Please explain

Friends, please help me understand the question. An analyst is comparing a firm to its competitors. The firm has a deferred tax liability that results from accelerated depreciation for tax purposes. The firm is expected to continue to grow in the forseeable future. How should the liability be treated for analysis purposes? A- It should be treated as equity at its full value. B-It should be treated as a liability at its full value. C- The present value should be treated as a liability with the remainder being treated as equity. It was even more difficult for me as I didn’t understand the options. Thanks!


I agree. Answer should “b.” Basically, if the company is expected to grow in the future, it will be able to earn enough to pay its liabilities. The question implies that the company’s deferred tax liabilities will neither grow nor remain on the balance sheet for the foreseeable future. If this were the case, then the deferred tax liability would actually be “equity-like” and the analyst would have to make the adjustment to equity (option “a”). I have seen a couple of different variations on this question, and they usually try to throw you off with the present value stuff - DTAs and DTLs do not involve any PV calculations. PV should be used only for finance leases, from what I remember. Hope this helps.

i do agree with B. the deferred taxes should be treated as an equity only if the analyst believes that the company will not be able to pay its liabilities in the foreseeable future

Do we have the answer here? I was thinking it was something different but dont’ want to share the opinion and muddy the waters.

It’s B because the deferred tax liability will reverse. When a DTL reverses, it needs to be paid off, so it should be treated as a liability.

turbolt Wrote: ------------------------------------------------------- > Do we have the answer here? I was thinking it was > something different but dont’ want to share the > opinion and muddy the waters. It never hurts to share your thinking. For all we know, you could be the right ONE! ansumania - can you confirm the answer per your test prep package?

All, That is what I was confused about. The answer is A. Please share your thoughts.

turbolt - if you were thinking the answer is “a,” please share your understanding of the subject. Thanks. I revisited the CFA reading on income taxes, and I still think the answer should be “b.” There is no “uncertainty” about the amounts and timing of tax payments, unless the question implies that. I guess you could argue that since this may be a growth firm, it has a higher business risk, and as a result, those tax liabilities will never be addressed (at least in the near future)?

I think this is more of a question of: “Is this def tax liability likely to reverse” Explanation: since you actually paid less taxes from the accelerated depr, growing business means depr will keep increasing , so you never really have to pay the deferred liability. I’m 70% sure

@iteracom if this is the case then when the def tax is likely to reverse? growth company means increasing revenues/ net income a growth company is not necessary increasing its asset base

The reason the answer is (a) IMO is that if by deferring the tax liability in effect the company has basically got a source of interest free funding for a certain period of time related to the depreciated asset. Since the company has good growth prospects, as an Analyst one would consider this as an ongoing reccurrence. Thus considered as equity.