rise to adjustments to revenue/purchases. IFRIC 13. Customer loyalty programmes. ED 309. Revenue from contracts with customers (Level 1: Knowledge and awareness only).

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NOTE:

THE REST OF STUDY UNIT 6 IS BASED ON THE ASSUMPTION THAT YOU HAVE ALREADY STUDIED THE PRESCRIBED STUDY MATERIAL.

SECTION A - ADDITIONAL INFORMATION


Overview of IAS 18
IAS Definitions

Revenue Fair value

18.7

Sale of goods Significant risks and rewards of ownership transferred No managerial involvement or effective control Revenue measured reliably Probable inflow of economic benefits Cost measured reliably Rendering of services By reference to stage of completion, only if: Revenue measured reliably Probable inflow of economic benefits Stage of completion measured reliably Cost measured reliably Interest, Royalties and Dividends Probable inflow Cost measured reliably

18.14

18.20

Recognition

18.29

Interest Effective interest rate

Royalties Accrual basis

Dividends Shareholders right

18.30

ment Measure

At fair value of consideration received taking into account any trade discounts and volume rebates Specific measurement principles for: Financing transactions Exchanges of goods/services

18.9 18.11 18.12

Disclosure

Accounting policy Amount of revenue for each significant category Amount of revenue arising from exchanges of goods/services

18.35(a) 18.35(b)

18.35(c)

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SECTION B - QUESTIONS ON REVENUE


QUESTION 6.1 (15 marks) Paradise Ltd entered into the following transactions during the year ended 28 February 20.11: On 1 March 20.10 consignment sales with a sales value of R500 000 were sent to Pharmacies Ltd. By 28 February 20.11 Pharmacies Ltd had already sold 60% of the consignment at a profit of 10%. On 1 February 20.10 Paradise Ltd received R75 000 when goods were ordered that were only delivered on 30 March 20.10. On 1 February 20.11 Paradise Ltd received R100 000 (the selling price) from its major customer for the manufacturing of goods that must be delivered on 1 April 20.11. On 30 June 20.10 Paradise Ltd entered into a exchange agreement with its competitor, Beach Ltd, in terms of which Paradise must give Beach 100 blue T-shirts in exchange for 100 green Tshirts (with a similar value) for selling in Paradises shop. On the same date Sign Ltd renovated the street front of Paradises shop. Sign Ltd accepted 40 T-shirts and R800 from Paradise as full payment. Paradise Ltd usually sells T-shirts at R30 each. Sign Ltd would normally charge R2 200 for the work done. On 15 August 20.10 Paradise Ltd entered into an agreement with Big-T Ltd in terms of which Big-T Ltd must pay royalties to Paradise Ltd on an annual basis, based on the number of Paradise T-shirts sold. The agreement came into effect on 1 September 20.10. According to the agreement R5 per T-shirt must be paid to Paradise Ltd. By 28 February 20.11 Big-T Ltd had sold 500 Paradise T-shirts. On 20 February 20.11, goods to the value of R50 000 were shipped to a customer subject to installation and inspection. The buyer accepted delivery on 26 February 20.11. The installation was completed on 1 March 20.11. You can assume that the installation process is not simple. On 30 June 20.10, goods to the value of R30 000 was sold by lay-by (lay away). On this date, R10 000 was received. On 22 February 20.11, another R10 000 was received. The goods are on hand, but are not ready for delivery.

Ignore VAT. It is not the policy of the company to grant any settlement discount. The total revenue for 20.11 before taking into account the above transaction, amounted to R1 211 000. REQUIRED Marks (a) Explain what the primary issue is in accounting for revenue. (b) Calculate the profit before taxation for the year ended 28 February 20.11, after taking the above transactions into account, if the profit amounted to R400 000 before the above transactions. (Assume that the correct cost of sales has already been taken into account in determining the profit.) (c) Disclose the above transactions in the notes to the financial statements of Paradise Ltd for the year ended 28 February 20.11. Assume that all amounts mentioned above can be measured reliably. 2 7

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QUESTION 6.1 - Suggested solution (a) The primary issue in accounting for revenue is determining when to recognise revenue. Revenue is recognised when it is probable that future economic benefits will flow to the entity and these benefits can be measured reliably (IAS 18.Objective). (2)

(b) Profit before taxation Comment Given Consignment sales (60% x 500 000) (IAS 18 Appendix .2 (c)) Sales of goods manufactured in current year (IAS 18 Appendix .4) Sales of goods still to be manufactured Repairs T-shirt sales (exchange agreement) Royalties (500 x 5) Goods shipped subject to installation and inspections Lay-by sales 1 2 2 3 3 4 5 6 R 400 000 300 000 75 000 (2 200) 1 400 2 500 776 700 Total () (1) (1) () (1) (1) (1) () () (7)

Comments to profit before tax 1. Consignment sales Consignment sales are recognised as revenue by the shipper (seller) when the goods are sold by the recipient (buyer) to a third party (IAS 18 Appendix .2(c)). As the recipient, Pharmacies Ltd, only sold 60% of the goods it purchased under consignment at yearend, R300 000 (R500 000 x 60%) would be recognised as revenue by Paradise Ltd (shipper/seller) for the year ended 28 February 20.11. 2. When an order is placed and payment is received in advance for delivery of goods not in inventory, (for example the goods are still to be manufactured), revenue is recognised only when the goods are delivered to the buyer (IAS 18 Appendix .4). The exchange of goods or services for goods or services that are of a similar nature and value, does not generate revenue (IAS 18.12). In the question the exchange of blue Tshirts for green T-shirts was not recognised as revenue. However, the exchange of Tshirts for repairs generated revenue as the goods exchanged are dissimilar in nature and value. IAS 18.9 requires that the sale be measured at the fair value of the consideration received.

3.

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In the records of Paradise Ltd Dr R J1 Repairs (P/L) Revenue from sale of goods (P/L) Bank (SFP) Recording an exchange agreement * Fair value of services received Less: Cash payment In the records of Sign Ltd J2 T-shirts (40 x R30) (SFP) Bank (SFP) Revenue from repairs (value of goods received) (P/L) Recording an exchange agreement 1 200 800 2 000 2 200 1 400* 800 2 200 800 1 400 Cr R

4.

Royalties As the royalties would accrue in terms of the relevant agreement (R5 per T-shirt sold), revenue arising from the royalties would be recognised by Paradise Ltd as and when a Paradise T-shirt is sold by Big-T Ltd.

5.

Where goods are shipped subject to installation and inspection, revenue is recognised when the buyer accepts delivery and the installation is complete. However, revenue is recognised immediately upon the buyers acceptance of delivery when the installation process is simple or when the inspection is performed only for the purpose of final determination of contract prices (IAS 18 Appendix .2(a)). Revenue from lay-by (lay away) sales is recognised when the goods are delivered or a significant deposit is received. In this case, 66.67% (20 000/30 000) of the selling price had already been received. Although this amount is significant, revenue has not been recognised as the goods are not ready for delivery. (IAS 18 Appendix.3.) COMMENT Revenue recognition should not be viewed in isolation, as it probably will be tested with other topics, rather than alone.

6.

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(c)

PARADISE LTD NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.11 1. Accounting policies 1.1 Sale of goods Revenue from the sale of goods is recognised when the significant risks and rewards of ownership are transferred to the buyer and it is probable that the economic benefits, which could be measured reliably, will flow to the entity. 1.2 Royalties Royalties are recognised in accordance with the substance agreement on an accrual basis. 2. Revenue Sale of goods (300 000 + 75 000 + 1 400 + 1 211 000) Royalties of the relevant (1) R 1 587 400 2 500 (1) (1)

(2)

R1 400 included in sale of goods, was raised from the exchange of goods for repairs. (1) Total (6)

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QUESTION 6.2 (20 marks) You are the audit manager in charge of the audit of Amalgamated Computer Systems Ltd, a large listed company providing services within the entire spectrum of the computer industry. The company's year-end is 31 December 20.11. Your audit senior has identified the following transaction and disclosure which is a cause of concern to him: Sale of Turnkey Computer System to Oppiekoppie Town Council Amalgamated Computer Systems Ltd sold a computer system and custom built software to the Oppiekoppie Town Council for an amount of R8 000 000. The sale agreement was concluded on 30 June 20.11. The computer system was installed by the company and on 30 September 20.11 the customer inspected the system and declared that it is to their satisfaction. The terms of the purchase agreement are as follows: 1. 2. 3. The Town Council will make two payments of R4 000 000 each on 30 September 20.12 and 30 September 20.13. Any additional maintenance charges would be for the Town Council's account. To assist Amalgamated Computer Systems Ltd with the financing of the development of the system, the town council lent an amount of R3 000 000 to Amalgamated Computer Systems Ltd for the period 1 August 20.11 to 30 June 20.12. This loan will attract interest at an annual rate of 18%, payable on 30 June 20.12. This interest rate represents a fair discount rate.

