Question

The statutory federal tax rate had been 35% for a number of years. Assume that late in the third quarter of 2020, a new rate, 40%, was approved as the new enacted rate, effective as of January 1, 2020 You are an assistant controller with Zenics Inc., a manufacturer of laser printers. The CEO of the company is concemed about what effect, if any, the new tax rate will have on 2020 earnings. At the beginning of the year, Zenics had a deferred tax asset of $10 million and a deferred tax liability of $6 million. There was no need for a valuation allowance, nor is it expected that any will be needed this year. Youes timate that pretax GAAP income will be approximately $5 million in 2020 and that taxable income will be about $7 million. The company is publicly traded, with 500,000 shares outstanding all year

Answer 1

Increase in the tax rate from 35% to 40% will have an effect on the Balance sheet and Income statement in the following manner:

As we know deferred tax asset is an asset on a company's balance sheet that may be used to reduce its taxable income. So the Income in the balance sheet will be reduced with $10 million . The current liability increases due to increase in 5% statutory tax rate. The income statement also have an effect leading to decrease in profit and the income tax in the expenses also increases.

Effect on EPS (Earning per Share):

Due to Increase in tax rate the calculation of EPS also differs . As the Earning available to shareholders will be reduced , EPS rate will be decreased respectively.

Yus, there will be negative impact on the earnings. it is advisable to increase the deferred tax liability in the current period in order to save the earnings from having a negative impact as it does not indicate the company should pay more tax in the current period.

Effect on company's stock price : Increase in tax rate results in decrease in the earnings of the company which may lead to a negative impact on the investors, thereby leading to decrease in company's stock price.