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Summary CIMA F1 Notes
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Chartered Institute of Management Accountants Operational Level F1F1 Financial Reporting
Structure
C. Principles of taxation (20%)
1. Features of taxation and the regulatory environment
2. Corporate income tax and capital tax computations
3. International taxation
A. Regulatory environment of financial reporting (10%)
4. The regulatory environment
5. Code of ethics
6. Corporate governance
B. Financial statements (45%)
7. The conceptual framework
8. Introduction to single entity accounts
9. Non-current assets: IAS16 Property, plant and equipment and IAS36 Impairment of assets
10. IFRS5 Non-current assets held for sale and discontinued operations
11. IFRS16 Leases
12. IAS2 Inventories and IAS10 Events after the reporting period
13. IAS7 Statement of cash flows
D. Managing cash and working capital (25%)
14. Short-term finance and investments
15. Working capital management
16. Working capital management: accounts receivable and payable
17. Working capital management: inventory control
18. Working capital management: cash control
Jack Gould 1 of 52
,Chartered Institute of Management Accountants Operational Level F1
F1C1: Features of taxation and the regulatory environment
• Governments need tax revenue to finance expenditure on public services; it can be used to
stimulate one sector of the economy and control another
• Wealth of Nations (Adam Smith): tax should have the following characteristics:
• Fair (equity; reflect person’s ability to pay) • Convenient (convenience; easy to pay)
• Absolute (certainty; certain not arbitrary) • Efficient (efficiency; low collection costs)
• 3 major principles of modern/good tax policy:
• Equity: fairly levied between individual taxpayers
• Efficiency: cheap and easy to collect
• Economic effects: should reflect ability to pay; burden of tax relative to wealth of the individual
Definitions
• Direct tax: imposed directly on the person/enterprise required to pay the tax directly to authorities
• UK examples: income tax; capital gains tax; corporation tax
• Indirect tax: imposed on one part of the economy with the intention that the tax burden is passed
on to another; the tax is ultimately imposed on the final consumer of the goods/services
• UK example: sales taxes such as Value Added Tax (VAT)
• Tax bases: taxes can be classified by tax base, ie what is being taxed/what is liable for tax
• Income: income taxes; tax on company profits
• Capital or wealth (assets): taxes on capital gains; taxes on inherited wealth
• Consumption: excuse duties; sales taxes such as VAT
• Incidence: the distribution of the tax burden, ie who is paying the tax
• Formal incidence: person who has direct contact with the tax authorities; who is legally obliged
to pay the tax, ie for VAT the entity making the sale is responsible for paying the tax authorities
• Effective / actual incidence: person who actually bears the cost of the tax; who bears the tax
burden, ie for VAT the consumer purchasing from the entity bears the cost of the tax
• Taxable person: the person (individual or entity) accountable for the tax payment
• Competent jurisdiction: jurisdiction of a tax authority is its legal right to assess, collect and
enforce payment of tax on those taxable persons within the competent jurisdiction (ie country)
• Hypothecation: tax revenue devoted entirely to specific expenditure, ie road tax to maintain roads
• Tax gap: gap between tax theoretically/due to be collected/paid and amount actually collected
• Tax rate structure:
• Progressive: take an increasing proportion of income as income rises; the more a person earns
the higher their average rate of tax will be
• Proportional: take the same proportion of income as income rises
• Regressive: take a decreasing proportion of income as income rises; hits the poor hardest
Sources of tax rules
• Domestic legislation produced by a national government of the country, ie UK Finance Acts
• Tax legislation is law, thus adherence is mandatory. It is updated each year by UK Finance Acts
following proposals made by the Chancellor of the Exchequer in the Budget
• Precedents based on previous legislation/case law; also interpretations ie UK tax bulletins
• Case law refers to decisions made in tax cases brought before the courts; cases often challenge
current tax legislation or argues an interpretation of the law should be applied. These rulings are
binding and therefore provide guidance on the interpretation of tax statues
• Directives from supra/international bodies, ie European Union (EU) guidelines on VAT
• Agreements/treaties between countries, ie UK/USA Double Tax treaty to avoid double taxation
• Foreign income can be taxed twice: once in country of origin and once in country of residency
DIRECT TAXES
Tax on trading income (corporate income tax):
• Trading income relates to income from the main business activity, ie corporate income tax
• Tax base used to calculate tax on trading income should be taxable profits
