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Special Items in Accounting

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Special Items in Accounting


Dheeraj Vaidya
Corporate Bridge Academy
dheerajvaidya@corporatebridge.net
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Special Items in Accounting

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Inventory Valuation Methods

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Methods of Inventory Accounting

Special Items in Accounting

First-In First-Out (FIFO)




This method assumes that the first units purchased are the first units sold

The cost of most recent purchases is assigned to ending inventory

Last-In First-Out (LIFO)




The LIFO inventory costing method assumes that the last units purchased are the first to be sold

The costs of beginning inventory and earlier purchases go to ending inventory

Weighted average costing




This method assumes that the units are sold without regard to the order in which they are purchased

Instead, it computes COGS and ending inventories as a simple weighted average

Example
Summary Inventory Records
Inventory on January 1st, 2006
Inventory purchased in 2006
Cost of goods available for sale in 2006
Inventory sold in 2006

No. of units
600
200
800

$/unit
100
150

Total cost
60,000
30,000
90,000

550

250

137,500

Calculate gross profit for the following methods of inventory valuation


a) FIFO
b) LIFO
c) Weighted Average Costing
Also show the Balance sheet and Income Statement Flow

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Methods of Inventory Accounting




FIFO:

Special Items in Accounting

Calculation of gross profit

FIFO
Sales
COGS (550 @ $100)
Gross Profit


137,500
(55,000)
82,500

Balance Sheet Effect


Assets

Liability

Shareholders Equity
$55,000 flows
through the Income
Statement as expense

$55,000
cost of goods sold

Inventory cost as on January 1st,


2006 is taken

LIFO:


Calculation of gross profit

LIFO
Sales
COGS (200 units @ $150)
COGS (350 units @ $100)
Gross Profit


Last purchased inventory taken first


and the remaining from the
beginning of the year inventory

137,500
(30,000)
(35,000)
72,500

Balance Sheet Effect


Assets
$65,000
cost of goods sold

Liability

Shareholders Equity
$65,000 flows
through the Income
Statement as expense

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Methods of Inventory Accounting




Weighted Average Cost

Special Items in Accounting

Calculation of Weighted average cost

Total cost
Total units
Average cost


90,000
800
112.5

Calculation of gross profit

Weighted Average cost


Sales
COGS (550 @ $112.5)
Gross Profit


Balance Sheet Effect


Assets

Liability

Shareholders Equity
$61,875 flows
through the Income
Statement as expense

$61,875
cost of goods sold

Weighted average cost taken as per


calculation above

137,500
(61,875)
75,625

Summary
Summary
FIFO Costing
LIFO Costing
Average Costing

COGS
55,000
65,000
61,875

Ending Inventory
35,000
25,000
28,125

Private and Confidential Not for Circulation

FIFO: 200*150+50*100 = $35,000


LIFO: =250*100 = $25,000
Average Costing: = 112.5 * 250 = $28,125

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Financial Statement Effects




In an environment of Stable Prices

Special Items in Accounting

All three inventory valuation methods (FIFO, LIFO and Weighted Average costs) will yield the same
results for Inventory, COGS and Earnings

In an environment of Rising Prices and Increasing or Stable Inventory


Item

LIFO

FIFO

COGS

Higher

Lower
Higher as inventory reflects the most
recently purchased items

Ending Inventory
and Working Capital

Lower as inventory reflects the prices


of items purchased at lower prices

Net Worth

Lower because earnings and inventory


is lower

Higher because earnings and inventory


is higher

Lower Taxes

Higher Taxes

Lower because COGS is higher

Higher because COGS is lower

Same

Same

Higher because of lower tax outgo

Lower because of higher tax outgo

Taxes

Earnings

Pre-tax Cash Flows

After-tax Cash flows

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Analytical adjustments

Special Items in Accounting

Profitability


LIFO produces higher COGS balances and are better measure of true economic costs

In an environment of rising prices, LIFO produces income that are lower than FIFO

