Chapter 3 - Adjustment To Profit

Question 1

Basics

Answer 1

Start with profits per account. Add back expenditure which is disallowable for tax. Then deduct receipts in the accounts that are not taxable as trading income. Then deduct capital allowances. This gives tax adjusted profit

Question 2

Disallowed Expenditure

Answer 2

Three main categories:

• Capital expenditure: gives ‘enduring benefit’ to the business
• Expenditure incurred which is not wholly and exclusively for trade
• Specific disallowables in law and statutes

Question 3

Examples of Disallowables

Answer 3

Depreciation & amortisation
Capital expenditure
Profits/losses on fixed asset sales
Legal fees on acquisition of assets (EXCEPT short lease renewals <50 yrs)
Expenses not incurred wholly and exclusively for trade
Private expenditure by the proprietor
Drawings by proprietor
Normal clothing
Children’s wages
Wages not paid within 9 months of period end
Selling price of goods taken for own use

Question 4

Capital Expenditure

Answer 4

Includes cars, premises and other equipment such as printers and computers. Capital additions in P&L should be disallowed and added back.

Question 5

Enduring Benefit

Answer 5

Something with enduring benefit is not allowable. Enduring benefit = will benefit the business for many years. Usually a one off cost like a van. Should be capitalised and on the balance sheet.

Question 6

Repairs

Answer 6

Repairs are allowable, replacing or making alterations/improvements to assets is not as it’s capital expenditure.

Question 7

Repairs cont.

Answer 7

Where using modern standard tech as part of a repair, it doesn’t always mean an improvement, eg double glazing when replacing windows

Question 8

Initial Repairs

Answer 8

Any initial repairs to make an asset usable are classed as capital and disallowed

Question 9

Provisions

Answer 9

Provisions are allowable providing they’re in accordance with FRS 102:

1) there’s an obligation to make a payment at the reporting date as a result of a past event
2) it is probably that an economic transfer will be required to settle the obligation
3) a reliable estimate can be made on the obligation

Question 10

Private Expenses

Answer 10

Private use adjustment is only made where the owner of the business deducts expenses which wholly or partly relate to private affairs

Question 11

Private Expenses Cont.

Answer 11

When a co pays for employee private expense (e.g a gym membership):

1) the expense is an allowable deduction for the business
2) employee will (usually) have a taxable benefit

Question 12

Clothing

Answer 12

Job specific clothes are disallowable, protective clothing is allowed.

Question 13

Drawings

Answer 13

Disallowed and should be added back

Question 14

Wages Paid to Spouse

Answer 14

Must be actually paid, the spouse must play a part in the business and the wages cannot be excessive. If any of those apply they are disallowed

Question 15

Wages Paid to Children

Answer 15

Allowable if it’s not unreasonable for the child to be employed and the payment is in the nature of wage and not pocket money

Question 16

Goods for Own Use

Answer 16

Where trader takes some stock for themselves, it’s assumed that they bought the stock at cost, then sold it to himself at retail price. Add the sales prices to the accounts profit

Question 17

Services for Own Use

Answer 17

Disallow the cost of providing the service and disallow the cost of raw materials taken for private use

Question 18

Income not Taxed as Trading Income

Answer 18

• Rental Income
• Bank Interest
• Profits on sale of fixed assets
• Sundry miscellaneous income
  Any non trading income is deducted when calculating taxable trade profit

Question 19

Income on Long Service Contracts

Answer 19

Businesses must recognise their WIP within their accounts and pay tax on it as the work arises, not when the work is completed and billed