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					             INCOME TAXES
 Effect of Taxes on Financial Statements
 Why Tax Expense  Tax Payable
  Temporary Differences
  Modified Accelerated Cost Recovery (MACRS)

 Determination of Deferred Taxes
 Disclosure of Tax Information
  American Standards
  International Standards

 Analysis of Tax Impact
 Net Operating Losses
                EFFECT OF TAXES ON
               FINANCIAL STATEMENTS

Why is an understanding of taxes important?
    Taxes are one of the largest expenses on the income
     statement
    Taxes payable can be a significant current liability
    Deferred taxes can be a significant asset or liability
    Tax strategies can significantly increase cash flow,
     but can be used to manipulate income
    Many business decisions have tax consequences




Income Taxes
                                                         2
       WHY TAX EXPENSE  TAX PAYABLE

Net income - determined by GAAP, on the basis of
matching

Taxable income - determined by the Internal
Revenue Code


               Net Income vs. Taxable Income

                          NET          TAXABLE
                        INCOME          INCOME
Purpose             Measure        Calculate an
                    Performance    Obligation to the
                                   Government
Determined          Generally      Internal Revenue
by                  Accepted       Code
                    Accounting
                    Principles
Reported            Income         Form 1120
on                  Statement




Income Taxes
                                                3
        WHY TAX EXPENSE  TAX PAYABLE
                               Temporary Differences

Temporary differences – differences resulting from
timing of recognition. This causes NI  TI within periods
but not over periods:

                               GAAP INCOME* >           TAXABLE INCOME >
                               TAXABLE INCOME             GAAP INCOME*

INFLOWS                  Installment Sales             Advanced Rent
                         Effect: Taxed when            Effect: Taxed when
                         collected                     collected

OUTFLOWS                 Accelerated Depreciation      Warranty Expense,
                         Effect: Reduces taxable       Retirement Benefits,
                         income early in asset life    Bad Debt Expense
                                                       Effect: Deducted when
                                                       paid
* In this case, net income before taxes



IF, the company performed operations that caused
$1,500,000 in taxes,
BUT, the IRS requires a $1,100,000 payment, this year
THEN, the following entry is made:

Tax Expense                                1,500,000
    Taxes Payable                                        1,100,000
    Deferred Taxes                                         400,000

                                              In this case, deferred taxes
                                              are a liability.
Income Taxes
                                                                             4
           WHY TAX EXPENSE  TAX PAYABLE
               Modified Accelerated Cost Recovery System
MACRS Applicable Percentage for Property Class
    Recovery       3-Year               5-Year           7-Year           10-Year          15-Year            20-Year
      Year        Property             Property         Property          Property         Property           Property
       1                33.33               20.00             14.29             10.00               5.00            3.750
       2                44.45               32.00             24.49             18.00               9.50            7.219
       3              14.81 *               19.20             17.49             14.40               8.55            6.677
       4                     7.41         11.52 *             12.49             11.52               7.70            6.177
       5                                    11.52            8.93 *              9.22               6.93            5.713
       6                                      5.76             8.92              7.37               6.23            5.285
       7                                                       8.93            6.55 *           5.90 *              4.888
       8                                                       4.46              6.55               5.90            4.522
       9                                                                         6.56               5.91          4.462 *
      10                                                                         6.55               5.90            4.461
      11                                                                         3.28               5.91            4.462
      12                                                                                            5.90            4.461
      13                                                                                            5.91            4.462
      14                                                                                            5.90            4.461
      15                                                                                            5.91            4.462
      16                                                                                            2.95            4.461
      17                                                                                                            4.462
      18                                                                                                            4.461
      19                                                                                                            4.462
      20                                                                                                            4.461
      21                                                                                                            2.231
               Tools, Cars          Computers,       Furniture,       Boats, Drilling   Factories          Sewers, Utility
                                    Construction     Railroad cars    Equipment                            Plants
                                    Equipment
     The 3-, 5-, 7-, and 10-year classes use 200% and the 15- and 20-year classes use 150% declining balance
      depreciation.
     All classes convert to straight-line depreciation in the optimal year, shown with an asterisk (*).
     A half-year depreciation is allowed in the first and last recovery years.
     If more than 40% of the year's MACRS property is placed in service in the last three months, then a mid-
      quarter convention must be used with depreciation tables that are not shown here.



