What is the current value of the nasdaq deferred taxes?

Sensei answered 5 months ago …

Your question is a little vague. I'm not sure whether you're asking, "What are deferred taxes?", or your interest is specifically in NASDAQ's deferred taxes. If it's the latter, I can't help you. If it's the former, read on.

This is an accounting question and, as some who have followed my prior posts know, I'm a Chartered Accountant (a Canadian "CPA".) To understand what deferred taxes are, we have to make a few assumptions for our example ...

Company X is a manufacturer of widgets that has income of $250,000 a year before depreciation and amortization. (It could be in any industry, but let's say its widgets for now.) To make those widgets, it buys $1 million of equipment. The "life expectancy of the equipment is 10 years. Also, let's assume it's tax rate is 25%. Finally, we'll assume that the accountants have decided (and, for the purposes of this discussion, we'll assume) that "straight-line" depreciation is appropriate (i.e. $100,000 of depreciation expense annually.)

But the government wants companies to make widgets ... lots of widgets. How do they do that? Well, one way is to allow companies that buy equipment that makes them the opportunity to write-off the equipment for tax purposes over, say, 4 years.

For accounting purposes, after depreciation and before taxes the company's net income for FINANCIAL STATEMENT purposes is ($250K - 100K =) $150,000. Since the financial statements must be prepared using "Generally Accepted Accounting Principles" (GAAP), the accountants are required to reflect the "tax expense" on that income - in this case, 25% of $150,000, or $37,500 - on the company's income statement.

But, there's a problem. The tax rules will allow the company to write-off its equipment over 4 years. That's ($1 million / 4 =) $250,000. The company's ACTUAL TAXABLE INCOME is ($250K - 250K =) zero. Its tax liability is actually (25% of zero =) zero!

But GAAP requires the financial statements to reflect taxes of $37,500! Oh my. Whatever shall we do??

The answer is to show the amount ($37,500) as a tax expense on the income statement as required by GAAP, and the contra entry as a liability on the Balance Sheet.

But it isn't really a current liability. The company doesn't have to write a cheque! So, how do we show it on the Balance Sheet? Answer: "Deferred Income Taxes". The company's Balance Sheet will show "Deferred Taxes" increasing by $37,500 in each of the first 4 years until, at the end of that time, the amount will be $150,000.

Fast forward to Year 5. Once again, the company has financial statement income of $150,000 and a tax expense (according to GAAP) of $37,500. But the equipment has been written-off for tax purposes! It's taxable income is $250,000. It owes taxes of (25% of $250,000 =) $62,500!!! Now what?

The accountants will show the expense on the company's income statement as $37,500, show the "true" tax liability ($62,500) as a current liability on the Balance Sheet and REDUCE the "Deferred Taxes" amount by the difference of ($62,500 - 37,500 =) $25,000. At the end of Year 5, you'll see "Deferred Taxes" of only ($150K - 25K =) $125,000. And if you do the math, you'll see that by the end of Year 10, the Balance Sheet will show "Deferred Taxes" of zero (i.e. you won't see it captioned.)

Unfortunately, it isn't that simple. Companies don't buy equipment as a "one-off". Even if it didn't buy a single asset in that time, by the end of Year 9, that original machine is getting pretty "ratty". Right? It has to be replaced! So the process begins all over again in Year 9 when they buy a replacement machine for, maybe, $1.5 million. Or, maybe business is expanding and they need another one in Year 3. It will take until Year 13 to "resolve" the deferred taxes on that machine. And what about the third one they buy in Year 7?

The point here is that, for the most part, deferred taxes are never really paid off so long as the company is a going concern. They're always buying new equipment or taking advantage of some other tax benefit like this one. And, because of this ...

There is no way to calculate "the current value" of deferred taxes. As a matter of fact, if you think about it, a reduction in those amounts can only mean one of two things. Either:

1. The tax law has changed and those "fast write-offs" no longer exist (a warning about the government's view of the industry), or

2. The company is no longer buying equipment (a warning of the future of its business.)

Either way, this is a company you don't want to own anymore.