Gross margins and profit margins are lower due to lower income under LIFO

For FIFO firms, profitability ratios should be recalculated using estimates of what COGS would
have been under FIFO

Liquidity


FIFO produces inventory figures that are higher and are a better measure of economic value

LIFO, however, uses prices that are outdated (in an environment of rising prices)

Liquidity ratios such as current ratios are higher under FIFO than in LIFO

For LIFO firms, Liquidity ratios should be recalculated using inventory balances that have been
restated using LIFO reserve
Assets
LIFO Reserve

Liability
LIFO Reserve
x Tax Rate

Shareholders Equity
LIFO Reserve
x (1-Tax Rate)

Solvency


Solvency ratio like debt ratio, debt-to-equity ratio will be lower under FIFO because of higher denominator

For firms that use LIFO, ratios should be calculated using asset and equity figures restated by
using LIFO reserve

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Special Items in Accounting

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Change in depreciation policy

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Change in Depreciation Policy

Special Items in Accounting

Depreciation Policies


Straight Line Depreciation Method

Sum-of-years digit Method

Double declining method

Written Down value method

Effect of Changes in Depreciation Methods




Impact on Cash Flows




NO IMPACT?

Impact on Earnings


Firm that chooses an accelerated method of depreciation instead of using straight-line will tend to have
greater depreciation expense and lower net income

Will continue if the firm is investing in new assets that the lower depreciation on old asset is more than
offset by the higher depreciation on new assets

Impact on Operating Performance




ROE?

Retained Earnings?

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Special Items in Accounting

Impact of Change in Depreciation Policy

Depreciaton Expense
Net Income
Assets
Equity
Return on Assets
Return on Equity
Turnover Ratios
Cash Flows


Straight Line
Lower
Higher
Higher
Higher
Higher
Higher
Lower
Same

Accelerated (WDV)
Higher
Lower
Lower
Lower
Lower
Lower
Higher
Same

Change in depreciation policy of Jet Airways from WDV to SLM




Wrote back Rs9.2bn into its P&L, which helped the company to report profits during the quarter

It also helped Jet to report higher net worth, which will help in keeping reported gearing low

TCS, the software major, increased its depreciation policy on computers from 2 years to 4
years. As a result, 1QFY09 PBT was higher by an estimated Rs500m (c.4% of net profit in
1QFY09).

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Special Items in Accounting

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Operating and Financial leases

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Introduction to Leases

Special Items in Accounting

Leases


Contractual agreement between the lessor (owner of asset) and the lessee (rents the asset)

Gives the lessee the right to use specific property

Specifies the duration of the lease and rental payments

Obligations for taxes, insurance, and maintenance may be assumed by the lessor or the lessee

Who are the concerned parties?




Lessee: Transportation (Trucks, Aircrafts), Real Estate (Building), Construction Agriculture

Lessors: Captive Leasing companies, Banks and other Independents

Rationale for leases


Financial

Operational

Leasing ready-to-use equipment can be more


attractive if the asset requires lengthy preparation
and set-up

Leases may not require any money down and may


be a less costly means of financing

Leasing avoids having to own the asset that will be


required only seasonally, temporarily or
sporadically (leasing contract can be tailored)

Lease payments can be tailored to suit the lessees


cash flows (up to 100% financing, instead of 80%
limit by banks)

Leasing for short periods protects against


obsolescence

Leases may contain less restrictive covenants than


other types of lending arrangements

Disadvantages of leases?
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Lessees Perspective: Capital Leases vs. Operating Leases

Special Items in Accounting

Operating Leases


Leases that do not transfer substantially all the benefits and risks of ownership are operating leases

Lessee rents the property

Lessee accrues rent expense

Capital lease


Capitalize a lease that transfers substantially all of the benefits and risks of property ownership, provided
the lease is non-cancelable

Lessee economically owns the property

Lessee records the leased asset in the balance sheet (i.e. capitalizes the asset) and reflects the
corresponding lease obligation

Leases that do not meet any of the four criteria are accounted for an Operating
Lease


Test1: Transfer of ownership

Test 2: Bargain purchase option?

