Analysis of Income Taxes and Employee Stock Options

1
Analysis of Income Taxes and Employee Stock
Options

• Chapter 14
• UWYO COB ACCT2000

2
Learning Objectives

• Deferred taxes
• Understand
• deferred tax expense
• deferred tax liabilities
• deferred tax benefit
• deferred tax assets
• Make necessary adjustments to these accounts
• Stock-based compensation is not required

3
Deferred Income Taxes - Concepts

• Income tax expense should be based on the firms
  book income
• Income tax payment is based on the firms tax
  income
• Current deferred tax expense is the difference
  between 1 and 2
• Deferred income taxes liabilities are the
  cumulative amount of 3

4
Deferred Income Taxes An example

• Inputs
• Historical value 500,000
• Salvage value 0
• Useful life 5 years
• Book depreciation method
• straight-line
• Tax depreciation
• Accelerated (rates from IRS)
• Compare book and tax depreciation
• Total tax depreciation Total book depreciation
• In early years tax depreciation gt book
  depreciation
• In late years tax depreciation lt book
  depreciation
• Page 593-596

5
Deferred Income Taxes An Example
6
Deferred Income Taxes An Example
More examples P14-11and P14-17
7
Deferred Income Taxes - Timing Differences
8
Deferred Income Tax - Timing Differences

• Revenues recognized for book purposes before they
  are taxable
• Installment receivables are taxable when payment
  is received
• Revenues are taxable before they are recognized
  for book purposes
• Subscriptions collected in advance are taxable
  when payment is received
• Expenses that are deductible before they are
  recognized for books purposes
• MACRS depreciation for tax, straight-line for
  books
• Expenses recognized for books purposes before
  they are deductible
• Cannot estimate product warranty costs for income
  tax purposes deduct actual expenditure

9
Deferred Income Taxes - Basis Differences

• Deferred tax assets
• Tax credits reduce asset basis and depreciation
  deductions
• Deferred tax liabilities
• Currency indexing (in some jurisdictions) allow
  greater deductions
• Deferred tax assets or liabilities
• Business combinations accounted for using the
  purchase method

10
Deferred Income Taxes - Permanent differences

• Revenue and expenses with no tax effect
• Tax-free interest (see P14-16)
• Non-deductible fines and penalties
• Permanent differences
• Not recognized as deferred assets or liabilities
• Cause the effective tax rate to differ from the
  statutory rate
• Reconciled in the notes to the financial
  statements

11
Calculating Deferred Income Taxes

• Identify cumulative temporary differences
• Determine applicable tax rate
• Temporary difference tax rate deferred tax
• Adjust the balance sheet account(s)
• Change in deferred tax balance is an element of
  deferred tax expense

12
Adjustments for valuation allowance

• Balance sheet
• Deferred tax assets valuation allowance
• Retained earnings valuation allowance
• Income statement
• Tax expenses - ? valuation allowance
• Net income ? valuation allowance
• See Case 14-1

13
Adjustments for tax rate change

• Tax rate ? net deferred tax liabilities
• Balance sheet
• Deferred tax liabilities amount due to rate
  change
• Retained earnings - amount due to rate change
• Income statement
• Tax expenses amount due to rate change
• Net income - amount due to rate change
• Tax rate ? net deferred tax liabilities
• Tax rate ? net deferred tax assets
• Tax rate ? net deferred tax assets

14
Other adjustments

• Reclassify between current and non-current
  deferred tax assets or between current and
  non-current deferred tax liabilities
• Recognize deferred tax liabilities or assets
  arising from tax-book basis differences that were
  originally thought to be permanent (hence no
  deferred taxes was recognized).

15
Summary

• Concepts
• deferred tax expense
• deferred tax liabilities
• deferred tax benefit
• deferred tax assets
• Adjustments
• Valuation allowance
• Tax rate change
• Current / non-current
• Permanent / temporary

16
Problems and Case

• Concepts
• P14-1 (B), P14-2 (A), P14-3 (D), P14-4 (A), P14-5
  (D)
• P14-11 1,000,000(40-20)3570,000 deferred
  tax liability
• P14-16 no temporary difference -gt no differed
  tax liability
• P14-17 tax depr(15.26)-book depr(9.51)5.57,
  deferred tax liab _at_ the end of 2000 is
  5.57352.0125
• Adjustments
• Comprehensive Case 14-1
• Valuation allowance P14-7 (B), P14-12 NI ? by
  1,000
• Current / non-current P14-8 (A), P14-10 (D)