Question

Madina Ltd had its head office located in Thohoyandou, South Africa. Quring the landslide on 31 December 2021, a building nearby, which it owned and was renting to Molamu Limited, was destroyed. As Molamu Ltd was a valued tenant, on 5 January 2022, Madina Ltd decided that it will move its own head office to another utilisation building nearby, which was currently also used for administrative purposes and to lease this original head office building to Molamu Limited is a i replacement. On 31 January 2022 Madina started moving its office equipment to the new utilisation building and started operating accordingly on the new offices from 28 February 2022. Madina has 31 March year end. Other information: The head office was purchased on the 01 January 2020 for R450 000 (total usefullife: 10 years) The fair value of the head office building was: - R430 000 on 31 December 2021 and; - R440000 5 January 2022 and; - R450000 on 31 January 2022 and; - R480000 on 28 February 2022 and; - R450000 on 31 March 2022. - Workshop Limited uses the: Cost model to measure its property, plant and equipment and Fair value model to measure its investment properties. - SARS allows 5% allowance on office buildings, not apportioned. - Where necessary a normal tax rate and inclusion rate for CGT is 28% and 80% respectively.. The deferred tax adjustment to be made on the date of transfer to reflect the re-classification of PPE to Investment property will be?

A. R11 550 (asset).
B. R23 520 (liability).
C. R7 770 (asset).
D. R26 250 (Liability)

Answer 1

The deferred tax adjustment is a liability of R23,520, calculated from the revaluation surplus on the reclassification of the property from PPE to investment property, using the tax rate and capital gains inclusion rate.

Step-by-step explanation:

The student's question pertains to the reclassification of property, plant, and equipment (PPE) to investment property and the resulting deferred tax adjustment. Since Workshop Limited uses the cost model for PPE and the fair value model for investment properties, the reclassification will trigger an accounting adjustment.

Here is how to calculate the deferred tax liability:
The building's carrying amount for PPE before reclassification on 31 January 2022 would have been its historical cost minus two years of depreciation (since it was purchased on 01 January 2020 and has a useful life of 10 years). Thus, the carrying amount is R450,000 - (2/10 * R450,000) = R450,000 - R90,000 = R360,000.

Considering reclassification to investment property, we look at the fair value on reclassification date. On 31 January 2022, the fair value is R450,000. The difference between the carrying amount and the fair value is R450,000 - R360,000 = R90,000. This is the revaluation surplus.

To calculate the deferred tax on this surplus, we use the tax rate of 28%, applied to the inclusion rate for capital gains tax, which is 80%: R90,000 * 28% * 80% = R20,160.

Since the fair value is higher than the carrying amount, a deferred tax liability arises, making it option B. R23,520 (liability).