ACCT 20002 Intermediate Financial Accounting LECTURE 1 INTRODUCTION EXAMPLES OF ACCOUNTING STANDARD RECORDING Example Artwork of sentimental value Photographs of sentimental value Obsolete plant now retired from use Café s panoramic view of coast to attract customer Employees Receipt of shares as a gift Assets/Liability definition assets definition (no future economic benefit) assets definition (no control) Assets/liability recognition Income/Expense definition and recognition Donation of $10 000 assets definition assets recognition income Gold discovery assets definition assets recognition income Expenditure of developing a new line of chemical-free cosmetics Guarantee employee s loan Court order Sued for negligence assets definition liability definition liability definition liability definition assets recognition (fails possibility if not yet possible to predict whether the project will prove to be commercially relevant) liability recognition (fails possibility if employee unlikely to default on loan) liability recognition (if likely to default on loan) liability recognition (fails measured reliably if don t know how much the repair work will cost) liability recognition (if know a minimum amount have to pay) liability recognition (fails possibility if likely win the case) liability recognition (if likely loss the case) expense expense
LECTURE 4 ACCOUNTING FOR INCOME TAX Tax payable approach no longer used, coz it ignores the difference between accounting profit and taxable profit Balance sheet approach - Income Tax Payable based on taxable profit (assessable income minus deductible expense) - Income Tax Expense based on accounting profit (profit or loss before deducting tax expense) - account for difference of carrying amount in B/S Current tax & deferred tax For tax purpose, current tax payable is current tax liability only For Accounting purpose, to be consistent with revenue & expense recognition principle, need to recognize both from current year transaction: 1. Current tax consequence 2. Future tax consequence Temporary difference: Timing differences between recognition of assessable items as revenue (vice versa) and deductible items as expenses (vice versa), they will reconcile / offset over time - Recognition of assessable income & allowance deduction: on cash flow basis - Recognition of accounting revenue/expense: on accrual basis Goodwill impairment Rationale, these differences must be considered in order to ensure the usefulness of the information provide in financial statement Accounting GAAP (Expense/Revenue) Acquired goodwill recognized as an asset, never amortised, but impairment loss recognised as an expense Income Tax Act (Deductible/Taxable) No tax deduction for an impairment loss of goodwill Entertainment outlays Expense Not deductible Fines and penalties Expense Not deductible Royalty Revenue Revenue Not taxable Accrued expense Recognised as asset and expense Recognised as a tax deduction when paid (provision for expense) Prepaid expense Initially an asset and subsequently Recognised as a tax deduction when paid expensed when used Interest receivable Recognised as asset and expense Recognised as a taxable revenue when received Unearned revenue (Revenue received in advance) Initially a liability and subsequently revenue when earned Recognised as a taxable revenue when received Depreciation Acct estimated depn expense Tax deprecation deduction Bad and doubtful debts Allowance for doubtful debts Written off as bad debts Tax losses Not recognised Offset against future taxable income DTL vs DTA: DTL: if future taxable benefits exist [Taxable TD], you need to pay more tax in the future, it s a bad thing. => DTL DTA: if obligations will be settled [Deductible TD], you need to pay less tax in the future, it s a good thing. => DTA Deprecation: if accounting estimates on depreciation > tax rate, acct excessive deprecation ; added in current tax worksheet if accounting estimates on depreciation < tax rate, acct short deprecation ; deducted in current tax worksheet Permanent differences: Treatment of a transaction by tax legislation (ITAA provisions) and accounting standards (the Conceptual Framework) of one can never be recognised by another Accounting profit Taxable income Revenue (income) may NEVER be Assessable income (e.g. capital gains on pre-1985 investments, some foreign income) Expense may NEVER be Allowable deduction (e.g. entertainment, goodwill impairment) Tax incentives (deduction, exemption from tax liabilities) (e.g. deduction allowed for 125% of expenditure on certain R&D)
