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									     Five Things Non-Accountants
    Should Know about Accounting

                     Lillian F. Mills
                 Associate Professor in
             Accounting, University of Texas
September 29, 2006                             1
               1: Book income matters
• Public companies prefer to report high net
     – Contracts based on book income induce preferences.
     – Capital markets may also be short-term inefficient.
• Only rate decreases, credits, and permanent
  deductions increase book income.
     – Accelerating deductions don’t.
• SO: Doesn’t everyone want a rate cut?

September 29, 2006                                       2
          2. Tax rate changes affect
         accumulated deferred taxes
• Deferred tax liability = tax owed later.
     – e.g., Tax effect of accelerated depreciation
• Deferred tax asset = future refund.
     – e.g., Tax effect of NOL carryforward
• If statutory rate decreases:
     – Firms with a net liability position have a gain
     – Firms with a net asset position have a loss
          • Thus, firms with net tax assets lobby against rate
            cuts and prefer permanent deductions (Sec 199)

September 29, 2006                                               3
    3. Tax expense not = taxes paid
• Total tax expense = current + deferred
• Current tax expense differs from tax paid:
     – Stock options
     – Tax cushion
     – Prior/future effects of NOLs, etc.
• Media should especially guard against labeling
  corporations as “high” or “low” taxpayers based
  on hasty inspection.

September 29, 2006                                  4
4. Accounting mixes valuation methods
          and permits discretion
• Accounting concepts attempt to balance:
     – “relevance” (fair values more informative) VS.
     – “reliability” (can we audit the number?)
     – Thus, accounting mixes different valuation
• Accounting requires estimation; hence
  permits management discretion
     – Caution against using book income for tax
September 29, 2006                                      5
  5. Consolidation rules differ book v. tax
• Financial statement = worldwide-controlled
  corporations (>50 percent)
• U.S. tax return = domestic affiliates (80
• Cross-border accounting critical for tax,
  less so for book.
     – Hence, complex regs needed transfer-pricing.
     – Schedule M-3 helps IRS see entity

September 29, 2006                                6
•     Corporations care about book income and
      lobby to avoid losses and increase income
     –     Rate changes affect deferred tax assets and
•     Caveats in using financial statement data to
      assess tax policy
     –     Accounting mixes methods and allows discretion
     –     Hard to tell how much U.S. tax is paid
     –     Hard to tell what income is subject to U.S. tax
•     Continued cross-education among disciplines
      improves policy.
September 29, 2006                                           7

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