Fair Value or Impairment Accounting vs. Capital Account

Overview

When deciding between "All assets and liabilities that are subject to fair value or impairment accounting" and "All assets and liabilities held on capital account at the end of a Tax Period," it's essential to understand the nature of your business's assets and liabilities. Each approach suits specific scenarios based on asset type, accounting policies, and tax strategies.

Key Differences Fair Value or Impairment Accounting vs. Capital Account

All Assets and Liabilities Subject to Fair Value or Impairment Accounting

This option focuses on items that are periodically reassessed to reflect their current market value (fair value) or adjusted for impairment (a significant decline in value). Tax impacts are recognized based on these periodic adjustments, even if the asset isn’t sold.

Examples

Financial Instruments:

Stocks, bonds, or derivatives held for trading (e.g., public company shares).

Example: If you own AED 100,000 in shares and their value increases to AED 120,000 at year-end, the AED 20,000 gain is taxable.

Stock Inventory:

Adjusted to net realizable value if market prices drop below cost.

Example: AED 100,000 in inventory valued at AED 80,000 due to a market drop would recognize a AED 20,000 impairment deduction.

Machinery:

Subject to impairment testing if its recoverable amount drops below the book value (e.g., due to obsolescence or damage).

Example: A machine purchased for AED 100,000, now worth AED 60,000, triggers a AED 40,000 impairment deduction.

Investment Properties:

Adjusted annually to fair value under applicable accounting standards.

All Assets and Liabilities Held on Capital Account

This option covers assets and liabilities retained for long-term use or investment purposes. Tax is recognized primarily upon the disposal or realization of these items.

Examples

Stock Inventory:

Treated as an operational asset. Costs are deducted as inventory is sold, not based on market value adjustments.

Example: AED 100,000 in stock sold for AED 150,000 would recognize AED 100,000 as the cost of goods sold, with AED 50,000 as taxable profit.

Machinery:

Depreciated over its useful life as a long-term asset.

Example: A machine costing AED 100,000 depreciates by AED 20,000 per year over 5 years, reducing taxable income annually.

Property, Plant, and Equipment:

Held for business use and reported on the balance sheet until disposal.

Example: A property purchased for AED 1,000,000 and sold after 10 years for AED 800,000 would recognize a AED 200,000 loss at the time of sale.

Long-Term Liabilities:

Loans or bonds used to finance machinery or property investments.

Recommendation

Choose Fair Value or Impairment Accounting if:

Your business deals with assets sensitive to market conditions (e.g., financial instruments, fluctuating inventory prices). Impairment testing is a critical aspect of your accounting policies.

Choose Capital Account if:

Your assets are primarily long-term investments or operational in nature (e.g., machinery, property). You prefer a tax approach based on realization events, such as sales.

If you’re unsure which method to use, consulting an accountant or financial advisor can help align your accounting approach with your business needs and legal requirements. See our list of FTA approved accountants in UAE here.