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Financial Analysis of TopStyle Ltd

TopStyle Ltd is a manufacturer and retailer of smartphone accessories. TopStyle Ltd was incorporated on 1 July 2021. The profit before tax for the year ended 30 June 2023 amounted to R2 800 000, after taking into account the information below:

Administration building

The administration building was acquired on 1 October 2021 at a cost of R1 500 000 and on this date, it was available for use, as intended by management. Depreciation on the administration building is written off over its estimated useful life of 15 years according to the straight-line method. A residual value of Rnil was allocated to the administration building. The SA Revenue Service does not allow a tax allowance on the administration building. No other administration buildings were acquired or sold during the year.

On 20 December 2021 TopStyle Ltd made a payment of R80 000 to an independent security company, for security services to be rendered at the administration building for the period from 1 January 2022 to 31 December 2022. The directors of TopStyle Ltd decided to employ their own full time security staff from 1 January 2023. TopStyle Ltd paid security fees of R30 000 to their own security staff for the period 1 January 2023 to 30 June 2023.

Delivery vehicles

The directors of TopStyle Ltd decided to replace the old delivery vehicles, used to distribute their smartphone accessories, with hybrid delivery vehicles to decrease their operating costs. On 1 January 2023 the old delivery vehicles were sold for R320 000. The old delivery vehicles were acquired on 1 October 2021 at a cost of R300 000 and on this date, they were available for use, as intended by management. On 30 June 2022 the carrying amount and tax base of the old delivery vehicles amounted to R262 500 and R243 750 respectively. On the date of sale, the carrying amount and tax base of the old delivery vehicles amounted to R237 500 and R206 250 respectively.

On 3 January 2023 the new hybrid delivery vehicles were acquired for R600 000 and on this date, they were available for use, as intended by management. No other delivery vehicles were acquired or sold during the year.

Depreciation on delivery vehicles is written off over its estimated useful life of 6 years according to the straight-line method. A residual value of R80 000 was allocated to the new hybrid delivery vehicles (old delivery vehicles: Rnil). The wear and tear allowance on delivery vehicles is written off over 4 years, apportioned for part of a year, according to the straight-line method, in terms of section 11(e) of the Income Tax Act. The tax allowance on the old delivery vehicles and the new hybrid delivery vehicles for the year ended 30 June 2023 amounted to R37 500 and R75 000 respectively.

During the current financial year TopStyle Ltd paid various traffic fines for traffic violations committed by the companys vehicle drivers, for which the company is liable for. The total traffic fines paid for the current financial year amounted to R9 800.

Foreign income

Foreign income received from the United Kingdom for the current financial year amounted to R210 000. The foreign income reived is correctly accounted for in profit before tax. This income is not taxable in South Africa in terms of a double taxation agreement.

ASSIGNMENT 01 (Second semester) (continued)

During the current financial year, TopStyle Ltd paid R45 500 for the foreign tax due on this foreign income. However, the assessment that was subsequently received from the United Kingdoms tax authorities indicated that foreign tax amounting to only R42 000 was due in respect of this income. The foreign tax paid and the overpayment of foreign tax for the current year have not yet been recorded in the accounting records of TopStyle Ltd.

Provision for warranty costs

On 1 July 2022, TopStyle Ltd started to sell smartphone accessories with a two-year assurance-type warranty against manufacturing defects. TopStyle Ltd makes a provision in its annual financial statements for these future warranty costs to repair defective smartphone accessories returned by customers. The provision for warranty costs is not deductible for tax purposes, but the SA Revenue Service does allow actual warranty costs paid as a deduction for tax purposes. On 30 June 2023, the balance of the provision for warranty costs in the statement of financial position of TopStyle Ltd amounted to R80 000. During the financial year ending on 30 June 2023, TopStyle Ltd did not incur any warty costs regarding the warranty given for smartphone accessories sold.

Taxation

The SA Normal tax rate changed from 28% in 2022 to 27% in 2023. The 2022 tax assessment showed an assessed loss of R5 000 for the prior year, which agrees with the accounting records of TopStyle Ltd. The inclusion rate for capital gains has remained constant at 80%.

The company provides for deferred tax on all temporary differences using the statement of financial position approach. There are no other exempt or temporary differences except those mentioned in the question. There is certainty beyond any reasonable doubt that the company will have sufficient taxable profit in future against which any deductible temporary differences can be utilised.

Assume all amounts are material.

REQUIRED:

Marks

a) Calculate the deferred tax balance in the statement of financial position of TopStyle Ltd for both the years ended 30 June 2022 and 30 June 2023, using the statement of financial position approach. Indicate in your answer if the balance is a deferred tax asset or deferred tax liability.

