ACCA Taxation (F6) Practice Exam

What is the definition of a balancing allowance?

1. Profit on sale of asset

2. Loss on sale of asset

3. Neutral effect on account

4. Additional charge on profits

The correct answer is: Loss on sale of asset

A balancing allowance arises when an asset is sold for less than its tax written down value at the time of the disposal. This situation represents a loss on the sale of the asset for tax purposes. When a business disposes of an asset, the tax written down value reflects the cost of the asset, adjusted for any capital allowances that have been claimed over the years. If the selling price of the asset is less than this value, the business can claim this loss against taxable profits, resulting in a reduction of tax liability. In this context, a balancing allowance effectively allows the taxpayer to recover some of the initial investment in the asset through their tax filings, reflecting the economic reality that the asset did not generate expected returns. This is particularly relevant for businesses managing their taxable profits and cash flow. The other options relate to different scenarios: profit on the sale of an asset would normally not result in a balancing allowance but rather an adjustment to taxable income, while a neutral effect on account and an additional charge on profits do not describe the mechanism involved in balancing allowances accurately.