Semester 2 Week 2 PP (Long term liabilities and Taxation) Flashcards
Langlands has taken out a loan of £500,000. Every year they pay £100,000 capital plus interest.
Is this a current or non-current liability?
It’s both!
The loan has a current element (the amount we’ll pay in the next year), and a non-current element (the remainder which will be paid in more than one year).
We therefore would have to split the loan up.
Kashgar has taken out a loan of £1,000,000 on 1 January 20X1 repayable over five years. Each year they will pay interest of 4% of the original balance plus the principal. Payments are made on 31 December each year.
Calculate the current and non-current liability as at 31 December 20X1.
NB: As the only return is the interest (there are no bonuses etc.) effective interest = nominal interest.
Opening balance = £1,000,000
Annual payment (capital) = 1,000,000/5 = £200,000
Annual payment (interest) = 4% x 1,000,000 = £40,000
Balance at end year 1 = 1,000,000 + 40,000 – 240,000 = £800,000.
So total liability at end year 1 = £800,000.
We next have to look one year ahead in the future.
Yr 2
Opening balance = £800,000
Annual payment (interest) = 4% x 1,000,000 = £40,000
Balance at end year 2 = 800,000 + 40,000 – 240,000 = £600,000.
So total liability at end year 2 = £600,000.
Therefore at the end of year 1 £800,000 in total is outstanding.
£600,000 of this is still outstanding at the end of year 2, therefore this is a non-current liability at the end of year 1 (i.e. it will not get paid within the next year).
As a total of £800,000 is outstanding at the end of year 1 and £600,000 is a non current liability the remaining £200,000 (£800,000 - £600,000) is a current liability (it will get paid over the next year).
What are the journals for tax?
Tax paid in the year:
Dr P/L tax charge
Cr Bank
Being tax paid in year
Tax due but not paid will be recorded as
Dr P/L tax charge
Cr Tax creditor/payable
Being tax due
Larger companies pay tax in 4 instalments paid in month 7, 10, 13 and 16 of the company’s year (i.e. not the calendar year)
Example: Sweetman Plc is a large company with a June year end. For the year ended 30 June 2022 it will pay the instalments in…
January 2022 (Month 7)
April 2022 (Month 10)
July 2022 (Month 13)
October 2022 (Month 16)
When paying in 4 instalments, 2 will therefore be paid in the current year, 2 will be paid in the next year.
As 2 instalments relate to the current year but will be paid next year there will be an accrual/payable at the end of the year.
Crestly Plc. has a 31 March year end and an estimated tax charge of £3,000,000.
The first two corporate tax payments were paid on time and have been correctly recorded by the accountant. No other entries for taxation have been made.
Prepare any adjustment required at the year end and state the amount in the P/L for taxation and on the statement of financial position.
Total tax due = £3,000,000
Therefore each payment is £3,000,000/4 = £750,000
Two payments made (and recorded), two payments still due.
So paid = £750,000 x 2 = £1,500,000
Still due = 2 x £750,000 = £1,500,000
Dr P/L Tax 1,500,000
Cr Tax payable 1,500,000
Being tax accrual
So the tax charge in the P&L will be £3,000,000 (the full amount), and there will be a tax payable of £1,500,000
Nairn Ltd. has a December year end. During the year the accountant estimated a total tax charge of £2,500,000 and the instalments were based on this. The instalments were paid on time and were recorded correctly.
At the year end the accountant estimates that the actual tax charge will be £2,000,000.
Prepare the journals to correctly account for this.
Original estimate = £2,500,000/4 = £625,000
So 2 x £625,000 = £1,250,000 has been paid.
If £2,000,000 in total is due then £2,000,000 - £1,250,000 = £750,000 is still due.
Dr P/L tax charge 750,000
Cr Tax accrual 750,000
Being year end tax payable
Coll Ltd. has a 30 June year end. At 30 June 20X4 the tax charge for the year was estimated to be £1,800,000. Accordingly a tax payable of £900,000 was recognised at the year end.
A payment of £450,000 was made in July 20X4 but by October 20X4 when the final payment was due the tax charge was estimated at £2,000,000.
Prepare the journal to account for this final.
As £900,000 was in creditors at the end of the prior year and £450,000 has been paid in this year £900,000 - £450,000 = £450,000 remains in creditors.
