Earnings Non Recurring Deferred Tax

ACCOUNTING ANALYSIS – OPERATING ACTIVITIES
EARNINGS, NON-RECURRING, DEFERRED TAX
Rendy Siswanto, CFA

siswanto.rendy@gmail.com
Prodi Akuntansi – Fakultas Bisnis
Deferred Tax
Rendy Siswanto, CFA

Double Book?
Temporary Difference
Permanent Difference
Financial Accounting Tax Standard

Standard Accounting Report Tax Report
• Company needs to create several financial reports due • The difference between Financial Accounting and Tax
to : Reporting purposes lead to temporary and permanent
• Difference users difference.
• Difference in user’s needs
• Difference standards and regulations to follow
Rendy Siswanto, CFA

Terminology
Accounting Tax
Tax. Inc < Acc. Inc

Tax. Inc > Acc. Inc Asset Liability Tax Base Asset < Car. Amt Asset Liability
Tax Base Asset > Car. Amt Tax Base Liab > Car. Amt
Tax Base Liab < Car. Amt Deferred Tax Asset Deferred Tax Liability Long-lived Asset
(Valuation allowance) Taxes Payable Tax Base
(Acc. Depr – Tax ver.)
Long-lived Asset Temporary Difference

Carrying Amount Income Tax Paid
(Acc. Depreciation)
Revenue Rp xx Accounting Income
Expenses (Rp x) + Non-deductible Exp.
+ Income included under tax but not recognized in Accounting Temporary /
Also called “Accounting Income” EBT Rp xx - Deductible Exp which not recognized in Accounting Permanent
Income Tax Exp. (Rp x) - Income not included under tax but recognized in Accounting Difference
Inc. Tax Exp. = Taxes Payable + ΔDTL - ΔDTA Net Profit Rp xx = Taxable Income reduce
Tax loss carryforward
Rendy Siswanto, CFA
Terminology
Accounting Tax
• Accounting Income: Pretax financial income based on financial accounting • Taxable Income: Income subject to tax based on the tax return.
standards. • Taxes Payable: The tax liability on the balance sheet caused by
• Income Tax Expense: Expense recognized in the income statement that taxable income.
includes taxes payable and changes in deferred tax assets and liabilities. • Income Tax Paid: The actual cash flow for income taxes including
• Deferred Tax Liabilities (DTL): Excess of Income Tax Expense over Taxes payments or refunds from other years.
Payable. • Tax Loss Carryforward: A current or past loss that can be used to
• Deferred Tax Assets (DTA): Excess of Taxes Payable over Income Tax Expense reduce taxable income in the future.
• Valuation Allowance: Reduction of DTA based on the likelihood the assets will • Tax Base: Net amount of an asset or liability used for tax reporting
not be realized. purposes.
• Carrying value. Net Balance Sheet value of an asset or liability
• Permanent Difference: Difference between taxable income and accounting
income that will not reverse in the future.
• Temporary Difference: Difference between the tax base and carrying amount
or taxable income and accounting income that will result in either taxable
amount or deductible amount in the future.
Rendy Siswanto, CFA
The Differences
Occur when :
• Certain revenues and expenses are recognized in the income statement but never on the tax return or vice-versa.
• Assets and/or liabilities have different carrying amounts and tax bases.
• The timing of revenue and expense recognition in the income statement and the tax return differ.
• Gain or loss recognition in the income statement differs from the tax return.
• Tax losses from prior periods may offset future taxable income.
• Financial statement adjustments may not affect the tax return or may be recognized in different periods.
Rendy Siswanto, CFA

Deferred Tax Liabilities (DTL)
• Created when income tax expense is greater than taxes payable due to temporary differences.
• Occur when:
• Revenues (or gains) are recognized in the income statement before they are included on the tax return.
• Expenses (or losses) are tax deductible before they are recognized in the income statement.
• Expected to reverse and result in future cash outflows when the taxes are paid.
Rendy Siswanto, CFA

Deferred Tax Assets
• Created when taxes payable is greater than income tax expense due to temporary differences.
• Occur when:
• Revenues (or gains) are taxable before they are recognized in the income statement.
• Expenses (or losses) are recognized in the income statement before they are tax deductible.
• Tax loss carryforwards are available to reduce future taxable income.
• Expected to reverse and result in future tax savings.
Rendy Siswanto, CFA

