The course builds on my Introduction to Financial Accounting course, which you should complete first. In this course, you will learn how to read, understand, and analyze most of the information provided by companies in their financial statements. These skills will help you make more informed decisions using financial information.
Video 8.6: 3M Company: Income Taxes
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Week 8: Deferred Taxes
There are two certainties in life, and we will cover one of them this week (the other is beyond the scope of the course). We will NOT teach you how to prepare your own tax return. Instead, we will discuss how companies have to prepare "two sets of books": their financial statements and their tax returns. The rules are different for these two sets of books, leading to permanent differences and to temporary differences. We will cover both types of differences, with a main focus on "deferred taxes", which are the byproduct of temporary or timing differences between tax reporting and financial reporting. Finally, we will touch on other tax issues, such as Net Operating Loss Carryforwards and the rule that requires companies to disclose how much they are trying to cheat on their taxes (sorry, that should say "use tax planning strategies to manage their taxable income").
Rencontrer les enseignants
Brian J BusheeThe Geoffrey T. Boisi Professor
Accounting
Hello I'm Professor Brian Bushee.
Welcome Back.
The last thing on our agenda for this week is to look at the 3M company's
statements and check out all of their disclosures related to income taxes so
that we can see some of this cool stuff that we learned this week.
Let's get started.
Okay we start on page 48 with 3M's balance sheet.
Let's take a look at all the places that they have deffered taxes so
in current assets, no.
Long term assets, noted for taxes huh?
Liabilities oh, here's accrued income taxes, that's their word for
income tax payable.
But I still don't see any deferred taxes,
I don't see any deferred taxes in long term liabilities.
Hey, maybe 3M doesn't have any deferred taxes, and we can end this video early.
Yeah I wish.
It turns out the deferred tax assets and deferred tax liabilities are buried in
the other asset and other liability lines on the balance sheet.
We'll see a supplemental disclosure in a little bit,
which will show us exactly how much deferred tax assets and
deferred tax liabilities are shown on the balance sheet.
We'll make a quick stop on the Statement of Cash Flows, page 51, and
then we can see in the operating section there is deferred income taxes.
There is accrued income taxes, also known as income taxes payable.
So as long as 3M has these two line items in the STF,
then all of these other things can be handled on a pre-tax basis.
All the tax effects will go into deferred income taxes and accrued income taxes.
Jumping ahead to footnote four.
Supplemental balance sheet information which is on page 66.
Here's where we can see the details on the deferred taxes.
So in other current assets there's current deferred income taxes.
Under other long term assets here we have long term deferred income taxes, so
there's about $578 million in long term, about $472 in current,
so these are expected to reverse in the next year.
These are expected to reverse beyond the next year.
And current liabilities, now there's deferred income and deferred income taxes.
Deferred income taxes is what we're looking for.
This deferred income is like an unearned revenue account.
So this is a liability to deliver future goods or services.
The current liability for deferred income taxes is about 45 million.
Other liabilities it's the same thing.
There's deferred income, but what we're looking for is deferred income taxes.
And that's $167 million.
And, so, this is the example of the jurisdictional netting where you
end up seeing deferred taxes all over the place on the balance sheet.
And again what this represents is in some countries they may
have more differed tax assets,
than differed tax liabilities, so those countries show up in the number here.
Or if theres some current ones they'll show up,
up here in the current, there we go, up here in the current [LAUGH] and
if you have, you can have some countries which have more deferred
tax liabilities than deferred tax assets and so they end up in this number here.
Or if they have a current portion, the current portion would end up there.
So you're not going to see any of these numbers in the footnotes.
The footnotes will show you the overall total.
So I've never found these balance sheet disclosures that useful, especially since
they never tell you, like, which countries have the net deferred tax assets, and
which countries have net deferred tax liabilities.
Not that I'm criticizing the accounting rule setters.
But, I've always found, for this reason, the balance sheet is not as useful as
the footnotes, because the footnotes, you get so much more information.
Because you don't have these weird things, like jurisdictional netting,
in the footnotes, as I'll show you in a little bit.
And then NOTE Six provides supplemental cash flow information.
This is on page 69, and we actually looked at this during the cash flow week, but
I want to take another look at it now.
Here's the disclosure of cash income tax payments.
So as I said earlier in the week, it's a required disclosure that
somewhere companies tell you how much cash they paid for taxes.
This allows you to get a sense for, of the current tax payable that we'll see in
a second how much was actually paid in cash.
Also, as we talked about earlier with free cash flow.
Some analysts for valuation like to pull cash taxes out of operating cash flow, and
if you wanted to do that here's the cash taxes number if you want to
remove it from operating cash flow.
If we slide down to page 70, here's the big enchilada.
Note Seven income taxes.
So the top part of the note is income before taxes.
So this is the pre-tax income.
US versus international.
Wow!
Looks like 3M is making most of their income internationally.
Huh. That's cool.
Good job, 3M!
And then below that.
You get the provision for income taxes, so
remember provision is another word for expense.
So this number right here 1840 is the income tax expense number for 3M.
We see how much of it is currently payable.
Currently payable would be the income tax payable that we were talking about.
This is what's going to go to the government.
That adds up to be about 1,736.
And then the difference between the two is the deferred taxes,
which were about 104 during the year.
So here's the information we get on the expense,
the payable to the government and the deferred.
Below that we get the components of deferred tax assets and liabilities.
So here, we get to see all of the deferred tax assets all the deferred tax
liabilities and the valuation allowance.
