# QUESTION ONE: Legal Case – Accounting Treatment ## Relevant Definitions **Contingent Liability:** A possible obligation arising from past events, confirmed by uncertain future events not wholly within the entity's control, or a present obligation not recognized because the outflow of resources is not probable or cannot be measured reliably (IAS 37). **Event After the Reporting Period:** Events that occur between the end of the reporting period and the date the financial statements are authorized for issue (IAS 10). - **Adjusting Events:** Provide evidence of conditions that existed at the end of the reporting period. - **Non-Adjusting Events:** Indicative of conditions that arose after the reporting period. ## Application to Fresh Limited ### Timeline - **31 December 202:** Reporting period ends. - **4 February 2021:** Court judgement against Fresh Limited (before financial statements authorized for issue). ### Situation Analysis - As at 31 December 202, legal advice suggested losing was unlikely, but potential cost was R900,000. - On 4 February 2021, after year-end but before financial statements were issued, Fresh Limited was found liable for R1,000,000 damages plus R180,000 legal fees. ### Accounting Treatment #### At 31 December 202 - **At year-end:** The obligation was only a possible obligation (contingent liability), as losing the case was "unlikely." - **Disclosure:** Disclose a contingent liability in the notes, describing the nature and estimated financial effect (IAS 37). #### After Year-End, Before Financial Statements Issued - **Court ruling provides evidence of a present obligation as at 31 December 202.** - **IAS 10 requires adjusting for events after the reporting period that provide evidence of conditions existing at year-end.** - The court case related to circumstances existing at 31 December 202. #### Required Adjustments - **Provision:** Recognize a provision for R1,180,000 (R1,000,000 + R180,000) in the financial statements for the year ended 31 December 202. - **Disclosure:** In addition to the provision, disclose the nature of the obligation and the amount recognized. ## Summary Table | Date | Event | Accounting Treatment | |---------------------|-----------------------------------------|-----------------------------------------------------------| | 31 Dec 202 | Year-end | Disclose contingent liability in notes | | 4 Feb 2021 | Court ruling (before FS issued) | Recognize provision for R1,180,000 in 202 FS | --- # QUESTION TWO: Taxable Profit and Taxation Note ## Step 1: Start with Accounting Profit - **Profit before tax:** R400,000 ## Step 2: Adjust for Tax Purposes ### (a) Add Back Non-Deductible Expenses - Donations: R150,000 (of which R100,000 not deductible) - Fines: R10,000 (not deductible) **Add back:** R100,000 (donations) + R10,000 (fines) = R110,000 ### (b) Deduct Non-Taxable Income - Dividends received: R40,000 (exempt from tax) **Deduct:** R40,000 ### (c) Adjust for Capital Gain #### Building Sale Details - **Original cost (base cost):** R500,000 - **Accumulated depreciation/wear and tear:** R300,000 - **Net book value:** R500,000 - R300,000 = R200,000 - **Sale profit (per accounts):** R350,000 - **Capital Gain (for tax):** Sale price - base cost Let sale price = Net book value + profit = R200,000 + R350,000 = R550,000 Capital gain = R550,000 - R500,000 = R50,000 - **Accounting profit includes total profit on sale, R350,000, but for tax only R50,000 is taxable as capital gain.** - **Accounting profit overstates taxable profit by R300,000 (R350,000 - R50,000), because the other R300,000 relates to recouped depreciation, which is taxable as income (since no temporary differences are assumed, treat this as fully taxable).** **No adjustment needed unless tax treatment of depreciation recoupment differs. Given 'no temporary differences,' assume full R350,000 is taxable as income.** #### Capital Gain Tax Calculation - **Capital Gain:** R50,000 - **Inclusion rate:** 22.4% - **Taxable Capital Gain:** R50,000 × 22.4% = R11,200 - **The R11,200 is taxed as part of taxable income.** ## Step 3: Calculate Taxable Profit | Description | Amount (R) | |-------------------------------|-------------| | Accounting profit | 400,000 | | Add: Non-deductible donations | 100,000 | | Add: Non-deductible fines | 10,000 | | Less: Dividend income | (40,000) | | Subtotal | 470,000 | | Add: Taxable capital gain | 11,200 | | **Taxable profit** | **481,200** | ## Step 4: Calculate Current Income Tax - **Tax rate:** 28% - **Current tax:** R481,200 × 28% = R134,736 --- ## 2.2 Taxation Note as at 31 December 202 ### Tax Reconciliation | Description | Amount (R) | |----------------------------------------------------------|--------------| | Accounting profit before tax | 400,000 | | Add: Non-deductible expenses | | |  - Donations | 100,000 | |  - Fines | 10,000 | | Less: Non-taxable income | | |  - Dividends | (40,000) | | Add: Taxable capital gain (included at 22.4%) | 11,200 | | **Taxable profit** | 481,200 | | Income tax at 28% | 134,736 | ### Taxation Note Structure (Example) #### Taxation - South African normal taxation is calculated at 28% of the taxable profit for the year. - The tax expense for the year is reconciled as follows: ```markdown ### Taxation Note (as at 31 Dec 202) | Description | Amount (R) | |-----------------------------|------------| | Taxable profit | 481,200 | | Income tax at 28% | 134,736 | ``` - **No deferred tax** is recognized as there are no temporary differences. --- ## Final Summary ### Question 1: Fresh Limited must recognize a provision of R1,180,000 for the court case as an adjusting event after the reporting period, replacing any prior contingent liability note. ### Question 2: - **Taxable profit:** R481,200 - **Current income tax:** R134,736 - **Taxation note:** Provides reconciliation from accounting profit to taxable profit, listing all adjustments and the final tax calculation.