Test 3: Lease term > = 75% of economic life ?

Test 4: Present value of payments >= 90% Fair Market Value?

Yes

Capital Lease

No

Operating Lease

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Lessees Perspective: Classification of Leases

Special Items in Accounting

Example : Lessees Perspective: Classification of Leases


An equipment with a market price of (FMV) of US$100,000 and useful life of 5 years is leased
to a lessee for a period of 4 years. The lease payments are US$26,000 a year. The borrowing
rate for the firm is 8%, and the rate implicit in the lease is 7%. There is no provision for
Lessee to purchase asset at the end of the lease term, nor any bargain purchase option.

Test 1
Does the lease transfer ownership of the property to the lessee by the end of the
non-cancellable lease term?
Answer

No

Test 2
Does the lease contain an option to purchase the leased property at a bargain price?
Cost to purchase asset at end of lease
Estimated asset value at end of lease

na
na

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Lessees Perspective: Classification of Leases

Special Items in Accounting

Test 3
Is the lease term greater than or equal to 75% of the estimated economic life of the
leased property?
Estimated useful life (years)
75% of estimated useful life
Non-cancellable Lease term (years)
Difference

5.0
3.8
4.0
-0.25

Difference is negative
implies capital Lease

Test 4
Does the present value of rental and other minimum lease payments, excluding that portion
of the payments representing executory cost, equal or exceed 90 percent of the fair value
of the leased property?
Value of leased asset
90% of value of leased asset (at lease inception)
"Present Value" of lease
Difference

$100,000
$90,000
$88,067
$1,933

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If difference is negative,
then Capital Lease

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Lessees Perspective: Operating Lease Accounting

Special Items in Accounting

Operating Lease ( At inception)

Assets

Shareholders Equity

Shareholders Equity

No Entry

No Entry

Liability

Operating Lease ( as payments are made)


Assets

Liability

Cash reduced by
periodic lease
payments

Flows through Income


statement as rent
expense

Effect on Cash Flows




Total lease payment reduces cash flow from operations

Operating leases do not affect the lessees liabilities and hence, are referred to as off-balance
sheet financing

Footnote disclosure of lease payment for each of the next five years is required

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Lessees Perspective: Capital Lease Accounting




Capital Lease ( at inception)

Special Items in Accounting

Assets

Present value of
minimum lease
payment

Liability

Shareholders Equity

Shareholders Equity

Present value of
minimum lease
payment

Capital Lease ( as payments are made)


Assets

a)

Cash reduced by
periodic lease
payments

Liability

Lease obligation is
reduced by periodic
lease payment LESS
Interest payment

Flows through Income


statement as Interest
expense and
Depreciation expense

b) Leased property is
reduced by
depreciation
amount

Interest expense = Discount rate times the Lease liability at the beginning of the period

Depreciation Period calculations

If lease transfers ownership, depreciate asset over the economic life of the asset.

If lease does not transfer ownership, depreciate over the term of the lease.

Effect on Cash Flows




Only portion of the lease payment that is considered interest payment reduces CFO

Part of the lease payment considered payment on principal reduces CFF


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Lessees Perspective: Example

Special Items in Accounting

Example (continued) : Operating lease and Capital Lease


An equipment with a market price of (FMV) of US$100,000 and useful life of 5 years is leased
to a lessee for a period of 4 years. The lease payments are US$26,000 a year. The borrowing
rate for the firm is 8%, and the rate implicit in the lease is 7%. There is no provision for Lessee
to purchase asset at the end of the lease term, nor any bargain purchase option