£450,000 x 3 = £1,350,000 has been paid therefore £2,000,000 - £1,350,000 = £650,000 is still due
Dr Tax creditor 450,000
Dr P/L tax 200,000
Cr Bank 650,000
Being final payment for 20X4
Note that the under-provision goes through the P&L in the 20X5 year end.
Tiree Ltd. has a December year end. At 31 December 20X2 the tax charge for the year was estimated at £3,000,000.
Accordingly at 31 December 20X2 a tax creditor of £1,500,000 was recognised.
A payment of £750,000 was made in January 20X3 but by April 20X3 when the final payment was made the tax charge was estimated at £2,700,000.
Prepare the journal for the payment in April 20X3.
As £1,500,000 was in creditors at the end of the prior year and £750,000 has been paid in this year £1,500,000 - £750,000 = £750,000 remains in creditors.
£750,000 x 3 = £2,250,000 has been paid therefore only £2,700,000 - £2,250,000 = £450,000 is still due although £750,000 is in creditors
Dr Tax creditor 750,000
Cr P/L tax 300,000
Cr Bank 450,000
Being final payment for 20X2
Note that the over-provision goes through the P&L in the 20X3 year end.
What happens when you make a tax loss?
Broadly speaking if a company makes a loss it can do two things.
1. Offset the loss against previously paid tax (and get a refund).
2. Carry the loss forward against future profits (will look at later).
If a company can carry a loss back and get a refund the journal would be as follows:
Dr tax debtor
Cr P/L tax charge
Being tax refund
A company should only prepare this journal if they are confident they will receive the refund.
Blackbird Plc. bought a building a number of years ago for £800,000.
In the year to 31 December 20X6 the building was revalued to £1,200,000.
The current tax rate is 20%.
For tax purposes the tax due on the sale of the building would be 20% x (sale proceeds – original cost).
So at the year end Blackbird has a gain of £400,000 (£1,200,000 - £800,000) recognised in the financial statements.
There is, however, no tax currently due as the building still remains owned by the company, it has been revalued not sold.
Does this mean we can just ignore the tax impact?
Therefore is thus building was sold at its carrying value, tax of 20% x (£1,200,000 - £800,000) = £80,000 would be due.
What is deferred tax?
There is no tax currently due therefore no tax charge to be recognised.
BUT
If we just ignored the tax this would not give a true and fair view.
Deferred tax solves this problem, it recognises the future tax consequences of transactions entered into at the year end date.
In simple terms deferred tax aims to give us a better indication of the real position a business is in.
Essentially it’s saying if the company was to sell all its assets at carrying value at the year end date, and settle all its liabilities at carrying value how much more (or less) tax would be due.
Claymore Ltd. has a general bad debt provision of £50,000 at 31 December 20X5. The tax rate is 20%.
What does this mean?
As the general bad debt provision is not allowable for tax it will have had no impact on taxable profits.
At some point in the future, however, specific customers will not pay and will need to be written off - this is allowable for tax.
Therefore if this was settled at the year end date Claymore would have £50,000 less of taxable profits and therefore pay £50,000 x 20% = £10,000 less tax.
This leads to a deferred tax asset of £10,000.
How do we recognise deferred tax assets?
A deferred tax asset means that you would pay less tax if the item settled – what does this require?
That you’re paying tax in the first place!
Therefore we should only recognise deferred assets if we are confident that there will be profits in the future to offset them against.
This is particularly the case where there are deferred tax assets arising from losses. If the company is currently loss making why are we confident that they will make profits in the future?
What are the causes of deferred tax?
In real life there are theoretically many things that can give rise to temporary differences and therefore deferred tax. The most common, however, are:
1. Accelerated Capital Allowances: The difference that arises from non-current assets being depreciated for accounting purposes but receiving capital allowances for taxation purposes.
2. Revaluation of assets.
3. General bad debt provisions.
4. Pension assets and liabilities.
Deferred tax only occurs where there is a difference between accounting and tax treatment which will/can cause future tax consequences.
There would not be deferred tax if there is no difference in treatment between accounting or tax treatment or if there is a permanent difference.
Can you offset deferred tax assets and liabilities?
It is possible to offset deferred tax assets and liabilities providing they are:
1, Levied by the same tax authority.
2. Could be offset if the tax charge crystallised (i.e. became ‘real’ tax due for payment.
