ANALYSIS OF FINANCIAL STATEMENT

1. ANALYSIS OF FINANCIAL STATEMENT PRESENTEDBY: IQBAL AHMAD ABDAN(FCA) ABDAN & CO Chartered Accountants 2/37,39 Arkay Square Main Shahrah-e-Liaquat New Challi Karachi. Contact # 32424194-32423407 Friday September 09 2011

2. PLAN OF PRESENTATION Analysis of Financial Statements IAS relating to Tax Laws Inadmissibility under the tax laws. Tax Depreciation. Gain on Sale of Fixed Assets Conclusion and Question Answer session

3. Analyzing the Financial Statements • What does it mean and purpose? • Review the fairness and appropriateness. • Comparisons with previous and expected results. • Future strategy. • Analyzing the financial Statement with the perspective of Income Tax Ordinance 2001. • Key Financial Ratio • Balance Sheet Ratio (Current Ratio – Quick Ratio – Debt equity Ratio etc ..) • Profit & Loss Ratio (Gross Profit Ratio – Net Profit Ratio – Stock turnover etc..)

4. IAS Relating to Tax Law Relevant Income Tax Section IAS INCOME TAX • IAS – 1 Preparation of Financial Statement • IAS – 2 Inventories • IAS – 11 Constructions Contracts • IAS – 12 • Income Taxes • Section – 32 & Section 34 • Section – 35 • Section – 36

5. (Presentation of Financial Statement) IAS - I INCOME TAX (S-32 & 34) • Objective The Objective of this standard to prescribe the basis for presentation of general purpose of financial statement the principle of consistency and generally acceptable accounting principle. • Objective Subject to this ordinance a person’s income chargeable to tax shall be computed in accordance with the method of accounting regularly employed by such person.

6. METHOD OF ACCOUNTING IAS - I INCOME TAX(S 32 & 34) • Basis of Accounting The accounting standard states that an entity shall prepare its financial statements, except for cash flow information, using the accrual basis of accounting. • Basis of Accounting A company shall account for income chargeable to tax under the head “Income from Business” on accrual basis” While other person may account for such income on cash or accrual basis.

7. Basis of Accounting Cash Basis Income recognize when received and expense when paid. Accrual Basis Income and expense are recorded in the period in which they are due.

8. IAS-2 INVENTORIES INCOME TAX (S- 35) IAS -2 The IAS-2 relates to the inventories valuation and disclosures. Inventories should be valued lower of cost or net realizable value. The valuation method may be applied using FIFO or weighted average method. Income tax ordinance 2001 provides the same basis for valuation of stock as IAS-2 state. However the following treatment for valuation have also been prescribed. If CASH BASIS method of accounting adopted • Prime Cost Method or • Absorption cost method If accrual Basis method of accounting adopted absorption cost method will be followed

9. Continued…, IAS INCOME TAX Cost Formulas:- The Cost of inventories of items that are not ordinarily interchangeable and good or services produced and segregated for specific project shall be assigned by using specific identification of their individual cost. • Prime Cost Method The sum of direct material cost direct labor cost and variable FOH. • Absorption Cost Method The sum of Direct Material Cost +Direct Labour Cost and FOH(Fixed plus variable)

10. CONSTRUCTION CONTRACT IAS 11 INCOME TAX (S-36) The objective of this standard is to prescribe the accounting treatment of revenue and cost associated with construction contracts. Contract revenue and cost associated with the construction contract shall be recognized by reference to the stage of completion of the contract activity. A fixed price contract is a Construction contract in which the contractor agrees to a fixed contract price or a fixed rate per unit of output, which in some cases is subject to cost escalation clause. A cost plus contract is a construction contract in which the contractor is reimbursed for allowable or otherwise defined costs, plus a percentage of these cost or a fixed fee. • Section 36 “Income from Business” on an accrual basis shall compute such income arising for a tax year on the basis of the percentage of completion method. • “Percentage of Completion Method” Means the principle under which revenue and expenses arising under a long-term contract are recognized by reference to the stage of completion of the contracts.

