Analysis of Income Taxes
Refresher reading access
Introduction
Differences between tax laws and financial accounting standards result in differences between accounting profit (i.e., income before taxes on the income statement) and taxable income, or income computed under the prevailing tax laws in a given jurisdiction. These differences can be temporary or permanent. Temporary differences result in deferred tax assets and liabilities on the balance sheet and are important for capturing the income tax effects of all current period activities, even if tax consequences occur in the future. Current and deferred income tax expenses are used to calculate the effective tax rate, which is commonly used by analysts in estimating after-tax profitability measures like free cash flow. Given temporary and permanent differences, the effective tax rate typically differs from the statutory and cash tax rates for an issuer. Company disclosures of income tax related information in the notes to financial statements is typically one of the most extensive note disclosures.
Learning Outcomes
The candidate should be able to:
- contrast accounting profit, taxable income, taxes payable, and income tax expense and temporary versus permanent differences between accounting profit and taxable income
- explain how deferred tax liabilities and assets are created and the factors that determine how a company’s deferred tax liabilities and assets should be treated for the purposes of financial analysis
- calculate, interpret, and contrast an issuer’s effective tax rate, statutory tax rate, and cash tax rate
- analyze disclosures relating to deferred tax items and the effective tax rate reconciliation and explain how information included in these disclosures affects a company’s financial statements and financial ratios
1.25 PL Credit
If you are a CFA Institute member don’t forget to record Professional Learning (PL) credit from reading this article.