LECTURE 4.1 CURRENT TAX CURRENT TAX WORKSHEET Accounting Profit (or loss) + assessable amount differs from revenue + expense differs from deductible amount + expense not deductible for tax revenue differs from assessable amount deductible amount differs from expense revenue not assessable Less tax losses from previous periods = Taxable Income Current tax @ 30% Less installments paid Current tax payable Record current tax payable Income Tax Expense (ITE) Income Tax Payable (ITP / Current tax liability) LECTURE 4.2 DEFERRED TAX #Step 1: Determine CA #Step 2: Determine TAX BASE (TB) Tax base (TB) of an asset or liability is the amount attributed to that asset or liability for tax purpose Economic benefits (EB) are taxable if the future cash inflow is a result of recognition of revenue. Deductible amount (DA) represents the amount deductible for tax purpose in the future For an asset If the economic benefits (EB) are taxable: Tax Base (TB) = deductible amount (DA) for tax purposes If the economic benefits (EB) are not taxable: Tax Base (TB) = carrying amount (CA) of asset (*Note before allowance of doubtful debts) For a liability For all liabilities other than revenue received in advance: Tax Base (TB) = carrying amount (CA) deductible amount (DA) For revenue received in advance: Tax Base (TB) = carrying amount (CA) revenue received in advance (non-taxable revenue). TAX BASE OF ASSETS Asset EB Taxable? CA DA TB (= CA) DTA DTL Cash/investment Not taxable CA 0 CA Account Receivables CA 0 CA Not taxable (Allowance for DD) (allow for DD) 0 0 CA < TB Loan receivables Not taxable CA CA Asset EB Taxable? CA DA TB (= DA) Inventories Taxable LCNRV Cost Cost may CA < TB Research cost Taxable Cost Cost Interest receivable Taxable CA 0 0 CA > TB Accrued revenue Taxable CA 0 0 CA > TB Prepaid expense Taxable CA 0 0 CA > TB PPE (non-revalued) Or intangible asset Taxable CA on acq. (acct dep n) CA on acq. (tax dep n) CA on acq. (tax dep n) If CA < TB If CA > TB PPE (revalued) Taxable Revalued CA CA before reval CA before reval If CA < TB If CA > TB TAX BASE OF LIABILITIES Liability CA DA TB (CA less DA) DTA DTL Accrued expense (e.g. wages) Pyt of CA Pyt of CA Nill CA > TB (Provisions) Account payable CA Nill CA Loans payable (Borrowings) CA Nill CA Accrued penalties CA Nill CA Liability CA Non-taxable revenue TB (CA less nontaxable revenue) Revenue received in advance Earned CA Earned CA Nill CA > TB
#Step 3: Determine Temporary Differences (TD) Definition: TD are difference between the CA of an asset or liability in the balance sheet and its TB DTA: Deferred Tax Asset - are the amounts of income taxes recoverable in future periods in respect of: a) the deductible TD; b) the carry forward of unused tax losses; c) the carry forward of unused tac credits - arise from deductible TD - DTA = total deductible TD x 30% - The future benefit of a DTA: o Tax deduction with no expense in a future period i.e. future deductible pty of accrued expense o Non-assessable revenue recognised in a future period i.e. future recognition of unearned revenue DTL: Deferred Tax Liability - are the amounts of income taxes payable in future periods in respect of: taxable TD - arise from taxable TD - DTL = total taxable TD x 30% - The present obligation of a DTL: o Expense with no tax deduction in a future period i.e. future allocation of prepaid expense o Assessable income with no revenue recognised in future period i.e. future receipt of accrued revenue DTD: Deductible Temporary Difference means that the entity is paying HIGHER TAX now (TAXABLE PROFIT > ACCOUNTING PROFIT), hence creates a deferred tax asset (DTA), in the future will pay less and get deduction. When: CA of an asset in B/S < Tax base Receivables net of doubtful debts Inventory net of an LCNRV write-down NCA due to accelerated depreciation CA of a liability in B/S > Tax base Accrued expense Unearned revenue TTD: Taxable Temporary Difference means that the entity is paying LOWER TAX now (TAXABLE PROFIT < ACCOUNTING PROFIT), hence it creates a deferred tax liability (DTL), in the future will pay more and taxable. When: CA of an asset in B/S > Tax base Prepaid expense Accrued revenue NCA due to decelerated depreciation CA of a liability in B/S < Tax base Complex financial instruments (no examples addressed in IFA2) TEMPORARY DIFFERENCE CA TB TD Acct receivable 50,000 50,000 Allowance for DD (1,000) 0 49,000 50,000 1,000 => Deductible TD, DTA Accrued interest revenue (A) 4,000 0 4,000 => Taxable TD, DTL Prepaid insurance (A) 8,000 0 8,000 => Taxable TD, DTL Equipment 240,000 240,000 Accumulated Dep n (30,000) (24,000) 210,000 216,000 6,000 => Deductible TD, DTA Buildings 200,000 200,000 Accumulated Dep n (5,000) (8,000) 195,000 192,000 3,000 => Taxable TD, DTL Land (after revaluation) 350,000 300,000 50,000 => Taxable TD, DTL Accrued wages (L) 11,000 0 11,000 => Deductible TD, DTA Unearned revenue (L) 2,000 0 2,000 => Deductible TD, DTA
