Analyzing the Tax Rate in Financial Reporting Procedures

1. Analyzing the Tax Rate ACTG 6920 Session 3 Professor Kile

2. Analyzing the Tax Rate The Tax Expense reported on the income statement is a taxable amount based upon earnings as measured by GAAP. The amount of taxes actually paid is a taxable amount based upon earnings as measured by Tax Code.

3. Analyzing the Tax Rate The amount of taxes paid on the income statement is a GAAP (financial reporting) Measure- not the actual amount of taxes Paid.

4. Analyzing the Tax Rate To determine the amount of taxes actually Paid, one must find “Current Tax” in the Footnotes. Examples: Pacific Sunwear of California Buckle

5. Creating a Tax Worksheet • Open the tax spreadsheet; • Create a table containing the marginal tax rates • Federal = 35% • Additional State Taxes = ( + ) • Foreign Differential * = ( - ) • Create a table containing the effective tax rates • Create a table containing the actual tax rates

6. Calculating the Tax RateActual (Current)

7. Calculating the Tax Rate Effective Tax Rate = Tax Expense divided by Earnings Before Tax Example: Kohls

8. Calculating the Tax Rate Problems with using the Effective Rate Examples: Citigroup (2006 – 2008)

9. Calculating the Tax Rate - Default

10. Calculating the Tax Rate An alternative is to consider the default Rates. Example: Phillips-Van Heusen But, sometimes these are given in Amounts Examples: Citi Trends Pacific Sunwear of California

11. Indirect Evidence – Tax Footnote Tax Deferred Asset: Created when IRS>GAAP Tax Deferred Liability: Created when GAAP>IRS

12. Big Bath – Tax Valuation A build up of Deferred Tax Liability may signal a revenue or earnings quality issue.

13. Indirect Evidence of Revenue Quality Build-up of Tax Deferred Liabilities: Over time, GAAP income & IRS income should mostly balance out and thus, track each other. Build-ups of Tax Liabilities could indicate that companies are accelerating the recognition of revenue or are managing earnings upward.

14. Indirect Evidence of Revenue Quality Such build-ups in Tax Liabilities occurred During the 1990s, prior to the market “corrections” of 2000 – 2002 and during the years prior to the 2008 market decline. According to CFO Magazine, the gap between the two numbers rose from Negligible in 1992 to $93 billion in 1996 To $160 billion in 1998 (1/4th of reported income)

15. Big Bath – Tax Valuation A build up of Deferred Tax Assets may signal a big bath

16. Big Bath – Tax Valuation A Tax Valuation Allowance occurs when asset realization is doubtful. (remember that “assets are expenses waiting to happen”). When the valuation is removed It becomes an immediate expense. EXAMPLES: Men’s Wearhouse, General Motors, Citigroup