Your audit senior has established that the cost of the system to Amalgamated Computer Systems Limited, inclusive of software, amounted to R5 000 000. Amalgamated Computer Systems Ltd has included the following amounts in its statement of profit or loss and other comprehensive income for the year ended 31 December 20.11: Profit on sale of computer system Interest paid on loan from Oppiekoppie town council R3 000 000 R 225 000

On 31 December 20.11 the loan of R3 000 000 was set off against the amount receivable from the town council resulting in a net debtor of R5 000 000 being disclosed on the statement of financial position. No further mention was made of the loan from the town council in the financial statements. REQUIRED Discuss the acceptability, in terms of IFRS, of the accounting treatment of the above transactions. Also indicate at which amounts all items evident from the information will be included in the financial statements. Marks 25

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QUESTION 6.2 - Suggested solution COMMENT This is a specific theoretical question, as it covers revenue recognition, as well as financial instruments, two specific topics. Contrary to this you also get general theoretical questions where the principles of the Conceptual Framework must be applied. Such a general theoretical question will usually relate to an item for which there is no standard, or the question will specifically require that you make use of the Conceptual Framework in your arguments. Note that marks are not awarded for the copying of requirements and definitions, but the marks are rather awarded for the application of requirements and definitions. Make sure whether calculations are required in such a question, by reading the required part very carefully. In this question amounts are required, but it is not always the case. In terms of IAS 18.14 revenue from the sale of goods should be recognised when all the following conditions have been satisfied: (a) The significant risks and rewards of ownership of the goods have been transferred to the buyer. The entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold. The amount of revenue can be measured reliably. It is probable that the economic benefits associated with the transaction will flow to the entity. The costs incurred or to be incurred in respect of the transaction can be measured reliably.

(b) (c) (d) (e)

The computer system was ordered and has been installed and made operational for the town council. In addition, the town council is now responsible for the maintenance of the system. A (1) purchase agreement has been entered into by both parties which includes the method of payment. The above items all indicate that risks and rewards of the system have passed from (1) Amalgamated Computer Systems to the town council and that the company has satisfactorily performed its obligations in terms of the contract by 30 September 20.11. (1) There is also no indication that the company retains continuing managerial involvement to the degree usually associated with ownership nor effective control over the computer system.

(1)

It is probable that the economic benefits associated with the sale will flow to Amalgamated Computer Systems, as the collectability of the purchase price is reasonably assured. The sale has been (1) made to a town council and the purchase agreement also stipulates when payment is due from the town council. (1) Both the amount of revenue and the costs in respect of the transaction can be measured reliably:

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(a)

Costs The costs already incurred have been ascertained by the audit senior to be R5 000 000. As the town council will be liable for any additional maintenance charges, no further costs should be incurred by Amalgamated Computer Systems Ltd. (1)

(b)

Revenue The selling price is stipulated in the sale agreement, and can therefore be measured reliably. (1) The price of R8 000 000 is however collectible in equal annual instalments over a period of 2 years. The pattern of payment per the sale agreement is thus similar to a hire purchase (1) agreement in that payments are deferred, therefore these payments should rather be present valued in order to determine the fair value (IAS 18.11 & .30). The rate to be used is 18%. Therefore, the fair value of the sale is R6 262 568 (PMT = 4 000 000; (1) n = 2; i = 18%). Interest on this receivable should be recognised using the effective interest method. Therefore, at year-end, interest receivable will amount to R281 816 (6 262 568 x 18% x 3/12). (1)

According to IAS 1.32 assets and liabilities may not be offset against each other, except when offsetting is required or permitted by a standard or interpretation. As both the amount receivable (1) and the loan represent financial instruments, they should be dealt with in accordance with IAS 32 & IFRS 9. According to IAS 32.42 a financial asset and a financial liability may be offset, only when the entity has a legally enforceable right to set off the recognised amounts, and intends either to settle on a net basis or to realise the asset and settle the liability simultaneously. As there is no (1) intention to settle the amount receivable and the loan simultaneously (the repayment dates are (2) different) offsetting of these amounts should not be allowed. The loan of R3 million is a separate liability and is not a part payment of the purchase price as far as the town council is concerned. (1) This loan should be disclosed separately as a current liability and not set off against the accounts receivable. (1) For the year ended 31 December 20.11, the statement of profit or loss and other comprehensive income would therefore include the following: R Revenue Cost of sales Interest received Finance cost 6 262 568 (5 000 000) 281 816 (225 000) () () () ()

The statement of financial position as at 31 December 20.11 would disclose the following: R Current liabilities 3 000 000 225 000 () ()

Amount receivable from town council long-term portion [C1] (as a non-current asset) short-term portion (under current assets) (2 872 738[C1] + 281 816)

3 389 830 3 154 554 Total Maximum

(1) (1) (22) (20)

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CALCULATION C1. Amortisation table Capital 30 September 20.11 30 September 20.12 30 September 20.13 Interest Balance 6 262 568 3 389 830 -

2 872 738 3 389 830

1 127 262 610 170

COMMENT Both of the above payments represent an instalment of R4 000 000 and the above table split the instalments into the capital and interest components.

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SECTION C - SPECIFIC OUTCOMES


After you have studied this study unit, you should be able to do the following: 1. 2. 3. 4. 5. 6. 7. 8. Identify the objective of IAS 18 Revenue. Measure revenue at the fair value of the consideration received. Determine when revenue from the sale of goods should be recognised. Determine when revenue from the rendering of services should be recognised. Determine when revenue from the use by others of entity assets should be recognised. Disclose revenue in accordance with International Financial Reporting Standards. Accounting treatment of customer loyalty programmes. Have a basic knowledge and awareness of ED 309.

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SELF-ASSESSMENT QUESTIONS
QUESTION 1 TOPIC Income tax, change in estimate, presentation of financial statements and revenue Revenue Income tax Income tax presentation of financial statements, prior period error and revenue Income tax presentation of financial statements, prior period error and revenue MARKS MINUTES

40 20 40

60 30 60

2 3 4

50

75

40 190

60 285

SELF ASSESSMENT QUESTIONS The purpose of the self-assessment questions is to assist you in determining if you have mastered the topics covered in this tutorial letter. In order to gain the maximum value from these questions and to improve your exam technique, it is suggested that you approach these questions as follows: 1. Prepare to attempt each of the questions as if it is a formal test or exam by doing the following: a. b. c. d. e. f. g. h. 2. Ensure that it is quiet and that you will not be disturbed. Prepare the place where you are going to attempt the question by only keeping your books that is allowed to be taken into an examination venue and your financial calculator next to you. Use reading time for the question as is done in the tests and exam. Only start writing when your reading time has lapsed. Attempt the question as seriously as if it was a real test or exam. Keep within the time limit when you attempt the question and DO NOT refer to the suggested solution. If the time runs out and you prefer to complete the question, complete the question in a different colour pen and make a note of how much extra time you spend on the question. Take a quick break after you have completed the question. Take sufficient time to mark your answer and to calculate your mark.