Your answer must comply with the requirements of IAS 12, Income taxes.

b) Calculate the current tax expense in the statement of profit or loss and other comprehensive income of TopStyle Ltd for the year ended 30 June 2023. The movement in temporary differences in the current tax calculation should be calculated using the statement of financial position approach.

Your answer must comply with the requirements of IAS 12, Income taxes.

c) Prepare the journal entry to record the foreign tax payment and foreign tax overpayment in the accounting records of TopStyle Ltd for the year ended 30 June 2023.

Assignment 01: Financial Analysis of TopStyle Ltd

This assignment will involve calculating the deferred tax balance and the current tax expense for TopStyle Ltd for the year ended 30 June 2023. Additionally, we will prepare the necessary journal entries for the foreign tax payment and overpayment.

Part A: Deferred Tax Balance Calculation

Deferred Tax Assets and Liabilities

To calculate the deferred tax balance, we will identify temporary differences arising from the administration building, delivery vehicles, and warranty provision.

Administration Building
- Carrying Amount: R1,500,000
- Tax Base: R1,500,000 (No tax allowance)
- Temporary Difference: R0
- No deferred tax effect.
Old Delivery Vehicles
- Carrying Amount at sale (1 January 2023): R237,500
- Tax Base at sale: R206,250
- Temporary Difference: R31,250 (Carrying amount > Tax base)
- Deferred tax liability: R31,250 * 27% = R8,437.50
New Hybrid Delivery Vehicles
- Carrying Amount at year-end (30 June 2023): R600,000 - (R600,000 - R80,000) / 6 * 6 months = R530,000
- Tax Base: R600,000 - R75,000 = R525,000
- Temporary Difference: R5,000 (Carrying amount > Tax base)
- Deferred tax liability: R5,000 * 27% = R1,350
Provision for Warranty Costs
- Carrying Amount: R80,000
- Tax Base: R0 (not deductible for tax)
- Temporary Difference: R80,000
- Deferred tax asset: R80,000 * 27% = R21,600

Summary of Deferred Tax Balances

Deferred Tax Liability from old delivery vehicles: R8,437.50
Deferred Tax Liability from new hybrid delivery vehicles: R1,350
Deferred Tax Asset from warranty provision: R21,600

Total Deferred Tax Calculation (30 June 2023)

Total Deferred Tax Liability: R8,437.50 + R1,350 = R9,787.50
Total Deferred Tax Asset: R21,600

Net Deferred Tax Position as at 30 June 2023:

$Deferred Tax Asset−Deferred Tax Liability=21,600−9,787.50=R11,812.50 (Asset)\text{Deferred Tax Asset} - \text{Deferred Tax Liability} = 21,600 - 9,787.50 = \text{R11,812.50 (Asset)}$

Deferred Tax Balance as at 30 June 2022:

Since there were no changes in the relevant assets or liabilities from previous years that would create a deferred tax balance in 2022 apart from those that arose in 2023 calculations, we can assume that the deferred tax position for 2022 is R0.

Part B: Current Tax Expense Calculation

Profit Before Tax for the Year Ended 30 June 2023

Profit Before Tax: R2,800,000

Adjustments to Profit Before Tax for Current Tax Calculation

Additions:
- Traffic Fines (not deductible): +R9,800
- Provision for warranty costs (not deductible): +R80,000
Deductions:
- Foreign income (not taxable): -R210,000

Adjusted Profit Before Tax Calculation

$ \text{Adjusted Profit} = 2,800,000 + 9,800 + 80,000 - 210,000 = \text{R2,679,800} $

Current Tax Expense Calculation

$ \text{Current Tax Expense} = \text{Adjusted Profit} \times \text{Tax Rate} $ $ = 2,679,800 \times 27% = \text{R722,486} $

Part C: Journal Entry for Foreign Tax Payment and Overpayment

To record the foreign tax payment and foreign tax overpayment in the accounting records of TopStyle Ltd:

Journal Entry

Date          Account Title                      Debit          Credit
30 June 2023  Foreign Tax Expense                42,000
              Foreign Tax Payable                               42,000
              (To record foreign tax due)

              Prepaid Foreign Tax Expense        3,500
              Foreign Tax Expense                               3,500
              (To record overpayment of foreign tax)

Explanation of Journal Entries:

The first entry recognizes the actual foreign tax expense based on the assessment received.
The second entry adjusts for the overpayment of foreign tax that has not yet been recorded.

Conclusion

In conclusion, this analysis has calculated the deferred tax balances for TopStyle Ltd and determined its current tax expense for the financial year ending 30 June 2023. Additionally, we have prepared journal entries to accurately reflect the foreign tax payments and overpayments in the accounting records in compliance with IAS 12.