Temporary difference matrix CA > Tax base CA < Tax base Assets Taxable TD (DTL) Deductible TD (DTA) Liabilities Deductible TD (DTA) Taxable TD (DTL) (not in IFA2) DEFERRED TAX WORK SHEET CA TB Deductible TD Taxable TD Relevant Assets CA < TB CA > TB Relevant Liability CA > TB CA < TB TDs Total DTDs Total TTDs Deferred taxes @ 30% [It s the amount adjusted to] DTDs at end (= Total DTDs x 30%) Previous balance TTDs at start TTDs at start Deferred tax adjustment DR DTA 11,000 [It s the amount adjusted by] CR ITE 11,000 #Step 4: Determine the Closing Entry of Deferred Tax #Step 5: Determine the movement in DTA and DTL accounts #Step 6: Determine the Deferred Tax Adjustment entry TTDs at end (= Total TTDs x 30%) DR ITE 22,000 CR DTL 22,000 Income Tax Expense (ITE) the aggregate amount in respect of both current tax and deferred tax Income Tax Expense (ITE) = Income Tax Payable (Current tax liability) + DTL DTA The journal entries adjust the deferred tax balances from what they were at the previous reporting date to the balance we require them at the current reporting date. On the reporting date: Adjustment for current tax ITE Income Tax Payable Adjustment for in DTAs from previous year DTA in A offset against ITE ITE (the adjustment amount is subject to prior DTA balance) Adjustment for in DTLs from previous year ITE (OCI or P/L) DTL in L offset against ITE (the adjustment amount is subject to prior DTL balance) Closing entry (2) P&L ITE
LECTURE 7 CONSOLIDATION I LECTURE 7.3 CONSOLIDATION PROCEDURE Wholly-owned equity: Controlling interest = 100% - Even if owned 100% shares, still treated as indirect acquisition - The parent => do the consolidated journal entry, but it s owned by group, neither parent nor subsidiary The parent/subsidiary => do it s own general journal entry (1) #STEP 1: Combine like items of assets, liabilities, equity, income, expenses and cash flows of the parent with those of subsidiaries => Consolidation worksheet (2) #Step 2: Offset (eliminate) the CA of the P s investment in S and the P s portion equity of S => Consolidation Journal => then post to Consolidation Worksheet Note: intragroup losses may indicate an impairment Date acquired Date of consolidation PRE-acquisition: equity that exists AT DATE of acquisition, need to eliminate: Share capital Net profit Reserves - Why eliminate the assets and liabilities of the subsidary? P records shares acquired in S as an asset the Investment in S of P at $150. This asset represents the actual net assets of S; that is, the ownership of the shares gives P the right to all the assets and liabilities of S. To include both the asset Investment in S of P and the assets and liabilities of S in the CFS would double count the assets and liabilities of the subsidiary. On consolidation, the investment account is therefore eliminated. - Why eliminate the equity of the subsidairy? P has equity of $300, which represents P s net assets including the Investment in S of P at $150. And the investment in S represents the actual net assets (equity) of S. That means, the equity of P effectively includes the equity of S. To include both equity of P and S in the CFS would double count the pre-acquisition equity of the subsidairy. On consolidation, the equity of the subsidiary at acquisition date is therefore eliminated. Acquisition analysis: POST-acquisition: movement in reserves AFTER acquisition = parent s reserves + subsidiary s postacquisitoin reserves = GROUP RESERVES Fair value of net identifiable assets and liabilities of S (FV at acquisition date not reporting date) = $170,000 + $140,000 (Total Equity) + ($170,000 $150,000)(1 30%) (BCVR land) + ($330,000 $310,000)(1 30%) (BCVR equipment) + ($80,000 $75,000)(1 30%) (BCVR inventories) + $20,000(1 30%) (BCVR patent) $15,000(1 30%) (BCVR contigent liability) Consideration transferred = 100,000 shares x $5 (FV) (Investment in S) Goodwill = Consideration FVNA = $500,000 $475,000 = $25,000
