Studying for Dec. '09 Level I exam and I am getting clobbered by the Income Tax section in the Financial Reporting and Analysis reading (as provided by CFAI). I have Schweser notes orderd and on the way but in the meantime looking for any additional resources to help me understand this seemingly acrane subject area. Thanks! Congrats to all who just finished the exam. Your hell just ended (at least for a moment) and mine is just begining!
probably the worst reading in l1 i had to go at it a couple of times to get it, schweser is a lot more clear than CFAI who jumps right into an example from page 1. use both.
use schweser to understand the concept, but make sure you also cover the CFAI material, especially the EOC questions. Don’t let it discourage you. You have time. Take as long as you need on this SS, there are few others that will require more time. Maybe move on to SS10 and then come back to it. I separated the tax reading from the lease reading - let your brain rest between those sections : ) trust me - we feel you.
Terrible reading, drill through it finished off SS9 and just sit in-front of a question bank until your at approx 50%. Then revisit the chapter, it will make much more sense.
Schweser is necessary. Don’t even look at CFAI except to do the end of reading questions.
these guys are coming out with their sample income taxes chapter soon. Its the reading thats ‘coming next’ apparently http://www.elanguides.com/samples.php Let us know what you think…
Thanks to all for the great input. Feels much better knowing this reading/topic seems to cause universal pain.
I may be heavy biased towards finding FRA in generally really easy having passed the CPA and work in a big 4, but income taxes isn’t so bad. Main thing you should do is try to look at it big picture. Why does the company create a DTA or a DTL? Goes back to accrual accounting and is driven by the fact that what they report on their income statement is accrual accounting and tax returns are generally cash basis. So if they paid tax of $1000 based n their TR, and tax of $500 on their income statement, $1000 cold cash went out the door, but they only recorded $500 hitting their bottom line for financial reporting purposes. So they must balance out by recording a $500 asset (DTA) which will be recognized in the future. It’s a prepaid tax asset basically (deferred consumption). Exact opposite scenario for DTL. They claimed $1000 as a tax expense on I/S but only paid $500 out the door. $500 will need to be the plug as the balance owed to the govt but not yet paid. So just ask yourself how much they paid for tax purposes vs. financial reporting purposes and then logically fill in the gap as to whether it’s an asset or liability. As to the specifics, I don’t think CFAI really grills you too hard on the exact types of transactions that create these temporary and permanent differences, you can usually figure it out based on the questions. It’s fairly straightforward though. If it will reverse in the future (ie: was created simply by a timing difference of 10 years of depreciation for the IS and 5 years on the tax return) its temporary. Tax-exempt bond: permanent. One method I developed that I found pretty invaluable for solving these problems was the “Income Tax Square”: TI x SR = TP +DTL -DTA (net of valuation allowance) PTI x ETR = ITE Just plug in all info you know, then you can work up/down and across just like excel and back into any other information. TI = taxable income, SR = statutory rate, TP = taxes payable. PTI = pretax income, ETR = effective tax rate, ITE = income tax expense. BTW it becomes clearer looking at this how the B/S and I/S relate, how taxable income and pretax income, and how taxes payable and income tax expense are developed. Note the top line is all BS bottom line is all IS - difference is purely driven by DTL/DTAs. Good luck, it’s tough but will all make sense in the end!
I think the main thing you need to know in this section is that when the financial statement has pre-tax income greater than taxable income; then you pay less taxes than you should have(always using the financial statement as the base). Hence you will have a deferred tax liability. The flip is also true, when taxable income is greater than financial statement pretax income, you paid more than you should have, and you have a deferred tax asset Know that Income Tax Expense = Income Tax Payable + Change in Liability - Change in Asset. ( You dont need to memorize this formula, if you know the journal entry. Expenses are always debited, as well as assets. Liabilities and Payables are credit accounts) The only other important thing to know is that this only happens for temporary differences, as permanent differences never revert. When taxes change, the assets and liabilities move in direct proportions. I may be missing something, but I think this is the main meat of this section. Best of luck