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Discussion > Accounts > Others >

Valuation of goodwill - capital employed

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Audit Assistant


[ Scorecard : 46]
Posted On 13 February 2012 at 13:33 Report Abuse

Preference Capital

Hello..  I would like to know why we do not deduct preference capital when calculating capital employed in the valuation of goodwill. Pref capital is similar to debentures. The shareholders cannot get any return other than the agreed interest rate. The funds from the pref capital subscripttion are also used in the business so why is not deducted? . 

Provision for tax

There seems to be a difference in the calculation of tax provision when calculating for FMP and capital employed. I would like to know why the manner of calculating tax differs. I have currently understood that the tax provision in capital employed refers to the past period whereas in FMP it is for the future period.

Income from Non operating assets - tax effect - Capital Employed

I have currently understood that the reason income from non-operating assets are taxed when preparing capital employed is because the income is received in cash and used in the business. Hence, included in cash/operating assets as the case may be.

Assuming Income from non-operating assets is reinvested. In the following cases Would the tax provision on the non-operating income be excluded when calculating capital employed.

a. Non operating income expended for non-operating expenses

b. Non operating income used for Non operating assets

Thank you very much for your time 


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Jithin
Learner


[ Scorecard : 717]
Posted On 15 February 2012 at 21:48

Answer to Q No.1

 

Why preference share capital isnt deducted: Because it is part of the capital employed. Simple as that!

 
Why preference share capital is not a liability whereas debunture is a liability: Yeah it is true that preference share capital is repayable(in the case of redeemable pref shares) & provides a fixed amount of periodical payment to its holders, similar to debuntures. But does that make preference share capital a liability like debuntures? Definitely not. There are several factors which distinguish pref. shares from debuntures. But the most simple & striking feature according to me which helps us to identify pref shares  as capital & debuntures as a liability, is the manner of payment to the stakeholders. The interest on debuntures is a charge to P&L a/c & is payable whether the company is making profits or not. On the other hand, pref dividend is an appropriation of profits & can be paid only when adequate profits are available. The return the preference shareholders get on their investment is in the form of a share in the profits of the company. If u invest money in a business entity & get a return in the form of profit share, ur investment is in the nature of capital. This is a fact regardless of the form of the entity in which u r investing, which may be sole proprietorship,partnership,company, etc. Hence the amount contributed by preference shareholders is capital just as in the case of equity shareholders. The fact that they receive a fixed amount of dividend & arent conferred voting rights doesnt make their contribution a liability.
 
Q.No.2
 
Actually the answer lies in ur question itself. We know that FMP is the profits that we expect in future. While estimating FMP, we may use historical data,e.g. FMP calculated as an average of previous years' profits. But it is just because we cant foresee the actual profits we are going to earn in future. If u have info about any of the future events  which will have an impact on the future profits, u should use it in the calculation of FMP. For example, if the tax rate is likely to change in the future, u have to use the revised rate instead of the present rate. But for the purpose of capital employed, u have to use the current tax rate. Here the tax provision cant be calculated at the tax rate likely to prevail in the future ,as in the case of FMP, since we are computing the 'capital employed' of the present & not of the future.
 
 
I didnt get ur 3rd doubt..may be bcoz I havent seen any G/W valuation problem involving income from non-operating assets. But if u elaborate ur doubt a bit thru an example, I will try to answer.



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