Question Tag: Tax Effects

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  • 20 Marks

CR – May 2015 – L3 – Q4 – Accounting Policies, Changes in Accounting Estimates, and Errors (IAS 8)

Discuss implications of changes in accounting policy for intangible assets and demonstrate retrospective application in financial statements.

LIKELY EFFECT LIMITED

Likely Effect Limited has shown a sincere intention to be IFRS compliant. Among a number of events and transactions, there is the need to change the accounting policies of the company in trying to comply with a few other standards. As the Consultant of the company, your attention was drawn to the fact that prior to 2013, the company had capitalized training costs.

According to IAS 38, training cost is regarded as an internally generated intangible asset and cannot be capitalized. Therefore, there is the need for a change of accounting policy which must be applied retrospectively.

The training costs capitalized in 2012 was N6m while the total for periods before 2012 was N12m.
Training costs incurred in 2013 is N4.5m. Retained earnings were N600m and N649m at the beginning and end of 2012 respectively. The corporate income tax rate is 30% for the relevant periods. Additional information available is given below:

2013 (N’M) 2012 (N’M)
Income tax expense 24 21
Profit after tax 56 49
Share capital 50 50

Required:

(a) Advise the directors on the implication of the change in accounting standard relating to treatment of intangible assets and tax effect on the company. (5 Marks)

(b) Prepare statements of profit or loss and other comprehensive income and changes in equity showing a retrospective application of the change in policy. (7 Marks)

(c) Analyze the effects of the change in accounting policy on periods before 2013. (8 Marks)

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  • 30 Marks

FM – May 2016 – L3 – Q1 – Investment Appraisal Techniques

Calculation of Adjusted Present Value (APV) for a proposed project and analysis of its application in investment appraisal.

Katam Pie has adopted a strategy of diversification into many different industries in order to reduce risk for the company’s shareholders. This has resulted in frequent changes in the company’s gearing level and widely fluctuating risks of individual investments. Presently, the company has a target debt-to-asset ratio i.e., D/(E + D) of 25%, an equity beta of 2.25, and a pre-tax cost of debt of 5%.

On January 1, 2016, Katam Plc with a year-end of December 31, is considering the purchase of a new machine costing N750million, which would enable it to diversify into a new line of business. The new business will generate sales of N522.50million in the first year, growing at 4.5% p.a. A constant contribution margin ratio of 40% can be expected throughout the 15-year life of the project. Incremental fixed cash costs will be N84.32million in the first year, growing by 5.4% p.a.

A regional development bank has offered a 10-year loan of 3% interest to finance 40% of the cost of the machine. The balance of 60% will be financed equally by a 10-year commercial loan (with annual interest of 5%) and a fresh round of equity. The issue cost on the commercial loan will be 1%, and the new equity will incur an issue cost of 3%. All issue costs are on the gross amount raised for the respective capital. Issue costs on debt are allowed for tax purposes.

A firm that is already in the business of the new project has a gearing ratio of 20% (debt to asset) and a cost of equity of 18.1%. Its corporate debt is risk-free.

The tax rate is 30% payable in the year the profit is made. Tax depreciation of 20% on cost is available on the new machine. Katam Pie has a weighted average cost of capital of 14% and a cost of equity of 17.5%. The risk-free rate is 4%, and the market risk premium is 7%.

You are required to:

  1. Estimate the Adjusted Present Value (APV) and advise whether the project should be accepted? (21 Marks)
  2. Explain:
    i. The circumstances under which the use of APV is appropriate. (5 Marks)
    ii. The major advantages and limitations of the use of the APV method. (4 Marks)

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  • 20 Marks

CR – May 2015 – L3 – Q4 – Accounting Policies, Changes in Accounting Estimates, and Errors (IAS 8)

Discuss implications of changes in accounting policy for intangible assets and demonstrate retrospective application in financial statements.

LIKELY EFFECT LIMITED

Likely Effect Limited has shown a sincere intention to be IFRS compliant. Among a number of events and transactions, there is the need to change the accounting policies of the company in trying to comply with a few other standards. As the Consultant of the company, your attention was drawn to the fact that prior to 2013, the company had capitalized training costs.

According to IAS 38, training cost is regarded as an internally generated intangible asset and cannot be capitalized. Therefore, there is the need for a change of accounting policy which must be applied retrospectively.

The training costs capitalized in 2012 was N6m while the total for periods before 2012 was N12m.
Training costs incurred in 2013 is N4.5m. Retained earnings were N600m and N649m at the beginning and end of 2012 respectively. The corporate income tax rate is 30% for the relevant periods. Additional information available is given below:

2013 (N’M) 2012 (N’M)
Income tax expense 24 21
Profit after tax 56 49
Share capital 50 50

Required:

(a) Advise the directors on the implication of the change in accounting standard relating to treatment of intangible assets and tax effect on the company. (5 Marks)

(b) Prepare statements of profit or loss and other comprehensive income and changes in equity showing a retrospective application of the change in policy. (7 Marks)

(c) Analyze the effects of the change in accounting policy on periods before 2013. (8 Marks)

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  • 30 Marks

FM – May 2016 – L3 – Q1 – Investment Appraisal Techniques

Calculation of Adjusted Present Value (APV) for a proposed project and analysis of its application in investment appraisal.

Katam Pie has adopted a strategy of diversification into many different industries in order to reduce risk for the company’s shareholders. This has resulted in frequent changes in the company’s gearing level and widely fluctuating risks of individual investments. Presently, the company has a target debt-to-asset ratio i.e., D/(E + D) of 25%, an equity beta of 2.25, and a pre-tax cost of debt of 5%.

On January 1, 2016, Katam Plc with a year-end of December 31, is considering the purchase of a new machine costing N750million, which would enable it to diversify into a new line of business. The new business will generate sales of N522.50million in the first year, growing at 4.5% p.a. A constant contribution margin ratio of 40% can be expected throughout the 15-year life of the project. Incremental fixed cash costs will be N84.32million in the first year, growing by 5.4% p.a.

A regional development bank has offered a 10-year loan of 3% interest to finance 40% of the cost of the machine. The balance of 60% will be financed equally by a 10-year commercial loan (with annual interest of 5%) and a fresh round of equity. The issue cost on the commercial loan will be 1%, and the new equity will incur an issue cost of 3%. All issue costs are on the gross amount raised for the respective capital. Issue costs on debt are allowed for tax purposes.

A firm that is already in the business of the new project has a gearing ratio of 20% (debt to asset) and a cost of equity of 18.1%. Its corporate debt is risk-free.

The tax rate is 30% payable in the year the profit is made. Tax depreciation of 20% on cost is available on the new machine. Katam Pie has a weighted average cost of capital of 14% and a cost of equity of 17.5%. The risk-free rate is 4%, and the market risk premium is 7%.

You are required to:

  1. Estimate the Adjusted Present Value (APV) and advise whether the project should be accepted? (21 Marks)
  2. Explain:
    i. The circumstances under which the use of APV is appropriate. (5 Marks)
    ii. The major advantages and limitations of the use of the APV method. (4 Marks)

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