• Accounting standards and the tax system often differ in their definition of what can be shown as
an income/expense; therefore accounting profit must be adjusted to calculate taxable profit
Jack Gould 2 of 52
,Chartered Institute of Management Accountants Operational Level F1
A c c o u n t i n g pr o f i t − D i s a l l o w a bl e i n c o m e + D i s a l l o w a bl e e x p e n s es + A c c o u n t i n g d e pr e c i a t i o n − Ta x d e pr e c i a t i o n = Ta x a bl e pr o f i t
• Rules for allowed and disallowed items will vary according to the tax regime of a given country:
• Accounting profit: profit before tax reported to shareholders in the statement of profit/loss
- Disallowable income (exempt from tax or taxed under other rules): income included in
accounting profit which does not relate to the main trading activity
• Examples: rental income, dividend income, interest receivable
+ Disallowable expenses: expenses allowable under accounting standards but cannot be
claimed for tax purposes
• Examples: entertaining customers, gift aid payments, political donations
+ Accounting depreciation: depreciation is an accounting entry with a rate decided by each
business; thus is not allowed for tax purposes as it is too subjective
- Tax depreciation allowance (or capital allowances): deducted instead of accounting
depreciation, in order for tax authorities to have a standardised calculation of depreciation
• Given if the asset is owned at the accounting date (no apportionment for mid-year acquisition)
• Only given on certain items of capital expenditure
• Some jurisdictions offer 100% first year capital allowance to encourage new investment
• Written down value (WDV): represents cost of the asset less accumulated tax depreciation
allowance, which must be used to calculate the capital allowance at the beginning of the year
= Taxable profit: then charged at the appropriate tax rate for that accounting period
Capital taxes:
• Capital gain: profit made on disposal of a chargeable asset; investments (such as listed stocks
and shares) and other non-current assets
• Capital tax: tax charged on profit made on disposal of a chargeable asset; UK Capital Gains Tax
P r o c e e d s − Co s t s t o s el l − O r i g i n a l c o s t − Co s t s t o b u y − E n h a n c e m e n t s − A l l o w a n c e f or i n f l a t i o n = Ta x a bl e g a i n
• Simply put, the gain is calculated as proceeds from sale less cost of the asset:
- Costs to sell the asset: such as legal fees, estate agent fees
- Original cost of the asset
- Costs to purchase the asset: such as legal fees, estate agent fees
- Enhancement costs: such as improvements or extensions to the original asset
- Indexation allowance (allowance for inflation): calculated on all allowable costs from the
purchase date to the disposal date of the asset, thus reducing the gain
= Chargeable gain: then charged at the appropriate tax rate for that accounting period
INDIRECT TAXES
Types:
• Unit taxes: based on the number or weight of items
• Ad valorem taxes: based on the value of items
Examples:
• Excise duties: unit tax on certain goods produced by few large suppliers at large sales volumes,
with inelastic demand and no close substitutes, such as alcohol, tobacco, vehicles, in order to:
• Discourage over-consumption of harmful products
• Pay for extra costs caused by the products, such as increased healthcare or road infrastructure
• Tax luxuries, hence raising government revenue
• Property taxes: based on either the capital value or annual rental value of the property
• Wealth taxes: on an individual’s or company’s total wealth, including pensions, insurance and art
• Consumption taxes: imposed on the consumption of goods and added to the purchase price
• Single stage taxes: apply to one stage of production only, such as manufacturing or retail level
• Multi-stage sales taxes: charged at each stage of production; each time a product is sold
• Cascade tax (no refunds): tax is taken at each stage of production; government does not
provide refunds thus it is a business cost
• Value added tax (VAT) (refunds): charged each time a product is sold; government allows
businesses to claim back all tax paid, thus entire tax burden is passed onto the consumer
Jack Gould 3 of 52
,Chartered Institute of Management Accountants Operational Level F1
Value added tax (VAT)
• VAT payable = output tax - input tax
• Output tax: VAT charged on sales to customers
• Input tax: VAT paid on purchases
• Taxable supplies:
• Standard Rated: taxed at the standard rate of VAT
• Higher Rated: taxed at a higher rate
• Zero Rated: taxed at a rate of 0% (ie UK basic foodstuffs and children’s clothing); businesses
apply zero output VAT on sales, but may still reclaim input VAT on purchases
• Exempt: not subject to VAT (ie UK finance and insurance); exempt supplies are outside the VAT
system, thus suppliers cannot charge output VAT on sales nor claim input VAT on purchases
• Selling price:
• Net price: selling price exclusive of VAT. If the exclusive price is given, VAT is calculated by:
VAT = E x cl u s i v e pr i c e × Ta x r a t e