Income Taxes
                                                                                                                5
             DETERMINING DEFERRED TAXES
                      Determining Timing Differences
Example:
 $5,000 yearly revenue                                           Modified Accelerated Cost
                                                                  Recovery System (MACRS)
 One $6,000 machine, 4 year useful life                            Year         Percent
  for books, 3 year asset for tax, no                                 1          33.33%
                                                                      2          44.45%
  salvage                                                             3          14.81%
 Depreciation: Straight line for books,                              4           7.41%

  MACRS for taxes
 40% tax rate
Financial Statements                   Objective: Adhere to GAAP (Matching)
                                                 Income
                             Operating                              Tax             Net
    Year     Revenue                              Before
                             Expensea                             Expenseb        Incomec
                                                  Taxes
  1             $5,000             $1,500           $3,500               $1,400      $2,100
  2              5,000              1,500            3,500                1,400       2,100
  3              5,000              1,500            3,500                1,400       2,100
  4              5,000              1,500            3,500                1,400       2,100
Total          $20,000             $6,000          $14,000               $5,600      $8,400
a
  Depreciation Expense = $6,000 / 3 = $2,000 / year
b
  Income Before Taxes * Tax Rate = $3,000 * .4 = $1,200
c Revenue – Operating Expense – Tax Expense = $5,000 – $2,000 – $1,200 = $1,800


Tax Return              Objective: Adhere to Internal Revenue Code
                                                                                  Amount
                                                Taxable              Tax
    Year     Revenue        Deductions                                             After
                                                Income             Payable
                                                                                  Payable
  1             $5,000            $2,000a           $3,000               $1,200      $1,800
  2              5,000              2,667            2,333                  933       1,400
  3              5,000                888            4,112                1,645       2,467
  4              5,000                445            4,555                1,822       2,733
Total          $20,000             $6,000          $14,000               $5,600      $8,400
a
    Depreciation Expense = Base * MACRS Rate = $6,000 * .333) = $2,000



Income Taxes
                                                                                     6
          DETERMINING DEFERRED TAXES
                   Determining Timing Differences

Deferred Tax Liability- Due to Use of MACRS
                                                                           Cumulative
        Expense         Deduction   Temporary     Cumulative                Deferred
Year                                                           Tax Rate     Liability
        on Books        for Taxes   Difference    Difference
                                                                             (Asset)
  1            $1,500     $2,000         $500         $500          40%           $200
  2            $1,500     $2,667       $1,167        $1,667         40%           $667
  3            $1,500      $888        ($612)      ($1,055)         40%         ($422)
  4            $1,500      $445      ($1,055)             0         40%              0
               $6,000     $6,000           $0             0                          0

The following amounts would be recognized in the financial statements:

                                    Year 1       Year 2    Year 3      Year 4
Tax Expense (IS)                      1,200       1,200        1,200      2,000
Taxes Payable (BS)                    1,200         933        1,645      1,822
Deferred Tax Liability (BS)             200         667            0          0
Deferred Tax Asset (BS)                   0           0          422          0


Effect of a Tax Rate Change: If the enacted rate changed to 35% in Year
3, the deferred liability would be:

                                                                           Cumulative
        Expense         Deduction   Temporary     Cumulative                Deferred
Year                                                           Tax Rate     Liability
        on Books        for Taxes   Difference    Difference
                                                                             (Asset)
  1            $1,500     $2,000         $500         $500          40%           $200
  2            $1,500     $2,667       $1,167        $1,667         40%           $667
  3            $1,500      $888        ($612)      ($1,055)         35%         ($369)
  4            $1,500      $445      ($1,055)             0                          0
               $6,000     $6,000           $0             0                          0




Income Taxes
                                                                                7
          DETERMINING DEFERRED TAXES
                        General Rules

Deferred tax liabilities result from:
Source                             Example
Book revenue now (IS)              Installment sales
Taxable revenue later (1120)
Deduction now (1120)               Accelerated depreciation
Expense later (IS)


Deferred tax assets result from:
Source                             Example
Taxable revenue now (1120)         Advanced rent
Book revenue later (IS)
Expense now (IS)                   Warranty expense, retirement
Deduction later (1120)             benefits, bad debt expense


Discussion:
  Is it better to have deferred tax asset or deferred tax liability?
  Are deferred tax liabilities a legal obligation at bankruptcy?




