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Five Things Non-Accountants Should Know about Accounting. Lillian F. Mills Associate Professor in Accounting, University of Texas. 1: Book income matters. Public companies prefer to report high net earnings. Contracts based on book income induce preferences.
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Five Things Non-Accountants Should Know about Accounting Lillian F. Mills Associate Professor in Accounting, University of Texas
1: Book income matters • Public companies prefer to report high net earnings. • 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?
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)
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.
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 methods. • Accounting requires estimation; hence permits management discretion • Caution against using book income for tax base.
5. Consolidation rules differ book v. tax • Financial statement = worldwide-controlled corporations (>50 percent) • U.S. tax return = domestic affiliates (80 percent) • Cross-border accounting critical for tax, less so for book. • Hence, complex regs needed transfer-pricing. • Schedule M-3 helps IRS see entity differences.
Conclusions • Corporations care about book income and lobby to avoid losses and increase income • Rate changes affect deferred tax assets and liabilities • 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.