So deferred tax assets.
We see things like pensions and employee benefits, stock based compensation.
Here's net operating loss carryforwards, which we talked about earlier in the week.
Inventory, now this is not LIFO FIFO because if you use LIFO for
taxes you have to use it for books.
There would not be a deferred tax asset.
This has to be a difference between like weighted average and FIFO.
Other net, that this might include all the other things that they do
that create a deferred tax asset.
So that gives them about 25.93 in deferred tax assets.
Which by the way is larger than the number down here for deferred tax liabilities.
That's pretty common given that there's more items that generate
deferred tax assets.
We see that 3M has a valuation allowance.
That's the amount that they expect to not be able to get in tax savings,
because it's not more likely than not how do we say that,
less than 50% chance that they'll get those tax savings in the future, so
they create a valuation allowance.
Huh.
Interesting.
Their valuation allowance went down during the year.
So the valuation allowance went down by, looks like 53, so
the journal entry there is what.
Debit valuation allowance is a counter asset and credit income tax expense.
That credit of income tax expense will directly, directly increase net income so
3M had an increase of net income of 53 million in 2012 just
due to this valuation allowance.
And so one of the things we're going to want to look for in a little bit is,
did they have a good reason for reducing this Valuational allowance?
Then we see the Deferred Tax Liabilities.
So there's some things with Insurance Receivables.
Accelerated depreciation, this is they use accelerated for taxes, but
then straight line for the books.
In amortization of intangibles is the other category of
deferred tax liabilities.
And then we can see net, net, they have a net deferred tax asset of 838,
which is, we saw it did not show up anywhere on the balance sheet.
Because on the balance sheet we show the jurisdictional netting stuff.
But that's why I think the best place is to go is the footnote,
because it cuts through all this jurisdictional netting.
And you see the totals, you know, this total is reflected on the balance sheet.
It's just spread across those four line items.
Current and non current liabilities and assets.
So one thing's to look at in the tax notes.
So they mention that this stuff all shows up in the balance sheet.
You can find it in Note Four.
It's spread out all over the place.
Then they talk about they're net operating loss.
Carryforwards give you the total amounts.
Talk about the Federal tax, which have 17 and 19 years to go.
State tax ones have five to ten years.
International, it's about seven years.
And so they give you some more detail on the, carry forwards, then
they talk about the 29 million dollars of valuation allowance that we saw.
Oh, and here's the explanation for why it went down.
It was due to the closure of audits with certain taxing authorities.
So I think what that means is they had some tax benefits that they thought
they might not get because they thought they would be disallowed in an audit.
They made through the audit, It wasn't disallowed.
They get to use the tax savings.
And so they reversed out the valuation a lot.
So that does sound somewhat legitimate to me.
And I'm not just saying that as someone whose dad and
grandmother used to work for 3M.
Then the last thing I want to show you is the reconciliation of the effective rate
to the statutory rate, so the first line is the statutory tax rate, which is 35%.
Then you see the permanent differences, so
state income taxes which were extra tax on the same income.
International income taxes where they may have gotten some rebates that
are not deductible for their tax return, there used to be a US R&D credit they were
getting, reserves for tax contingencies, the Medicare Modernization Act of 2010.
You all remember that, well that was a one-time effect on their taxes.
A domestic manufacturer's deduction.
And then all other net gives an effective tax rate of 29%.
And, one last time, you don't want to use this 29% to do tax calculations because
it reflects all of this stuff here that changed their tax rate,
instead if you're doing tax calculations you want to just use 35%.
Then the rest of the footnote provides more details on effective rates,
and what some of these permanent differences are.
So if you want to read about the Med, Medicare Modernization Act there you go,
there's a whole paragraph on that, but I'm running out of steam.
And I'm going to wrap up here.
Before I get to the unrecognized tax benefits which I
do not want to talk about.
Okay. So I'll spend maybe one or
two minutes talking about these UTBs or unrecognized tax benefits.
Just to give you a little knowledge to be dangerous.
So companies will engage in aggressive tax-planning strategies,
trying to do things to reduce their taxes.
Now, some of these, when they get audited later on by a tax auditor, get disallowed.
The auditor says, We're not going to let you do that.
You have to pay us extra taxes.
So what the company has to do is, at the time they're doing the tax planning,
they have to create an expense for
the expected amount of these tax benefits that will get disallowed.
Basically a provision for these being overturned in an audit.
Then what'll happen is down the road if there's a tax audit, and
it is over turned, it'll just come out of the reserve.
But if the, if the statute of limitations expires and
the company goes seven years and never has to, have their tax planning reversed,
then at that point the reserve gets reversed out into tax expense as a gain.
So it’s just a way to try to do something like we do with bad debt expense,
where we're anticipating something happening in the future.
But making an expense for it today.
Now a few years ago the financial accounting standards board and
the international finance reporting standards passed rules to try to
make this more transparent.
And it used to be companies would do these things and hide them.
But now you actually have to provide a table like the one you see here.
Which basically says,
here's all the aggressive tax plannings we've done this year.
And then you can see where they've had things,
come back out of the reserve because it was disallowed.
Or, things where they've gotten through and
it's actually been able to back into tax expense.
So, I know that's much more than a minute or
two, but that gives you a little flavor of what's going on with these UTBs.
So I think I've probably taxed your patience enough with all of
this discussion of income taxes, so we'll go ahead and wrap up the week.
Rest up, and I'll see you next week with Accounting for Shareholders' Equity.
See you then.
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