DTL charged directly to equity provision, directly, charged, equity, excess

hardwork24

CFAI text Vol 3. P468, 2nd last paragraph, it is stated :
The revaluation surplus is reduced by the tax provision associated with the excess of the fair value over the carry value and it affects retained earnings (300,000 x 40% = 120,000).
Is it that a tax expense of 120,000 shall be recorded on the income statement and paid to tax authority in the year of the revaluation ?  Can anyone help ? Thanks !

malbec

S2000magician, following an upward revaluation of 300, we would indeed see assets go up by 300, the DTL increase by 120 but the reamaining 180 would be taken to revaluation surplus within equity (via O.C.I). Under IFRS, the revaluation surplus would be stated net of the deferred tax effect which the revaluation gives rise to.
Alpha668, I read this example in the book, but I really don’t get what they are trying to do there??? It seems to suggest that we do not recognise the DTL on the revaluation.

bchadwick

Alpha668, I share your pain. I find this example impossible to reconcile.
S2000magician, this is the setup:
On 1 January 2006 a bulding is revalued to €1,200,000. Its book value just prior to the revaluation was €900,000 and its tax base was €800,000. The revaluation is of course not recognised for tax purporses.
Over the course of the year 2006, the building is depreciated at 5% straigh-line (€60,000). At the same time, depreciation for tax purposes is charged at €100,000. The tax rate is 40% and the DTL recognised on the B/S prior to the revaluation is €40,000.
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When you combine the effects of the revaluation and depreciation at different rates, you see that 2006 gives rise to a €340,000 overall widening in the gap between carrying amount and tax base (€300,000 from the revaluation and €40,000 from the difference in depreciation rates).
IMO, the proper accounting for this would be:
Revaluation (1 January 2006):
Building (assets): increase by €300,000
Revaluation surlpus( equity): increase by €180,000
DTL (liabilities): increase by €120,000
The different accounting and tax depreciations charged over the course of the year would give rise to a further increase in the DTL, but this time it would be charged to the income statement and not the revaluation surplus:
DTL (liabilties): increase by €16,000 (40% x €40,000)
Deferred tax charge (Income Statement ): €16,000
  
What the Curriculum seems to suggest is that the DTL is only increased due to the difference in depreciation rates, i.e. 40% of €40,000 - €16,000. If that is the case, the DTL recognised as at 31 December 2006 would only be €56,000 (€16,000 higher than at the beginning of the year). This is the €56,000 which alpha668 was referring to in previous posts. This is a treatment which I find baffling and it goes against my understanding of IFRS.
all the best!

AndyNZ

S2000magician & Wojtek,
Thank you so much again !  Maybe it’s better to have someone to send an e-mail to CFAI for clarifing this issue.

hw0799

Alpha668, this example certainly qualifies for reporting to CFAI. Will write to them and we’ll see. In any case, well done for spotting this!

luda002

This is an example from hell.   I don’t even get what they’re saying.
Are they saying that DTL reflected on the balance sheet should amount
DTL = tax rate * (new carrying amount - tax base) - revaluation surplus * tax rate
which equals $56,000?
I don’t understand this at all. If only a $56,000 increase is reflected on the balance sheet under liabilities, and the assets have increased by $300,000, is the increase in equity $244,000 ?? So confusing…

jonh

Wojtek,
Would you please kindly advise the response from CFAI regarding this issue ?   Thanks !

yodacaia

Initially, the CFAI’s response was that the solution is correct. I replied with further arguments but got no further response. I didn’t really have time to fight a battle but will surely follow up soon.

chandsingh

I consulted with many people in accounting field but no one agreed to those statements in this example. I am very disappointed that CFAI has not responded to this issue until now, maybe they don’t have the rationales supporting their statements in this example at all.
One more fundamental question :
If the revaluation of the building resulted in a tax provision of 120K, a revaluation surplus of 180K and a DTL of 16K whereas the carrying amount of the building (an asset) was increased by 240K (from 900K to 1140K), would the left side and the right side of 2006 balance sheet be equal ?