Example : Deferred Tax Liability
Assume the original cost of an asset is $30,000. The asset has a 3-year life and no salvage value is expected. In tax reporting, the asset
is depreciated using an accelerated depreciation method with depreciation $15,000 in year 1, $10,000 in year 2, and $5,000 in year 3.
The firm recognize straight-line depreciation expense of $10,000 each year in its income statements. EBITDA is $100,000 each year. If
the firm’s tax rate is 30%. In each year of the asset’s life, Calculate:
• The firm’s income tax expense
• Taxes payable
• Tax Base and Carrying value
• Deferred Tax
Rendy Siswanto, CFA

Answer
Tax Reporting
Income Statement Year 1 Year 2 Year 3 Total Metrics Year 1 Year 2 Year 3
EBITDA $100,000 $100,000 $100,000 $300,000 Asset’s Cost $30,000 $30,000 $30,000
Depreciation Expense $15,000 $10,000 $5,000 $30,000 Acc. Depr. (Tax) $15,000 $25,000 $30,000
Taxable Income $85,000 $90,000 $95,000 $270,000 Acc. Depr. (Acc) $10,000 $20,000 $30,000
Tax Rate 30% 30% 30% 30% Tax Base $15,000 $5,000 -
Tax Payable $25,500 $27,000 $28,500 $81,000 Carrying Amount $20,000 $10,000 -
Difference $5,000 $5,000 -
Financial Accounting Reporting
Tax Rate 30% 30% 30%
Income Statement Year 1 Year 2 Year 3 Total Deferred Tax Liab (DTL) $1,500 $1,500 -
EBITDA $100,000 $100,000 $100,000 $300,000
We can also reconcile DTL, Taxes Payable, and Income Tax Expense using the formula :
Depreciation Expense $10,000 $10,000 $10,000 $30,000
Inc. Tax Exp. = Tax Payable + ΔDTL - ΔDTA
Pre-tax Income $90,000 $90,000 $90,000 $270,000
Metrics Year 1 Year 2 Year 3
Tax Rate 30% 30% 30% 30%
Tax Payable $25,500 $27,000 $28,500
Income Tax Expense $27,000 $27,000 $27,000 $81,000
ΔDTL $1,500 - ($1,500)
Rendy Siswanto, CFA
Inc. Tax Expense $27,000 $27,000 $27,000
Example 2 : Deferred Tax Liability
Assume the original cost of an asset is $30,000. The asset has a 5-year life, and no salvage value is expected. The depreciation method
is the same for both financial reporting and tax reporting, but in tax reporting, the asset depreciated within three years. EBITDA is
$50,000 each year. If the firm's tax rate is 30%. In each year of the asset's life, Calculate:
• The firm’s income tax expense
• Taxes payable
• Tax Base and Carrying value
• Deferred Tax
Rendy Siswanto, CFA

Example : Deferred Tax Asset
Consider warranty guarantees and associated expenses. Pretax Income (financial reporting) includes an accrual for warranty expense,
but it is not deductible for taxable income until the firm has made actual expenditures to meet warranty claims. Suppose :
• A firm has sales of $10,000 for each of two years.
• In financial reporting, warranty expenses estimated 2% of annual sales ($200).
• The actual expenditures of $400 to meet all warranty claims was not made until the second year.
• Tax rate is 30%.
Calculate :
• Income Tax Expense
• Tax Payable
• Tax Base and Carrying Value
• Deferred Tax
Rendy Siswanto, CFA

Earnings & Non-Recurring
Rendy Siswanto, CFA

Income Statement Simple Structure
Sale of goods and services in
the normal course of business
Revenues Rp xx
Cost of Good Sold (COGS) (Rp xx)
Gross Profit Rp xx
Operational Expenses (exc. Depr) (Rp xx)
EBITDA Rp xx
Expenses : Amounts
incurred to generate Depr. Expense (Rp xx)
revenue (grouped by nature)
Operating Income (EBIT) Rp xx
Interest Expense (Rp xx)
If not result from ordinary
business activities, recognize Net Income before Tax (EBT) Rp xx
as gains and losses. Income Tax (Rp xx)
Net Income after Tax (EAT) Rp xx
Rendy Siswanto, CFA

Earnings Before
Income Statement
Interest & Tax (EBIT)
Earnings Before Under US GAAP,