After marking your own answer, it is very important that you reflect on the mark and how you have experienced the level of difficulty of the question. a. b. c. d. e. f. Did you complete your answer in the time limit? How many minutes did you use extra? How many marks did you score after the available time expired? Do you need to refer back to specific study units to clarify the accounting treatment of certain items? Is your answer set out in a logical manner, i.e. is it easy to follow your workings when marking your answer? Identify how you can inprove your exam technique.

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QUESTION 1 (40 marks)

YOU HAVE 15 MINUTES TO READ THIS QUESTION


My Little Horses Ltd (hereinafter referred to as MLH) is in the industry of manufacturing and selling tiny multi-coloured soft toy horses. You are responsible in assisting the new accountant with various issues that arose while finalising the annual financial statements for the year ended 30 April 20.11. The issues are listed below: 1. MLH has been selling their soft toy horses to various retail and toy stores for many years and has developed a good relationship with their customers. The selling price per soft toy horse is R228 (including VAT). The cost to manufacture one toy horse from start to finish is R114 (including VAT). Throughout the financial year ended 30 April 20.11, 15 230 toy horses have been sold as part of MLHs normal business operations. Sales represent 30 percent cash on delivery sales and 70 percent credit sales which is paid after 30 days. If debtors settle their accounts early, they qualify for an 8% early settlement discount. 40 percent of the companies purchasing on credit, opt to settle early in order to receive the 8% settlement discount. On 1 March 20.10, a special order was placed by a new company, Birthdays Are Us Ltd, who will purchase a significant quantity of soft toy horses to be included in their party hampers. A contract was signed between the two parties for MLH to manufacture 8 550 soft toy horses. The delivery date of the 8 550 soft toy horses was 1 May 20.10. A special lower selling price of R171 (including VAT) per toy horse was agreed for this large order. The selling price will be settled in 12 monthly instalments of R126 506,43 each (including VAT), payable in arrears. The first instalment was payable on 31 May 20.10. The interest rate implicit in this transaction is 7% per annum, compounded monthly. The accountant believes that the special order should be treated as other income in the statement of profit or loss and other comprehensive income, as it is a once-off transaction. The accountant was not sure how or when to process this special order and therefore did not account for it at all. 3. 4. Included in the administrative expenses of R120 000 is distribution costs of R30 000. Since incorporation, MLH has been insured by Best Insurance Ever Ltd to secure itself against fire and water damage. Each year on 1 January, MLH make an annual cash payment to Best Insurance Ever Ltd for the years insurance premiums. On 1 January 20.10, MLH paid the annual insurance premium of R75 000. The insurance contract stipulates an escalation clause of 10% per annum. On 1 January 20.11, LH paid the annual insurance premium for 20.11. The total annual insurance premium for 20.11, as well as the pro-rata expense relating to the 20.10 premium, is included in the other expenses amount of R167 500. A machine was purchased on 1 May 20.8 at a cost of R2 540 000. The company has always depreciated machinery at 20% per annum on the reducing balance method, apportioned for part of a year. Depreciation has not been raised for the year ended 30 April 20.11. On 30 April 20.11 the company revised the depreciation method and it was established that depreciation on machinery should rather be written off on the straight-line basis over the remaining useful life, apportioned for part of a year. The machinery had a remaining useful life of three years on 30 April 20.11. In terms of section 12C of the Income Tax Act, the SARS allows a 40% deduction in the first year and 20% in the subsequent three years, not apportioned for part of a year

2.

5.

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6.

MLH purchased a new factory building on 1 November 20.9 and it was immediately available for use. The companys accounting policy is to depreciate their factory buildings over their estimated useful life of 13 years and to revalue factory buildings at the beginning of each year. The residual value of the factory building is zero. The carrying amount of the factory building on 30 April 20.10 was R625 000. On 1 May 20.10, MLH revalued the factory building up to R950 000. The revaluation surplus will be realised when the factory building is sold or derecognised. The SARS allows a 5% per annum deduction on factory buildings in terms of section 13(1)(b) of the Income Tax Act that is not apportioned for part of a year. The revaluation and the depreciation for the year for the new factory building have not yet been processed in the trial balance.

7.

A piece of land, owned by MLH, which is across the road from the factory building, was acquired by the company on 1 May 20.8 but was not used by the company. On 30 April 20.11, MLHs management sold the land for R300 000. The originally cost of the land was R150 000. The accounting policy of MLH is to measure land at cost in terms of IAS 16 and to recover the carrying amount through sale for deferred tax purposes. The sale of the land has not yet been processed in the trial balance of MLH. Assume that the profit on the sale of land is subject to capital gains tax. During the year ended 30 April 20.11, MLH received dividend income of R50 000. The prior year tax assessment (30 April 20.10) of MLH reflected an assessed tax loss of R350 000. The company recognised a deferred tax asset for the carry forward of this unused tax loss as they were certain that future taxable profit will be available against which the unused tax loss can be utilised. MLH donates toy horses annually to various non-profit organisations, in which they are actively involved. For the year ended 30 April 20.11, MLH donated horses with a cost price of R47 500 (excluding VAT). This amount is included in other expenses. The SARS has indicated that they will not allow the amount as a deduction for income tax purposes. During the year, MLH performed research on developing new soft toys they want to bring into the market. Research costs amounting to R25 500 were paid in cash. This amount is included in other expenses. The SARS allows a deduction of 150% per annum for this research expenditure in terms of section 11D of the Income Tax Act.

8. 9.

10.

11.

Additional information Other income amounted to R122 300 (excluding dividends received) for the year. The income tax rate is 28%. Assume that 66,6% of all capital gains are included in taxable profit and taxed at 28%. No temporary differences other than those apparent from the information above existed on 30 April 20.10 and 30 April 20.11. On 15 May 20.10, a proposed decrease in the tax rate for companies from 28% to 27% was tabled for consideration to the Minister of Finance. It is alledged that the Minister is strongly considering the proposed decrease. The company is certain on 30 April 20.11 that there will be sufficient future taxable profit and future taxable capital gains to utilise against unused tax losses and credits.

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REQUIRED

YOU HAVE 1 HOUR TO ANSWER THIS PAPER


Marks (a) (b) Discuss the recognition and measurement of the proposed revenue arising from the special order from Birthdays Are Us Ltd in the annual financial statements of MLH. Prepare the statement of profit or loss and other comprehensive income for My Little Horses Ltd for the year ended 30 April 20.11. (c) A single statement of comprehensive income is required. Expenses should be classified according to their function. The tax effect of each component of other comprehensive income must be disclosed separately on the face of the statement of profit or loss and other comprehensive income. Comparative figures are not required. Start your current tax calculation with profit before tax as calculated in the statement of profit or loss and other comprehensive income. Deferred tax should be calculated using the balance sheet method. Earnings per share presentation and disclosure are not required. 4 7 29

Prepare all the journal entries with regards to the taxation of My Little Horses Ltd for the year ended 30 April 20.11 in terms of IAS 12. Journal narrations are not required.

Please note: Your answer should comply with International Financial Reporting Standards (IFRS). Amounts must be rounded to the nearest Rand. (Source: UNISA CTA Test 1 2010)

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QUESTION 1 - Suggested solution (a) Recognition and measurement The sale of the soft toy horses represents the sale of goods. In terms of IAS 18.14, revenue from the sale of goods should be recognised when all the following five conditions have been met: (a) The entity has transferred to the buyer the significant risks and rewards of ownership of the goods In terms of the contract the soft toy horses must be delivered to Birthdays are Us Ltd on 1 May 20.10 on which day the significant risks and rewards of ownership will be transferred. (1) The entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold. Once the soft toy horses are delivered on 1 May 20.10, no involvement or control over the goods will exist. () The amount of revenue can be measured reliably The revenue recognised is usually determined by agreement between the entity and the buyer of the asset (IAS 18.10) which is R171 per horse including VAT. () Revenue excludes VAT, as it is an amount collected on behalf of a third party (the SARS) (IAS 18.8). () Revenue (including VAT) (R171 x 8 550) Less VAT (R171 x 8 550 x 14/114) Revenue R1 462 050 (R 179 550) R1 282 500 (1) (1)

(b)

(c)

Revenue is measured at the fair value of the consideration received or receivable taking into account the amount of any trade discounts and volume rebates allowed by the entity (AS 18.10) - The revenue is receivable in 12 instalments of R126 506,43 and the present value of the future instalments is the fair value of the consideration receivable. (1) The present value of the future instalments is calculated as follows: (HP calculators should be set on 12 P/YR and for Sharp calculators the interest rate should divided by 12) N 12 months I 7% per annum PMT R126 506,43 (including VAT) FV Rnil PV = R1 462 050 (including VAT) (The present value is hereby proved to be equal to the cash price)

(1)

The difference between the nominal value and the present value of the future instalments receivable is unearned finance income. Nominal value of instalments (R126 506,43 x 12 = R1 518 077 R179 550 (VAT)) R1 338 527 Present value of instalments (R1 282 500) Unearned finance income R 56 027 (1)

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The unearned finance income (R56 027) would be recognised over time using the effective rate method (IAS 18.30(a)). () The interest revenue would be disclosed as revenue if it is a significant category of revenue (IAS 18.25(b)). As the R56 027 is not significant, it can be disclosed as other income or finance income. ()

4.

