Analyzing the Tax Rate

ACTG 6920Session 3Professor Kile

Analyzing the Tax Rate

The Tax Expense reported on the incomestatement is a taxable amount based uponearnings as measured by GAAP.

The amount of taxes actually paid is a taxable amount based upon earnings as measured by Tax Code.

Analyzing the Tax Rate

The amount of taxes paid on the incomestatement is a GAAP (financial reporting)Measure- not the actual amount of taxesPaid.

Analyzing the Tax Rate

To determine the amount of taxes actually Paid, one must find “Current Tax” in theFootnotes.

Examples:Pacific Sunwear of CaliforniaBuckle

Creating a Tax Worksheet

1. Open the tax spreadsheet;2. Create a table containing the marginal tax rates

Federal = 35%Additional State Taxes = ( + )Foreign Differential * = ( - )

3. Create a table containing the effective tax rates4. Create a table containing the actual tax rates

Calculating the Tax RateActual (Current)

2012 2011 2010

Current federal 590 497 561Current state 60 60 69Deferred federal (66) 124 35Deferred state (9) 11 3

$575 $692 $668

Calculating the Tax Rate

Effective Tax Rate =Tax Expense divided byEarnings Before TaxExample: KohlsIncome before income taxes 1,561 1,859 1,788Provision for income taxes 575 692 668Net income 986 1,167 1,120

Calculating the Tax Rate

Problems with using the Effective Rate

Examples: Citigroup (2006 – 2008)

Calculating the Tax Rate - Default

2012 2011 2010Provision at statutory rate 35.0% 35.0% 35.0%State income taxes 2.2 2.7 2.7Tax-exempt interest income (0.1) — (0.3)Federal HIRE Act tax credit — (0.4) —Other Federal tax credits (0.3) (0.1) —Provision for income taxes 36.8% 37.2% 37.4%

Calculating the Tax Rate

An alternative is to consider the defaultRates.Example:Phillips-Van HeusenBut, sometimes these are given in AmountsExamples:Citi TrendsPacific Sunwear of California

Indirect Evidence – Tax Footnote

Tax Deferred Asset:Created when IRS>GAAP

Tax Deferred Liability:Created when GAAP>IRS

Big Bath – Tax Valuation

A build up of Deferred Tax Liabilitymay signal a revenue or earningsquality issue.

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.

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 1992to $93 billion in 1996To $160 billion in 1998 (1/4th of reported income)

Big Bath – Tax Valuation

A build up of Deferred Tax Assetsmay signal a big bath

Big Bath – Tax Valuation

A Tax Valuation Allowance occurswhen 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