Operating Lease
If we assume that the lease is an Operating Lease
a) Balance Sheet: No Impact
b) Income Statement Effect: Lease payments of $26,000 treated as expense
c) Cash Flow: Lease payment of $26,000 treated as outflow for Cash flow from operations

Capital Lease
In the earlier illustration, the lease was a capital Lease
Balance Sheet at Inception
a) Present value at 7% is $88,067
b) Both Asset and Liability increases by the present value of lease payments at inception
Assets

US$88,097

Liability

Shareholders Equity

US$88,097

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Lessees Perspective: Accounting




Capital Lease: Balance Sheet Effect (as payments are made)


=

Special Items in Accounting

Assets

a)

Cash reduced by
periodic lease
payments of
US$26,000

Liability

Lease obligation is
reduced by periodic
lease payment
US$26,000 LESS
US$6,165

Shareholders Equity
Flows through Income
statement as Interest
expense of US$6,165
and Depreciation
expense of US$22,017

b) Leased property is
reduced by
depreciation
amount of
US$22,017

Capitalized lease calculations

Year
0
1
2
3
4

(a)
Beginning
Leasehold
Value
$88,067
$68,232
$47,008
$24,299

(b)
Interest
Expense (a) X
7%
$6,165
$4,776
$3,291
$1,701

(c)
Lease
payment

$26,000
$26,000
$26,000
$26,000

(d)
Ending
(e)
(f)
Leasehold value Depreciation Book Value
(a+b-c)
Expense
of Assets
$88,067
$88,067
$68,232
$22,017
$66,051
$47,008
$22,017
$44,034
$24,299
$22,017
$22,017
$0
$22,017
$0

Note: a) The book value of assets decline each year by the depreciation amount as shown in column (f)
b) Depreciation (term of 4 years) = $88,067/4 = $22,017
c) Principal repayments equals the lease payments LESS interest expense
d) The asset (column f) is being depreciated at a rate that is different from the rate of amortization for
the liability (column d), the two values are equal only at the inception and termination of the lease

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Comparison of Operating and Capital Leases




Income Statement Effect

Year
1
2
3
4

Capital Lease

Operating Expense =
Total Expense
$26,000
$26,000
$26,000
$26,000

Operating Expense
$22,017
$22,017
$22,017
$22,017

Non-operating
expense
$6,165
$4,776
$3,291
$1,701

Total Expense
$28,181
$26,793
$25,307
$23,718

Income Statement Effect


Income Statement Effects
$29

 Operating income is higher for capital lease


(This is because depreciation expense for capital lease
is lower than the lease payments)
 Net income is lower in early years for capital lease

Operating
lease

$28

Expense ('000 $)

Special Items in Accounting

Operating Lease

$27
$26
$25
$24

Capital lease

$23
$22
$21
1

Years

Cash Flow Effect


Operating Lease
Year
1
2
3
4

Cash flow from


operations
($26,000)
($26,000)
($26,000)
($26,000)

Capital Lease
Cash flow from
operations
($6,165)
($4,776)
($3,291)
($1,701)

Cash flow from


financing
($19,835)
($21,224)
($22,709)
($24,299)

 In operating lease, the total cash payment reduces


cash flow from operations
 In capital lease, the part of lease payment considered
payment on principal reduces cash flow from financing
activities
 Total CF is unaffected by the accounting treatment

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Lessees Perspective: Ratio Effects




Effect on Financial Statements

Special Items in Accounting

Financial Statement

Capital Lease

Operating Lease

Assets

Higher

Lower

Liabilities

Higher

Lower

Net Income (in early years)

Lower

Higher

Cash flow from operations

Higher

Lower

Cash flow from financing

Lower

Higher

Total Cash Flow

Same

Same

Effect on Ratios
Financial Statement

Capital Lease

Operating Lease

Current ratio

Lower

Higher

Working Capital

Lower

Higher

Asset Turnover

Lower

Higher

Return on assets

Lower

Higher

Return on equity

Lower

Higher

Debt/Equity

Higher

Lower

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Special Items in Accounting

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Capitalization vs Expensing

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Capitalization versus expensing