It is probable that economic benefits associated with the transaction will flow to the entity It is probable that economic benefits will flow to the entity because a contract has been entered into in terms of which Birthdays Are Us Ltd is contractually obliged to pay for the soft toy horses as dictated by the terms of the contract. ()

5.

The costs incurred in respect of the transaction can be measured reliably The costs incurred to manufacture the horses can be reliably measured as R100 per horse (R114 x 100/114). The total cost incurred is R855 000 (R100 x 8 550). ()

Conclusion Since all the above recognition criteria for the sale of goods have been met, the revenue from the contract will be recognised on date of delivery (1 May 20.10) at the fair value of the consideration receivable of R1 282 500. (1) MLH is in the business of selling soft toy horses and the special order was for 8 550 soft toy horses, which is in line with MLHs normal business operations. Therefore the income on the contract should be recognised as revenue and not as other income. () Communication skills: Logical flow and conclusion (1) Total marks (12) Maximum 7 (b) MY LITTLE HORSES LTD STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 APRIL 20.11 R Revenue ([C1] + 1 282 500 (part a)) Cost of sales [C2] Gross profit Other income (57 027 (part (a)) + 150 000 [C6] + 50 000 dividends + 122 300 other income) Distribution costs Administrative expenses (120 000 - 30 000) Other expenses (167 500 - 55 000 [C3] + 406 400 [C4] + 76 000 [C5]) Profit before tax Income tax expense PROFIT FOR THE YEAR 4 260 270 (2 378 000) 1 882 270 378 327 (30 000) (90 000) (594 900) 1 545 697 (449 833) 1 095 864 (4) (1)

(2) () (1) (6) (17)

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Other comprehensive income Items that will not be reclassified to profit or loss: Revaluatuion surplus Gain on property revaluation [C5] Tax expense (325 000 x 28%) or [C8]

234 000 325 000 (91 000)

() ()

Other comprehensive income, net of tax 234 000 TOTAL COMPREHENSIVE INCOME FOR THE YEAR 1 329 864 Communication skills: Presentation and layout Total marks Maximum (c) Journals to account for taxation for the year ended 30 April 20.11 Dr R J1 Income tax expense (P/L) [C7.1] Other creditors: SARS Recognise provision for income tax payable Revaluation surplus (OCI) [C8] Income tax expense (P/L) (17 688 + 98 000) [C8] Deferred tax liability (SFP) Recognise increase in deferred tax liability 334 165 334 165 91 000 115 668 206 668 Total marks Maximum CALCULATIONS C1.1 Revenue Sales price per horse (R228 x 100/114) Total sales (15 230 x R200) Cash sales (R3 046 000 x 30%) Credit sales Allowance account for settlement discount (R2 132 200 x 40% x 8%) R200 3 046 000 913 800 2 132 200 (68 230) 2 977 770 Cr R

(1) (34) (29)

(1) () (1) (1) (1)


(5) (4)

J2

[1] [] [] [1] [3]

C1.2 Unearned finance income Balance on 1 May 20.10 R56 027 The instalments started 31 May 20.10 and the 12th instalment was paid on 30 April 20.11. As a result the entire R56 027 is recognised as income for the year ended 30 April 20.11.

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C2. Cost of sales Cost per horse (R114 x 100/114) Horses sold (15 230 + 8 550) Cost of sales (R100 x 23 780) R100 23 780 2 378 000

[1] [1]

C3. Prepaid expenses (insurance premium) From 1 Jan 20.10 - 31 Dec 20.10 Prepaid expense on 30 April 20.10 (75 000 x 8/12) Expense included in other expenses for year ended 30 April 20.11 (75 000 x 110/100) Expense that should be included in other expenses for year ended 30 April 20.11 (82 500 x 4/12) Prepaid expense on 30 April 20.11 (82 500 x 8/12) (add back from other expenses) 75 000 50 000 82 500 27 500 55 000 [1] [1] []

C4. Machinery Carrying amount Cost on 1 May 20.8 Depreciation for year ended 30 April 20.9 (2 540 000 x 20%) Carrying amount on 30 April 20.9 Depreciation for year ended 30 April 20.10 (2 032 000 x 20%) Carrying amount on 30 April 20.10 Depreciation for year ended 30 April 20.11 (1 625 600 / 4 years) Carrying amount on 30 April 20.11 2 540 000 (508 000) 2 032 000 (406 400) 1 625 600 (406 400) 1 219 200

[] [] [] [1] [3]

USEFUL LIFE OF MACHINERY The change in estimate needs to be accounted for from 1 May 20.10. Note that the remaining useful life on 30 April 20.11 was three years which means that on 1 May 20.10 it was four years. C5. Factory building Carrying amount on 30 April 20.10 (6 months of 13 years have lapsed) Cost of building on 1 November 20.9 (625 000 x 13/12,5 years) Fair value on 1 May 20.10 Carrying amount on 30 April 20.10 Revaluation surplus Depreciation for year ended 30 April 20.11 (950 000/12,5 years) Carrying amount as at 30 April 20.11 (625 000 + 325 000 - 76 000) 625 000 650 000 950 000 625 000 325 000 76 000 874 000

[1] [1] [1] [3]

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C6. Sale of land Proceeds on sale Cost of land Profit on sale of land Capital gain that is taxable (150 000 x 66,6%) 300 000 (150 000) 150 000 99 900

[] []

C7.1 Current tax Profit before tax Non-taxable/non-deductible items: Dividends received not taxable Add back entire capital gain as not taxable Donation not deductible Additional research cost deduction (25 500 x 50%) Include capital gain that is taxable [C6] Taxable profit before temporary differences Movement in temporary differences (taxable) [C8] Taxable profit before unused tax loss Unused tax loss Taxable profit Tax at 28% C7.2 Income tax expense Current tax [C7.1] Deferred tax - Movement in temporary differences (through P/L) [C8] - Unused tax loss utilised [C8] Income tax expense 334 165
[]

1 545 697 (50 000) (150 000) 47 500 (12 750) 99 900 1 480 347 63 100 1 543 447 (350 000) 1 193 447 334 165

[] [] [] [] [] [] [] []

17 668 (debit P/L and credit deferred tax liability) 98 000 (debit P/L and credit deferred tax liability) 449 833 [5]

C8 Deferred tax Carrying amount 30 April 20.10 Prepaid expenses [C3] Machinery [C4] Factory building [C5] Land Unused tax loss Net deferred tax liability Temporary difference 50 000 609 600 7 500 667 100 (350 000) 317 100 Deferred tax (dr)cr 14 000 170 688 2 100 186 788 (98 000) 88 788 [] [1] [1] [1] []

Tax base

50 000 -1 2 1 625 600 1 016 000 3 617 500 625 000 150 000 150 000 350 000

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FAC4861/102 NFA4861/102 ZFA4861/102 Temporary difference 55 000 711 200 289 000 1 055 200 325 000 63 100 350 000 738 100 Deferred tax (dr)cr 15 400 199 136 6 80 920 295 456 91 000 17 668 98 000 206 668 [] [1] [3]

