Last week, I used an example to illustrate the impact the new tax accounting rules under ASU 2016-09 will have on companies’ P&L statements. If your company is profitable, this is something you can do using your own financials. In this week’s blog entry, I explain how.
Finding the Numbers
I found all the numbers for my example in the company’s 10-K. I didn’t even have to pull up the full 10-K; I used the interactive data on EDGAR—it took me about 5 minutes. Here’s where to look:
- You can find your company’s net earnings, tax expense, and basic EPS in your income statement (“income statement” is the less cool way to say “P&L,” which is shorthand for “profits & loss statement”).
- You can usually find your excess tax benefit or shortfall in your cash flow statement or the statement of stockholders’ equity (or you may already know this amount, if you manage the database that this information is pulled from).
- The number of shares used in your basic EPS calculation will be indicated in either your income statement or your EPS footnote.
What To Do With the Numbers
Once you have collected that data, you can do the following:
- Post-Tax Earnings: The tax benefit represents how much post-tax earnings would be increased (or, if you have a shortfall, how much earnings would be decreased).
- Effective Tax Rate: Subtract the tax benefit (or add the shortfall) to tax expense and divide by pre-tax earnings to determine the impact on your effective tax rate.
- Earnings Per Share: Divide the tax benefit (or shortfall) by the shares used in the basic EPS calculation to figure out the impact on basic EPS.
Do these calculations for the past several years to see how much the impact on earnings varies from year to year.
Stuff You Should Be Aware Of
This exercise is intended to give you a general idea of the impact of the new tax accounting rules for your company. There are lots of complicated rules that govern how earnings and tax expense are calculated that have nothing to do with stock compensation, but that, when combined with the rules for stock compensation, could change the outcome for your company. This is especially true if your company isn’t profitable—if you are in this situation, it may be best to leave the estimates to your accounting team.
Also, I’ve suggested calculating the impact only on basic EPS because it’s a little harder to figure out the impact on diluted EPS. In diluted EPS, not only will the numerator change, but the number of shares in the denominator will change as well, because excess tax benefits no longer count as a source of proceeds that can be used to buy back stock. See my blog entry, “Update to ASC 718: Diluted EPS” for more information).
– Barbara
Tags: ASC 718, ASU, ASU 2016-09, earnings-per-share, FASB, tax accounting
For today’s blog entry, I use an example to illustrate the impact the new tax accounting procedures required under the recently issued ASU 2016-09 will have on companies’ P&L statements.
A Refresher
Under the old ASC 718, all excess tax benefits and most tax shortfalls for equity awards were recorded to paid-in-capital. An excess tax benefit occurs when the company’s tax deduction for an award exceeds the expense recognized for it; a tax shortfall is the opposite situation—when the company’s tax deduction is less than the expense recognized for the award. The nice thing about old ASC 718 is that paid-in-capital is a balance sheet account, so these tax effects didn’t impact the company’s profitability. Under the amended ASC 718, all excess tax benefits and shortfalls are recorded to tax expense, which ultimately impacts how profitable a company is.
Effective Tax Rates
Not only do changes to tax expense impact a company’s profitability, they also impact the company’s effective tax rate. This rate is calculated by dividing the tax expense in a company’s P&L by its pre-tax earnings. A company’s effective tax rate is generally different from the company’s statutory tax rate because there are all sorts of credits that reduce the tax a corporation pays without reducing income and there are items that can increase a company’s tax expense that don’t increase income.
An effective tax rate that is lower than the statutory tax rate is good; it shows that the company is tax efficient and is keeping its earnings for itself—to use to operate and grow the company or to pay out to shareholders—rather than paying the earnings over to Uncle Sam. Just like you want to minimize the taxes you pay, shareholders want the company to minimize the taxes it pays.
An Example
This example is based on a real-life company that grants stock compensation widely. I’ve rounded the numbers a bit to make it easier to do the math, but my example isn’t that far off from the real-life scenario.
The company reported pre-tax income of $900 million for their most recent fiscal year and tax expense of $250 million. That’s an effective tax rate of 28%, which is probably less than their statutory tax rate.
The company reported (in their cash flow statement) an excess tax benefit for their stock plans of $70 million. Under the old ASC 718, that tax benefit didn’t impact the company’s earnings. But if it had been recorded to tax expense as is required under the amended ASC 718, it would have reduced the company’s tax expense to just $180 million. That reduces the company’s effective tax rate from 28% to just 20%.
In addition, the company’s basic earnings-per-share is $1.30, with 500 million shares outstanding. The tax benefit would have increased basic earnings per share by 14 cents, which is an increase of just over 10%.
Next week, I’ll explain how you can apply this example to your own company.
– Barbara
Tags: ASC 718, ASU 2016-09, FASB, tax accounting