To pass SBR you not only need to have the technical knowledge but you also need to be able to apply and explain that knowledge in the exam in such a way that earns you the marks! Let’s dissect and understand how you would earn marks at SBR by looking at this question.
The Question
Q Explain to an investor the deferred tax implications of an impairment loss. The impairment loss has arisen after the asset has been put to an alternative use. (4 marks)
My thoughts
My thoughts on planning this answer. It covers two accounting issues. Impairment & deferred tax. Assume two marks each. First you might start with a general explanation of the terms, starting with impairment. Ensure though that the answer relates to the stakeholder’s perspective and is not a regurgitation of facts but is applied. Investors are very interested in the impact of accounting treatments on both profit and cash flow. Plan to use headings. Always write in small paragraphs as it helps the marker give you marks. My answer below applies these points. It gets four out of four. Don’t you agree?
Answer
Impairment loss
Impairment losses are recognised when the carrying value of an asset exceeds the amount that can be recovered from the asset either by selling it or using it. Because the asset is being put to an alternative use then the recoverable amount will be the present value of the future cash flows expected from the asset.
Assuming the asset has not been revalued then the loss will be charged to profit and reduce earnings. There is no immediate cash out flow associated with impairment losses; rather it signals less cash inflows in the future.
Deferred tax
Deferred tax is provided for on all year end temporary differences between the carrying value of an asset and it’s tax base. In this case the carrying value of the asset has been reduced by the impairment loss; but as this is a non-cash expense no immediate tax relief will be given and thus the tax base of the asset remains.
Impairment losses give rise to deductible temporary differences and therefore deferred tax assets. The corresponding entry is to acknowledge a tax credit that reduces the tax expense. This results in an impairment loss reducing post tax earnings.