Tax (EBT) IFRS, & PSAK can
be presented Statement
Earnings After Tax separately or
of
together.
(EAT or Net Income) Comprehen
sive Income
Statement of
Other
Other
Comprehensive
Comprehensive
Income
Income
Comprehensive
Income
Rendy Siswanto, CFA

Consolidated If there are non-controlling
parties who also own the
company
If has controlling interest

(e.g through an acquisition)
Parent Subsidiary
Income Statement Income Statement
Reported as the non- Rendy Siswanto, CFA

controlling interest or siswanto.rendy@gmail.com
Consolidated minority interest Prodi Akuntansi – Fakultas Bisnis
Revenue Recognition
When delivering something or
doing some effort to another party.
WHEN
Revenues and any related expenses be
EARNED MATCHING PRINCIPLE recognized together in the same
reporting period
+
REALIZED MEASURED CONSIDERATION Cost can be measured objectively when
there’s an agreement between the
OBJECTIVITY PRINCIPLE parties involved.
When there’s a deal.

Unearned Revenue Account Receivables
Rendy Siswanto, CFA

Keep in mind when Analyzing Revenues
• How conservative are the firm’s revenue recognition policies.
• How judgment and estimates affect the firm’s revenues.
Rendy Siswanto, CFA

Expense Recognition
Expenses that are tied to revenue generation,
MATCHING PRINCIPLE
recognized together in the same period
Expenses that are not directly tied to revenue generation

(period cost), recognized in the period incurred
Rendy Siswanto, CFA

Keep in mind when Analyzing Expenses
• Pay attention to estimation, it is possible for firms to delay or accelerate the expense recognition.
• Delayed expense recognition increases current net income (more aggressive)
• Pay attention to the decrease in bad debt expense, is it because the collection improved? Or expense
decreased to manipulate net income?
• Analysts should compare a firm’s estimates to other firms within the industry.
• If warranty expense is significantly less than peers, is it because of higher quality products, or the expense
recognition more aggressive?
• Seek the accounting policies and significant estimates in the footnotes, and MD&A.
Rendy Siswanto, CFA

Non-Recurring Items
Discontinued One that management has decided to Implication to analysis:
Operations dispose of, but either has not yet done so. • Discontinued operations do not affect net
income from continuing operations.
• Exclude discontinued operations when
forecasting future earnings.
• Actual event (when selling assets) may
Phaseout period provide information about the future cash
Actual Disposal flows of the firm.
Develops a formal plan

for disposing • Income or loss from discontinued operations reported
separately after Income from continuing operation (net of
tax).
Measurement • Past income statements must be restated separating
Date income or loss from the discontinued operations.
• Accrue any estimated loss during the phaseout period.
• Any expected gain cannot be reported until after the sale Rendy Siswanto, CFA
is completed. siswanto.rendy@gmail.com
Non-Recurring Items
Unusual or Unusual in nature, or Implication to analysis:
Infrequent items Infrequent in occurrence. • Review and determine whether Unusual
or Infrequent Items should be included
when forecasting future earnings.
Include:
• Gain or losses from the sale of assets
• Impairments, write-offs, write-downs,
and restructuring costs.
Included in income from continuing

operations and reported before tax
Rendy Siswanto, CFA

Accounting Changes Modified retrospective:
adjust the beginning values
Change in accounting policies e.g. changing inventory costing method Adjust retrospectively
Change in accounting estimates e.g. changing useful life of an asset Adjust prospectively
Prior-Period Adjustments e.g. correction of an accounting error Adjust retrospectively
Implication to analysis:
• Accounting estimate changes typically do not affect cash flow, but need to review to
determine their impact on future operating results.
• Prior-period adjustments also typically do not affect cash flow, but should review
adjustments because errors may indicate weakness in the firm’s internal controls.
Rendy Siswanto, CFA

Operating vs Non-Operating
• Reported separately in the Income Statement.
• For nonfinancial firms, nonoperating transactions may result from investment income and financing
expenses.
• For financial firms, investment income and financing expenses are usually considered operating activities.
Rendy Siswanto, CFA

Basic EPS (Earning Per Share)
𝑁𝑁𝑁𝑁𝑁𝑁 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 − 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃. 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷
𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑜𝑜𝑜𝑜 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂
Example:
Net Income = Rp 1.1 billion
Common Shares on January 1st = 10 million shares
Additional Issue on July 1st = 2 million shares
There’s no preferred stock
Calculate Basic EPS per December 31st
Rendy Siswanto, CFA