Carrying amount 30 April 20.11 Prepaid expenses [C3] Machinery [C4] Factory building [C5] Deferred tax liabiity 55 000 1 219 200 874 000

Tax base 4 508 000 5 585 000


1

Movement in temporary differences (through OCI) (taxable) Movement in temporary differences (through P/L) (taxable) (1 055 200 - 667 100) 325 000 [C5] Movement in unused tax loss (deductible) (0 - (350 000)) Total movement in temporary differences

[] [1] [1] [11] [26]

2 3 4 5 6

Tax base of prepaid expenses is amounts deductible in future. As already deducted for tax purposes in the financial year that it was paid, no future tax deductions exist. 2 540 000 - (2 540 000 x 40%) -(2 540 000 x 20%) = 1 016 000 650 000 - (650 000 x 5%) = 617 500 2 540 000 - (2 540 000 x 40%) -(2 540 000 x 20%) - (2 540 000 x 20%) = 508 000 650 000 - (650 000 x 5%) - ( 650 000 x 5%) = 585 000 As the carrying amount of the factory building is recoverable through use, deferred tax is raised at 28%.

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QUESTION 3 (40 marks)

YOU HAVE 15 MINUTES TO READ THIS QUESTION

Extra Ltd, a supplier of building materials, approached you with the request to assist the accountant with the finalisation of the companys annual financial statements for the year ended 30 June 20.11. You agreed to assist the accountant and after further investigations, you gathered the following information: 1. During the year ended 30 June 20.11 the Minister of Finance announced that the tax rate would change from 29% to 28% for financial year ends starting on 1 July 20.10 or later. The company made donations of R10 000 during the year ended 30 June 20.11 which is not deductible for tax purposes. During the year ended 30 June 20.11, a fine of R5 000 was paid to the SARS for the late submission of Extra Ltds 20.10 income tax return which is not deductible for tax purposes. During the year ended 30 June 20.11, Extra Ltd received dividend income of R80 000 which is not taxable. A new manufacturing plant was purchased 1 January 20.10 and it was available for use as intended by management and brought into use immediately. The companys accounting policy is to depreciate this manufacturing plant on the straight-line basis over its estimated useful life, apportioned for part of a year. On the date of purchase, management estimated the useful life of the manufacturing plant to be 10 years with no residual value. The carrying amount of the manufacturing plant on 30 June 20.11, correctly calculated by the accountant, is R680 000. The SARS allows a tax deduction in respect of the manufacturing plant in accordance with Section 12C of the Income Tax Act, not apportioned for part of a year, on the following basis: 6. 40% of the purchase price in the first year in which the asset is purchased; and 20% per year for each of the following three years.

2.

3. 4.

5.

Equipment to the value of R700 000 was acquired on 1 July 20.8. The equipment has no residual value and it is the companys accounting plocy to depreciate equipment on the straight-line basis over the expected useful life of seven years. On 30 June 20.11, management estimated that the remaining useful life of the equipment was only three years. The accountant has correctly accounted for this change in estimate. The SARS allows a Section 12C deduction on the equipment on the same basis as for the manufacturing plant. Extra Ltd owns a factory building. The carrying amount of the factory building on 30 June 20.10 and 30 June 20.11, correctly calculated by the financial accountant, amounted to R1,4 million and R1,2 million respectively. There have been no additions or improvements to the factory building since it was acquired. The tax base of the factory building on 30 June 20.10 for deferred tax purposes, was R1,28 million. The SARS allows a tax deduction of R320 000 per year in respect of this factory building.

7.

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8.

Extra Ltd also owns an office building that was purchased during the year ended 30 June 20.11 at a cost price of R2,5 million. This office building is occupied by the administration, sales and finance departments of Extra Ltd. The depreciation for the year ended 30 June 20.11 on this office building was R125 000, correctly calculated by the financial accountant. The office building does not qualify for a tax deduction in terms of Section 13 of the Income Tax Act. On 1 April 20.11, a cash amount of R250 000 was received for training courses that Extra Ltd will present to builders. Five training courses of R50 000 each will be presented monthly from 1 April 20.11 until 31 August 20.11. This R250 000 has been correctly recorded by the accountant.

9.

Additional information 1. The accounting profit before tax, after taking all the above information into account, as correctly calculated by the accountant, is R100 000. Extra Ltd had a taxable profit for the financial year ended 30 June 20.10 and does not have unused tax losses or credits as at 30 June 20.10. It is probable that sufficient taxable profit will be available in future to utilise any deductible temporary differences or unused tax losses as at 30 June 20.11.

2.

3.

REQUIRED

YOU HAVE 1 HOUR TO ANSWER THIS PAPER

Marks Prepare only the notes to the annual financial statements of Extra Ltd for the year ended 30 June 20.11 in accordance with IAS 12 Income Taxes. Note Round all amounts to the nearest Rand. Comparative amounts are not required. A detailed deferred tax calculation is required for 30 June 20.10 and 30 June 20.11 calculated using the balance sheet method. 40

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QUESTION 3 - Suggested solution EXTRA LTD NOTES FOR THE YEAR ENDED 30 JUNE 20.11 3. Income tax expense Major components of tax expense R SA Normal taxation Current tax - Current year [C1] Deferred tax - Movement in temporary differences [C2] (365 000 x 28%) - Change in tax rate [C2] - Unused tax loss created [C2] (205 000 x 28%)

(38 600) 102 200 (6 200) (57 400) 38 600

(5) (18) (2) (2)

Tax rate reconciliation Accounting profit 100 000 Tax at 28% 28 000 Tax effect of deductible/non-taxable items: - Donations not deductible (10 000 x 28%) 2 800 - Fine not deductible (5 000 x 28%) 1 400 - Dividends not taxable (80 000 x 28%) (22 400) - Depreciation on office building not deductible (125 000 x 28%) 35 000 Change in tax rate [C2] (6 200) Income tax expense 38 600 The Minister of Finance decreased the income tax rate from 29% to 28% for financial years starting on or after 1 July 20.10. (IAS 12.81(d)) Communication skills: Presentation and layout

() () (1) (1) (1) (1) (1)

(1) (1) (35)

10.

Deferred tax Analysis of temporary differences: Property, plant and equitpment - Accelerated deductions for tax purposes [C2] (100 800 + 135 800 + 67 200) 303 800 Revenue received in advance [C2] (28 000) Unused tax loss for normal tax [C2] (57 400) Net deferred tax liability 218 400 Communication skills: Presentation and layout Total marks

(2) (1) (1) (1) (5) (40)

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CALCULATIONS C1. Current tax Profit before tax Non-taxable/non-deductible items: Donations not deductible Fine not deductible Dividends not taxable Depreciation on office building not deductible Taxable profit before temporary differences Movement in temporary differences [C2] Tax loss for the year Tax at 28% 100 000 10 000 5 000 (80 000) 125 000 160 000 (365 000) (205 000) [4] [] [] [] [] [1] [1] []

C2.