Special Items in Accounting

Capitalize


Means show the cost as an asset on the balance sheet

These assets have future benefits

Expense


Benefits are immediate

Or future benefits are too uncertain or immaterial

Costs flow through the financial statements

Cost incurred

Capitalization

Expensing

Income
Statement

Balance Sheet

Net Income
(Depreciation or
Amortization
Expense)

CFI Outflow

Net Income
(Expense)

CFO outflow

Management discretion in exercising these choices can significantly impact the financial
statements and the ratios

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WorldCom Case

Special Items in Accounting

Most infamous example of inflating earnings through improper capitalization of


expenses

Transaction

$3.8bn 2001-02
expenditure on
line costs

Regulators?

What was
required as per
GAAP

What WorldCom
did?

Accounting
Treatment

$3.8bn must be
treated as
operating
expense

WorldCom
capitalized the
costs

Financial
Statement
Effects

Pre-tax Income
should be
deducted by
$3.8bn

$3.8bn was
capitalized and
put on the
balance sheet
(for
amortization)

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WorldCom declared
bankruptcy in July 2002.
Chief accounting and
finance executives charged
with securities fraud

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Financial Statement Effects

Special Items in Accounting

Income Statement Effects


Income Statement

Expensing

Capitalizing

Income Variability

Greater variability

Smoothening effect on net


income from year to year

Less matching of revenues and


costs

Cost deferred and matched with


revenues

Profitability (Early years)

Lower as all expenses flow


through the IS

Higher as cost is amortized

Profitability (Later years)

Higher as all cost has been


expensed

Lower due to amortization of


capitalized cost

Expensing

Capitalizing

Asset and Liability

Lower

Higher

Leverage Ratios (debt/equity,


debt/asset)

Higher

Lower due to higher base

Book Value/Share

Lower

Higher

Expensing

Capitalizing

Cash Flow from Operations

Lower

Higher

Cash Flow from Investing

Higher

Lower

Same

Same

Matching of revenues

Balance Sheet Effects


Balance Sheet

Cash flow effects


Cash Flow

Total Cash Flows

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Special Items in Accounting

Capitalization of interest


Capitalized interest is the interest incurred during the construction of long-lived assets.

Capitalized interest is included as the initial cost of the asset on the balance sheet instead of
being charged off as interest expense on the income statement

Qualifying assets for capitalized interest

They must require a period of time to make them ready for use

Assets under construction for use in operations

Discrete assets intended for sale or lease

What is the Capitalization period?




Capitalization period begins when

Expenditures for the asset have been made

Activities for readying the asset are in progress

Interest costs are being incurred

Capitalization period ends when

Asset is substantially complete and ready for its intended use

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Special Items in Accounting

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Intangibles Assets

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Special Items in Accounting

Intangibles Capitalized or Expensed




Patents

Goodwill

Advertisements

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Intangibles Capitalized or Expensed

Special Items in Accounting

Accounting for Research and Development




Future benefits from R&D expenditures is highly uncertain at the start of a project

SFAS 2 requires virtually all R&D expenditures to be expensed as incurred

Principle of conservatism is applied in case of R&D

However, when one firm buys another firm, the total purchase price must be apportioned
among the individual assets acquired
Immediately written off

$5,000

$4,000

In-process
R&D (no future
alternative)

$600

In-process R&D with


almost certain future

$400

Tangible Assets

Purchase price

SFAS 2 requires that a portion of purchase price be allocated to in-process R&D and be
immediately written off

Managers have a strong incentive to allocate a large portion of the purchase price to
purchased in-process R&D

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Intangibles Capitalized or Expensed

Special Items in Accounting

Accounting for Software Development Costs




More liberal for accounting internal expenditures for software development

Software development cost is a major costs for many small, growth service companies and
thats their main asset

