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Thread: Smoothing Liability

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    Smoothing Liability

    Hi Guys,

    Each year a financial audit is conducted on the company I currently work for.
    I've notice an account called smoothing liability, which relates to a 5 year finance lease agreement. Each year there is either a debit or credit to the income statement and balance sheet.

    What I'd like to know, is how is it calculated and why?

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    Silver Member geraldenek's Avatar
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    Hi JKS

    It is an IFR's standard were the total lease including yearly increases gets calculated for the 5 year period and then devided by 5 again to get the amount for the year.

    This amount has got nothing to do with tax and will be taken off the tax calculation and the correct amount incurred for the year will then be deducted.
    Geraldene Kapp
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    www.mytaxhelp.co.za

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    Gold Member Mark Atkinson's Avatar
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    Hi JKS,

    I think what Geraldene is saying is the following:

    The correct accounting treatment of an operating lease is to record what we call equalised lease payments each year in your Statement of Comprehensive Income (Income Statement), as opposed to the actual payments for the year. The equalised lease payments, as Geraldene has pointed out, equal the total lease liability divided by the total number of lease payments.

    To my knowledge the smoothing account is used to record the differences each year between the actual lease payments and the equalised payments.

    So as an example:

    Say after determining your equalised lease payments, in the current year it happens to be R2000 higher than your actual lease payments.

    This would result in a Debit to the Income Statement (Increasing the lease payment from actual to equalised) and a corresponding Credit to the Balance Sheet (the smoothing account) to the amount of R2000.

    The effect is obviously exactly the opposite if the actual payment is more than the equalised payments.
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    Dave A (30-Aug-11), JKS (31-Aug-11)

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    Silver Member geraldenek's Avatar
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    Thanks Mark - sometimes i'm not that good in explaining things.

    also want to mention that from last year it changed and only companies who need to comply with full IFR's needs to do this. As for SME's (which is most of the cases for companies) don't need to do this anymore.
    Geraldene Kapp
    Professional Tax Help
    www.mytaxhelp.co.za

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    Mark Atkinson (30-Aug-11)

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    Site Caretaker Dave A's Avatar
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    So essentially this applies to leases with a set escalation clause over the period of the lease?
    The trouble with opportunity is it normally comes dressed up as work.

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    Gold Member Mark Atkinson's Avatar
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    Quote Originally Posted by Dave A View Post
    So essentially this applies to leases with a set escalation clause over the period of the lease?
    Yip. It would apply to any operating lease where not every payment is equal.
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    Diamond Member wynn's Avatar
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    This is obviously used for a business trading in a Mall where a portion of the lease is tied to the turn over (say R1,000 per m2 and 5% of turnover)
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    I completely understand it now. thanks guys

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    Silver Member geraldenek's Avatar
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    Quote Originally Posted by wynn View Post
    This is obviously used for a business trading in a Mall where a portion of the lease is tied to the turn over (say R1,000 per m2 and 5% of turnover)
    Hi Wynn

    No you do it with lease agreements that is more than one year with a fixed percentage esculation. If the lease merely says "increases in line with CPI" then it would not need to be smoothed.
    Geraldene Kapp
    Professional Tax Help
    www.mytaxhelp.co.za

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    Diamond Member wynn's Avatar
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    Quote Originally Posted by geraldenek View Post
    Hi Wynn

    No you do it with lease agreements that is more than one year with a fixed percentage esculation. If the lease merely says "increases in line with CPI" then it would not need to be smoothed.
    These are 5 year leases and the rate is partly calculated on 5% of the business turnover so you may have 30m2 @R1000.oo=R30,000.oo and if your turnover is R300,000.oo you pay an additional R15,000.oo so your total rent is 45,000.oo but next month your turnover is 350,000.oo your rent will increase by R2,500.oo
    It would also decrease proportionally if you have a bad month.

    I don't know if all Old Mutual Properties follow this formula but Vincent Park in East London does. (My figures are thumbsucks though)
    "Nobody who has succeeded has not failed along the way"
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    Read the first 10% of my books "Didymus" and "The BEAST of BIKO BRIDGE" for free
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