Peter Ltd owns an asset with a cost price and base cost of R30 000 and a carrying amount of

Question

R24 000 which was revalued to a net replacement value of R40 000. The South African
Revenue
Service allowed a tax allowance of R7 500 on the asset and the tax rate is 28%. 66.6% of all
capital gains are taxable.
Calculate the deferred tax implications of the revaluation of the asset of Peter Ltd
if:
(a) the asset is used; and
(b) the entity sold/is of the intention to sell the asset.
Do the journal entries for both cases.
Round off all calculations to the nearest rand

Answer 1

To calculate the deferred tax implications for Peter Ltd related to the revaluation of the asset, we need to consider both scenarios: when the asset is being used and when the asset is intended to be sold.

Initial Information:

• Cost Price / Base Cost: R30,000
• Carrying Amount: R24,000
• Net Replacement Value: R40,000
• Tax Allowance: R7,500
• Tax Rate: 28%
• Taxable Capital Gains Rate: 66.6%

(a) When the Asset is Used:

1. Calculate the revaluation surplus: \[ \text{Revaluation Surplus} = \text{Net Replacement Value} - \text{Carrying Amount} = R40,000 - R24,000 = R16,000 \]

2. Determine the tax impact:

   • The tax base of the asset post-revaluation: \[ \text{Tax Base} = \text{Carrying Amount} - \text{Tax Allowance} = R24,000 - R7,500 = R16,500 \]

   • The tax implication of the revaluation surplus is: \[ \text{Taxable Gain} = \text{Net Replacement Value} - \text{Tax Base} = R40,000 - R16,500 = R23,500 \]

   • Only 66.6% of the gain is taxable: \[ \text{Taxable Portion} = 66.6% \times R23,500 = R15,661 \]

3. Calculate the deferred tax liability: \[ \text{Deferred Tax} = \text{Taxable Portion} \times \text{Tax Rate} = R15,661 \times 28% = R4,392.08 \approx R4,392 \]

Journal Entry for Scenario (a):

• Debit: Asset (Revaluation Surplus) R16,000
• Credit: Revaluation Surplus (Equity) R16,000
• Credit: Deferred Tax Liability R4,392

(b) If the Entity Sold or is Intending to Sell the Asset:

1. Revaluation surplus and tax implications remain the same as calculated in (a) since these values don't change unless the tax rates or asset conditions change.

2. When the entity sells the asset, the whole gain becomes taxable since it's not being used anymore.

3. The total tax implications upon sale:

   • The full gain is now taxable at the normal rate of 28%: \[ \text{Full Taxable Gain} = R23,500 \]

   • Calculate the full tax liability: \[ \text{Total Tax Liability} = R23,500 \times 28% = R6,580 \]

4. The deferred tax liability will need adjustment because now the entire gain is taxed. The adjustment requires:

   • Remove the deferred tax liability from previous calculations (which was based on only the 66.6% portion) and recognize the full liability.
   • The additional tax impact is: \[ \text{Additional Tax Impact} = R6,580 - R4,392 = R2,188 \]

Journal Entry for Scenario (b):

• Debit: Asset (Revaluation Surplus) R16,000
• Credit: Revaluation Surplus (Equity) R16,000
• Credit/Debit: Deferred Tax Liability R2,188 (adjustment to full tax liability)

Summary of Journal Entries:

For both scenarios, the revaluation of the asset results in an increase in the revaluation surplus of R16,000 and the deferred tax implication changes depending on the context of the asset's use.

1. Scenario (a) — Asset Used:

   • R16,000 revaluation surplus to equity
   • Deferred Tax Liability of R4,392

2. Scenario (b) — Asset Sold or Intended to Sell:

   • R16,000 revaluation surplus to equity
   • Adjust Deferred Tax Liability reflecting new total.

Conclusion:

Thus, these journal entries effectively capture the implications of asset revaluation under both scenarios, accurately reflecting the changes in deferred tax liabilities for Peter Ltd along with the revaluation surplus in equity.