Page 17 - CIMA MCS Workbook August 2018 - Day 2 Suggested Solution

SUGGESTED SOLUTIONS

EXERCISE THREE (TAXATION)

To: Bertrand Durrand
From: Finance Assistant
Date: Today
Subject: Information Required

Hello Bertrand
Thank you for your email. I hope that the following information may be of some use as you prepare
for your meeting.
Accounting Depreciation.

When non-current assets are purchased by the business the initial cost is capitalised in the statement
of financial position in accordance with the accounting requirements of IAS 16 Property, plant and
equipment (IAS 16). In addition, IAS 16 requires that the capitalised cost of property, plant and
equipment is written off over its expected useful life to the business, which results in an annual
expense included in the statement of profit and loss. This process is referred to as accounting for
depreciation.
Depreciation is calculated by making and estimate of how long the business will use the asset and
what the asset may be worth at the end of its useful life to GymFIT. The two most common methods
of calculating the annual depreciation charge are as follows:

• Straight-line method

This is calculated based upon the initial cost of the asset less its estimated residual value to
GymFIT, to arrive at the depreciable amount. The depreciable amount is then divided by the
number of years that GymFIT expects to use the asset in the business to arrive at the annual
depreciation charge. This will result in the same annual depreciation charge for the asset in the
statement of profit and loss each year.

• Reducing balance method

This is calculated based upon applying a fixed percentage to the carrying amount (cost less
accumulated depreciation to date) of the asset annually. Consequently, the annual depreciation
charge for an asset calculated on this basis will reduce year by year.

Problems of accounting depreciation for tax purposes.
It can be appreciated that the calculation of the annual depreciation charge requires the exercise of
judgement and making assumptions and estimates: it is not a precise science.
Consider the situation If two businesses purchased an identical asset for use in their business. Each
business may make different assumptions and judgements regarding how many years it may be used
in the business, along with their estimate of residual value at the end of its useful life. Each business
may also choose a different method of calculating the annual depreciation charge: straight-line or
reducing balance.
Even if all other factors were identical between the two businesses, there would be a different annual
depreciation charge in the statement of profit or loss, leading to a different profit before tax and also
a different carrying amount for the asset in the statement of financial position.

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