11. Income Taxes IAS-12 • The objective of this standard is to prescribe the accounting treatment for income Taxes. The principle issue is how to account for the current and future tax consequences of transaction and other events of the current period that are recognized in the financial statement.  Relevant terms: • Accounting Profit & Taxable Profit. • Deferred Tax. • Deferred Tax Assets & Deferred Tax Liabilities.

12. Income Taxes IAS-12 What is Accounting Profit & Taxable Profit ? Accounting profit is the profit disclosed by an entity in its financial statement however taxable profit is the profit that is determined applying the relevant tax rules to ascertain the taxable profit. What is deferred Tax ? Deferred Tax is any amount of tax that will be payable or deductible in future period when the carry amount of an assets or liability will be settled in accordance with the prescribed rules relating to accounting items. • What is Deferred Tax Assets & Deferred Tax Liabilities? Deferred tax assets The amounts of income taxes recoverable in future period in respect of carry forwards of unused tax credits or carry forwards of unused tax losses. Deferred Tax Liabilities The amounts of income taxes payable in future period in respect of taxable temporary differences.

13. INADMISSIBILITY UNDER THE TAX LAWS

14. Principles governing deductions • ONUS OF PROOF • Onus on the Taxpayer to prove that deduction claimed, is admissible under the law. • Burden to produce Sec 174 (2) • i) receipt • ii) evidence of transaction • iii) other record • iv) circumstances giving rise to claim of deduction OR. • v) reasonable cause of non-production of any of above

15. Principles governing deductions 3. Once onus discharge by tax payer, it will be shifted on the commissioner to prove with the definite information acquired from audit or otherwise S. 122(5). 4.Expenditure should relate to the tax year according to the method of accounting employed by the taxpayer. No past or future tax year relating expenditure is permissible. 5.Deduction allowable only if business carried out during the year in which expenditure is incurred. Business closed or discontinued before commencement of tax year, no deduction allowed.

16. Principles governing deductions 6.Expenditure allowable in computing taxable income only if incurred for the purpose of taxpayer own business. Expenditure incurred by the parent company for the benefit of subsidiary company cannot be allowed except relief available u/s 59B. 7.Profit of illegal business is taxable, expenditures incurred for carryout illegal business is also allowable. 8. Revenue expenditure and losses incidental to business and incurred during the course of business are admissible.

17. Principles governing deductions 9. Expenditure incurred wholly and exclusively for the purpose of business is permissible . 10.Secret Commission whether deductable in order to be entitled to deduction of payment made to persons whose names are not disclosed, the assessee has to: Establish the practice prevailing in that line of business for making such payment s; to adduce satisfactory evidence to establish the payment ;and to satisfy the authorities that the payment were made for the purpose of business. (Joshi v CIT , 209 ITR 324, 108 ITR 500, 137 ITR58, 25 ITR 102, 16 ITR 260)

18. DEDUCTION NOT ALLOWED Section-21 Cess,rate or tax levis on the profits or gain or assessed as percentage or otherwise of the profit or gain. S.21 (a) Any amount of tax deducted from the amount derived by the person , sales of goods, services, execution of contract , export,etc. s.21(b) Default of deduction or payment of tax on salary, rent, brokerage, Commission, profit on debt, payment to non resident, payment for service or fee S.21(c)

19. DEDUCTION NOT ALLOWED Entertainment expenses in excess of prescribe limit or violation of conditions. S.21(d), Rule 10. Contribution to unrecognized provident fund, unapproved pension fund, superannuation fund, gratuity fund. S 21(e) Contribute to employee beneficial fund and failure to make effective arrangement to secure tax deduction u/s 149 on the payment out of fund to the employee chargeable to tax s 21(f)

20. DEDUCTION NOT ALLOWED Any fine penalty paid or payable by the persons for the violation of law, rule or regulation S. 21(g) Personal expenditure incurred by the person. S.21(h) Any amount carried to reserve fund or capitalized in any way S.21(i) Any profit on debt, brokerage, commission , Salary or other remuneration paid by AOP to any member of the association. s.(21) (j)

21. DEDUCTION NOT ALLOWED Expenditure paid or payable under single account head in aggregate exceeding Rs. 50,000 paid otherwise than : Cross Cheque Cross bank Draft Cross pay order Other cross banking instrument s, Verifiable transfer of payment or Verifiable credit card payment Exemption/non applicability. Expenditure not exceeding Rs. 10,000/- Expenditure on account of utility bills.

