Can someone help me with this. I m talking about deferred tax and valuation allowances. In one of the problems, in the disclosure for the firm’s effective tax rate and its reconciliation to the statutory rate, valuation allowance is taken as a reconciling item. I do not understand how valuation allowance can cause a difference between the effective tax rate and statutory rate. As far as my understanding goes, valuation allowance reduces the deferred tax asset and does not have an income statement impact. thanks in advance Sudeep
valuation allowance is a contra account to the DTA - that means that a change in the VA changes the DTA. From the equation: Income tax expense = taxes payable + change(DTL) - change(DTA) you can see that a change in the DTA leads to a change in income tax expense, which is on the income statement. Hence why valuation allowance is a way to manipulate earnings. edit: removed nonsense.
Statutory Tax Rate is the tax rate which is legally imposed on you by the government and Effective Tax Rate is what you end-up paying to the government. So if you increase the Valuation Allowance, you do so, if you think that you are not going to realize the deferred assets in the future, the above equation causes a Income Tax expense to rise. Realization of a DTA is dependent on whether there will be sufficient future taxable income, which could be easily controlled by the management… Do despite, the Statutory Tax Rate of an corporate entity being 30%, the corporate can end up paying more or less taxes by controlling the VA (and hence controlling the delta of DTA) Dunno if I sound correct, but this is what I think!! - Dinesh S
dinesh.sundrani Wrote: ------------------------------------------------------- > Statutory Tax Rate is the tax rate which is > legally imposed on you by the government and > Effective Tax Rate is what you end-up paying to > the government. > —actually, statutory tax rate is the one you end up paying…remember, statutory tax rate is the one the government imposes on you and you have to pay that for tax reporting on the other hand, because of different allowed deductions or accounting methods used, or gain/loss realized on book but not allowed for tax deductions, your pretax income might be different from your taxable income, so there are deferred taxes to take care of the temporary difference, but for permanent differences, there is no treatment, so that’s why the effective tax rate is different from the statutory one for example, for simplicity, say you have some fixed asset, worth 1000, (0 salvage) 5 yr lift, straight line for financial and double declining for tax, and 2000 revenue in yr 1, stat tax rate 30% so for tax based, taxable income = 2000 - (1000*0.4) = 1600, so for 30%, you have tax payable of 480 now for financial, pretax income = 2000 - (1000/5) = 1800 DTL = (400-200)*0.3 = 60 income tax expense = tax payable + DTL = 480+ 60 = 540 hence, reported effective tax rate is 540/1800 = 30% same as stat rate, cos you don’t have any permanent differences but supposed you have 100 of those tax exempt interest from those municipal bonds, your tax based calculation doesn’t change, but your financial pretax income will change, pretax income = 2000 - (1000/5) + 100 = 1900 but DTL and income tax expense to not change, so your effective tax rate is 540/1900 < 30% —maybe you want to post the problem?..is it a question from schweser? > So if you increase the Valuation Allowance, you do > so, if you think that you are not going to realize > the deferred assets in the future, the above > equation causes a Income Tax expense to rise. > > Realization of a DTA is dependent on whether there > will be sufficient future taxable income, which > could be easily controlled by the management… > > Do despite, the Statutory Tax Rate of an corporate > entity being 30%, the corporate can end up paying > more or less taxes by controlling the VA (and > hence controlling the delta of DTA) > > Dunno if I sound correct, but this is what I > think!! > > - Dinesh S
Thanks for the posts guys that was really helpful. reading through your post, dinesh, you said “Do despite, the Statutory Tax Rate of an corporate entity being 30%, the corporate can end up paying more or less taxes by controlling the VA (and hence controlling the delta of DTA)” but i think the VA will only affect the Income tax expense line in the P&L and cannot control the amount of tax that will be paid by the company. I feel that the tax is paid based on the Taxable income which wont be affected by Valuation allowance. If at all, valuation allowance will widen or shorten the gap between the company’s effective tax rate (income tax paid/pre tax income) and the statutory rate. thanks, Sudeep
sudeep.ellath Wrote: ------------------------------------------------------- > Thanks for the posts guys that was really helpful. > > > reading through your post, dinesh, you said > > “Do despite, the Statutory Tax Rate of an > corporate entity being 30%, the corporate can end > up paying more or less taxes by controlling the VA > (and hence controlling the delta of DTA)” > oops sorry, that is what I meant (but framed the sentence incorrectly) … It indeed controlls the gap between effective and statutury rates. - Dinesh S