CFA Level I · CFA Level I Exam · Analysis of Income Taxes
An analyst sees that a company's effective tax rate fell sharply this year because of a one-time release of a valuation allowance. When forecasting future earnings, the analyst should most appropriately:
The analyst should base forecasts on a sustainable rate, such as the statutory rate or a normalized long-run effective rate. The valuation allowance release is a one-time item that will not repeat, so carrying the temporarily low rate forward would overstate future net income.
- Ause the lower rate for all future periods
- Buse a rate based on the statutory or a sustainable rateCorrect
- Cassume the rate will fall further each year
Explanation
A valuation allowance release is a non-recurring item, so the lower effective rate is not sustainable. Analysts should forecast using a normalized rate, typically near statutory or long-run effective rate. Extrapolating the temporary drop would overstate future earnings.
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