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What is Tax?
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Tax Part 1
When to use
When constructing a basic Financial Model
- Hand in hand with Accounting:
- Accounting principles
- Determine presentation of information in financial statements
- Match financing to its purpose
- Establish the amount of tax payable
- Financial statements reflect company position and performance
- Tax Legislation affects this through items such as tax payable liabilities, tax paid, deferred tax assets and liabilities
- Theoretical Tax expense
- Tax Expense is calculated based on accounting profit
- Tax Rate applied to Net Profit Before Tax (NPBT)
- Resulting Income Tax Expense is paid in same period
- Effective tax rate = Theoretical tax rate
- Based on accounting concepts not tax legislation
- Financial reporting would therefore impact tax office revenues
- Not all revenues are assessable / deductible
- Permanent Differences
- Some Income Statement revenues or expenses will never be assessable or deductible for taxation purposes
- These are termed “Permanent Differences” although International Financial Reporting Standards (IFRS) now calls them “Temporary Differences”
- Adjust NPBT to calculate Accounting Taxable Profit
- Accounting Taxable Profit is multiplied by tax rate to determine Tax Expense for period
- Tax Payable
- Most entities experience time delay between incurrence of tax liabilities and payment to government
- Delay creates accounting liability on Balance Sheet
- Reflects tax payable carried forward to next period
- Tax payable liability is identical to Dividend Payable and Interest Payable liability account
- Basic accounting matching concept
- Tax Losses
- The government does not refund the tax associated with a Taxable Loss
- Instead, entities are allowed to accumulate tax losses and offset against future positive taxable profits
- Accumulated tax losses are recorded on balance sheet as an asset as they reduce future tax paid
- “Tax Effected” value
- Asset reduced when Tax Losses used
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