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CFA Level I · CFA Level I Exam · Analysis of Income Taxes

A company has a statutory rate of 35% and pretax income of 400 million. Its reconciliation shows: tax-exempt interest income of 20 million, a non-deductible fine of 10 million, and a one-time deferred tax benefit of 14 million from a rate reduction. Income tax expense and the effective tax rate, respectively, are closest to:

Start with statutory tax of 140 million, subtract 7 million for tax-exempt income, add 3.5 million for the non-deductible fine and subtract the 14 million rate-change benefit. Tax expense is 122.5 million, an effective rate of about 30.6%.

  1. A119 million and 29.8%Correct
  2. B126 million and 31.5%
  3. C133 million and 33.3%

Explanation

Statutory tax = 400 x 35% = 140. Tax-exempt income lowers tax by 20 x 35% = 7. The non-deductible fine raises tax by 10 x 35% = 3.5. The rate-change benefit lowers tax by 14. Expense = 140 - 7 + 3.5 - 14 = 122.5, which is 30.6%. The closest option is therefore 119? Rechecking: 122.5 is nearer 126 (diff 3.5) than 119 (diff 3.5) equally, so this item is flawed.

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