Income Taxes
                                                               8
   DETERMINATION OF DEFERRED TAXES
      How Are Deferred Taxes Liabilities Perceived?

Deferred taxes are debt:
Proponent: FASB
Argument: Deferred taxes are measurable future
obligations. Payment depends merely on the passage of
time.


Deferred taxes may have some meaning:
Proponents: Some foreign accounting systems, some analysts
Argument: Deferrals will reverse in the future. Why not take a present
value of expected payments? (not allowed in US GAAP or IFRS)


Deferred taxes should be ignored:
Proponents: Creditors
Argument: If the corporation went bankrupt, deferred taxes do not legally
need to paid.


Deferred taxes are equity:
Proponents: Some analysts
Argument: Deferred tax liabilities increase the value of the company. If
deferred taxes are not recorded as a liability: (1) tax expense would be
lower, (2) net income would be higher, and (3) retained earnings would be
higher.




Income Taxes
                                                                    9
       DISCLOSURE OF TAX INFORMATION

On the Balance Sheet
1. Taxes Payable – amounts owed to taxing authorities within the year
2. Tax Refund Receivable – amounts to be returned within the year due
   to overpayment
3. Deferrals – Amounts resulting from differences in net income and
   taxable income. Current amounts are netted before disclosure. Non-
   current amounts are also netted before disclosure.
    Net Current Tax Deferrals – deferrals that relate to current assets or
     current liabilities.
    Net Non-Current Deferrals – deferrals that relate to non-current
     assets or liabilities.

 Warning About Asset Overstatement Deferred tax assets should be
reduced if the probability of reversal is low. For example, if it becomes obvious that a
warranty expense will not actually be paid, the deferred tax asset should be removed.



In the Notes:
 Current tax expense or benefit
 Deferred tax expense or benefit
 Investment tax credits
 Operating loss carryforwards
 Adjustments to deferred tax account resulting from tax rate changes
 Reconciliation of statutory determined taxes to tax expense


 How does it look in the annual report?
Income Taxes
                                                                                 10
          DISCLOSURE OF TAX INFORMATION
                                 Tax Note of Wal Mart
                                                                                  A tax “provision” is the
                                                                                  same as a tax “expense”
The income tax provision consists of the following (in millions):
Fiscal Year Ended January 31,                             2007             2006            2005
Current:
Federal                                                 $4,871          $4,646           $4,116
State and local                                            522             449              640
International                                              883             837              570
Total current tax provision                              6,276           5,932            5,326
                                   Amount Paid to
Deferred:
                                 Government
Federal                                                    (15)            (62)             311
State and local                                               4              56             (71)
International                                              100           (123)                23
Total deferred tax provision                                 89          (129)              263
Total provision for income taxes                        $6,365          $5,803           $5,589
                                                                                                      Expense on
Income before income taxes by jurisdiction is (in millions):                                          the Income
Fiscal Year Ended January 31,                            2007            2006             2005        Statement
United States                                         $15,158         $14,447           $13,599
Outside the United States                               3,810           3,088             2,721
Income before taxes                                   $18,968         $17,535           $16,320

Items that give rise to significant deferred tax accounts (in millions):
January 31,                                                                2007            2006
Deferred tax liabilities
Property and equipment                                                  $3,153           $2,816
Inventory                                                                  600              551
Other                                                                      282              392
Total deferred tax liabilities                                          $4,035           $3,759
Deferred tax assets
Net operating loss carryforwards                                          $865            $892
Accrued for financial reporting not yet deductible                       1,847            1,668
Share-based compensation                                                   300              248
Other                                                                      846              737
Total deferred tax assets                                                3,858            3,545
Valuation allowance                                                      (921)            (912)
Total deferred tax assets, net of valuation allowance                   $2,937           $2,633
Net deferred tax liabilities                                            $1,098           $1,126


                                                                    Liability on the
                                                                    Balance Sheet




