Tomkins PLC is a British company that operates in three business sectors: industrial and automotive, air systems components, and engineering and construction products. Before 2005 Tomkins prepared its accounts in accordance with United Kingdom (U.K.) accounting standards. Like U.S. reporting, U.K. financial reporting is investor-oriented. As a result, British companies report different income amounts for tax and financial reporting purposes. British companies receive different tax treatment for such items as depreciation (capital allowances), and they receive tax credits for operating losses. In 2004 Tomkins reported income of ₤171.8 million and reported total shareholders’ funds of ₤1,398.7 million at year-end. Tomkins provided the following disclosures related to taxes in its annual report.
If Tomkins had used U.S. GAAP its income would have been higher by ₤96.1 million in the current year. Stockholders’ equity at year-end would have been ₤764.9 million higher if Tompkins had applied U.S. GAAP.
Reconciliation to Accounting Principles Generally Accepted in the United States of America (Unaudited)_Partial
The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United Kingdom (“U.K. GAAP”) which differ in certain respects from accounting principles generally accepted in the United States of America (“U.S. GAAP”). The following is a summary of the material adjustments to profit attributable to shareholders and shareholders’ equity determined in accordance with U.K. GAAP, necessary to reconcile to net income and shareholders’ equity determined in accordance with U.S. GAAP.
Reconciliation from U.K. GAAP to U.S. GAAP
3 January 2004
12 months
£ million
Profit attributable to shareholders
Net income under UK GAAP ........................171.8
U.S. GAAP adjustments:
Goodwill amortisation .............................11.9
Goodwill impairment ........................ ....(30.0)
Reversal of U.K. provision
for impairment ................................51.4
Intangibles amortisation ........................ ..(1.6)
Valuation of net assets acquired
in a business combination ...........................(0.2)
Gain/(loss) on disposal of operations .....................22.6
Pension costs ..............................3.4
Share options ........................ ......(4.0)
Capitalised interest ..............................2.2
Deferred income tax ........................ ....(2.1)
Derivatives ............................... 29.5
Restructuring costs ........................... 13.0
Net income under U.S. GAAP ......................267.9
Explanation of the deferred tax difference is as follows:
In Tomkins consolidated financial statements, deferred tax is provided in full on all liabilities. Deferred tax assets are recognized to the extent it is regarded as more likely than not that there will be suitable taxable profits from which the future reversal of the underlying timing differences can be deducted, and for this purpose Tomkins considers only future periods for which forecasts are prepared. Under U.S. GAAP, deferred taxes are provided for all temporary differences on a full asset and liability basis. A valuation allowance is established in respect of those deferred tax assets where it is more likely than not that some portion will not be realized. The look forward period is not limited to the period for which forecasts are prepared. Instructions
Use the information in the Tomkins disclosure (page 834) to answer the following.
(a) Prepare the journal entry that would be required to reconcile Tomkins’ income to U.S. GAAP for the differences in deferred taxes under U.S. and U.K. accounting standards.
(b) In light of the information disclosed, explain why you think Tomkins’ equity under U.S. GAAP would be higher at year-end in the current year.