Deferred tax Carrying amount 30 June 20.10 Manufacturing plant [C3] Equipment [C4] Factory building 760 000 500 000 1 400 000 480 000 280 000 1 280 000
1

Tax base

Temporary difference

Deferred tax (dr)cr 29%

Decrease in tax rate (159 500 x 1/29) Deferred tax liability (after rate change) (159 500 x 28/29) Change in tax rate Movement in temporary differences (excluding tax loss) (taxable) (985 000 - 620 000) Movement in unused tax loss (deductible) (445 000 - 0) Total movement in temporary differences

280 000 220 000 120 000 620 000 620 000 365 000 (205 000) 160 000

81 200 63 800 34 800 179 800 (6 200) 173 600 (6 200) 102 200 (57 400) 38 600

[1] [1] [1]

[1]

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2

Carrying amount 30 June 20.11 Manufacturing plant [C3] Equipment [C4] Factory building Office building Revenue received in advance Unused tax loss Net deferred tax liability
1

Temporary difference 360 000 485 000 240 000


IAS 12.15(b)(ii)

680 000 320 000 3 625 000 140 000 1 200 000 960 000 4 2 375 000 6 (100 000) -7 205 000

(100 000) 985 000 (205 000) 780 000

Deferred tax (dr)cr 28% 100 800 135 800 67 200 (28 000) 275 800 (57 400) 218 400

[1] [1] [2] [2] [1] [12]

800 000 - (800 000 x 40%) = 480 000 800 000 - (800 000 x 40%) - (800 000 x 20%) = 320 000 1 280 000 - 320 000 = 960 000 2 500 000 - 125 000 = 2 375 000 5 The temporary difference arises at initial recognition of the factory building and at the time of the transaction, affects neither the accounting profit nor tax profit. 6 250 000 x 2/5 months = 100 000 7 Carrying amount (100 000) minus amounts not taxable in future (100 000) = 0
2 3 4

C3. Manufacturing plant Useful life on 1 January 20.10 Useful life on 30 June 20.10 Useful life on 30 June 20.11 Cost of manucaturing plant (680 000 x 10/8,5 years) Depreciation for year ended 30 June 20.10 (800 000 / 10 x 6/12) Carrying amount on 30 June 20.10 10 years 9,50 years 8,50 years 800 000 (40 000) 760 000

[1] [] [] [2]

C4. Equipment Carrying Tax base amount 700 000 700 000 (100 000) (280 000) 600 000 420 000 (100 000) (140 000) 500 000 280 000 125 000 625 000 (140 000) 140 000 [1]

Purchase price on 1 July 20.8 Depreciation for year ended 30 June 20.9 (700 000 / 7) (700 000 x 40%) Carrying amount on 30 June 20.9 Depreciation for year ended 30 June 20.10 (700 000 / 7) (700 000 x 20%) Carrying amount on 30 June 20.10 Depreciation for year ended 30 June 20.11 (700 000 / 4) (700 000 x 20%) Carrying amount on 30 June 20.11

[1] [] [2] [] [5] [24]

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YOU HAVE 19 MINUTES TO READ THIS QUESTION

Potter Limiteds annual report for the year ending 31 December 20.11 must still be finalised. The following is an extract from the trial balance on 31 December 20.11: Notes Sales Franchise fees recognised Cost of sales and services Other income Other expenses Office building at revalued amount Equipment at cost Accumulated depreciation on equipment Inventory Revaluation surplus Other creditors: SARS Other creditors: Foreign country tax authority Allowance account for credit losses Notes 1. Included in revenue is an amount of R33 400 that was received from Dumble Ltd for goods that were only delivered to Dumble Ltd on 15 January 20.12. Potter Ltd started a customer loyalty program in December 20.11. In terms of the customer loyalty program, the customer receives one loyalty credit for each R2 000 spent. Only cash purchases qualify for loyalty credits. Each loyalty credit gives the client the right to R100 discount on a future cash purchase. It is expected that 80% of the loyalty credits granted will be redeemed and as a result the fair value of each credit is R80. The total cash sales during December 20.11 where clients spent more than R2 000 each, was R210 900. Potter Ltd has not yet recorded any entries with regard to the customer loyalty program. Any person can apply to start a Potter franchise. The franchise contract stipulates that R424 000 is payable to Potter Ltd. Potter Ltd will then supply specified assets with a fair value of R202 000 to the franchise. The balance of R222 000 is the franchise fees for the initial twelve months, starting 1 November 20.11. After the first twelve months, the franchise fees will be payable monthly in advance. The minimum term for a franchise contract is five years. One new franchise contract was entered into on 1 November 20.11. Potter Ltd delivered and installed the assets to the value of R202 000 on 2 November 20.11. The cost of sales on the installation of the assets was correctly recorded. The only journal entry passed for the franchise contract revenue received is as follows: 1 November 20.11: Bank (SFP) Franchise fees recognised (P/L) Dr R 424 000 424 000 Cr R 1,2 3 4 797 500 4 5 7 8 8 6 7 9 4 360 000 1 026 542 750 000 2 467 000 652 300 330 000 108 000 97 500 105 000 160 000 Dr R Cr R 2 187 500 3 456 800

2.

3.

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4.

The following items are included in other income for 20.11: R Foreign income (not taxable in South Africa as taxation of 35% is payable in the foreign country) Dividends received not taxable 300 000 60 000

5.

The following items, amongst others, are included in other expenses for 20.11: R Traffic fines (not tax deductible) Loss on sale of land (capital loss for tax purposes) Increase in allowance for credit losses (25% of balance is allowed for tax purposes) Finance costs Depreciation Distribution costs 8 000 50 000 20 000 78 000 120 500 90 000

6.

During the financial year, the financial manager realised that there was an error in the accounting program calculating the values of inventory. An investigation brought to light that inventory has been undervalued since 20.6. The values of closing inventory on 31 December 20.9, 20.10 and 20.11 were initially calculated as follows by the accounting program: R 20.9 20.10 20.11 320 000 180 000 330 000

The accounting program has been corrected and the closing inventory on 31 December 20.10 and 20.11 has been re-calculated as set out below. It was not practical to recalculate the value of inventory on 31 December 20.9. R 20.10 20.11 The financial manager has not yet processed any journal entries to correct this error. 7. It is Potter Ltds policy to revalue its office building annually on 31 December. The first revaluation was done on 31 December 20.11. The office building was acquired on 1 January 20.8. The journals below was posted on 31 December 20.11. Assume that these journals are correct. Dr R Office building (revalued amount) (SFP) Accumulated depreciation (SFP) Office building at cost price (SFP) Revaluation surplus (OCI) Revaluation surplus (OCI) Deferred tax (SFP) 750 000 400 000 1 000 000 150 000 42 000 42 000 Cr R 200 000 440 000

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The SARS allows a Section 13 deduction of 5% per year on the office building, not apportioned for part of a year. 8. 9. The tax base of equipment was R2 016 700 as at 31 December 20.10 and R1 712 700 as at 31 December 20.11. The SARS account in the general ledger on 31 December 20.11 is as follows: R Balance on 1 January 20.11 (provision relating to the 20.10 tax assessment) Payment made in final settlement of 20.10 assessment (no fines or interest were charged) Provisional payments in respect of 20.11 (45 000) 42 500 10 000 7 500

10.

The tax rate during 20.10 was 29% and this rate was reduced to 28% during 20.11 for financial year ends starting on or after 1 January 20.11. The inclusion rate for capital gains tax is 66,6%. The company has already been assessed for 20.10 and the assessment will not be reopened for the adjustment of the closing inventory values (refer to note 6). It is expected that capital gains will be generated in the future. The directors of the company are uncertain about the ability of the company to generate taxable profit in the future. The balance of retained earnings on 31 December 20.10 was a credit of R123 400. There are no temporary differences than those arising from the information provided.

11.

12. 13. 14.

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REQUIRED

YOU HAVE 75 MINUTES TO ANSWER THIS PAPER

Marks (a) Prepare the journal entries to rectify the error in the opening inventory value on 1 January 20.11, including the tax implications thereof, in the accounting records of Potter Ltd for the year ended 31 December 20.11 (refer to note 6). Note Journal narrations are not required. Your answer must comply with International Financial Reporting Standards. 4

(b) Prepare the statement of profit or loss and other comprehensive income for Potter Ltd for the year ended 31 December 20.11. Note Income and expense should be classified by function. The gross amounts and tax effect of each item of other comprehensive income need to be disclosed separately. Comparative figures and earnings per share presentation and disclosure are not required. Deferred tax should be calculated using the balance sheet method. (c) Prepare the income tax expense note to the financial statements of Potter Ltd for the year ended 31 December 20.11. Comparative figures are not required. Deferred tax should be calculated using the balance sheet method.