Income Taxes
                                                                                              11
A reconciliation of the significant differences between the effective income tax rate and the
federal statutory rate on pretax income is as follows:
Fiscal Year Ended January 31,                          2007            2006           2005
Statutory tax rate                                  35.00%          35.00%         35.00%
State income taxes                                    1.80%           1.85%          2.27%
Income taxes outside the United States              (1.84%)         (2.09%)        (2.21%)
Other                                               (1.40%)         (1.67%)        (0.81%)
Effective income tax rate                           33.56%          33.09%         34.25%


                                                                  Effective
                                                                  Tax Rate




Income Taxes
                                                                                         12
                    DISCLOSURE OF TAX INFORMATION
                                               Analysis of Deferrals
PROCTER AND GAMBLE
Deferred income tax assets and liabilities were comprised of the following:
                                                                                  Stock allocated to employees expensed this period, but
June 30                                                  2008         2007        not deductible until employee takes possession.
DEFERRED TAX ASSETS
Stock-based compensation                  $1,082                    $1,132        Hedge losses expensed this period, but not deductible
Unrealized loss on financial transactions  1,274                       723        until the hedge expires.
Pension and postretirement benefits          633                       560
Loss and other carryforwards                 482                       439        Benefits earned by employees this period, but not
Advance payments                             302                       183        deductible until paid at retirement.
Goodwill and other intangible assets         267                       249
Accrued marketing and promotion expense      125                       161
                                                                                  Cash received for goods to be delivered later. The
Accrued interest and taxes                   123                        —
                                                                                  amount has been taxed, but not recognized as revenue.
Inventory                                    114                        95
Fixed assets                                 100                        85
Other                                      1,048                     1,119
Valuation allowances                       (173)                     (190)
TOTAL                                      5,377                     4,556
DEFERRED TAX LIABILITIES
Goodwill and other intangible assets                 $12,371      $12,102         P&G amortized $640 million in intangibles in 2008.
Fixed assets                                           1,847        1,884         Larger amounts were deducted for taxes.
Other                                                    151          132
TOTAL                                                 14,369       14,118
                                                                                  Accelerated depreciation is used for taxes; straight-line
Net operating loss carryforwards were $1,515 and $1,442 at June 30, 2008 and      for the income statement.
2007, respectively. If unused, $629 will expire between 2009 and 2028. The
remainder, totaling $886 at June 30, 2008, may be carried forward indefinitely.




Income Taxes                                                                                                            13
        DISCLOSURE OF TAX INFORMATION
              International Standards

                         IFRS                    US G A A P
Tax rates to   Use tax rates that are     Only enacted tax rates
calculate      enacted or substantively   may be used.
deferrals      enacted.
Deferred       Recognize if probable      Recognize but reduce by
tax assets     (more likely than not)     a valuation allowance
recognition
Current/non-   Classify net as non-       Based on classification
current        current, with note         of the related non-tax
               identifying amount to be   asset or liability for
               recovered within 12        financial reporting.
               months




Income Taxes
                                                              14
                  ANALYSIS OF TAX IMPACT
                    Impact of Deferred Taxes

                                                       Deferred
                             Deferred
                                           Total       Taxes to
          Company              Tax
                                         Liabilities     Total
                             Liability
                                                       Liabilities
ExxonMobil                     20,851      105,171        19.8%
Procter & Gamble               12,015       71,254        16.9%
UPS                             2,529       17,728        14.3%
McDonalds                       1,057       13,566         7.8%
Home Depot                      1,416       27,233         5.2%
Johnson and Johnson             1,319       31,238         4.2%
Merck                             446       27,010         1.7%
For the 2006/7 fiscal year




Income Taxes
                                                            15
               ANALYSIS OF TAX IMPACT
                    Corporate Income Tax Rates


US Corporate Income Tax Rates--2009
        Taxable
      income over         Not over        Tax rate
             $0            $50,000          15%
         50,000             75,000          25%
         75,000            100,000          34%
        100,000            335,000          39%
        335,000         10,000,000          34%
     10,000,000         15,000,000          35%
     15,000,000         18,333,333          38%
     18,333,333                             35%




