Dee For has recently qualified as a pilot and is now intending to set up a private company in the near future to run small charter passenger flights from her home town. Most of her business plan has been written but she has recently learned that the company’s forecast statement of comprehensive income and statement of financial position may be incorrect as she has not taken into account the likely impact of deferred tax on those financial statements. She has therefore asked you for help and, following a meeting, the following facts come to light:
(i) The aircraft would cost $1m. It would have a life of five years after which, it would have no residual value and will then be scrapped. Depreciation will be on a straight-line basis.
(ii) The government of the country in which she lives has recently introduced a scheme for new entrepreneurs which provides a tax allowance on capital expenditure of this type of 25% per annum using the reducing balance method. In this country, depreciation is not a deductible expense for tax purposes. Also in this country, a balancing adjustment is allowed whenever the asset is sold or scrapped. (iii) Corporate income tax is currently set at 30%. It has remained unchanged for many years now and the government has indicated there are no plans to change it.
(iv) The company’s forecast annual accounting profit before tax is $2m per annum over the next five years.
(a) Demonstrate the impact of the above on the company’s forecast statements of comprehensive income statements and balance sheets for each of the next five years by comparing the ‘nil provision’ method with the ‘full provision method’.
(b) Explain the ‘partial provision’ method and whether it could apply to Dee For’s company.
(c) Explain how your answer to (a) would be affected by a government announcement that it intends to increase the corporate income tax rate in the near future.