14

32

(Source: UNISA CTA Test 1 2009)

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QUESTION 4 - Suggested solution (a) POTTER LTD Journals on 1 January 20.11 Dr R J1 Cr R (1) () (1) () (1)

J2

Inventory (SFP) [C1] 20 000 Retained earnings (SCE) 20 000 Adjust the opening inventory balance Retained earnings (SFP) [C1] 5 800 Deferred tax (SFP)* 5 800 Raise deferred tax on adjustment to inventory Communication skills: Presentation and layout *The SARS has indicated that it will not re-open the prior year assessment to rectify the error. As a result, the SARS does not recognise the new inventory balance for tax purposes and a taxable temporary difference arises which gives rise to a deferred tax liability. Total marks

(4)

(b)

POTTER LTD STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20.11 20.11 R 5 417 500 (4 707 500) 710 000 360 000 (90 000) (858 542) (78 000) 43 458 (17 254) 26 204

Revenue (2 187 500 + 3 456 800 - 33 400 - 8 400 (C2] - 185 000 [C3] Cost of sales (4 757 500 - 90 000 [C1] Gross profit Other income Distribution costs Other expenses (1 026 542 - 78 000 - 90 000) Finance costs Profit before tax Income tax expense PROFIT FOR THE YEAR Other comprehensive income Items that will not be reclassified to profit or loss: Revaluation surplus Gain on property revaluation Tax expense

(4) (2) () () (1) () (1) ()

108 000 150 000 (42 000)

() (1)

Other comprehensive income, net of tax 108 000 TOTAL COMPREHENSIVE INCOME FOR THE YEAR 134 204 Communication skills: Presentation and layout Total marks

(1) (14)

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(c) POTTER LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.11 3.Income tax expense 20.11 R Major components of tax expense SA normal tax Current tax - Current year - Overprovision for prior year (45 000 - 42 500) Deferred tax - Change in tax rate [C4] - Movement in temporary differences [C4] - Unused capital loss created [C4] - Unused tax loss created [C4] SA normal tax Foreign tax Income tax expense Tax rate reconciliation Accounting profit Tax at 28% Tax effect of non-taxable/non-deductible items: - Dividends received not taxable (60 000 x 28%) - Traffic fines not deductible (8 000 x 28%) - Capital loss on sale of land not deductible (18 000 x 33.4% x 28%) Change in tax rate Overprovision for current tax for prior year Effect of different tax rate on foreign income (300 000 x (35% - 28%) Income tax expense The income tax rate decreased from 29% to 28% for financial years starting on or after 1 January 20.11. (IAS 12.81(d)

(2 500) (2 500) (85 246) (3 530) (37 184) (9 324) (35 208) (87 746) 105 000 17 254 43 458 12 168 (16 800) 2 240 4 676 (3 530) (2 500) 21 000 17 254

(4) (1) (1) (14) (2) (1)

(1)

() () (1) (1) (1) (1) (1) (2)

Total marks Maximum Total marks

(33) (32) (50)

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CALCULATIONS C1. Prior period error 20.10 200 000 (180 000) 20 000 (5 800) 14 200 P/L
1

Correct inventory values Incorrect inventory values Tax effect @ 28% (29% for 20.10)
1

90 000 (25 200) 64 800

20.11 440 000 (330 000) 110 000 (30 800) 79 200

[1] [1]

Closing inventory increases with R90 000 which decreases cost of sales (which increases gross profit). [3] C2. Customer loyalty program Cash sales of more than R2 000 210 900 Cash sale per loyalty credit 2 000 Credits 105,45 Round down as only full credits are awarded 105 Value per loyalty credit 80 Total value of loyalty credits awarded 8 400 The following journal must be passed to account for the customer loyalty program: Dr 8 400 Cr 8 400 [2] C3. Franchise contract revenue Monthly franchise fees Franchise fees received in advance (222 000 x 10/12) Revenue (P/L) Franchise fees received in advance (SFP) 222 000 185 000 Dr 185 000

[1] [] []

Revenue (P/L) Customer loyalty credits (SFP)

[1] Cr 185 000 [1]

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C4. Current tax Profit before tax Non taxable/non-deductible items: Foreign income not taxable in SA Dividends received not taxable Traffic fines not deductible Add back entire capital loss not deductible Capital loss on sale of land that is deductible (R50 000 x 66,6%) Taxable profit before temporary differences Movement in temporary differences (deductible) [C5] Movement in unused capital loss (deductible) [C5] Taxable loss Tax at 28% 43 458 (300 000) (60 000) 8 000 50 000 (33 300) (291 842) 132 800 33 300 (125 742) [] [] [] [] [1] [] [] [] [4]

C4. Deferred tax Deferred tax (dr)cr 29% 5 800 30 450 35 670 30 450 102 370 (3 530) 98 840 (3 530) 42 000 (37 184) (9 324) (35 208) (43 246)

Carrying amount 31 December 20.10 Inventory [C1] Office building Equipment (given) Allowance account for credit losses 200 000 1 700 000 2 139 700 140 000
3

Temporary Tax base difference 180 000 2 595 000 2 016 700 35 000
4

20 000 105 000 123 000 105 000 353 000 353 000 150 000 (132 800) (33 300) (125 742) (141 842)

[2] [2] [1] [2]

Decrease in tax rate (102 370 x 1/29) Deferred tax liability (after rate change) (102 370 x 28/29) Change in tax rate Movement in temporary differences (through OCI) (taxable) Movement in temporary differences (through P/L) (excluding capital loss) (370 200 - 248 000 - 150 000) (deductible) Movement in unused capital loss (deductible) Movement in unused tax loss (deductible) Total movement in temporary differences

[1]

[1] [1]

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FAC4861/102 NFA4861/102 ZFA4861/102 Temporary difference (33 400) (8 400) 190 000 102 000 120 000 370 200 (33 300) (125 742) 211 158 Deferred tax (dr)cr 28% (9 352) (2 352) 53 200 28 560 33 600 103 656 (9 324) (35 208) 59 124 [1] [1] [1] [1] [2]

Carrying amount 31 December 20.11 Revenue received in advance Customer loyalty credits Property Equipment Allowance account for credit losses Unused capital loss (R50 000 x 66.6%) Unused tax loss Net deferred tax liability (33 400) (8 400) 750 000 8 1 814 700 160 000

Tax base 6 7 560 000 1 712 700 40 000


9 5

33 300 125 742

[2] [1] [19]

1 2 3 4 5 6 7 8 9

Accumulated depreciation is R400 000 for 4 years = R100 000 per year. R1 000 000 (R100 000 x 3 years) = 700 000 700 000 - (700 000 x 5%) - (700 000 x 5%) - (700 000 x 5%) = 595 000 160 000 - 20 000 = 140 000 Carrying amount (R140 000) - (R140 000 x 75%) deductible in future = 35 000 33 400 - 33 400 = Rnil 8 400 - 8 400 = Rnil. The customer loyalty credits are deferred revenue and will only be recognised as revenue when the entity has fulfiiled its obligations by granting the discount. 700 000 - (700 000 x 5%) - (700 000 x 5%) - (700 000 x 5%) - (700 000 x 5%) = 560 000 2467 000 - 652 300 = 1 814 700 Carrying amount (R160 000) - (R160 000 x 75%) deductible in future = 40 000

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QUESTION 5 (40 marks 60 minutes)

YOU HAVE 19 MINUTES TO READ THIS QUESTION

Baltons Ltd is a listed South African company that manufactures and distributes office furniture. Baltons Ltds financial year-end is 31 December. The trial balance of Baltons Ltd as at 31 December 20.11 is as follows: Dr R Cr R 1 000 000 610 000 2 186 000 98 000 756 000 310 000 4 850 000 3 210 000 5 170 637 21 000 850 000 50 000 3 560 000 1 981 650 22 000 000 180 000 5 105 000 200 000 11 723 013 4 240 000 31 550 650 31 550 650

Notes Share capital (1 000 000 shares) Revaluation surplus (31 December 20.10) Retained earnings (31 December 20.10) Deferred taxation (31 December 20.10) Equipment at cost Accumulated depreciation on equipment Factory building at revalued amount Accumulated depreciation on factory building Bank and cash Other payablers: SARS Trade and other receivables Allowance account for credit losses Inventory Trade and other payables Revenue Finance costs Dividends received Dividends paid Cost of sales Other operating expenses 1 4 2 2 1 1 4 3

NOTES 1. Factory building The factory building was purchased on 1 November 20.1 for R4 125 000. The factory building is depreciated using the straight-line method over the total estimated useful life of 10 years. The SARS allows a 5% per year deduction in terms of Section 13 of the Income Tax Act. The tax deduction is not apportioned for part of a year. Depreciation has been provided for and is included in cost of sales. It is the companys policy to revalue its factory buildings at the end of every year. The fair value and useful life of the factory buildings remained unchanged for the year ended 31 December 20.11. The revaluation surplus will be realised when the related assets are sold or derecognised.