• Gross price: selling price inclusive of VAT. If the inclusive price is given, VAT is calculated by:
I n cl u s i v e pr i c e
VAT = × Ta x r a t e
100 + Ta x r a t e
• VAT registration: required by a taxable person (individual or entity) producing a taxable supply
(standard, higher or zero rated), therefore must:
• Keep appropriate VAT records
• Charge VAT on taxable supplies to customers and issue sales invoices that include VAT
• Register for VAT so they can claim VAT back on purchases used for taxable supplies
• Complete a quarterly VAT return and make payments to the tax authority
IMPACT OF EMPLOYEE TAXATION
Explanation Examples
Income/ Employees are taxed on average • Salaries
earnings under income tax, which • Bonuses
earnings includes… Commissions
•
• Benefits in kind: non-cash benefits in lieu of further cash payments, such as company cars,
accommodation, or private medical insurance
Basis of Dependent on the country, such as… • France: earnings of previous year
assessment • Switzerland: average earnings of previous two years
• UK: earnings in current tax year
Expenses Employees can deduct expenses • Business travel
which are wholly, exclusively and • Pension schemes
necessary for employment, such as… • Subscriptions to professional bodies
Social Employees and companies must pay • Public health service
social security tax based on salary, to • Retirement benefits
security tax fund benefits (in the UK) such as…
• UK Pay-As-You-Earn (PAYE) benefits
• Makes payment of tax easier for the tax payer as it is in instalments
• Tax is deducted at source (before income is paid to the taxpayer) therefore lower risk of default
• Tax collected earlier therefore improves government cash flows as cash is received earlier
• Tax collected regularly throughout the year therefore easier to forecast tax revenues
• Administration costs are largely borne by employers, rather than government
Sa l a r y + Ea r n i n gs − E x p e n s es = Ta x a bl e i n c o m e
• Taxable income charged at appropriate tax rate for the accounting period, via employer with PAYE
ADMINISTRATION
Record-keeping: entities must keep records to satisfy tax requirements for:
• Corporate income tax: all records to support financial statements and additional records to
support adjustments to statements when completing tax returns
• Sales tax: record should be maintained of sales and purchases, such as:
• Overseas subsidiaries: records concerning transfer pricing policy between subsidiary and parent
• Employee tax: detailed records of employee tax, social security contributions, deductions from
employee wages, employer contributions and an analysis of any other deductions
• Tax authority deadlines for filing tax returns/paying taxes:
• Enables government to enforce penalties for late payments
• Ensures tax deducted at source by employers is paid over promptly
• Ensures tax payers know when they have to make payment
• Ability to forecast cash flows
• Payment of tax: depends on tax authority and type of tax
Jack Gould 4 of 52
,Chartered Institute of Management Accountants Operational Level F1
• Minimum retention of records: to enable tax authorities to challenge records at a later date
• UK: 6 years for all records relating to earnings and capital gains
Power of tax authorities
• Tax authorities have powers to impose penalties and charge interest on late payments, as well as:
• Review and query tax returns
• Request special reports if submitted information is believed to be inaccurate
• Examine previous records
• Enter and search the entity’s premises to seize documents; however no power to arrest
• Exchange information with foreign tax authorities in other jurisdictions
Tax avoidance and tax evasion
• Tax avoidance: minimising tax liability within the scope of the law; but public perception would be
that the entity is not paying its fair share of tax and thus results in adverse impact on the business
• Tax evasion: illegal manipulation of the tax system to minimise tax liability; the intentional
disregard of the law to escape tax
• Methods of preventing/reducing the incidence avoidance and evasion:
• Reducing opportunity: such as by deduction of tax at source and the use of third party reporting
• Simplifying tax structures/laws: such as by minimising allowances, exemptions and relief
• Increase perceived risk: by auditing tax returns and payments
• Communication: between authorities and entities
• Fair tax system: changing social attitude through an honest system to encourage commitment
• Reducing lost revenue: by reviewing the penalty structure
F1C2: Corporate income tax and capital tax computations
BALANCING CHARGES AND ALLOWANCES
• Accounting profit or loss: when an asset is disposed of, accounting profit/(loss) is calculated
A c c o u n t i n g pr o f i t / (l o ss) = P r o c e e d s − Ca r r y i n g a m o u n t (SOFP )
- Accounting profit: if proceeds are greater than the carrying amount
+ Accounting loss: if proceeds are less than the carrying amount
• Balancing charge or allowance: when an asset is disposed of, accounting profit/(loss) is treated
as disallowable for tax purposes and replaced with a balancing charge/(allowance)
