Income Taxes (Reading 37)

So far, this is the worst chapter I've seen. The text is poorly written. Seems to me that the authors just lift the text from the technical specification wholesale.



Deferred tax Assets - Is like the company overpaying income tax which it expects a future refund (or a reduction in tax) provided there is future profit to remain taxable.



Deferred tax liability - Is like the company underpaying the income tax which it expects to pay back in later period provided there is future profit to remain taxable.



In the Income Statement: Income tax expense (based on accounting profit) = net increase in deferred tax liablity + tax payable (which is the amount that is going to be paid in cash to the authority)



Tax Base of an Asset = The amount that will be deductible for tax purposes in future periods as the economic benefits become realized. "Deductible" means able to reduce tax payable.



==>I still cannot mechanically understand how to determine the Tax Base of an Asset :(



Tax Base of a Liability = Carrying amount - any amount that will be tax deductible in future.

If the liability is a prepaid revenue, tax base of liability = carrying amount - the revenue that will not be taxable in future.

Completed Inventories (Reading 35)

This was another horrible chapter. The concepts are not difficult to grasp but the chapter was poorly written. Instead of giving a systematic explanation and formulae, it gave many examples instead. With so many figures in the example, it tends to cloud the underlying concepts. I have to make my own summary by extracting from the examples given. This was not a good chapter to read.

By end of this week, I've to complete 3 chapters. It looks to me that it is impossible. I spent one full day on Inventories itself.

Converting a financial statement from LIFO to FIFO

Adjustment for Inventory value in balance sheet:
Inventory (FIFO) = Inventory(LIFO) + LIFO Reserve
Total Assets (FIFO) = Total Asset (LIFO) + LIFO Reserve

Adjustment for Cost of Goods Sold in Income Statement:
Y2006 Cost of Goods Sold (FIFO) = Y2006 Cost of Goods Sold (LIFO) - (Y2006 LIFO Reserve - Y2005 LIFO Reserve)

Call this deltaReserve = (Y2006 LIFO Reserve - Y2005 LIFO Reserve)

Adjustment to Net Income:
Net Income (FIFO) = Net Income (LIFO) + deltaReserve * (1 - tax rate)

Estimated Cumulative tax savings under LIFO vs FIFO:
Cumulative Gross Profit Saved
= Cumulative Gross Profit (FIFO) - Cumulative Gross Profit (LIFO)
= LIFO Reserve

Cumulative tax saved under LIFO = LIFO Reserve * tax rate (assuming constant tax rate in previous years)

Adjustment to Tax Deferred Liability:
Increased in (Debt) tax deferred liability (FIFO) = LIFO Reserve * tax rate

Adjustment to retained earnings:
Increase in retained earnings (FIFO) = LIFO Reserve * ( 1 - tax rate)

LIFO and FIFO ratios:
Inventory turnover ratio (FIFO) = Cost of Goods Sold (FIFO) / Inventory (FIFO)

Number of days of inventory (FIFO) = 365 / Inventory turnover ratio (LIFO)

Gross Profit Margin (FIFO) = Gross Profit / Revenue = (Revenue - Gost of Goods Sold (FIFO) ) / Revenue

Current Ratio (FIFO) = Current Assets / Current Liability = Total Assets (FIFO) / (Total Liability (LIFO) + Increased in (Debt) tax deferred liability (FIFO))

Return On Assets (FIFO) = Net Income / Total Asset = Net Income (FIFO)/Total Assets (FIFO)

Debt To Equity (FIFO)
= Total Liability / Shareholders' Equity
= (Total Liability (LIFO) + Increased in (Debt) tax deferred liability (FIFO)) / (Equity (LIFO) + Increase in retained earnings (FIFO))

Understanding Cash Flow Statements

The Reading 34 turns out to be one of the greatest torture I have to go through. I took more than one and a half week on it. Partly because I had to work and hence could not have a continous study time of straight six hours but partly because the topic turns out to be deadly difficult. What is so difficult about cash flow right? Goodness, you cannnot imagine how accountants have invented horrible things probably just to make sure they keep their jobs! The Net Income to Operational Cash Flow reconciliation turns out to be non-trival. Familiarisation of accurals are extremely important. Determining how much cash the firm receives from sale of an equipment just examining the Income and Balance Sheet was not easy. But there are some standard formulaes that must be committed to the brain. Since my mind is fresh I'll type it here because I am sure these will become alien to me once again a few months down the road when I make my revisions:

Reconcile Net income to Operation Cash Flow:
Start:
+Net Income
- Depreciation Expense (because depreciation is recognised as an expense but there is no outflow of cash)
- Change in Accounts Receivable (because a positive change receivable means revenue but cash has yet to be collected from the customer)
+Change in Accounts Payable (because a positive change payable means expense was recognised but firm has yet to pay cash to suppliers)
- Change in Inventory (a positive change in inventory means cash is been paid to suppliers yet no expense is recognised)
= Cash Flow Due to Operations

Calculating Cash Received from sale of equipment:
First Step: Calculate Historical Cost of equipment sold -

Begin Equipment Historical Cost
+Equipment Purchase during the year
- Ending Equipment Historical Cost
= Historical Cost of equipment sold

Second Step: Calculate depreciation value of equipment sold -

Begin Accumulated depreciation
+Depreciation expense for the year
-ending Accumulated depreciation
= depreciation value of equipment sold

Third Step: Calculate cash received from equipment sold-
Book Cost of equipement sold = Historical Cost of equipment sold -depreciation value of equipment sold
Plus Gain (loss)
= cash received from equipment sold

Calculating cash paid to suppliers, customers, employees, and "other operating expenses", income taxes must be commtited to the brain cells.

Starts FSA-8 tonight

Tonight i'll start on the Study Session 8 of Financial Reporting and Analysis.

So far I am OK with FSA although I am running a little bit behind time. It looks to me that all the hype from the prep providers which have been saying how difficult FSA is isn't that true. In fact, reading the text really give a firm foundation in FSA.

Moved on to FSA

I have already started reading the financial reporting and analysis. Preliminarily, the text are quite easy. The explanations in the text are good enough. Previously I attended a free sample lecture on FSA from Stalla. After reading the text, it seems that the lectures were not relevant at all. It was taught too fast and the lecture spent too much time on debit and credit. In the text, debit and credit are considered optional reading! In fact, the text managed to explain the concepts of double entry accounting without even teaching the T-accounts. After reading Reading 30, I could do basic double entry accounting without figuring out the debits and the credits. I could also answer most of the questions at the end of the Reading. I think I made the right decision that it is not necessary to spent many on those prep-course. Phew!