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2.

Equipment Baltons Ltd depreciates equipment at 20% per annum according to the straight-line method apportioned for part of a year. The SARS allows a section 12C deduction in terms of the Income Tax Act of 40% in the first year of use and 20% per year for three years thereafter. The 12C deduction is not apportioned for part of a year. You may assume that the 12C deduction for 20.11 is R151 000 and that the tax base was R453 600 on 31 December 20.10. The depreciation has been calculated and is included in cost of sales. During the year ended 31 December 20.11, the accountant discovered that manufacturing equipment amounting to R200 000, which was acquired on 1 July 20.10, was incorrectly recorded as other operating expenses. The SARS indicated that the 20.10 assessment will be re-opened regarding this matter. No accounting entries have been processed by the accountant with regard to this matter.

3.

Allowance account for credit losses The allowance account for credit losses on 31 December 20.10 was R75 000. The movement in the allowance account is included in other operating expenses. The SARS allows 25% of the allowance account for credit losses as a deduction for tax purposes.

4.

Taxation No provision has been made as yet for income tax for the year ended 31 December 20.11. The tax rate changed during the current financial year from 29% to 28%. It is probable that the company will generate taxable profits in the future. The SARS accepts the accounting treatment of all the above transactions in all respects, except if the contrary is specifically mentioned. The details of the tax payable account in the general ledger are as follows: R (Dr) Cr 1 151 000 (1 172 000) (21 000)

Provision for tax for 20.10 Payment of 20.10 assessment including R10 000 interest

The interest paid to the SARS is not deductible for tax purposes. Deferred taxation You may assume that the balance on the deferred tax account as at 31 December 20.10 is correct, except for the tax effect of the incorrect recording noted in point 2. The deferred tax balance on 31 December 20.10 represents only taxable temporary differences on property, plant and equipment which are all taxable at the normal income tax rate. 5. Dividends paid A dividend of R200 000 was paid on 30 November 2011.

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REQUIRED

YOU HAVE 1 HOUR TO ANSWER THIS PAPER

Marks (a) Prepare the following note to the financial statements of Baltons Ltd for the year ended 31 December 20.11: (i) (b) Prior period error 7

Prepare the statement of changes in equity for Baltons Ltd for the year ended 31 December 20.11. Note: Comparatives and the total column are NOT required. Deferred tax should be calculated using the statement of financial position method. Ignore Value Added Tax (VAT) and Dividend Tax.

20

(c)

Prepare all the journal entries with regard to taxation for Baltons Ltd for the year ended 31 December 20.11 in terms of IAS 12 Income tax. Journal narrations are not required.

Your answers must comply with International Financial Reporting Standards.

(Source: FAC4861 Test 1 (2012))

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QUESTION 5 - Suggested solution (a) BALTONS LTD NOTES FOR THE YEAR ENDED 31 DECEMBER 20.11 2.Prior period error Equipment was incorrectly recorded as other expenses in the 20.10 financial year. The effect of the correction of the error on the 20.10 results is as follows: 20.10 R Increase in cost of sales (200 000 x 20% x 6/12) Decrease in other operating expenses Increase in tax expense (180 000 x 29%) Increase in profit Increase in equipment (200 000 - (200 000 x 20% x 6/12) Increase in deferred tax liability ((180 000 - 120 000) x 29%) [C3] Increase in tax payable ((200 000 - 80 000) x 29%) Increase in equity Increase in earnings per share (127 800 / 1 000 000) (20 000) 200 000 (52 200) 127 800 180 000 (17 400) (34 800) 127 800 R0,13 Total marks Maximum (1) (1) (1)

(1)

(1) (1) (1)

(1) (8) (7)

(b)

BALTONS LTD STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.11 Revaluation surplus R

Share capital R Balance at 1 January 20.11 Prior period error Restated balance Total comprehensive income for the year - Profit for the year [C1] Dividends Balance at 31 December 20.11

Retained earnings R

Total R

1 000 000 1 000 000

610 000 610 000

2 186 000 127 800 2 313 800 4 276 210 (200 000)

3 796 000 (1) 127 800 (1) 3 923 800 4 276 210 (200 000) 8 000 010 Total marks Maximum (18) ()

1 000 000

610 000

6 390 010

(21) (20)

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(c)

BALTONS LTD JOURNAL ENTRIES Dr R Cr R

Other expenses (P/L) 10 000 () Other payables: SARS (SFP) 10 000 Expensing of interest on SARS account Income tax expense (P/L) 1 765 275 (1) Other payables: SARS (SFP) 1 765 275 Raise provision for current tax payable (1 754 275 + 11 000) Deferred tax (SFP) 129 498 (1) Income tax expense (P/L) 129 498 Movement in deferred tax balance (125 519 + 3 979) Communication skills: Presentation and layout Total marks CALCULATIONS C1. Profit for the year Revenue Cost of sales Correction of error depreciation Finance costs Interest on SARS account Dividends received Other operating expenses Profit before tax Income tax expense [C2] C2. Income tax expense Profit before tax [C1] Non-taxable/non-deductible items: Dividends received Interest on SARS account Movement in temporary differences (deductible) (397 931 + 50 350) [C3] Taxable profit Tax @ 28% Underprovision for prior year (21 000 10 000) Movement in deferred tax (deductible) [C3] Change in tax rate [C3] 5 911 987 (105 000) 10 000 448 281 6 265 268 1 754 275 11 000 (125 519) (3 979) 1 635 777 22 000 000 (11 723 013) (40 000) (180 000) (10 000) 105 000 (4 240 000) 5 911 987 (1 635 777) 4 276 210

(1)

(2)

(2) () (6)

[] [] [] [] [1] [] [] [14] [18]

[] [] [] [1]

[] [1] [9] [1] [14]

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C3. Movement in deferred tax Carrying amount Tax base Temporary difference Deferred tax (Dr)/Cr 29% 98 000 17 400 115 400 (3 979) 111 421 28% 56 952 (60 550) (10 500) (14 098) (125 519) [10] C4. Equipment Accounting Cost on 31 December 20.11 (given) Tax base - 31 Dec 20.10 (given) Accumulated depreciation - 31 December 20.11 (given) S 12C deduction 20.11 (given) Prior period error Cost price Depreciation 20,10 (200 000 x 20% x 6/12) Tax deduction 20.10 (200 000 x 40%) Depreciation 20.11 (200 000 x 20%) Tax deduction 20.11 (200 000 x 20%)
1 2

31 December 20.10 Deferred tax liability (given) Equipment (correction of error) (part (a)) Subtotal Change in tax rate (115 400 x 1/29) Deferred tax liability 31 December 20.11 Equipment [C4] Factory building (4 850 000 3 210 000) Allowance for credit losses (given) Deferred tax asset Movement in deferred tax (deductible)

? 180 000

? 120 000

337 931 60 000 397 931 397 931

[1] [2] [1]

586 000 1 640 000 (50 000)

382 600 1 856 250


1

203 400 (216 250) (37 500) (50 350) (448 281)

[3] [2] [1]

(12 500)

Tax 453 600

756 000 (310 000) (151 000) 200 000 (20 000) (40 000) 586 000 (40 000) 382 600 200 000 (80 000)

4 125 000 (4 125 000 x 5% x 11 years) = 1 856 250 50 000 (50 000 x 75%) = 12 500

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