CFA Practice Question
Crucible Networks has been growing at a rapid rate in excess of 20% a year; this is expected to continue for the next eight to ten years. Crucible has had to make large investments in its electronic networks in a nascent industry that has a great deal of long-term promise. As a result of its investments, it has paid very little in taxes, due to substantial depreciation available to it under the tax law year after year. Crucible depreciates assets on an accelerated basis for tax purposes and a straight-line basis for reporting purposes. Which of the following statements is MOST appropriate for Crucible? An analyst may adjust ______
A. its deferred tax liabilities by crediting them to stockholders' equity.
B. its deferred tax liabilities by reclassifying them as an interest-free loan and credit the difference between their face value and discounted value to stockholders' equity.
C. adjust its deferred tax assets by reclassifying them as long-term accounts receivable and amortize them over time, similar to an installment sale.
Explanation: Deferred taxes represent the difference between the income tax expense (reported) and income taxes payable (to the government). If the former are greater, a liability is created. In this case, Crucible is not expected to pay much in taxes due to the high depreciation shield available for the next several years as a result of the high-growth nature of its business and required investments. An analyst may credit some or most of the liability to equity, as it may never be paid to the government. At the very least, the analyst may discount the liability and credit the difference to equity.
User Contributed Comments 4
| User | Comment |
|---|---|
| danlan | If the deferred tax liability is going to be reversed, is C correct? |
| jackwez | no C would not be correct.... in the long run the deferred tax liability is either recognized by the accounting books (since you usually pay this in cash anyways) or the liability will be revaluted with a credit to RE or income depending on the nature/timing of the revaluation. |
| Lambo83 | If the rapid growth is expected to continue for the next 8-10 years it should be expected the DTL can be reversed and therefore should be included in liabilities. Moreover the depreciation is based on Double Accelerating which suggests that after a couple years the depreciation for tax will be less than the straight-line depreciation for accounting and hence the DTL will be reversed. |
| harrybay | If I were an analyst I wouldn't do that. |