Disclosures for Deferred Tax Items

The following information about the deferred tax items is usually disclosed:

  • Total of all deferred tax liabilities ($48 million in our Illustration 16-10 Note).
  • Total of all deferred tax assets ($26 million in our Illustration 16-10 Note).
  • Total valuation allowance recognized for deferred tax assets.
  • Net change in the valuation allowance.
  • Approximate tax effect of each type of temporary difference (and carry forward).
  • Tax loss carry forwards
  • Reconciliation between the federal statutory and effective tax rates
  • Components of deferred tax expense (e.g., revenue and expense items that cause the deferred tax expense, assets, liabilities, such as depreciation, bad debts, installment sales, etc.)

Reconciliation of Effective Tax Rate

We learned that a firm’s income tax expense can differ from the amount of tax paid based on the statutory tax rate. The tax rate paid by the company is the effective tax rate calculated as follows:

Effective tax rate (ETR) = Income tax expense/Pre-tax income

An analyst can reconcile the two rates which will help him identify the reasonableness of the effective tax rate and also compare ETR with the statutory tax rate.

Some of the common reconciling items are:

  • Non-deductible expenses (Permanent Differences)
  • Rate adjustments
  • Change in valuation allowance
  • Difference in future income tax rates
  • Tax rate changes
  • Adjustments to tax reserves
  • Adjustments to prior year amounts

Example

Net income before taxes is $125,000. Tax expense is $52,700. Statutory rate is 36%. Tax reserves were increased by $5,000. Non-temporary add-backs were estimated at $10,000. Total temporary differences at the beginning of the year were $45,000, resulting in future tax liabilities of $16,000. Tax rates used for future taxes decreased by 2% during the year.

The following table summarizes the reconciliation:

Net Income$125,000 
Statutory rate45,00036%
Tax rate changes(900)(0.72%)
Change in tax reserves5,0004%
Non-deductible expenses3,6002.88%
Effective rate$52,70042.16%

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