B a l a n c i n g ch a r ge / (a l l o w a n c e) = P r o c e e d s − Ta x w r i t t e n d o w n v a l u e (T W DV )
+ Balancing charge (BC): tax profit on disposal of asset; if proceeds are greater than TWDV
- Balancing allowance (BA): tax loss on disposal of asset; if proceeds are less than than TWDV
• Accounting amount (profit or loss) is replaced by the tax amount (balancing allowance or charge):
• Tax depreciation allowance is not normally given in year of disposal
Trading losses
• When an entity makes a trading loss, assessment for the tax year will be nil; and the entity must
claim loss relief based on the rules of the tax regime (varies greatly between countries), such as:
• Carry losses forwards against future profit of the same trade
• Carry losses backwards against previous periods
• Offset losses against group company profits
• Offset losses against capital gains in the same period
Year Trading profit/(loss) Workings Taxable profit
1 25,000 Trading loss carried backwards against trading profit: 25,000 - 25,000 -
2 (45,000) -
3 15,000 Remaining balance of trading loss carried forwards against first available trading profit: 15,000 - 15,000 -
4 35,000 Remaining balance of trading loss carried forwards against trading profit: 35,000 - 5,000 30,000
Jack Gould 5 of 52
,Chartered Institute of Management Accountants Operational Level F1
Trading losses on cessation of business
• If an entity ceasing to trade, most countries allow losses to be carried back against profits of
previous years to generate a tax refund
• UK Terminal Loss Relief: enables the loss to be carried back 3 years
Capital losses
• Capital losses are often kept separate from trading activities; loss relief is claimed (depending on
the rules of the country) via ways such as:
• Carry losses forwards against future capital gains
• Carry losses backwards against previous capital gains
• Offset losses against taxable profit in the current period
Rollover relief
• Rollover relief: tax payment on a capital gain can be delayed if the full proceeds from the sale of
an asset are reinvested in a replacement asset, effectively postponing the gain until the
replacement is sold in the future
• Full deferral: £100,000 asset sold, creating a gain of £10,000. £100,000 is reinvested into a
replacement asset, thus the £10,000 gain can be deferred in full until the replacement is sold
• Partial deferral: £100,000 asset sold, creating a gain of £10,000. £95,000 is reinvested in a
replacement asset, thus the £5,000 gain not reinvested is immediately chargeable for tax while
the remainder £5,000 can be deferred until the replacement is sold
• Countries operating this system have strict rules on eligible assets, time scales of purchasing a
replacement asset, and whether partial deferral is allowed.
GROUP ISSUES
• Group: exists when one entity (parent company) controls another entity (subsidiary), commonly
through acquisition of a certain amount of ordinary shares (>50%), thus creating two tax issues:
Group loss relief
• Tax consolidation: enables losses to be surrendered between different entities of the group
• Each entity nevertheless produces their own individual accounts and is taxed individually; losses
may be transferred between group entities in order to save tax for the group as a whole
• Some countries enable losses to be surrendered only between resident entities; whereas other
countries allow overseas entities to be included based on profits within that country
• Capital losses: cannot usually be surrendered between group entities
• UK: group entities can transfer ownership of assets at nil gain/nil loss; capital gain/loss arises
only when the asset is sold to a third party outside the group, hence the group is effectively
treated as a single entity by the authorities for the purpose of Capital Gains tax
• Group relief may be used to:
• Save tax: the surrendering entity pays tax at a lower rate than the group entity receiving the loss
• Enable relief to be gained earlier: the surrendering entity may only be able to carry losses
forwards which results in the entity waiting for loss relief
Appropriations of profit
• Dividends are paid by companies out of post-tax profits
• Dividends often taxed twice: tax relief is not given for appropriations of profit such as dividends;
the dividend is then distributed to the shareholders who may be taxed on the income. Solutions:
• Classical system: shareholder is treated as independent from the entity; thus the dividend is
taxed twice, firstly as part of the entity's taxable earnings and secondly when received by the
shareholder as part of their personal income
• Imputation system: shareholder receives a tax credit for the underlying corporate income tax
paid by the entity; thus the entity is taxed on the taxable earnings used to pay the dividend,
while the shareholder receives a full credit and hence pays no tax on the dividend income
• Partial imputation system: shareholder offered a tax credit but only for part of the underlying
corporate income tax paid by the entity on taxable earnings used to pay the dividend
