P13-15. Financial statement effects of tax rate change
Requirement 1:
Both companies project pretax income of $100 million. Because
there are no permanent differences and no change in cumulative
temporary differences in 2017 for either company, both are also
Requirement 2:
The following analysis shows the changes in the deferred tax assets
and liabilities for each firm during 2017:
Boers will have increases in its deferred tax assets and liabilities of
$21.0 million and $27.0 million, respectively. The result is a
$315 $245 (0.38 0.35) $6
0.35
million million million
–· – =
). So, Boers’s income
tax expense is $38 million + $6 million = $44 million.
Bernstein will have increases in its deferred tax assets and liabilities
of $42.0 million and $6.6 million, respectively. The result is a
deferred income tax provision of negative $35.4 million. The
provision is negative because Bernstein is in a net deferred tax
Income Tax Reporting
Cases
Cases
C13-1 Pepsico: Analyzing the tax note
Requirement 1 ($ in millions):
Entry for 2013:
DR Net deferred tax asset/liability
Entry for 2015:
CR Income tax payable $1,981
Requirement 2:
Pepsico identifies several items that cause income tax expense to
Property, plant and equipment: This deferred tax liability arises
when a company uses a more accelerated depreciation method for
tax purposes than in its financial statements. The amount of the
deferred tax liability decreased slightly in 2015, indicating net
Intangible assets other than nondeductible goodwill: This deferred
tax liability arose because amortization is recognized faster for tax
purposes than for financial reporting. The effect is similar to that for
depreciation differences. It is common for intangibles to be
Net carryforwards: This deferred tax asset decreased slightly,
indicating carryforwards incurred in 2015 were less than
carryforwards used. Although Pepsico is profitable overall, it can
still have carryforwards if they pertain to jurisdictions where Pepsico
Stock-based compensation: This deferred tax asset decreased in
2015, indicating a net reversal. Stock-based compensation creates
a deferred tax asset because compensation expense related to
non-qualified stock options is recognized earlier for financial
Retiree medical benefits, Other employee-related benefits: In both
of these cases, there is a deferred tax asset because expense is
recognized earlier than a tax deduction is permitted. Accrual
accounting causes the costs of providing benefits to be accrued as
Pension benefits: Pension benefits, like other benefits, are accrued
over an employee’s working years for financial statement purposes.
However, pension plans generally create an income tax deduction
when contributions are made to the plan. The firm does not have to
wait until the benefit payment is made to take the tax deduction. As
Requirement 3:
The information in the income tax note about the income tax
provision pertains only to income taxes related to continuing
operations. That is, the $1,941 million shown for 2015 in the
Provision for income taxes section of the note is equal to the
amount shown in the income statement as income tax expense.
C13-2. Alphabet, Inc.: Analyzing tax notes
Requirement 1:
($ in millions)
Requirement 2:
Let X = pre-tax book income ($ in millions):
Expected tax provision at federal statutory tax rate =
Requirement 3:
Requirement 4:
The deferred tax liability related to depreciation and amortization
Let Z = difference between taxable income and book pre-tax income
($ in millions)
Requirement 5:
The foreign rate differential item in the tax rate reconciliation is
negative in all three years, indicating that the income tax provision is
lower than it would be if all pretax income had an associated 35%
income tax provision. Therefore, the income tax rate on foreign
income is, on average, lower than the 35% U.S. rate. Although the
Requirement 6:
The tax rate reconciliation includes any item that causes the income
tax provision to deviate from 35% of pretax income. A tax credit
C13-3. lululemon athletica vs. UnderArmour: Adjusting for
depreciation differences
Requirement 1:
To compute return on assets, we add back interest expense times
one minus the marginal income tax rate to net income. This amount
Requirement 2:
lululemon athletica
Begin by looking at the data for fiscal 2014 (year ended February 1, 2015) for
lululemon athletica. The deferred tax liability related to depreciation is
depreciation is:
Assuming the company’s marginal tax rate is the 35% statutory rate, we get:
Because lululemon athletica’s book depreciation was $58,364,000, tax
depreciation must have been $58,364,000 + $9,451,000 = $67,815,000.
Under Armour
Under Armour’s depreciation-related deferred income tax liability at
Under Armour’s book depreciation was $72,093,000, so tax depreciation must
have been $72,093,000 + $12,180,000 = $84,273,000.
Requirement 3:
Requirement 4:
Requirement 5:
The adjustment process affects the two companies’ return on assets
figures in the opposite direction, albeit not by significant amounts.
In lululemon athletica’s case, return on assets increased with the
adjustment, from 18.8% to 19.1%. For Under Armour, ROA fell from
11.5% to 11.4%. The reason the effect can be in either direction is
because the adjustment affects both the numerator and the
Requirement 6:
The adjusted figures are not affected by variations in depreciation reporting choices
across firms. So, the operating results of the two companies can be compared more