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Accounting: Being Conservative vs. Paying Taxes 1 Views


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00:00

Accounting Allah shmoop being conservative versus paying taxes Okay people

00:08

here's the word of the day and Morte Ization What

00:12

is it And why does it need to take up

00:13

valuable Breen space All right let's take a step back

00:16

for a sec Who will wait smaller Step back First

00:20

of all understand that there is a tug of war

00:22

between being conservative I'ii being aggressive in depreciating cost Such

00:27

that the company shows lower earnings and paying taxes Okay

00:31

What's Almost as if you pay a penalty for showing

00:35

that your mohr profitable rather than less profitable Right That

00:39

penalty arrives with shmoop axes If you are the drinking

00:45

straw extrusion company suck it and you buy four million

00:50

pounds of plastic for eight million box two bucks a

00:52

pound there Well you have some choices in the way

00:55

that you view that expense The conservative hard core gap

00:59

method would be to write down a large part of

01:01

that eight million dollars that inventory asset the day you

01:05

receive it largely reflecting the will of the basic reality

01:08

or fact that there's very little liquid demand for multi

01:12

million dollar pound blocks of plastic S O Maybe you

01:17

hate eight million dollars for this very raw material but

01:20

the day you get it well may be it's only

01:21

worth two million dollars because in real life if you

01:24

had to suddenly sell all that plastic there well there

01:27

ain't many takers on eBay Maybe two million is even

01:30

too high a number Well say you suddenly take a

01:33

six million dollar loss on plastic inventory Well for a

01:37

company which had saying twenty two million dollars in pre

01:40

tax profits all of a sudden instead of twenty two

01:43

million box on which they pay a thirty percent tax

01:45

to the government The new taxable profit base is on

01:49

ly sixteen million and basically the tax bill if you

01:52

ignore the plastic entirely Well it just went from six

01:55

point six million in taxes Toe four point eight million

01:58

So you are notionally serve a tive from a gap

02:02

perspective But you just withheld from the government one point

02:06

eight million dollars in taxes at least for now So

02:09

now in all likelihood you'll eventually sell those blocks of

02:12

plastic in extruded drinking straws Ah fourteen months in the

02:16

future Twenty eight months in the future sometime in the

02:19

future And then you will show more profits than you

02:22

would have had you waited well ten years ago Like

02:25

straight line Immer ties the expenses of that plastic at

02:28

eight hundred grand a year Something like that Well in

02:31

most contracts not all four million pounds would have been

02:34

delivered immediately or well Would have had some kind of

02:37

return policy attached to it But had you bought that

02:40

plastic block on the spot market maybe not like you

02:44

bought it right What would have happened had you taken

02:47

the opposite approach that is You just took eight hundred

02:50

thousand dollars a year for ten years in a straight

02:54

line reduction or depreciation of its value As you used

02:58

up that plastic Radha ble at about ten percent a

03:01

year on twenty two million dollars of Pretext profit you

03:04

subtract eight hundred thousand dollars a year in Year one

03:07

And by the way this is twenty two million of

03:09

pre tax and pre inventory profits there Yeah and you'd

03:12

show twenty one point two million dollars of pretax profit

03:16

there which is then taxable of thirty percent So you'd

03:18

pay six point three million dollars in change in taxes

03:22

right So if you end up working in a manufacturing

03:25

company it's likely you'll have tons of choices like this

03:28

All kinds of products which get depreciated and or contracts

03:32

which get advertised away to being worthless for which you

03:35

can choose to be aggressive in the way you account

03:38

for them or expense them heavily writing them down aggressively

03:41

in value or doing just the opposite Well why would

03:44

you want to show more profits early rather than less

03:48

Well some kind of sleazy accountants know that a sale

03:52

might be near term in the offing here meaning a

03:55

sale of the company and they want company toe look

03:58

more profitable than it really is But it is highly

04:01

likely that the other side Cam's took this excellent shmoop

04:04

accounting course and aren't fooled so well Why else might

04:07

an accountant and honest one choose toe frontload profitability rather

04:11

than push off profits away into the future thinking thinking

04:15

Well what if the company had lost two hundred twelve

04:19

million dollars over the last six years And what if

04:22

it had net operating loss Or in a wells that

04:25

had been carried forward and which were expiring Like you

04:28

only have seven years in some cases to use up

04:32

net operating loss carry forward tax chits So now you

04:36

wisely ask uh the tax structure of the US generally

04:40