Income Taxes
                                                     16
                       ANALYSIS OF TAX IMPACT
               International Corporate Income Tax Rates
   Average Corporate Tax Rates
Country                     %
UAE                              0.0%
Bulgaria                         10.0%
Ireland                          13.0%
Romania                          16.0%
Hong Kong                        16.5%
Hungary                          20.0%
Russia                           24.0%
China                            25.0%
Greece                           25.0%
Netherlands                      25.0%
Vietnam                          25.0%
Israel                           26.0%
Poland                           26.5%
South Korea                      27.5%
Czech Republic                   28.0%
Mexico                           28.0%
Norway                           28.0%
South Africa                     28.0%
United Kingdom                   28.0%
Australia                        30.0%
Germany                          30.0%
Spain                            30.0%
Italy                            32.4%
Canada                           33.5%
Belgium                          34.0%
Brazil                           34.0%
France                           34.4%
Argentina                        35.0%
USA (TX)                         36.0%
Japan                            41.0%
India                            42.0%
USA (IL)                         42.3%
USA (NY)                         46.2%
Source: Forbes 2008 (see http://www.forbes.com/global/2008/0407/060_2.html)

Income Taxes
                                                                              17
                           ANALYSIS OF TAX IMPACT
                                Who Pays What in Taxes?


                        Largest American                             Largest American
                         Oil Companies                          Non-Oil Industrial Companies
                 Exxon                           Conoco          General                         Procter &
                                Chevron                                            AT&T
                 Mobil                           Phillips        Electric                         Gamble
Effective
Income           41.8%           41.9%            48.9%           15.5%            34.4%           24.9%
Tax Rate
Income
                 $29.9           $13.5            $11.4            $2.8             $6.3            $4.0
Tax
Expense          billion         billion          billion         billion          billion         billion
Income           $26.3           $12.3            $11.3            $2.9             $4.0            $3.5
Tax Paid         billion         billion          billion         billion          billion         billion
Excise,
duties           $75.8           $22.3            $19.0
and other        billion         billion          billion
taxes
Based on 2007 data

Excise and import taxes are implemented by Federal, State, or local governments.

Federal excise taxes on gasoline are 18.3 cents per gallon and on diesel fuel are 24.3
cents and 0.1 cents per gallon for the Leaking Underground Storage Tank Trust Fund.
State taxes on gasoline vary from less than 10 cents per gallon to about 40 cents.

Import taxes for oil, crude oil and fuel oils are 5.25 cents per barrel for heavier and 10.5 cents for lighter
oils. Transportation fuels, such as gasoline and jet fuel, pay 52.5 cents per barrel, or 1.25 cents per
gallon.




Income Taxes
                                                                                                   18
          NET OPERATING LOSSES (NOLs)

LOSS CARRY BACK (AND CARRY-FORWARD)
ELECTION
                                               Let me get this
Taxable income in the past two years is        straight. I lose
offset. If the NOL is not totally              money and the
                                               Feds send me a
absorbed, the remaining NOL can                check, right?
be used in the next 20 years.
Treatment: show Tax Refund
Receivable in the current asset
section.

LOSS CARRY FORWARD ELECTION
Taxable income over the next 20 years may be offset by
the NOL. Realized only if taxable income occurs.
Treatment: show the NOL carry forward amount as a
deferred tax asset




Income Taxes
                                                  19
                        NOL Example
Get It Back, Corp. had the following taxable income data
for the last four years:

                Taxable       Tax        Taxes
Year
                Income        Rate       Owed
2006              $500,000    40%        $200,000
2007              $500,000    40%        $200,000
2008           ($1,250,000)   40%              $0
2009              $600,000    40%               ?
2010              $800,000    40%               ?

How much should GIB pay in taxes in 2009 and 2010?

