chapter 12 pensions, share options, leases, taxation and foreign currency
TRANSCRIPT
Chapter 12
Pensions, Share Options, Leases, Taxation and Foreign Currency
Financial Information Analysis 2Copyright 2006 John Wiley & Sons Ltd
Pensions
• Pension payments are a large cost for many firms• 2 principal types of pension scheme
• defined benefit: pension related to salary
• defined contribution: pension related to payments
• Defined contribution becoming increasingly common
• Accounting for pensions raises two issues:• How much to charge to Income Statement?
• How should underlying assets and liabilities be valued?
Financial Information Analysis 3Copyright 2006 John Wiley & Sons Ltd
Accounting for pension costs
• IAS 19:Accounting treatment depends on type• Defined contribution: expenses recognised in
period contribution payable;• Defined benefit:
• B/S liability equal to net of:• Present value of expected future payments• Deferred actuarial gains/losses and past service costs, and• Fair value of any plan assets at B/S date
• IS figure is generally the resulting change in B/S value• IAS 19 has
• prioritised B/S issues over IS • increased volatility
Financial Information Analysis 4Copyright 2006 John Wiley & Sons Ltd
Share Options
• Increasingly common as means of reward• Attractive for recipients and companies• Did not lead to any expense recorded in IS
• Accounting theory, frauds and abuse have caused change in accounting practice
• Considerable political issues• IFRS 2 requires annual charge in IS and
credit in B/S over vesting period
Financial Information Analysis 5Copyright 2006 John Wiley & Sons Ltd
Options: IFRS 2 example
• X plc grants option on 1/1/01 for 100k shares vesting on 31/12/03. Price 1/1/01 = £5
• IFRS 2: estimated cost to be charged to IS over vesting period (3 years)
• This will require various estimates etc.• price will rise to £5.50 @ 31/12/03 • 75% probability employee will satisfy requirements
1/1/01 value = 100k x .75 x £0.50 = £37,500• IFRS 2 requires this to be charged to IS over three
years = £12.5k per annum
Financial Information Analysis 6Copyright 2006 John Wiley & Sons Ltd
Leases
• Arrangements whereby lessee obtains right of use, often without obtaining legal title
• Finance Leases: most risks and rewards transferred to lessee
• Operating Leases: most risks and rewards of ownership retained by lessor
• IAS 17: assets and corresponding liabilities are created, regardless of legal fiction
Financial Information Analysis 7Copyright 2006 John Wiley & Sons Ltd
Accounting for leases
• IAS 17, accounting treatment depends on type:• Finance: asset and corresponding liability
shown in balance sheet of lessee• Operating: lessee merely shows leasing cost in
P&L
• Classification may have significant impact on relevant ratios e.g. Gearing
Financial Information Analysis 8Copyright 2006 John Wiley & Sons Ltd
Taxation
• Companies pay tax in their own right as separate legal entities
• UK resident companies liable to Corporation Tax
• Fixed rate of tax applied to profits (income and capital gains)
• Rate applies to financial year (April 1 - March 31)
• IAS 12 requires entities to account for Tax in a manner consistent with underlying transactions
Financial Information Analysis 9Copyright 2006 John Wiley & Sons Ltd
Deferred Tax
• Tax and accounting principles differ in UK• i.e., profit computed by accountants differs from
that computed by HM Customs & Revenue• permanent differences
• timing differences, e.g., Depreciation v. Capital Allowances
• Thus, tax due will also differ• This leads to ‘Deferred Tax’
Financial Information Analysis 10Copyright 2006 John Wiley & Sons Ltd
Deferred Tax
• IAS 12 introduces ‘Temporary differences’• “Differences between tax base of an asset or
liability and its B/S carrying amount”
• All Temporary differences are also Timing differences
• IAS 12 provides that balance sheet liability method be applied• This requires a recalculation of any potential
liability in light of changes in tax rates
Financial Information Analysis 11Copyright 2006 John Wiley & Sons Ltd
Deferred Tax example
• Y plc bought plant for £300k; now has carrying amount in B/S of £200k after depreciation. Capital Allowances to date equal £180k. CT is 30%
Accounts Tax
Cost 300 300Depreciation/Cap Allow 100 180Carrying Amount 200 120
Temporary difference = £80k: Deferred tax = £24k (80 x 30%)
Financial Information Analysis 12Copyright 2006 John Wiley & Sons Ltd
Foreign Currency
• Globalisation and dominance of MNEs mean foreign currency transactions more common
• IAS 21 distinguishes between two currencies:• Functional – primary economic currency
• Presentation – currency used for financial statements
• IAS 21 also distinguishes between:• Monetary items: items to be settled by cash – e.g.
debtors, creditors, loans, etc.
• Non-monetary items: other balances, e.g. fixed assets
Financial Information Analysis 13Copyright 2006 John Wiley & Sons Ltd
Foreign Currency – IAS 21
• 1. Transaction date: use exchange rate applying between foreign and functional currencies
• 2. Balance Sheet date: • Monetary items: use closing rate on that date
• Non-monetary items:• Where historic cost was used originally, these are retained
• Where fair value used, translate at rate for that date
• 3. Exchange differences arising on settlement of monetary items recognised in Income Statement
Financial Information Analysis 14Copyright 2006 John Wiley & Sons Ltd
Summary
• IFRS results in considerable changes in accounting practice
• Political issues have impinged on standard setting process, e.g. in relation to Options
• Important to understand these technical areas for informed analysis
• But emphasis must remain on bigger picture