Diluted EPS (Earning Per Share)
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑓𝑓𝑓𝑓𝑓𝑓 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠
𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊 𝐴𝐴𝐴𝐴𝐴𝐴. 𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 + 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜
+ +
Net Income Convertible Convertible Debt
(1 – tax rate)
- Preferred Dividens Preferred Dividends Interest
Shares from
+ + +
Weighted Average Shares from Shares from Stock
Convertible
Common Shares Convertible Debt Options
Preferred Stock
Rendy Siswanto, CFA

Example : Diluted EPS
A company reported Rp 100 billion of Net Income and they had:
• 100 million common shares outstanding for the entire year.
• 2 million shares, 10% Rp 10,000 par convertible preferred stock, convertible into 50 shares each
(outstanding for the entire year).
• 50,000, 6%, Rp 1 million par value of convertible bonds, convertible into 200 shares each (outstanding for
the entire year).
• 10,000 stock options, convertible into 1 share of stock at Rp 100 per share. The average market price was
Rp 200.
Assume a 30% tax rate, and calculate Basic & Diluted EPS.
Rendy Siswanto, CFA

Comprehensive Income
Definition: All changes to Equity other than Owner Contributions & Distributions.
NET INCOME + OTHER COMPREHENSIVE INCOME
Typical Other Comprehensive Income:

• Foreign Currency translation gains and losses.
• Adjustments for minimum pension liability.
• Unrealized gains and losses from cash flow hedging
derivatives.
• Unrealized gains and losses from available-for-sale
securities.
Rendy Siswanto, CFA

Example: Comprehensive Income
Calculate Comprehensive Income from the Financial figures below:
• Net Income: Rp 1 billion.
• Dividends received from available-for-sale securities: Rp 60 million.
• Unrealized loss from foreign currency translation: Rp 15 million.
• Dividends Paid: Rp 110 million.
• Reacquire Common Stock: Rp 400 million.
• Unrealized gain from cash flow hedge: Rp 30 million.
• Unrealized loss from available-for-sale securities: Rp 10 million.
• Realized gain on sale of land: Rp 65 million.
Rendy Siswanto, CFA

Financial Reporting & Earnings
Quality
Rendy Siswanto, CFA

High Quality
Relevance + Material
Completeness
High Quality Financial Reporting Decision useful
Faithful Representation Neutrality
Absence of Errors
High Quality Earnings Expected to continue in the future (earnings sustainability)
Quite possible that a firm has high financial reporting

quality but a low quality of reported earnings.
Rendy Siswanto, CFA

Spectrum from Best to Worst Quality
Financial Reporting Quality Earnings Quality
BEST 1 Compliant with GAAP and decision useful. Earnings are sustainable and adequate.
2 Compliant with GAAP and decision useful. Earnings are not sustainable or not adequate.
Earnings quality is low and reporting choices

3 Compliant with GAAP.
and estimates are biased.
Earnings is actively managed to increase,
4 Compliant with GAAP.
decrease, or smooth reporting earnings.
Numbers presented are based on the
5 Not Compliant with GAAP.
company’s actual economic activities.
Include numbers that are essentially fictitious
WORST 6 Not Compliant with GAAP.
or fraudulent.
Rendy Siswanto, CFA
Aggressive vs Conservative Financial Reporting
Aggressive Conservative
Capitalizing current period costs. Expensing current period costs.
Longer estimates of the lives of Shorter estimates of the lives of
depreciable assets. depreciable assets.
Higher estimates of salvage values. Lower estimates of salvage values.
Straight-line depreciation Accelerated depreciation.
Delayed recognition of impairments. Early recognition of impairments.
Less accrual of reserves for bad debt. More accrual of reserves for bad debt.
Avoid thinking about conservatism in financial reporting as

“good” and aggressive reporting as “bad”.
Conservative also can lead to reduces the usefulness of
financial statements (conservative bias).
Rendy Siswanto, CFA
Why Low Quality Reporting happened?
Motivation + Condition + Rationalization
Rendy Siswanto, CFA

Motivation on Low Quality Reporting
• To meet or exceed a benchmark number for EPS.
• Manager seeking to enhance her reputation and improve future career opportunities.
• Manager may be motivated by incentive compensation (bonuses) that depends on stock returns.
• To gain credibility with equity market investors
• To improve the way the company is viewed by its customers and suppliers.
• To avoid violating debt covenants.
• Intentionally make conservative accounting choices to increase the probability that future period earnings will
met or exceed the relevant benchmark amount.
Rendy Siswanto, CFA