22. DEDUCTION NOT ALLOWED Any salary paid or payable exceeding Rs. 15,000/-per month other than cross cheque or direct transfer of fund to the employee’s bank account S.21 (m) Any capital expenditure paid or payable other than allowed under the law. S.21 (n)

23. DEDUCTION NOT ALLOWED Expenditure relating to FTR income.S. 169 (2b).s. 67 apportionment, Rule 13. Expenditure relating to exempt income. Expenditure in violation of section 174(2). Capital losses other than allowed by the law, damage or destruction of capital assets, premium on redemption of debt, discount on issue of shares, loss on the sale of business, expenditure or losses before the commencement or after the closure or discontinue. That pre-commencement expenditures are allowed in accordance with section 25

24. DEDUCTION NOT ALLOWED Expenditure relating to any other head of income Anticipated future or contingent expenses or losses

25. SPECIAL ALLOWANCES Depreciation allowances S.22, 23, 23A Amortization of intangible S.24 Amortization of pre-commencement expenditures. S.25.

26. TAX DEPRECIATION

27. DEPECIABLE ASSETS “Depreciable asset” means any tangible movable property immovable property (other than unimproved land),, or structural improvement to immovable property, owned by a person that:- Has a normal useful life exceeding one year ; Is likely to loose value as result of normal wear and tear, or obsolescence; and Is used wholly or partially by the person in deriving income from business chargeable to tax, except the assets entire cost of which has been allowed as deduction in any other head.

28. Eligible Depreciable Assets Section 23(5). Eligible depreciable assets means a depreciable assets OTHER THAN- Any road transport vehicle unless the vehicle is playing for hire, Any furniture including fittings. Any plant machinery used previously in Pakistan, Any plant and machinery whose entire cost has been allowed as deduction under any other section in tax year of acquisition.

29. Depreciation Allowances Normal depreciation allowances.S.22 Initial depreciation allowancesS.23 First year depreciation allowances S.23A Accelerated depreciation to alternate energy project.S23B.

30. Initial Allowance Section 23. Initial allowance in the year in which eligible depreciable assets is used for the purpose of business for the first time or the tax year in which commercial production is commenced which ever is later, shall be allowable. Initial Allowances shall be computed by applying 50% rate to the Cost of the assets. In case of leasing company initial allowance shall be available to the extent of lease rental received in respect of such assets .

31. First Year Allowances Section 23A. Plant, machinery and equipments installed by the Industrial undertaking set up in the specified rural and under developed Area . Industrial undertaking is owned and managed by the Company First year allowances shall be computed at rate of 90% of the cost of the eligible depreciable asset put to use after July 1 2008, Federal Government may notify the specified area for the purpose of this allowance. First year allowance shall be lieu of initial allowance u/s 23.

32. NORMAL DEPRECIATION ALLOWANCES Depreciation allowances confined to person’s depreciable assets used in the persons business in the tax year.(owned and used in the tax year).s.22(1) Computation: Depreciation allowances shall be computed by applying the rate specified in part 1 of third schedule against the written down value of the asset at the beginning of the years. 22

33. NORMAL DEPRECIATION ALLOWANCES Where asset partly used for business and partly for private or personal purposes proportionate amount of depreciation Attributable to business use of the assets is allowed. 22(3) No depreciation if asset is disposed of during the tax year .s. 22(8) No depreciation for assets with one year normal life, however, allowed as revenue expenditures. Total Deduction allowed to a person during the ownership of a depreciable assets shall not exceed the cost of the assets .S .22(7)

