deferred tax accounting

Hi all, Even though this may be a stupid question, but can someone walk me through the rationale of the accounting effect on deferred taxes when there is a change in certain assets or liabilities. For example, 1). when “liability for pension benefits” increase by X, deferred income taxes decrease by X*tax rate 2). If inventory increases by X (due to previously miscounted inventory), deferred tax assets decrease by X*tax rate. Really appreciate the help. Thanks in advance!

  1. I need to think through this one and get back to you. 2. If you initially understated ending inventory, then you overstated COGS, which resulted in lower reported gross profit, lower taxes, and lower net income. As a result, I believe you would debit inventory, credit retained earnings for the change in COGS *(1-tax rate) and either credit DTA by the change in COGS * tax rate or perhaps credit DTL by the change in COGS * tax rate. I’m not sure about crediting DTA, I think it might be a credit to DTL. Curious to know what somebody else thinks.

Thanks for the comments, mdblanton. Anyone else…

Well first let’s ask: What is the relationship between a deferred tax asset and a pension liability? IMHO, there is no relationship whatsoever, because while contributions to the pension fund are fully tax deductible (I think within limits per employee), no deferred tax asset is created just because the liability goes up or down. Think of the pension liability like a simple loan that has to be paid via pension contributions. Do loans have any effect on the deferred tax asset account- The answer is no. Deferred tax liabilities arise due to differences between tax and book, while deferred tax assets typically arise from expected tax credits, NOL carrybacks, and carryforwards.

phBOOM Wrote: ------------------------------------------------------- > Hi all, > > Even though this may be a stupid question, but can > someone walk me through the rationale of the > accounting effect on deferred taxes when there is > a change in certain assets or liabilities. > > For example, > > 1). when “liability for pension benefits” increase > by X, deferred income taxes decrease by X*tax > rate > The section mainly dealing with this has to do with the switch from pre-2006 US GAAP standard to post-2006 standard. Pre-2006 The balance sheets of companies didn’t truly reflect the funded status of defined benefit retirement plans. This was due to the fact that when certain events happened (prior service cost chages, acturial change, etc) they were not immediately recognized. They were carried “off the financials”. These changes were then amortized back into the financials over time (ran through the income statment and to the balance sheet). For example, if the life expectancy of employees was increase (actuarial chagnge) then the pension liabilty (PBO), and consequently the net pension liability, would go up because the company would be on the hook for paying out benefits for a longer amount of time (so the PV would increase). So this actuarial loss is slowly recognized over time. Jump forward to post-2006, now companies are required to carry the funded amount of the plan on their balance sheet. So if the same actuarial change happened they would be required to recognize it immediatly. The examples in the text are dealing with how the company would reconcile these differences when the rule change happened. When the change from pre-06 to post-06 happens all the unrecognized losses from the pre-06 days must be recognized now. This leads to an immediate increase in the liability for pension benefits. Because A=L+E must balance, something else must happen. The after-tax adjustment is made to stockholders equity in other comprehensive income. I don’t fully understand why it is the after-tax value, maybe someone else could help there. My guess would be that it is like you are running everything through the P&L right at once (which you don’t actually) so you are using an after-tax number??? In any event, if you pension liabilty went up 100 then you figure out the after tax cost by: (100*[1-tax rate]). So if the tax rate is 40% then equity is reduced by 60 and DTL is reduced by 40 to make it balance. Note: Strangely nothing changes for the income statement, only the balance sheet.

CPA Response: mwvt9 is completely correct; I just want to extend on his/her explanation. Pension liabilities will increase as pension beneficiaries increase their claims on the company’s resources (aka, they work long enough to vest). As their claim increases, the owners’ claim will decrease. However, because both payments to pension funds and direct benefit payments to retirees are tax deductible (like the tax shield for interest payment), part of the liability will be absorbed by a reduction of taxes, and the owners’ claim to company resources (equity) will not fall by the full liability. Change in Pension Liability = Change in Pension Liability*Tax Rate [aka, Deferred Tax Change] + Change in Equity [accounting plug] Note: Do not confuse taxable events with financial statement events. Pension expense is recognized in the period in which the service is performed (+/- unimportant extraneous adjustments), but tax benefits of those expenditures will only be recognized when payments are made to funds/retirees (+/- unimportant tax adjustments) at a later date. The result is delay of the tax shield on current pension expenses until the future when cash expenditures are made and (resulting in a decreased deferred tax liability). For deferred taxes in general, deferred tax liabilities are beneficial as the company received a benefit in the current period but will not have to pay taxes until a future period. Thus, when a company is increasing its deferred tax liabilities, it is being effective at postponing its tax payments. Consequently, when the pension liability increase causes deferred tax liabilities to decrease, do not think of this event as positive (as in, the company will have less taxes to pay in the future), but rather in a negative light (as in, the company is speeding up its average tax payments). To sum up [memorize this and you’ll be fine for pretty much any deferred tax question]: -when assets increase this period and you don’t have to pay taxes until the future: deferred tax liability increases or deferred tax assets decrease, this is good. -when liabilities increase this period and you don’t get the tax benefit/shield of recognizing expenses for tax purposes until the future: deferred tax liabilities decrease, or deferred tax assets increase, this is bad. While ‘deferred tax liability’ has a negative ring to it, only the IRS gets to take advantage of the interest earned on taxes paid early. Hope this clears some confusion.

please dont say this is back at l2 again!