Statement 1: When analyzing a firm’s effective tax rate reconciliation disclosures, analysts watch out for companies that report high income tax expense on their financial statements compared to taxes payable because such companies are more likely to be using aggressive accounting method and have low quality earnings. Statement 2: High effective tax rates may result when a firm has significant restructuring charges since restructuring charges do not generally have tax cash flow effects in the year they are recorded, but can have significant effects on future cash flows. Statement 1 & Statement 2 ? A. Correct & Correct B. Incorrect & Correct C. Incorrect & Incorrect D. Correct & Incorrect. Please give me your opinions on this question. Many thanks.
Not sure on 1.) gut says incorrect, heres why Inc tax exp = tpayable + (Change DTL - Change DTA) – if deferred tax liabilities go up, this can increase inc tax expense, and just because it goes up doesn’t mean earnings are low quality, such the case is typical for companies that use SL dep on I.S. vs Accelerated on Tax Return. 2.) restructuring is recorded on the I.S. in the year incurred but not charged to taxes until later, so this statement would be correct in that initially the tax return would have more taxable income and greater taxes payable. Not sure how this affects the actual tax rate, however, so ill have to go with incorrect again. This is just off the top of my head so don’t take it at face value.
Thanks MarkCFAIL, As I consider, both are incorrect since: 1). That higher income tax expense compared with taxes payable just can prove the company use accelerated depreciation method, LIFO method,…for tax calculating report. --> Can not conclude it use aggressive accounting or low quality earning. 2).Effective tax rate=income tax expense OR tax payable OR tax paid / Pretax income. However, the restructuring charge just create the deferred tax assets (as it is not included in tax calculating until it paid). And the differences in DTA just lead the deferred tax expenses–>Just increase tax payable compared with income tax expense, but not both. --> Effective tax rate is not affected by restructuring charges. Taking out from textbook, the effective rate is affected by: + Diffident statutory tax rate + Permanent differences bwn financial and taxable income: tax exempt income, tax credit, nondeductible expenses. + Effect of tax rate and other tax law changes + Deferred taxes provided on the reinvested earnings of foreign affiliates and unconsolidated domestic affiliates. (Actually I am not clear with this point). Thanks.