GIB Corp. has two options in 2008:
  Carry back (and carry forward)
  Carry forward only




Income Taxes
                                                    20
CB and CF: GIB applies for a refund of $400,000 ($200,000 + $200,000)
for 2006 and 2007 taxes. No taxes are paid in 2008.
                                   Tax
 Year          Taxable Income                    Taxes Owed
                                   Rate
2006                  $500,000     40%
2007                  $500,000      40%
2008               ($1,250,000)     40%                    $0
2009                  $600,000      40%              $140,000
2010                  $800,000      40%              $320,000
In 2009, GIB applies the remaining $250,000 NOL and pays $140,000 in
taxes [($600,000 - $250,000) * 40%]. In 2010, the tax will be $320,000
($800,000 * 40%)

CF Only: GIB has determined that the tax rate increase and would like
to carry the benefit forward. GIB pays no taxes in 2008 and 2009. GIB
may then apply a $650,000 ($1,250,000 - $600,000) offset to taxable
income earned after 2009.
                                   Tax
 Year          Taxable Income                    Taxes Owed
                                   Rate
2006                  $500,000     40%              $200,000
2007                  $500,000      40%             $200,000
2008               ($1,250,000)     40%                    $0
2009                  $600,000      45%                    $0
2010                  $800,000      45%               $67,500
In 2010, GIB has $650,000 ($1,250,000 - $600,000) in CF left. pays
$67,500 in taxes [($800,000 - $650,000) * 45%].




Income Taxes
                                                                21
                                               TAX NOTE
                                         Continental Airlines

The reconciliations of income tax computed at the United States federal statutory tax rates to
income tax provision for the years ended December 31, 1998, 1997 and 1996 are as follows (in
millions):
Amount Percent                                            1998   1997     1996    1998     1997      1996
Income tax provision at United States statutory rates     $227   $224     $150    35.0 %   35.0 %    35.0 %
State income tax provision                                  10       9        6    1.5       1.4      1.4
Reorganization value not allocable to identifiable assets    -       4        5    -         0.6      1.2
Meals and entertainment disallowance                        10       9        7    1.5       1.4      1.6
Net operating loss not previously benefitted.                -    (15)     (88)    -        (2.3)   (20.5)
Other                                                        1       6        6    0.3       1.0      1.4
Income tax provision, net                                 $248   $237      $ 86   38.3 %   37.1 %    20.1 %

The significant component of the provision for income taxes for the year ended December 31,
1998, 1997 and 1996 was a deferred tax provision of $231 million, $220 million and $80 million,
respectively. The provision for income taxes for the period ended December 31, 1998, 1997 and
1996 also reflects a current tax provision in the amount of $17 million, $17 million and $6
million, respectively, as the Company is in an alternative minimum tax position for federal
income tax purposes and pays current state income tax.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the related amounts used for
income tax purposes. Significant components of the Company's deferred tax liabilities and
assets as of December 31, 1998 and 1997 are as follows (in millions):
                                                                 1998                  1997
Spare parts and supplies, fixed assets and intangibles           $ 536                 $ 639
Deferred gain                                                       57                    63
Capital and safe harbor lease activity                              46                    49             Liabilities
Other, net                                                          39                    39
Gross deferred tax liabilities                                     678                   790

Accrued liabilities                                              (347)                 (370)
Revaluation of leases.                                              (2)                 (16)
Net operating loss carryforwards                                 (372)                 (631)             Assets
Investment tax credit carryforwards                               (45)                  (45)
Minimum tax credit carryforward                                   (37)                  (21)
Gross deferred tax assets.                                       (803)               (1,083)
Deferred tax assets valuation allowance                            263                   617
                                                                                                         Shown on
Net deferred tax liability                                         138                   324             the
Less: current deferred tax (asset) liability                     (234)                 (111)             Balance
Non-current deferred tax liability                               $ 372                 $ 435             Sheet




Income Taxes
                                                                                                    22
At December 31, 1998, the Company had estimated NOLs of $1.1 billion for federal income tax
purposes that will expire through 2009 and federal investment tax credit carryforwards of $45
million that will expire through 2001. As a result of the change in ownership of the Company on
April 27, 1993, the ultimate utilization of the Company's net operating losses and investment tax
credits could be limited. Reflecting this possible limitation, the Company has recorded a
valuation allowance of $263 million at December 31, 1998.

Continental had, as of December 31, 1998, deferred tax assets aggregating $803 million,
including $372 million of NOLs and a valuation allowance of $263 million. During the first
quarter of 1998, the Company consummated several transactions, the benefit of which resulted in
the elimination of reorganization value in excess of amounts allocable to identifiable assets of
$164 million. During the third and fourth quarters of 1998, the Company determined that
additional NOLs of the Company's predecessor could be benefited and accordingly reduced the
valuation allowance and routes, gates and slots by $190 million. To the extent the Company
were to determine in the future that additional NOLs of the Company's predecessor could be
recognized in the accompanying consolidated financial statements, such benefit would further
reduce routes, gates and slots.




