Review Taxes and Marketable Securities

Taxes and Marketable Securities 15.515 RECITATION AGENDA – SESSION 6 TAXES • Summary of taxes • Tax practice problems • Summary of marketable securities • Marketable securities practice problem • Questions Taxes and Marketable Securities ACCOUNTING FOR INCOME TAXES • Permanent Differences: • Scope differences • Differences between financial statement (“pretax”) GAAP income and taxable income that will never be recaptured/reversed, e.g. Government Fines, Tax-Exempt Revenue. • Temporary Timing Differences – Differences between pretax GAAP income and taxable income that will be recaptured/reversed at some point in the future. Temporary differences create Deferred Tax Liabilities and Deferred Tax Assets • Deferred Tax Liabilities (DTL) • Taxable Income < Pretax GAAP Income • Taxes Payable < GAAP Income Tax Expense • Taxpayer pays lower taxes today. A liability must be recorded to account for the added taxes to be paid at some point in the future. • Deferred Tax Asset (DTA) • Taxable Income > Pretax GAAP Income • Taxes Payable > GAAP Income Tax Expense • Taxpayer pays higher taxes today. An asset must be recorded to account for the value of lower taxes to be paid at some point in the future. Taxes and Marketable Securities TIMING DIFFERENCES – BALANCE SHEET EQUATION If transaction creates a Deferred Tax Liability: GAAP Income Tax Expense=Taxes Payable to Governmental Agency +∆Deferred Tax Liability (Current expense) (Deferred tax expense) Assets 0 = Liabilities Taxes Payable ↑ Deferred Tax Liability ↑ + Retained Earnings Income Tax Expense ↓ OE If transaction creates a Deferred Tax Asset: GAAP Income Tax Expense =Taxes Payable to Governmental Agency -∆Deferred Tax Asset (Current expense) (Deferred tax expense) Assets Deferred Tax Asset ↑ = Liabilities Taxes Payable ↑ + Retained Earnings Income Tax Expense ↓ OE Taxes and Marketable Securities OTHER IMPORTANT CONCEPTS • Effective Tax Rate = GAAP Income Tax Expense / GAAP Pretax Income • Net Operating Losses • Carryback 2 years • Carryforward 20 years • Recorded as deferred tax assets • Valuation Allowance - If benefits of a deferred tax asset (never for a deferred tax liability) are not likely to be realized, the value of the deferred tax asset balance should be reduced by a “valuation amount” • Financial Statement Disclosure for Accounting for Taxes • Income statement ⇒ Income tax expense • Balance sheet ⇒ Deferred tax assets and liabilities, Income tax payable • SCF ⇒ Note changes in DTA/DTL in Operating section • Notes ⇒ More explanation Taxes and Marketable Securities TAX PROBLEM (PRATT E10-11) See Problem E10-11 in the course textbook. Taxes and Marketable Securities Ford Motor Company’s Tax Footnote For this information, see the "deferred tax assets" and "deferred tax liabilities" sections for 2002 and 2001 in Ford Motor Company's 2002 Annual Report (page 68). Taxes and Marketable Securities Questions Related to Ford’s Deferred Tax Footnote: a) Which was greater during FY 2002: depreciation/amortization expense for financial reporting purposes or depreciation/amortization deducted for tax purposes? b) Will future tax deductions for employee benefit plans be greater or less than future GAAP expenses for employee benefit plans? Taxes and Marketable Securities MARKETABLE SECURITIES • Readily marketable – convertible to CASH on DEMAND Classified • Trading securities – Objective is profit from short term price change - Current asset • Available-for-sale - Investments not classified as ‘trading securities’ - Current or non-current asset depending on management’s intent Recorded Purchase Price include • Direct costs • Incidental Acquisition costs Taxes and Marketable Securities Mark-to-market rule Readily marketable securities are to be carried at market price. Recording of gains and losses (or price increase/decrease): Trading securities Available-for-sales Sales of securities IS – Realized gains/losses from beginning of fiscal period IS - Realized gains/losses from date of acquisition Price change – not sold yet IS – Unrealized/Holding gains/losses SE – Unrealized price increase/decrease