Deferred Income Taxes
You are the financial controller of Nulife Corporation and have just come from a meeting of a local civic group. The meeting was an opportunity for you to present and explain your company’s financial statements for fiscal year recently ended. According to the 2006 balance sheet of Nulife Corporation, its debt-to-equity ratio was 1.05, calculated as $5,813 ( $5,524. Included in the total liabilities of $5,813 were the long-term deferred tax liabilities of $1,160.
A significant amount of time was spent discussing the large deferred tax liability reported by your company. Several members of the civic group questioned you about the nature of this liability. In particular, some argue that deferred tax liabilities should not be recognized and, therefore, should be excluded from liabilities when computing the debt-to-equity ratio. You were also asked why the long-term deferred tax liability wasn’t discounted to reflect the time value of money. You have no real answer, except to mumble something like, “That’s just the way the standard is written.”
1. What is the rationale for the argument that deferred tax liabilities should not be recognized and, therefore, should be excluded from liabilities when computing the debt-to-equity ratio? What would be the effect on Nulife’s debt-to-equity ratio of excluding deferred tax liabilities from its calculation? What would be the percentage change? 2. What might be the rationale for not excluding deferred tax liabilities when computing the debt-to-equity ratio? 3. How might you have better explained the lack of discounting of deferred income taxes? You should provide arguments for and against the discounting of deferred income taxes.
a. Ratio will drop to 0.84 (falls by 0.198%).
b. Uncertainty of reversal: it is not absolutely certain whether these obligations will actually come due in the future and therefore may be negatively...