This prompted FASB to be more liberal while formulating SFAS 86


Expensed as
incurred

Capitalized and
amortized

Technologically feasible

Research
expenditures

Development
expenditures

Before

After

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Special Items in Accounting

Intangibles Example
Example: Intangibles
An enterprise is developing a new production process. During the year 2001, expenditure incurred
was Rs. 10 lakhs, of which Rs. 9 lakhs was incurred before 1 December 2001 and 1 lakh was incurred
between 1 December 2001 and 31 December 2001. The enterprise is able to demonstrate that, at
1 December 2001, the production process met the criteria for recognition as an intangible asset.
The recoverable amount of the know-how embodied in the process (including future cash outflows
to complete the process before it is available for use) is estimated to be Rs. 5 lakhs.


How much is recognized as intangible assets

How much is recognized is expensed

During the year 2002, expenditure incurred is Rs. 20 lakhs. At the end of 2002, the recoverable
amount of the know-how embodied in the process (including future cash outflows to complete
the process before it is available for use) is estimated to be Rs. 19 lakhs.


How much is recognized as intangible assets?

What is the impairment?

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Intangibles: Capitalize/ Expense

Special Items in Accounting

Intangible Asset
Research and development

Treatment as per US GAAP


Expensed as incurred

Patents and copyrights

Costs incurred in development are expensed but if a patent or


copyright is purchased then the cost is capitalized

Franchise and license costs

Capitalized by the purchasing firm

Brands and trademarks

Capitalized by the purchasing firm

Advertising costs

Expensed as incurred

Goodwill

May be recognized and capitalized only in purchase transactions.


Under US GAAP goodwill is subject to an impairment test

Computer software &


development costs

All costs incurred in feasibility studies are expensed but subsequent


development costs of an established product can be capitalized

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Special Items in Accounting

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Deferred Tax

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Introduction to accounting for Income taxes

Special Items in Accounting

Difference between Financial & tax reporting

Indian GAAP

Income Tax Act

Generally accepted accounting


principles is a set of rules for
preparing financial statements

Internal Revenue Services


Code sets rules for preparing
tax returns

Pretax Financial Income

Taxable Income

Income Tax Expense

Income Taxes Payable

Income tax expense from GAAP and income tax payable from Income Tax Act do not equal

When income and expense are treated differently on financial statements than it is on the
companys tax returns results in Deferred tax asset or Deferred tax liabilities

Purpose of accounting for income tax




Recognize deferred tax liability or deferred tax asset for the tax consequences of amounts that will
become taxable or deductible in future years as a result of transactions or events that already have
occurred

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Special Items in Accounting

Temporary differences


Difference between the tax basis of an asset or liability and its reported (carrying or book)
amount in the financial statements that will result in taxable amounts or deductible amounts
in future years

Deferred Tax Liability


Accounting
Income >
Taxable Income

Future Taxable
Amounts

Deferred Tax
Liability

Accelerated depreciation on tax return (straight line on income statement)

Installment sales of property (installment method for taxes)

Unrealized gain from recording investments at fair value (taxable when asset is sold)

Deferred Tax Asset


Accounting
Income <
Taxable Income

Future
Deductible
Amounts

Deferred Tax
Asset

Rent or subscriptions collected in advance

Warranty expenses are accrued on income statement (tax deductible only when warranty claims are paid)

Deferred compensation cost is recognized as it is earned (tax deductible only when payments are made)

Asset impairment

Post retirement benefit expenses

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Deferred tax Illustration Temporary Difference

Special Items in Accounting

Example 1: Deferred tax calculations


Toy & Co. purchases an asset each year for three years. Asset 1 in the first year, Asset 2 in the second year and
Asset 3 in the third year. The cost of each of these assets is US$10,000, with no salvage value and 4 years life.
Double declining balance method is used on tax returns and straight line for financial statements
Calculate the Deferred tax liability from Year 1 to Year 4.
Tax return calculations (DDB)
Asset 1
Asset 2
Asset 3
Total DDB depreciation

