Question

The consolidated financial statements of FMCG Ltd and RG Ltd were presented to the Board. The Board is alarmed that the economic entity’s balance sheet (consolidated balance sheet) shows a deferred tax balance, when the accounts for FMCG Ltd had no deferred tax asset or deferred tax liability.

FMCG management is also planning to acquire another entity ABC Investments Ltd in the near future. Management pointed out to the Board that on acquisition, the financial results of this new subsidiary (ABC Investments Ltd) will also be consolidated in the economic entity financial statements.

One of the Board members noted that the new business to be acquired by FMCG Ltd is an investment company. Its financial statements should not be consolidated because it is involved in investments industry, whereas all of the other companies in the economic entity are involved in retail industry.

Required:

As the financial accountant you are requested to prepare a response to the following questions:

(a) Why does the economic entity have a deferred tax balance? (2.5 marks)

(b) Should the financial statements of proposed acquired business, ABC Investments Ltd, be consolidated into the economic entity and why? (2.5 marks)

Answer 1

1. A company may or may not have deferred tax balance depending on the nature of its business as follows,

Usually, Deferred tax concept arrives when there is a deferment of tax, in simple parlance when the payment of tax as per the Tax Provisions & the disclosure provisions is different, then there arises the concept of Deferred tax.

• Let us take an example let the depreciation calculated on Fixed assets be like
  • Tax provisions - 2000
  • Disclosure Requirements - 1000
• In the above example the tax calculated will be different in both the cases as the profit is different in both the cases.
• going with the same example tax actually paid will be less (compared with disclosure provisions) as the profit will be less because the expense of depreciation is more.
• Here comes deferred tax liability as we paid less tax and in future we should pay more.
• In the above example by reversing the amounts there will be deferred tax asset,as we will pay more tax.

And finally it is named as deferred tax because clearly we can observe that the tax is being deferred.

2. The financial statements of all the companies owned by a single entity is mandated to be consolidated by the statute, the entity cannot escape the consolidation of financials statements on the ground that they belong to different categories of business.

However the business may for optional consolidation of financials of companies belonging to different categories to know the performance of each category of business.