C13-4. ABC Inc.: Interpreting tax notes and reconciling statutory and
effective rates
Requirement 1:
Tax Amount Tax Rate
The expense at the statutory rate is calculated by multiplying the
earnings before income taxes of $10,891 by 35%. The tax effects of
amortization of goodwill (or cost in excess of net assets of acquired
companies) and state taxes are given in the problem. The effect of
Requirement 2:
The credit to the income tax liability represents the current portion of
the income tax expense. The decrease in the deferred tax asset
Requirement 3:
13-1
The decrease in the deferred tax asset for accounts receivable
The deferred tax asset for inventories is due to additional costs
inventoried for tax purposes and financial statement allowances. It
appears that certain costs that are considered as product costs for tax
purposes are treated as period costs for financial reporting purposes.
In addition, it seems that certain writedown of inventories (financial
statement allowances) are not allowed for tax purposes until the loss
due to writedown of inventories is realized through the sale of
The deferred tax asset for employee benefits suggests that the
company is using the accrual basis for expensing the cost of
employee benefits in the financial statements while using the cash
basis for tax purposes. The decrease in the deferred tax asset for
employee benefits suggests that ABC Inc. paid more of the employee
benefits in cash when compared to the tax expense during 2017.
The reduction in the deferred tax asset for accrual for costs of
restructuring is consistent with the current payment for restructuring
charges that were accrued in the GAAP income statement of the
The deferred tax asset for accrual for disposal of discontinued
operations was created to record the expected tax benefit from the
loss on discontinued operations reported in the GAAP financial
13-2
Since the company reports a deferred tax liability for plant and
equipment, it must mean that ABC Inc. is using a more accelerated
depreciation for tax purposes compared to the financial reporting
depreciation. However, the decrease in the deferred tax liability
C13-5. Understanding tax note disclosures
Requirement 1:
($ in millions)
Requirement 2:
Starbucks deferred $20.4 million in taxes in fiscal 2015. This deferral
resulted in a decrease in net deferred tax assets. Note that net
deferred tax assets declined by $72.2 million, from $1,209.6 million to
Requirement 3:
Let X = earnings before taxes ($ in millions):
Note to the instructor: Starbucks’ actual earnings before taxes (not
Requirement 4:
The tax jurisdictions in which the firm chooses to operate—indicated
by the 2.1 percentage point reduction in the effective tax rate
13-3
The domestic production activities deduction reduces the effective tax
rate for domestic activities deemed to be production, as defined by the
law. Although it may not seem that Starbucks’ products would fall
under this category, which is essentially a manufacturing process, as
Starbucks recorded a gain on the acquisition of a joint venture, under
Requirement 5:
Starbucks’ effective tax rate in the year ended September 27, 2015
was 29.3% However, had it not been for the gain on the joint venture
purchase, the effective tax rate would have been 3.7% higher, or
33.0%, down only slightly from the prior year (34.6%). It is not
Requirement 6:
According to the tax rate reconciliation, the litigation charge reduced
the income tax provision by $1,071.0 million. Further, the effective tax
Note to instructor: The actual pretax litigation charge reported in the
C13-6. Using tax note disclosures to forecast next year’s tax
provision
13-4
Requirement 1:
Given an assumption that income before income taxes will grow by 5%
Requirements 2 and 3:
The effective tax rate is income tax expense divided by income before
income taxes. Sirius XM’s 2012 effective tax rate was –$2,998,234 /
$474,468 = –631.9%. This very unusual effective tax rate arises because
of the reversal of the valuation allowance. As a result, this effective tax
Requirements 4 and 5:
Note: Effective tax rates are often stable from one period to the next for a
particular company. However, aberrations may occur that alter the
effective tax rate in a particular year. It is still possible to use the
information in the effective tax rate to forecast subsequent period income
tax expense by undoing the effect of the aberration and also considering
C13-7 Interpreting uncertain tax position disclosures
Requirement 1:
13-5
Requirement 2:
Requirement 3:
The note says the total liability for unrecognized tax benefits is $31.3
million and the table, which excluded interest and penalties, indicates
it is about $28.353 million. $31.3 million minus $28.353 million, or
C13-8: Tax note under IFRS
Requirement 1:
Lufthansa does not report a separate valuation allowance because
valuation allowances are not used under IFRS. Instead, a single-step
Requirement 2:
Lufthansa was not able to capitalize €498 million of deferred tax assets
because management did not deem it likely that those assets would be
Requirement 3:
Lufthansa reported a €135 million decrease (633–498) in the amount of
deferred tax assets it believes will not be realized. This likely indicates
Lufthansa expects relatively larger future taxable profits that will allow it to
13-6
13-7