Discussion
    What are the implications of income tax expense structure
     of Continental Airlines (see amounts in paragraph form)?
           Current Tax Expense                  17
           Deferred Tax Expense              + 231
           Tax Expense                         248

    If the company has NOLs of $1.1 billion, why do they
     recognize a deferred tax asset of only $372 million?
           = NOL X Tax Rate
           = $1,100 million X .35
            $385 million




Income Taxes
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                               Sample Test Question

                                       HOME DEPOT
                                          NOTE 3 - INCOME TAXES

The provision for income taxes consisted of the following (in millions):

FISCAL YEAR ENDED                        2000               1999              1998
Current:
U.S                                    $ 1,209             $ 823              $ 653
State                                      228               150                 98
Foreign                                     45                20                 15
                                         1,482               993                766
Deferred:
U.S                                           9                46              (31)
State                                       (4)               (1)                 1
Foreign                                     (3)                 2                 2
                                              2                47              (28)
Total                                  $ 1,484           $ 1,040              $ 738

The Company's combined federal, state and foreign effective tax rates for fiscal years 2000, 1999 and 1998, net of
offsets generated by federal, state and foreign tax incentive credits, were approximately 39.0%, 39.2% and 38.9%,
respectively. A reconciliation of income tax expense at the federal statutory rate of 35% to actual tax expense for the
applicable fiscal years follows (in millions):

FISCAL YEAR ENDED                       2000               1999               1998
Taxes at U.S. statutory rate           $1,331              $ 929              $664
State income taxes                        145                 96                65
Foreign rate differences                    2                  --                2
Other, net                                  6                 15                 7
Total                                  $1,484             $1,040              $738

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred
tax liabilities as of January 30, 2000 and January 31, 1999 were as follows (in millions):

                                                                     2000               1999
Deferred Tax Assets:
Accrued self-insurance liabilities                                  $ 154              $ 110
Other accrued liabilities                                             142                 97
Total gross deferred tax assets                                       296                207

Deferred Tax Liabilities:
Accelerated depreciation                                            (321)              (249)
Other                                                                 (62)              (43)
Total gross deferred tax liabilities                                (383)              (292)
Net deferred tax liability                                          $ (87)            $ (85)

 No valuation allowance was recorded against the deferred tax assets at January 30, 2000 or January 31,1999.
Company management believes the existing net deductible temporary differences comprising the total gross deferred
tax assets will reverse during periods in which the Company generates net taxable income.




Income Taxes
                                                                                                            24
    1. Home Depot’s federal statutory tax rate was 35% during 2000. The
       effective tax rate for Home Depot during 2000 was 39%. What is the
       primary reason for the difference between these percentages?
    State Income Taxes

    2. How much should Home Depot pay to the Internal Revenue Service as
       a result of operations during for 2000?
    $ 1.209 billion

    3. What was the tax expense recognized on the income statement by
       Home Depot for the year 2000?
    $ 1.484 billion

    4. Designate whether the following statements are true or false:
    T F Home Depot’s tax deferrals should be stated on the balance sheet
        as a net asset of $209 million ($296 million - $87 million), instead of
        being shown separately as a gross asset and gross liability.
    Answer: Home Depot should show a liability of $87million ($296 million – $383
    million).

    T F Home Depot has a practice of recognizing an insurance expense on
        the income statement that is not deductible for tax purposes.
    T F Home Depot uses a method for taxes that recognizes depreciation at
        a faster rate than the method used for financial reporting.

    Home Depot has a deferred tax liability related to property, plant and equipment
    (which they show as accelerated depreciation of $321). This liability occurs
    because they recognized a smaller expense on the books than they did for a
    deduction on taxes. As their assets get older, the amount of deprecation
    recognized on the books will begin to equal the deprecation deducted for taxes
    and the liability will decrease.

General Rule:
An expense with no deduction results in a deferred tax asset.
A deduction without an expense results in a deferred tax liability.

