Impact of tax rate change

[summer_bella]

Can someone please help me how to work this out?

On 1 April 2013, the company rate of income tax was changed from 35% to 30%. At the previous reporting date (30 June 2012) Montgomery Limited had the following tax balances:

• Deferred tax assets$26 250
• Deferred tax liabilities$21 000

What is the impact of the tax rate change on income tax expense?

increase $750 decrease $750 increase $875 decrease $875.

I tried but couldn’t get the correct answer.

thanks

[S2000magician]

The old DTA was $26,250 @ 35%; the new DTA will be $26,250 × 30% ÷ 35% = $22,500 @ 30%.

The old DTL was $21,000 @ 35%; the new DTL will be $21,000 × 30% ÷ 35% = $18,000 @ 30%.

Thus, ΔDTA = $22,500 – $26,250 = -$3,750; ΔDTL = $18,000 – $22,500 = -$3,000.

When the DTA decreases, income tax expense decreases; when the DTL decreases, income tax exense increases.

Thus, Δincome tax expense = ΔDTA – ΔDTL = -$3,750 – (-$3,000) = -$750; a decrease of $750.

(Fixed this.)

[zxfmontreal]

Hey I think you mixed the two numbers:

· Deferred tax assets$26 250

· Deferred tax liabilities$21 000

So the new DTA=26250*.3/.35=22500

The new DTL=21000*.3/.35=18000

Δincome tax expense = ΔDTL – ΔDTA=18000-21000-(22500-26250)=750

[S2000magician]

@zxfmontreal

Hey I think you mixed the two numbers:

· Deferred tax assets$26 250

· Deferred tax liabilities$21 000

So the new DTA=26250*.3/.35=22500

The new DTL=21000*.3/.35=18000

Δincome tax expense = ΔDTL – ΔDTA=18000-21000-(22500-26250)=750

I did, indeed.

Oops.

(Good thing _ I’m _ not taking this silly test!)

[summer_bella]

thanks guys.

Why did you divide 30%/35%?

[S2000magician]

@summer_bella

thanks guys.

Why did you divide 30%/35%?

When you originally computed the DTA and DTL, you calculated the timing difference – the difference between, say, depreciation for taxes and depreciation for financial statements – and multiplied that by 35% to get the tax effect. If the tax rate had been 30%, you would have multiplied by 30% instead. So, now that the tax rate has changed, you divide by 35% (to get back to the original timing difference: the difference in the original depreciation amounts), then multiply by 30% (as you would have done if that had been the tax rate).

[summer_bella]

thanks S2000magician. I get it now. If the tax rate increased to 40% instead of decreased to 30%, you would do the same and the answer is -750. right?

[S2000magician]

@summer_bella

thanks S2000magician.

My pleasure.

@summer_bella

I get it now.

Cool!

@summer_bella

If the tax rate increased to 40% instead of decreased to 30%, you would do the same and the answer is -750. right?

Yup.

[summer_bella]

Thanks

[S2000magician]

@summer_bella

Thanks

You’re welcome.

[passa11]

@S2000magician

@summer_bella

thanks S2000magician.

@summer_bella

If the tax rate increased to 40% instead of decreased to 30%, you would do the same and the answer is -750. right?

Yup.

i think answer should be +750, not -750.

correct me if I am wrong.

because DTA>DTL, so upward shift in tax rate means that increase in DTA is more than increase in DTL.

[Jwang1218]

@passa11

@S2000magician

@summer_bella

thanks S2000magician.

@summer_bella

If the tax rate increased to 40% instead of decreased to 30%, you would do the same and the answer is -750. right?

Yup.

i think answer should be +750, not -750.

correct me if I am wrong.

because DTA>DTL, so upward shift in tax rate means that increase in DTA is more than increase in DTL.

I believe that is correct. Increase in tax rate will increase both DTA and DTL. Vice Versa