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Five Key Accounting Insights for Non-Accountants

In the world of accounting, understanding fundamental concepts can greatly benefit non-accountants. This article outlines five essential points: the significance of book income, the effects of tax rate changes on deferred taxes, the distinction between tax expense and taxes paid, the mix of valuation methods allowing for discretion, and the differences in consolidation rules between book and tax. These insights not only illuminate the complexities of financial statements but also emphasize the influence of accounting decisions on tax policy and corporate strategy.

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Five Key Accounting Insights for Non-Accountants

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  1. Five Things Non-Accountants Should Know about Accounting Lillian F. Mills Associate Professor in Accounting, University of Texas

  2. 1: Book income matters • Public companies prefer to report high net earnings. • Contracts based on book income induce preferences. • Capital markets may also be short-term inefficient. • Only rate decreases, credits, and permanent deductions increase book income. • Accelerating deductions don’t. • SO: Doesn’t everyone want a rate cut?

  3. 2. Tax rate changes affect accumulated deferred taxes • Deferred tax liability = tax owed later. • e.g., Tax effect of accelerated depreciation • Deferred tax asset = future refund. • e.g., Tax effect of NOL carryforward • If statutory rate decreases: • Firms with a net liability position have a gain • Firms with a net asset position have a loss • Thus, firms with net tax assets lobby against rate cuts and prefer permanent deductions (Sec 199)

  4. 3. Tax expense not = taxes paid • Total tax expense = current + deferred • Current tax expense differs from tax paid: • Stock options • Tax cushion • Prior/future effects of NOLs, etc. • Media should especially guard against labeling corporations as “high” or “low” taxpayers based on hasty inspection.

  5. 4. Accounting mixes valuation methods and permits discretion • Accounting concepts attempt to balance: • “relevance” (fair values more informative) VS. • “reliability” (can we audit the number?) • Thus, accounting mixes different valuation methods. • Accounting requires estimation; hence permits management discretion • Caution against using book income for tax base.

  6. 5. Consolidation rules differ book v. tax • Financial statement = worldwide-controlled corporations (>50 percent) • U.S. tax return = domestic affiliates (80 percent) • Cross-border accounting critical for tax, less so for book. • Hence, complex regs needed transfer-pricing. • Schedule M-3 helps IRS see entity differences.

  7. Conclusions • Corporations care about book income and lobby to avoid losses and increase income • Rate changes affect deferred tax assets and liabilities • Caveats in using financial statement data to assess tax policy • Accounting mixes methods and allows discretion • Hard to tell how much U.S. tax is paid • Hard to tell what income is subject to U.S. tax • Continued cross-education among disciplines improves policy.

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