Page 19 - CIMA OCS August 2018 Day 2 Suggested Solutions

SUGGESTED SOLUTIONS

EXERCISE THREE (TAXATION)

To: Fred Thomas
From: Finance Assistant
Date: Today
Subject: Information Required

Hello Fred.
Thank you for your email. I hope that the following information may be of some use to you in your
meeting.
Accounting Depreciation.

When non-current assets are purchased by the business then initial cost is capitalised on the balance
sheet under the rules set out by IAS 16 Property, plant and equipment. This allows that rather than
the full cost of the asset being recognised in the year that it was purchased, the cost should be spread
over the useful economic life of the asset. This amount that is written off against the profit in each
year is known as depreciation.

Depreciation is calculated by firstly making estimates of how long the business will use the asset and
what the asset would be worth at the end of its life, and then IAS 16 allows for the following two
alternative treatments of depreciation.

• Straight Line Depreciation.

This is where the initial cost less the scrap proceeds are divided by the number of years of
economic life to arrive at the annual depreciation charge. This results in the same amount of
depreciation to be charged to the statement of profit and loss each year.

• Reducing Balance Depreciation

This is where the carrying amount of the asset is reduced by the same percentage each year
which results in a higher charge to the statement of profit and loss in the earlier years of
ownership and a smaller amount in the later years.

Problems of accounting depreciation for tax purposes.

If two separate businesses bought an identical asset but made different estimates about the useful
life and residual value and/or used the different approaches to calculating depreciation, then the two
businesses would calculate very different accounting profits, and therefore would pay very different
amounts of tax. For this reason tax authorities do not allow accounting depreciation to be used when
calculating taxable profits, and instead a more standardised system must be adopted in the form of
tax depreciation.

Tax depreciation.
In order that all businesses account for depreciation in the same way, Deeland’s tax regime has
specified that the use of a 25% reducing balance basis for plant and machinery (including vehicles
used for business purposes) in order to calculate the tax written down value (TWDV).
When the asset is first acquired the TWDV would be the same as the initial investment and this is
reduced by 25% and this 25% is charged to the taxable profits. This requires no estimate of economic
life or future sale proceeds.

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