• Split rate system: distinguishes between distributed profits and retained profits to charge a
lower rate of corporate income tax on distributed profits, to avoid double taxation of dividends
• Re-characterising debt: generally interest is tax deductible and dividends are not; thus group
entities transfer funds from one entity to another in the form of interest on inter-company loans
rather than dividends for the purpose of reducing tax
• Thin capitalisation rules: many countries address the issue of debt re-characterisation by
limiting amount of tax deductible interest; with any interest in excess classified as a dividend
Jack Gould 6 of 52
, Chartered Institute of Management Accountants Operational Level F1
F1C3: International taxation
Tax in a digital world
• Technological innovation is transforming business and enabling firms to trade internationally more
easily; this increasing utilisation of opportunities offered by the digital economy is causing tax
problems to arise more regularly, which are no longer solely an issue for large firms
• Tax regulators must consider new ways of ensuring tax is charged appropriately on income
earned by companies operating internationally within the digital economy
Corporate residence
• A company normally pays tax on its worldwide income in the country where it is resident
• Companies can be resident for tax purposes in either:
a. The country of incorporation
b. The country of control/central management (where head office is located/board meetings held)
• If a company is incorporated in one country but controlled in another, it is generally agreed by
the countries involved that is treated as resident solely in the country of central management
• Generation of profits from international trade results in questions over the relevance of corporate
residence and ethical issues for company directors over seeking tax haven residency to avoid tax
Double taxation
• Double taxation: some or all of the profits of a country may be taxed in more than one country
• Double taxation relief: double tax relief mitigates taxing overseas income twice, available if there
is a double tax treaty between two countries; each treaty is specific to each country. Methods:
• Exemption relief: countries agree on types of income (partially) exempt from tax in either country
• Tax credit: tax paid in one country may be deducted as a credit from the tax due in the other
country; relief is normally restricted to lower of the two tax charges arising on profits concerned
• Deduction relief: tax relief is gained by deducting foreign tax from the foreign income to result in
a net amount subject to tax in the country of residency
Types of overseas operations
• A multinational firm may trade from its country of residence without of physical operations abroad
• Alternatively, a company may set up overseas operations, run either as a subsidiary or branch:
Subsidiary Branch
Overseas subsidiary is treated as a separate entity for tax Overseas branch is treated as an extension of the existing
purposes; subsidiaries are legally independent of their foreign company for tax purposes; branches do not have a legal
parent company personality therefore the foreign parent company is fully liable
Parent company only pays tax on income received from subsidiary Transfers from the branch to the existing company are not usually
(may be dividends, interest or royalties), not on profits treated as dividends
Subsidiary liable for tax on profits based on country of residence Profits of the branch are subject to local taxation based on the
rules country of residence rules, subject to double tax relief
Loss relief may not be available for the group because the Loss relief usually available for the group
overseas subsidiary is paying tax under a different regime
Parent company not usually subject to capital tax on gains made Existing company usually subject to capital tax on gains made by
by the overseas subsidiary the overseas branch
Assets transferred to the parent may result in a capital gains tax Assets can be transferred between the existing company and
liability branch at nil gain/nil loss
Types of foreign tax
• Withholding tax: tax deducted at source before paying out the income, on payment of items such
as dividends, interest, rent, royalties, and capital gains; net income is then received by the
beneficiary in the foreign country:
Ne t i n c o m e = G r o ss p a y m e n t − W i t h ol d i n g t a x
• Underlying tax: if a company receives a dividend from an overseas subsidiary, the dividend will
be taxed once in the overseas country as part of normal tax on profits, and again in the country of
receipt as income on dividends. Tax on the profit used to pay the dividend is as underlying tax
• Foreign tax already suffered on profits out of which a dividend is paid to a domestic investor
Ta x o n pr o f i t s
Un d e r l y i n g t a x = × G r o ss d i v i d e n d
Pr of it a f ter t a x
• Withholding and underlying tax may be reduced using the various methods of double tax relief
Jack Gould 7 of 52
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