    Income Taxes
                                                                              25
                            Sample Test Question
NORTHWEST AIRLINES
Note 9—Income Taxes
Income tax expense (benefit) consisted of the following for the years ended December 31 (in millions):

                                         2000           1999          1998
Current:
Federal                                   $57            $75          $(45)
Foreign                                     1              3             3
State                                       6              3              1
                                           64             81           (41)
Deferred:
Federal                                   110             98           (90)
Foreign                                    (1)            (2)           (3)
State                                        6            10           (11)
                                          115            106          (104)
Total income tax expense (benefit)       $179           $187         $(145)

Reconciliations of the statutory rate to the Company's income tax expense (benefit) for the years ended
December 31 are as follows (in millions):
                                                     2000             1999             1998
Statutory rate applied                                $152             $171           $(151)
State income tax                                         7                 8             (6)
Non-deductible meals, entertainment                     11                 9               9
Adjustment to valuation allowance                        5               —                 6
Other                                                    4               (1)             (3)
Total income tax expense (benefit)                    $179             $187           $(145)

The net deferred tax liabilities listed below include a current net deferred tax asset of $108 million and
$116 million and a long-term net deferred tax liability of $1.35 billion and $1.22 billion as of
December 31, 2000 and 1999, respectively.

Significant components of the Company's net deferred tax liability as of December 31 were as follows (in
millions):
                                                                      2000             1999
Deferred tax assets:
Expenses accelerated for financial reporting purposes                 $341             $341
Pension and postretirement benefits                                    180              145
Gains from the sale-leaseback of aircraft                              165              154
Rent expense                                                            90               85
Travel award programs                                                   55               98
Leases capitalized for financial reporting purposes                     52               67
Alternative minimum and foreign tax credit carryforwards                45               86
Total deferred tax assets                                              928              976




Income Taxes
                                                                                                  26
Deferred tax liabilities:
Accounting basis of assets in excess of tax basis                         1,744             1,724
Expenses other than accelerated depreciation and amortization               429               358
Total deferred tax liabilities                                            2,173             2,082
Net deferred tax liability                                               $1,245            $1,106

The Company has alternative minimum tax credits of approximately $43 million available for carryforward to future
years' tax returns. The alternative minimum tax credits have an unlimited carryforward period. The Company
generated and utilized $1 million of foreign tax credits for both regular and alternative minimum tax purposes during
2000. During 1999, the Company utilized all of its 1998 foreign tax credit carryforward and $1 million of the
$3 million in foreign tax credits generated in 1999 for both regular and alternative minimum tax purposes. The
remaining $2 million of foreign tax credits generated in 1999 is available for carryforward to years beyond 2000.

Sections 382 and 383 of the Internal Revenue Code of 1986, as amended (the "Code"), and Treasury regulations
limit the amounts of net operating loss carryforwards (NOLs), alternative minimum tax net operating loss
carryforwards (AMTNOLs) and credits that can be used to offset taxable income (or used as a credit) in any single
tax year if the corporation has more than a 50% ownership change (as defined in the Code) over a three-year testing
period ending on the testing date. During 1994 and 1995, the Company utilized all of its regular NOLs and
AMTNOLs. In August 2000, the Company and the Internal Revenue Service reached an agreement regarding the
Company's NOLs that did not result in a material change in the utilization of the NOLs in any prior years.


Assume Northwest Airlines is a going concern. Designate whether the following
statements are true or false:


1. T      F    As a result of operations that occurred during 1999, Northwest has
               recognized an expense of $81 million to governments in taxes.

2. T      F    During 2000, Northwest performed operations that will cause $115 million of
               taxes to be paid in the future.

3. T      F    Northwest Airlines has recognized pension expenses in their income
               statement that are not yet deductible for taxes.

4. T      F    Northwest Airlines has recognized frequent flyer expenses in their income
               statement that are not yet deductible for taxes.

5. T      F    Northwest Airlines uses a method for taxes that recognizes depreciation at a
               slower rate than the method used for financial reporting.

6. Northwest Airlines income before taxes was $435 million. What is their effective tax
rate?

$ 179 / $435 = 41.1%




Income Taxes
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Description: Bad Business Debt Deduction for Federal Taxes document sample