34. Computation of Written Down Value WDV of New purchased depreciable assets in beginning of First Tax year: sec 22 (5a) cost of the asset to the person as reduced by the initial allowances u/s 23 / 23A (initial allowances are computed by applying prescribe rate on the original cost and normal allowances are computed by applying the prescribe rate on the WDV (Cost-Initial allowances). WDV of depreciable asset at the beginning of the subsequent year of years.Sec.22(5b) cost of the assets less total depreciation deduction including initial allowances allowed in the previous tax years.

35. Computation Of WDV Section 22(6) WDV of the depreciable asset partly used for business and partly for other purposes , shall be computed on the basis that the assets has been solely used to derived income from business chargeable to tax.

36. Depreciation to Leasing Company The leasing Company investment bank, a Moradabad Schedule bank or a development finance Institution are entitled to depreciation allowance in respect of assets owned and leased out to an other person only against the lease rental derived in respect of such assets. Leased shall be treated to be used by such lesser entiltled.s.22(12).

37. GAIN ON SALE OF FIXED ASSETS

38. Gain on Sale of Fixed Assets • Gain on disposal of depreciable asset is chargeable to tax under the income from business in year of disposal.(Gain is computed by deducting the WDV of the asset at the begging of the disposal tax year from the proceeds received. • Gain or loss of depreciable asset which is partly used for business and partly is used for other purpose is computed in the same manner except the normal WDV is increased by the amount depreciation not allowed attributed to other than business purposes.

39. Gain or loss on disposal of assets Sec 22(8) Gain on the disposal of depreciable of assets is chargeable to tax under the income from business in year of disposal. (Gain is computed by deducting by deducting the WDV of the asset at the beginning of the disposal tax year from the disposal consideration or proceeds received. Loss on disposal of depreciable assets is allowed as deduction in computing the person’ s income chargeable to tax in the year of disposal. Loss is excess of WDV over the disposal consideration/proceeds and computed by deducting the disposal proceed from the WDV of the asset.

40. Gain or loss on disposal of assets Gain or loss of depreciable assets which is partly used for business and partly is used for other purpose is computed in the same manner except the normal WDV is increased by the amount of depreciation not allowed attributed to other than business purpose. 22.(9)

41. Gain or loss on disposal Where depreciable asset used in Pakistan is exported or transferred out of Pakistan, shall be treated to have been disposed of at the time of export or transfer and consideration shall be treated to have been received equal to cost of the assets.s.22(14)

42. Rule for determination of cost of assets Section 76 Purchased assets (Consideration given , fair market value of consideration in kind , incidental expenses on acquisition and disposal, alteration and improvement cost). Personal assets applied to business used. (Fair market value) Self construction of assets (cost of production, incidental, alteration and improvement) Assets finance by foreign currency loan.(currency fluctuation gain or loss during the year for liability) Partial purchase of assets.(fair market value appointment) Acquisition of assets subject tax or exemption, cost shall be amount so charged or exempt plus amount paid by the person. Deduction or exclusion.(grant, subsidy, commission or other assistance to the extent not chargeable to tax) S.76

43. Rule for determination of consideration received Section 77. Total amount received or fair market value of the assets sold which ever is higher, including fair market value of any consideration received in kind. Compensation, indemnity or damages received under insurance policy, indemnity settlement, judicial decision or other agreement in case of assets loss or destroyed Assets discarded, ceased or applied to personal use, Fair market value of assets at the time. Residual value in case of leasing company except the residual value and amount realized value during the term of lease toward cost of the assets is not less than the original cost of the assets. In case of collective disposal of two or more asset in single consideration to be received apportioned according to their fair market value of each disposed of assets.

44. Rule for determination of consideration received (Section 22(13) (d)). Where the consideration received on the disposal of immovable property exceed the cost of the property , the consideration shall be treated as the cost of the property .

45. IAS Relating to Tax Law

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