A company has a net deferred tax asset of 40 million on its December 31, 20X6 balance sheet as a result of an asset impairment write-down that was taken during the year. During 20X7, the company learned that the statutory tax rate will be reduced from 40% to 35% effective on January 1, 20X8. Assuming that none of the impaired assets were sold or otherwise disposed of in 20X7, the effect of the change in the statutory rate on 20X7 income tax expense will be ( millions): a. $5 decrease. b. $2 decrease. c. $2 increase. d. $5 increase. - Dinesh S
I am going with C. Since it’s DTA and the tax rate is poised to decline, ur DTA goes down from (40*.4 = 16) to (40*.35=14). Thus, $ 2 increament in your income tax expense. Correct me if i m wrong.Thanks.
A? 0.35/0.4 * 40000000 = 35000000, which is a $5m decrease.
c tax rate down 5% dta down 5% to keep the balcne see equation equal… e must go down 5%… the only way for e to go down 5% is to increase your tax expense by 5%…
A company has a net deferred tax asset of 40 million on its December 31, 20X6 balance sheet as a result of an asset impairment write-down that was taken during the year. During 20X7, the company learned that the statutory tax rate will be reduced from 40% to 35% effective on January 1, 20X8. Assuming that none of the impaired assets were sold or otherwise disposed of in 20X7, the effect of the change in the statutory rate on 20X7 income tax expense will be ( millions): a. $5 decrease. b. $2 decrease. c. $2 increase. d. $5 increase. Old DTA = 40 M @ 40% New DTA = 35 M @ 35% Tax Expense = Tax Payable + Delta DTL - Delta DTA So Old Tax Expense was 40M Lower. New Tax Expense will be 35 M Lower So net effect is --> New Tax Expense has a 5M Increase --> Choice D CP
cpk123, you are correct but I don’t understand the explaination. - Dinesh S
The only change here is in the DTA, and when changing DTA/DTL for increase in tax rate, you increase/decrease the amount of the DTA/DTL by the magnitude of the move in taxes, not the absolute move…i.e. a change of tax rate from 50% to 40% is (50%-40%)/(50%) = 20%, not 50%-40%=10%. Since the tax rate is decreasing and the DTA is an Asset, the asset must decrease. Since the asset is decreasing, this will serve as an increase of expenses for the current period. Increase of expenses is (40%-35%)/(40%) = 12.5% * $40MM = $5MM and a likewise decrease of the DTA of $5MM to $40MM - $5MM = $35MM.
So, If we have a DTA and the Tax Rate decreases, then DTA also decreases and hence income tax expense will increase. likewise, if we have a DTA and Tax Rate increases, then DTA increases too and hence income tax expense will decrease. is this correct?? - Dinesh S
From what I understand, Yes! And it is the opposite for DTL.
Remember – 1. Income tax expense = Taxes payable + delta dtl - delta dta. 2. Both DTA & DTL are directly proportional to tax rates. So they will increase when tax rates increase & decrease when tax rates decrease.
get it now … Thanks finance03 and goel_ar for summing it up. - Dinesh S
Real world applicability of DTA…I cant believe it!!! 5:29PM General Motors to record non-cash charge of $39 bln for a deferred tax valuation allowance in its Q3 financial results (GM) 36.16 +0.16 : Co announced it will record a net non-cash charge of $39 bln for Q3 of 2007 related to establishing a valuation allowance against its deferred tax assets (DTAs) in the U.S., Canada and Germany. In accordance with the Financial Accounting Standards Board’s Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, GM has evaluated its DTAs quarterly to determine if valuation allowances were required. As previously disclosed in GM’s 2006 Form 10-K, GM had determined in prior periods that a valuation allowance was not necessary for its DTAs in the U.S., Canada or Germany based on several factors, including the degree to which the co’s three-year historical cumulative losses were attributable to special items or charges, several of which were incurred as a result of actions to improve future profitability; the long duration of its deferred tax assets; and the expectation of continued strong earnings at GMAC Financial Services and improved earnings in GM North America.
Great explanation finance03…Thx
i see what i did wrong i just took 40% - 35% and then multiplied that by 40… to get 2 mill expense… so we should take the % change… i got it now thanks guys/ gals