Income tax expense effect of tax rate change

[FisherSU]

As i've been wrestling with the Analysis of Income Taxes for a few days now, i wanna see if someone can point out if there is a flaw in my logic.

If i get a question concerning the effect of tax rate change on income tax expense, could i take the income tax expense before restatement and adjust for the relative change in tax rate and change in DTL and DTA.

In other words is equation: Income tax expense = Original ITE x relative tax rate change + changeDTL - changeDTA valid or should i stick to Taxes payable and DTL/DTA adjustments.

Here's an example (Schweser, p.202-03):
Asset: 120,000
Useful life: 4 years, no salvage value
CF generated by the asset: 50,000/year for 4 years
T= 40%
Tax purposes depreciation: SL over 3 years
Financial reporting: SL over 4 years

Suppose tax rates rise during year 2 to 50%. What will be the income tax expense in year 2?

This is what i did:
Relative change in the tax rate 50%/40% = 1.25
Original Income tax expense = 20 * 40% = 8
Change in DTL = 4 * 1.25 = 5 => change is 1

Income tax expense = 8 * 1.25 + 1 = 11

Seems that i got the answer right, but am not sure if it is a coincidence or there is a method to my madness

 

[FisherSU]

any updates n e one?

 

[alix12]

Gee, that is one of the topic in FSA that is really hard to sink-in in my coconut shell. Here's my computation shortcut, hope it will help you.

STEPS:

1.) Directly compute the ITE using the new tax rate (50%) which is 10,000

2.) Determine the increase in DTL due to the increase in tax rate. The computation will be ---> (.5/.4 x 4,000) - 4,000 = 1,000. In formula will be --> (new tax rate/old tax rate x old DTL) - old DTL.

3.) Add the 10,000 in step 1 in 1,000 to step 2 to get the new INCOME TAX EXPENSE due the the increase (change) in tax rate. 10,000 + 1,000 = 11,000 the new ITE.

NOTE:
Take note that the problem hasn't have DTA which if ever, it will complicate the problem. Assuming there is a DTA in the problem, the formula that I use in step 2 will be --> [(new Tax rate/old tax rate) x (old DTL - old DTA)] - (old DTL - old DTA). The step 1 & 3 still the same.

Dude the really important & have to memorize & know its logic in this reading is the --> INCOME TAX EXPENSE = tax payable + (change in DTL - change in DTA).

Also, TAX RATE has a positive (direct) relationship in ITE, TP, DTL, DTA. Meaning an increase (decrease) in tax rate will increase (decrease) the ITE, TP, DTL, DTA --> given that DTL is "GREATER" than DTA.

 

[FisherSU]

Thanks alix12, i guess i'll stick to the general approach (the one you used) instead of trying to figure out shortcuts. I have applied my shortcut to a few problems and if done right it delivers every time. On the other hand, it twists the whole logic of DTL/DTA adjustments and i don't wanna confuse myself more than i have to.

Thanks