Deferred Tax Liability – Effect of Tax Rate Change
In this video, we will discuss how
the change of tax rate changes the deferred tax liability (DTL). Please first
refer to the basics of “Deferred
Tax Liability”. The following is a part of the transcript. This
video requires Flash 8 or above. If it does not start, click the play button to
start.
|
|
When the tax rate changes, the DTL
(or DTA) left from the previous years have to be readjusted. And:
DTL_carried_from_last_year = DTL_last_year
x new tax rate/ old tax rate
The calculation of the tax expense is
very simple. All you have to do is just to use the following equation we have
learnt:
Tax Expense = Tax
Payable + Delta_DTL – Delta_DTA
Tax payable is still equals to the
new tax rate x the taxable income. For Delta_DTL:
Delta_DTL = DTL_carried_from_last_year
– DTL_last_year + DTL_of_this_year
However, tax expense is not just
simply the new tax rate x the pre-tax income. Instead, we have to use the above
equation to find the tax expense.
Let’s continue to work on the previous example. But we assume
tax rate changed to 40% in 2006.
Assume we have an asset with useful
life of 3 years (and salvage cost = 0) and costs $6000. Every year, the income
before subtracting the depreciation is $4000. Tax rate is 30% but changed to
40% in 2006 and 2007. In the income statement, we depreciate the asset for 3
years (so, each year $2000) for accounting but 2 years for tax return purpose
(so $3000/ year). We have the following table (please refer to the videos on
how we arrived this table):
|
|
2005 |
2006 |
2007 |
Total |
|
Income before dep. |
4000 |
4000 |
4000 |
12000 |
|
Depreciation (acct) |
2000 |
2000 |
2000 |
6000 |
|
Pre-Tax Income |
2000 |
2000 |
2000 |
6000 |
|
Tax expenses |
600 |
900 |
800 |
2300 |
|
Depreciation (Tax) |
3000 |
3000 |
0 |
6000 |
|
Taxable Income |
1000 |
1000 |
4000 |
6000 |
|
Tax payable |
300 |
400 |
1600 |
2300 |
|
DTL |
300 |
800 |
0 |
|
[...] Deferred Tax Liability – Effect of Tax Rate Change (Newest! Aug 19, 2007) [...]
Could you please post the Excel sheet so we can directly see the formulas.
Calculation of DTL for 2006 (i.e Column:2006, Row:DTL) You mention that when the rate changes we can no longer calculate tax expense as simply the new tax rate x the pre-tax income, and we have to use the use the equation.
Now for using the equation you need to find the value of Delta DTL 2006. You have provided the following calculation for Delta DTL 2006
Tax Expense – Tax Payable + DTL_carried_from_last_year i.e Delta DTL = 800 – 400 + 300*(0.4/0.3) = 800
Using this calculated value of Delta DTL (i.e 800) you calculate the value of Tax Expense Tax Expense = Tax Payable + Delta_DTL – Delta_DTA Tax Expense = 900
I dont figure out how you have come to Tax Expense as 900 when you allready used (the persumed incorrectly calculated Tax Expense) value of Tax Expense of 800 ?
Hi Vivek,
We DO NOT calculate the Delta_DTL from the given equation. Instead, Delta_DTL = DTL_carried_from_last_year (updated with new tax rate) – Last_year_DTL + Additional_DTL_this_year = 300*0.4/0.3 -300 + 400
In order to calculate the Additional_DTL_this_year, we used 800 (the presumed incorrectly calculated tax expense)-400. But although 800 is NOT the correct tax expense, it is the correct data to be used to calculate the Additional_DTL_This_year.
And the final Tax_expense = Tax payable + Delta_DTL = 400 + 300*0.4/0.3 -300 + 400