Year 1
5,000
5,000

Year 2
2,500
5,000
7,500

Year 3
1,250
2,500
5,000
8,750

Year 4
1,250
1,250
2,500
5,000

Income Statement (straight line)


Asset 1
Asset 2
Asset 3
Total SL depreciation

Year 1
2,500
2,500

Year 2
2,500
2,500
5,000

Year 3
2,500
2,500
2,500
7,500

Year 4
2,500
2,500
2,500
7,500

Cumulative Deferred Tax Liability


Deferred liability @ 30% tax rate
Cumulative Deferred liability

Year 1
750
750

Year 2
750
1,500

Year 3
375
1,875

Year 4
-750
1,125

Year 1: (5,000 2,500) * (30%) = 750


Year 2: (7,500 5,000) * (30%) = 750
Year 3: (8,750 7,500) * (30%) = 375
Year 4: (5,000 7,500) * (30%) = -750

Temporary difference
reverses from Year 4

If there is no reversal of deferred liability, the cumulative deferred liability will continue to
increase as long as the firm continues to grow

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Permanent differences

Special Items in Accounting

Permanent differences


Results mainly from revenues or expenses that affect pretax income or taxable income, but not both

No deferred liability or assets are created as these differences are permanent

Common sources of permanent difference

Tax-exempt interest received from US municipal bond obligations

Premium on life insurance policies where the company is beneficiary (not deductible for tax purposes)

Allowable tax credits

Goodwill amortization (under IAS)

As these differences are never deferred but are considered decreases or increases in the effective tax
rate

If the only difference between taxable and pretax incomes were a permanent difference, then tax expense
would be simply tax payable

Illustration: Permanent difference


Preliminary Income
Tax-exempt interest income
Premiums paid on life insurance
Pretax Income / Taxable Income
Preliminary tax liability (40%)
Less eligible tax credits
Tax expense / tax liability
Effective tax rate/ Statutory tax rate

Income Statement
80,000
20,000
-5,000
95,000
NA
NA
28,000
29.5%

Tax Return
80,000
80,000
32,000
-4,000
28,000
40.0%

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No deferred liability or
assets are created

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Deferred Taxes

Special Items in Accounting

Study of BSE-100 companies

Source of Deferred Tax


Depreciation
Fiscal allowances on fixed assets
Interest Accrued
Lease Adjustments
Deferred Revenues
Others

Companies
78 companies
HUL, ITC & M&M
Canara Bank, Allahbad Bank
SBI, MRPL, HDFC
ONGC
Others

% of total
94.75%
2.15%
0.67%
0.58%
0.44%
1.41%

Source: Chartered Accountant Journal, July 2006

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Special Items in Accounting

Analysts note on Deferred Taxes




The analyst should consider the firms growth rate and capital spending levels when
determining whether the difference will actually reverse

Impairment generally result in creation of Deferred tax assets since the write-down of assets
is recognized immediately for financial reporting, but not for tax purpose until the asset is
sold

Restructuring also leads to creation of Deferred tax assets since for financial reporting
purpose the costs are recognized immediately when restructuring is complete, but not
expensed for tax purpose until actually paid

Deferred tax liability or assets is expected to reverse




Valued for accounting purpose at its undiscounted value

Deferred tax liability or assets is NOT expected to reverse




The difference should be treated as Equity

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Special Items in Accounting

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Contingent Liabilities

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Special Items in Accounting

Contingent Liability


Contingent liabilities represent potential expenses for a company where the outcome is
dependent upon one of more future events

If it is probable the liability will crystallize then the full amount must be accrued in the
financial statements

However, if payment is less than probably (usually interpreted to be a probability of less than
50%) then no entry is made in the balance sheet; although a contingency is disclosed in the
notes to the accounts

Common contingencies include loan guarantees, product warranties and legal claims

Do Nothing
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