wants to encourage corporations to spend money especially on capital

04:44

equipment and research and development in technology and things that

04:48

employ people Why Well because putting people to work gets

04:52

politicians elected It makes the country more competitive relative to

04:56

other nations and it just looks cool The politicos you

04:59

know have a lot going on So one of the

05:00

ways the government encourages the spending is to allow companies

05:04

for years and sometimes decades to take previous losses and

05:09

deduct them against future gains So let's say you raised

05:13

a bunch of money from investors a decade ago and

05:15

started building your straw business You had to build the

05:18

melter of mayhem the Extrude er of access and the

05:22

fabulous resplendent whiz bang stripe painter thing Yeah and in

05:26

that process you burned two hundred twelve million dollars But

05:28

now suck It is starting to get profitable this year

05:31

The company has twenty one point two million dollars in

05:33

pre tax profits if it uses straight line depreciation of

05:36

its plastic inventory But what if you wanted to go

05:40

the opposite direction and show his much profit as you

05:43

can Could you not even take the eight hundred grand

05:46

and expense on the plastic you used in making straws

05:49

Well there probably is in fact a scenario where you

05:52

legally could What if you already had a ton of

05:55

plastic and you only bought this eight million dollars worth

05:58

for overflow like excess emergency Plastic Fund and you were

06:02

using a Fife O or first in first out accounting

06:05

method Or what if this eight million dollars was a

06:08

different type of plastic and just hold on for a

06:11

different type of straw Yeah well then you could probably

06:14

just leave it as is and appreciate zero dollars of

06:17

inventory this year and more to the point than the

06:19

legal extreme edge particulars Why would you want to do

06:22

this Like why would you actively seek to show Mohr

06:26

profits than you would notionally be vent act upon answer

06:30

because n a Wells or these IT net operating losses

06:33

expire in most cases Net operating loss carry forwards for

06:37

tax purposes only Lasted seven eight nine ten years or

06:40

so sometimes less And your company has twenty five million

06:43

ish dollars worth of n A wells that expire this

06:46

year That is when you spent your total two hundred

06:49

twelve million dollars plus you didn't spend it all in

06:51

one year You had losses for over a decade in

06:54

building this great little company and about six years ago

06:57

while you lost twenty five million dollars which will expire

07:00

as a loss that you can take or carry forward

07:03

because it has a maximum cap of seven years before

07:06

it's just well goes away as a tax deduction You

07:08

Khun take meaning that tax chit or tax deduction will

07:12

expire if you don't use it In other words suck

07:14

it must use this loss or lose it So it's

07:18

Wiley accountants will want toe optimize every penny of tax

07:22

shelter they can So what does that look like Financially

07:25

Well the company was able to ignore the eight million

07:27

dollars of purchased plastic entirely so it shows twenty two

07:31

million dollars in pre tax profits It had twenty five

07:34

million in Anna Welles to attribute to those profits or

07:37

go against them So it's tax Bill zero Well maybe

07:41

there are some filing fees or small nuggets of tax

07:43

costs here in there and certainly paying the accountants is

07:46

attacks cost but on the twenty two million dollars your

07:48

pre tax profits while the company keeps all of it

07:51

Welcome to America Quite a country and note at the

07:54

end of this year Suck It will still have a

07:57

remaining hundred eighty seven million dollars in an oil wells

08:01

with twenty nine million expiring next year and we're just

08:05

guessing here But there's no particular formula in this case

08:08

You have to get the basic idea that Anna Welles

08:11

do expire And if companies have profits that can go

08:13

against them They pay no tax So in this case

08:16

these six million bucks and change the company would have

08:19

paid in taxes Will they get to keep all that

08:21

money It's pretty nice and also note that the company

08:24

couldn't use up all of its Anna Welles right That

08:27

is three million dollars that had twenty five million It

08:30

could only use twenty two million Three million While that

08:32

went unused it expired and is now vapor Well what

08:36

could the company have done instead Well maybe with good

08:38

planning a year or two or three Earlier if they

08:41

knew their tax losses were going to expire maybe they

08:44

could have bought a company that had a bunch of

08:46

taxable profits where they're gonna wells you know could then

08:50

be deployed as a quote tax hedge unquote for a

08:53

buffer against the taxes the company would otherwise have to

08:56

pay And they could have done that Maybe at the

08:58

end of the day though no matter what companies do

09:00

to try to be clever Well the tax man will 00:09:03.306 --> [endTime] always come up so that's it

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