BCVR entry: Business Combination Valuation Entry (is a equity account) To record any unrecorded equity of the subsidary Purpose is to make consolidation adjustments so that the subsidisry s assets are reported at fair value (not at cost, because FV provides the most relevant information to users) Note, the only asset not measured at FV is goodwill. Pre-Acquisition entry: To eliminate investment in subsidairy out of group account (prevent double account of asset) To eliminate the pre-acquisition entry at consolidation out of group account (prevent double count of equity) Recognise goodwill and gain on bargin of purchase Goodwill => reocgnised in pre-acquisition entry Gain on bargin purchase => recognised in the pre-acquisition entry => at the first reporting date, as part of the Consolidated Profit & Loss => in subsequent period, the gain is included in RE opening BCVR entry FV increment Land Land DTL @30% BCRV (to recognise land at FV) Inventory Inventory DTL @30% BCRV (to recognise inventory at FV) Patent Patent DTL @30% BCRV (to recognise patent at FV) Contingent liability BCVR DTA @30% Contingent liability (to recognise contingent liability) (3) #Step 3: Elimination in full intragroup transactions => Consolidation Journal => then post to Consolidation Worksheet Pre-acquisition entry At the acquisition date (then repeat every reporting date) In the accounts of parent Investment in S 200m 200m Share capital Reserves (incl. BCVR) RE (1/7/16) Goodwill Investment in S (To eliminate the investment in S) Share capital Reserves (BCVR) RE (1/7/16) Gain on bargain purchase Investment in S (to eliminate the investment in S) Share capital Reserves (BCVR) RE (1/7/17) Investment in S (at subsequent reporting, gain is included in RE opening) Why eliminate all transactions b/w parties within the group? - Consolidated income statement (&CFS) show the result derived from operations (& CF activities) with parties external to the group. Consolidated balance sheet show the total assets controlled by the group and the total liabilities owed to parties outside of the group Issues about intra-group dividends 1. The declaration of dividends 2. The payment of dividends Interim dividends may be declared and distributed in the same period Final dividends may be declared before reporting date but not distributed until the following period 3. The recognition of dividends received Recognised when the s/h s right to receive payment is established Intra-group dividends and tax effects - Dividends received by parent constitute AI but tax free due to imputation credits attached to dividends - Dividends paid by subsidiary appropriations are from after-tax profits and are not tax deductible - So, no tax effects to consider in the consolidation process
Case 1: Intra-Group Dividends #Case 1.1: Dividends declared and paid in the same period Interim Div In the accounts of the P Dividend Revenue In the accounts of the S Dividend paid (RE) Dividend Revenue Dividend paid (RE) #Case 1.2: Dividends declared but not paid Final Div In the accounts of the P Dividend receivable Dividend Revenue In the accounts of the S Dividend declared (RE) Dividend payable Dividend Revenue Dividend declared (RE) Dividend payable (the amount unpaid) Dividend receivable Case 2: Other Intra-Group Services (Management Fees; Rent Services) In the accounts of the P / Account receivable Mgt Fees Revenue In the accounts of the S Mgt Fees Expense / A/c payable Management Fees Revenue Management Fees Expense Accounts payable (outstanding amount) Account receivable Case 3: Intra-Group Borrowings #Case 3.1: Intra-Group Loans In the accounts of the L Loan Receivables In the accounts of the B Loan payables #Case 3.2: Intra-Group interests In the accounts of the L In the accounts of the B / Accrued interest Interest Expense Revenue / Accrued Interest Revenue interest Expense Loan payables (from L) Loan receivables (to B) Interest Revenue Interest Expense Accrued Interest Expense (outstanding amount) Accrued Interest Revenue Case 4: Goodwill Adjustment (not an intra-group transaction) At the acquisition date At the first reporting date (30/6/18) In subsequent period (30/6/19) Goodwill In pre-acquisition entry Goodwill (impairment) Impairment loss Accu. impairment loss (to recognise goodwill impairment) Goodwill (impairment) RE (1/7/18) Accu. impairment loss (to recognise goodwill impairment)
CONSOLIDATION WORKSHEET AS AT 30 JUNE 2016 PARENT SUB DR Ref CR GROUP Gross profit Service revenue Dividend revenue Interest revenue Selling expense = PARENT + SUB DR + CR Admin expense General expense Goodwill impair exp PBIT SUM SUM SUM Borrowing costs ITE = PARENT + SUB DR + CR Net Profit SUM SUM Net Profit = PBIT + Borrowing costs + ITE RE O/B Div declared = PARENT + SUB DR + CR RE C/B SUM SUM RE C/B = Net profit + RE O/B + Div declared Share capital Reserves Payables & Accruals DTL Loans = PARENT + SUB DR + CR SUM SUM Total Equity (inclu. RE C/B) + Total Liability Receivables DTA PPE (at CA) Other NCA (loans) Investment in S Goodwill Accum. impairment = PARENT + SUB + DR CR SUM SUM Total Asset