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Corporation tax
There is one aspect of corporation tax that you will regularly encounter in
company accounts, but which did not appear in Wingate’s accounts.
Deferred tax
As I said when we talked about tax in the last session, taxable income
is usually different from profit before tax. Frequently, this is because
Revenue & Customs make adjustments which, while they reduce the tax-
able income in the current year, will increase it in future years. In other
words, the amount of tax to pay does not change but the timing of the
payment does.
In such cases, companies allow for the fact that they may have to pay this
extra tax some time (which can be several years) in the future, by recog-
nising a liability to the taxman called deferred tax. You will see this on
balance sheets under long-term liabilities. It is really no different from
corporation tax, otherwise. Sometimes it works the other way around and
companies pay more tax now than you might expect from their profits and
less in future. In this case, the company would have a deferred tax asset.
Exchange gains and losses
Many major companies have dealings abroad which involve them in for-
eign currencies. There are two principal ways in which a company can be
affected by foreign currencies:
The company trades with third parties, making transactions which
are denominated in foreign currencies.
The company owns all or part of a business which is based abroad
and which keeps its accounts in a foreign currency.
Let’s have a brief look at each in turn.
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Trading in foreign currencies
Suppose you sold some products to a customer in the USA for $7,000 to
be paid 90 days after the date of the transaction. You would translate the
$7,000 into pounds sterling at the exchange rate prevailing on the day
of the transaction and enter the transaction in your accounts. Assume
the exchange rate was $1.75 to the pound; this would make the $7,000
worth £4,000.
When the American customer pays (90 days later), the exchange rate is
likely to be different. Assume it is $1.60 per £; this would mean that the
customer is effectively paying you £4,375, when your accounts say you
should be getting £4,000. By waiting 90 days to be paid, you have made a
profit of £375.
This profit is known as an exchange gain. Naturally, if the exchange
rate had gone the other way, you would have made an exchange loss. If
these exchange gains or losses are material, they will be disclosed in the
accounts of the company.
Presumably, if a large proportion of your sales are overseas, your profits could be
substantially affected by exchange gains or losses?
Yes, it’s a major issue for some companies. Such companies employ
people in their finance departments to hedge the exposure. This means
creating an exposure to the foreign currency in a way that is equal and
opposite to the exposure you have from the original transaction. Then,
whatever happens to the exchange rate, you should end up with the same
amount of money in your own currency.
You would be surprised, however, how many companies choose not to
hedge their exposure, in the hope of making an exchange gain. Effectively
they are speculating on the currency markets. This is what banks have
whole departments doing 24 hours a day. Ordinary companies really
should not be trying to beat the banks at their own game they won’t be
able to in the long run and are virtually certain to end up making more
losses than gains.

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