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Basic Question 5 of 20

A firm has deferred tax liabilities that exceed deferred tax assets. Suppose there is an increase in future tax rates (when tax assets and liabilities will reverse). This will lead to total assets of the firm ______.

A. increasing and net equity increasing
B. remaining the same and net equity increasing
C. decreasing and net equity decreasing

User Contributed Comments 19

User Comment
YOUCANDOIT right..
gmilchev :)
gill15 Dont even want to read it...is there a one line answer...otherwise skip...
thekobe it is C, since the DTL exceed DTA
bantoo Very simple. The decrease in DTL will be more than DTA. The net impact is still positive. So, Assets will increase and so the equity. The right answer is A.
johntan1979 This is a confusing question because:
1. There is an increase in tax rate, AND
2. There is a reversal

I suppose you can incorporate BOTH, i.e. increased tax rate, and then the reversal, which I assume is what this question wants.

DTL > DTA, hence the net is DTL.

Based on the explanation given by AnalystNotes, if the net is DTA and tax rate increases, then:
Higher DTA, lower tax expense, higher total assets, higher equity

So if now the net is DTL, so it should be the opposite of all that. HOWEVER, a reversal (in the last year) reverses the effect of the opposite effect. Therefore, the answer is A, higher total assets and equity.
2014 text book says if tax rate increases; DTA and DTL increase.
A seems rite.
jonan203 tl:dr
robbiecow Net DTL: Reduction in tax rate will reduce liabilities, reduce income tax expense, and increase equity

Net DTA: Reduction in tax rate will reduce assets, increase income tax expense, and decrease equity

Net DTL: Increase in tax rate will increase liabilities, increase income tax expense, and reduce equity

Net DTA: Increase in tax rate will increase assets, decrease income tax expense, and increase equity
mdejesus Who TF thought it would be a good idea to write such a long explanation???
ascruggs92 johntan1979, all "reversal" means is that the benefit/or liability will be realized at that point. saying that the tax rate increases in the year of reversal (i.e. reconciliation between tax and accounting B/S) simply means that the current net DTA or net DTA needs to be recalculated at the new rate. In this question there is a net DTL; assuming the same rate of increase is applied to both the DTA and DTL, the DTL increases more due to its larger starting balance. A larger net DTL means lower assets & equity. so C is correct
ashish100 2014 takes the first prize.
xd2163 I do not agree with the answer.
If DTL > DTA, then after adjusting for tax rate change, Delta DTL > Delta DTA. Once they are reversed, or in other words, realized, we have Delta L > Delta A. We know that Delta A = Delta L + Delta E. To balance the equation, Delta E has to be less than 0. Therefore, my take is that asset will increase, liability will increase to a larger extent, and equity will decrease.
maryprz14 Amazing explanation. Could never be more clear than this. Thanks, Analyst notes.
isalya confused me even more. They just increase DTL and DTA by higher rate. I thought effect after actual utilization shoud be calculated. so se would get Dr income tax expense CR DTA and higher Dr DTL CR income tax expense
dbedford If you paid an extra $100 in taxes to the IRS based on their methods than what you showed payable on your financial statement then you have to reflect that you have less cash somehow because you actually paid the $100 to the IRS so... you show it as a DTA. Now if in the future the tax rate increases and that $100 paid in the past should be $120 under the newer future rate then you increase your DTA to $120 and instead of claiming that you paid $100 in the past you show that you paid $120 which increases your assets by $20 that you didnt pay but that you got to take advantage of frmo the future tax rate on your DTA
sshetty2 this explanation is epic; thank you AN!
maryprz14 Hey everyone; I get my words back, this question is confusing and I am not even sure if the answer is right.
Ewan2015 This makes no sense. If my DTL is larger than my DTA I would have a net DTL (i.e. I owe money to the tax authorities in the future for activity occurring in the past). If I then apply a higher tax rate to my net DTL my DTL gets bigger I would therefore have a decrease in net assets and a decrease in equity.
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I used your notes and passed ... highly recommended!
Lauren

Lauren

Learning Outcome Statements

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

CFA® 2024 Level I Curriculum, Volume 3, Module 9.