CFA Level I · CFA Level I Exam · Analysis of Income Taxes
A company's deferred tax liability of 400 relates to accelerated depreciation. An analyst concludes that the company will keep expanding its capital base, so the liability will most likely never reverse. The analyst's most appropriate treatment of the liability when computing solvency ratios is to:
The analyst should treat the deferred tax liability as equity. When it is not expected to reverse, no cash outflow will ever settle it, so it behaves like a permanent source of funds. Reclassifying it lowers liabilities and improves solvency ratios such as debt-to-equity.
- Atreat it as equityCorrect
- Btreat it as a liability
- Cignore it as a non-cash item
Explanation
If a deferred tax liability is expected not to reverse, it will never be paid, so analysts treat it as equity (increasing equity and reducing liabilities). If reversal is expected, it is treated as a liability. Ignoring it entirely is not the standard treatment.
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