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1、十 Investment Tools: Financial Statement Analysis: Liabilities1.A: Analysis of Income Taxesa: Define the key terms used in accounting for income taxes.Tax return terminology:1. Taxable income: Income based upon IRS rules that determine taxes due. 2. Taxes payable: The taxes due the government determi
2、ned by taxable income and the tax rate. This is also referred to as “current tax expense or benefit”. 3. Income tax paid: Actual cash flow for income taxes, including payments or refunds for other years. 4. Tax loss carryforward: The current net taxable loss that is used to reduce taxable income (th
3、us taxes payable) in future years. Financial reporting terminology:1. Pretax income: Income before income tax expense. 2. Income tax expense: The expense recognized on financial statements that includes taxes payable and deferred income tax expense. Thus income tax expense is not just what is owed a
4、s indicated on the tax returns. 3. Deferred income tax expense: The difference in income tax expense and taxes payable that results from changes in deferred tax assets and liabilities. Each individual deferred item is expected to be paid (or recovered) in future years. 4. Deferred tax asset: Balance
5、 sheet amounts related to the difference in tax expense and taxes payable that are expected to be recovered from future operations. 5. Deferred tax liability: Balance sheet amounts related to the difference in tax expense and taxes payable that are expected to result in future cash outflow. 6. Valua
6、tion allowance: Reserve against deferred tax assets based on the likelihood that those assets will be realized. 7. Timing difference: Results from a transaction being treated differently (timing or amount) on the tax return and financial statements. 8. Temporary difference: Differences between tax a
7、nd financial reporting that will affect taxable income when those differences reverse. Slightly broader than timing differences. b: Explain why and how deferred tax liabilities and assets are created.A deferred tax asset occurs when taxable income exceeds pretax income and this difference will rever
8、se in the future. For example, pretax income includes an accrual for warranty expense but warranty cost is not deductible for taxable income until the firm has made actual expenditures to meet warranty claims.Example: Let a firm have sales of $5,000 for each of two years. It estimates that warranty
9、expense to be 2% of year 1 sales or $100. No warranty is given for year 2 sales. The actual expenditure of $100 to meet warranty claims was not made until the second year. Assume a tax rate of 40%. Taxable income for two years appears below.Year 1 Year 2Revenue $5000 $5000Warranty expense 0 100Taxab
10、le income 5000 4900Taxes payable 2000 1960Net income 3000 2940In this example: year 1 tax expense (on financial statements) is $1,960 although taxes payable is $2,000. The difference of $40 (taxes paid greater than tax expense) is a deferred tax asset. In the second year, the temporary difference as
11、sociated with warranties is reversed when tax expense of $2,000 is $40 more than taxes payable of $1,960.c: Describe the liability method of accounting and deferred taxes.In the US the liability method (SFAS 109) replaced the deferral method (APB 11) of accounting for tax expense. The deferral metho
12、d of calculating deferred tax expense using current tax rates with no adjustment for tax rate changes is now used in only a few countries. The liability methods focus is on the measurement of deferred tax assets or liabilities associated with temporary (reversing) differences in taxable income (IRS)
13、 and pretax income (GAAP). The deferred asset or liability is measured at the tax rate that exists when the reversing event occurs (usually the current tax rate) and deferred tax expense is the sum (difference) of the increase (decrease) in the deferred tax liability and taxes payable. The major dif
14、ference between the deferral method and liability method is the treatment of changes in tax rates. The deferral method is unaffected by changes in tax rates while the liability method adjusts deferred assets and liabilities to reflect the new tax rates.d: Explain the factors that determine whether a
15、 companys deferred tax liabilities should be treated as a liability or as equity for purposes of financial analysis.If deferred assets or liabilities are expected to reverse in the future, then they are best classified as assets or liabilities. If however, they are not expected to reverse in the fut
16、ure, then they are best classified as equity. Deferred taxes in many cases (firm growth, changes in tax laws, or firm operations), may be unlikely to be paid. Even if they are paid, deferred taxes should be carried at present value (they are not). If it is determined that deferred taxes are not a liability (i.e., nonreversal is certain), then deferred taxes is stockholders equity. This decreases the debt-to-equity ratio, sometimes significantly. Sometimes, instead of reclassifying d