The condition / opportunities
• The company has weak internal controls.
• The board of directors provides inadequate oversight.
• Applicable accounting standards provide a large range of acceptable accounting treatments, no consequence in
the case of accounting fraud, or both.
The rationalization
• Make justification to break the rules.
• E.g: “I’ll fix it next period”, “I have to do it to get my bonus and pay for my parents’ care”.
Rendy Siswanto, CFA

Warning Signs
Revenue Recognition:
• Changes in revenue recognition methods
• Use of bill-and-hold transactions (buys the goods and receives an invoice but requests that the firm keep the goods at their location for a
period of time).
• Use of barter transactions.
• Use of rebate programs that require estimation of the impact of rebates on net revenue.
• Lack of transparency with regard to how the various components of a customer order are recorded as revenue.
• Revenue growth out of line with peer companies.
• Receivables turnover is decreasing over multiple periods.
• Decreases in total asset turnover, especially when a company is growing through acquisition of other companies.
• Inclusion of nonoperating items or significant one-time sales in revenues.
Rendy Siswanto, CFA

Warning Signs
Inventories:
• Declining inventory turnover ratio.
Capitalization Policies:
• Capitalizes costs that are not typically capitalized by firms in their industry.
Relationship of Revenue and Cash Flow:

• Ratio of operating cash flow to net income is persistently less than one or declining over time.
Rendy Siswanto, CFA

Other Warning Signs
• Depreciation methods, estimated asset lives, or estimates salvage values are out of line with those of peer companies in the industry.
• Fourth-quarter earnings show a pattern (either high or low) compared to the seasonality of earnings in the industry.
• Has significant transactions with related parties (entities controlled by management).
• Certain expenses are classified as nonrecurring but appear regularly in financial reports.
• Gross or operating profit margins are noticeably higher than are typical for the industry.
• Management typically provides only minimal financial reporting information and disclosure.
• Management typically emphasizes non-GAAP earnings measures and uses special or nonrecurring designations aggressively for
charges.
Rendy Siswanto, CFA


Earnings Non Recurring Deferred Tax

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ACCOUNTING ANALYSIS – OPERATING ACTIVITIES

EARNINGS, NON-RECURRING, DEFERRED TAX

Rendy Siswanto, CFA

Rendy Siswanto, CFA

Financial Accounting Tax Standard

Rendy Siswanto, CFA

Tax. Inc < Acc. Inc

Long-lived Asset Temporary Difference

Rendy Siswanto, CFA

Rendy Siswanto, CFA

• Expected to reverse and result in future tax savings.

Rendy Siswanto, CFA

Rendy Siswanto, CFA

Rendy Siswanto, CFA

Rendy Siswanto, CFA

Rendy Siswanto, CFA

Rendy Siswanto, CFA

Earnings Before Under US GAAP,

Rendy Siswanto, CFA

If has controlling interest

Reported as the non- Rendy Siswanto, CFA

When there’s a deal.

Rendy Siswanto, CFA

Rendy Siswanto, CFA

Expenses that are not directly tied to revenue generation

Rendy Siswanto, CFA

Rendy Siswanto, CFA

Develops a formal plan

Included in income from continuing

Rendy Siswanto, CFA

Prior-Period Adjustments e.g. correction of an accounting error Adjust retrospectively

Rendy Siswanto, CFA

Rendy Siswanto, CFA

Rendy Siswanto, CFA

Rendy Siswanto, CFA

Rendy Siswanto, CFA

NET INCOME + OTHER COMPREHENSIVE INCOME

Typical Other Comprehensive Income:

Rendy Siswanto, CFA

Rendy Siswanto, CFA

Rendy Siswanto, CFA

High Quality Earnings Expected to continue in the future (earnings sustainability)

Quite possible that a firm has high financial reporting

Rendy Siswanto, CFA

Earnings quality is low and reporting choices

Avoid thinking about conservatism in financial reporting as

Motivation + Condition + Rationalization

Rendy Siswanto, CFA

Rendy Siswanto, CFA

Rendy Siswanto, CFA

Rendy Siswanto, CFA

Relationship of Revenue and Cash Flow:

Rendy Siswanto, CFA

Rendy Siswanto, CFA

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