{"id":4248,"date":"2019-03-07T07:53:48","date_gmt":"2019-03-07T07:53:48","guid":{"rendered":"https:\/\/analystprep.com\/cfa-level-1-exam\/?p=4248"},"modified":"2025-11-27T19:26:27","modified_gmt":"2025-11-27T19:26:27","slug":"impact-tax-rate-changes","status":"publish","type":"post","link":"https:\/\/analystprep.com\/cfa-level-1-exam\/financial-reporting-and-analysis\/impact-tax-rate-changes\/","title":{"rendered":"Impact of Tax Rate Changes"},"content":{"rendered":"\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"name\": \"What effect will a decrease in the income tax rate have on deferred taxes and net profit after tax?\",\n    \"text\": \"A new tax law results in the income tax rate decreasing from 30% to 25%. What effect is this most likely to have on a company\\u2019s deferred taxes and net profit after tax?\\n\\n1. Deferred taxes: Increase; Net profit: Increase\\n2. Deferred taxes: Decrease; Net profit: Increase\\n3. Deferred taxes: Increase; Net profit: Decrease\",\n    \"answerCount\": 1,\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"text\": \"The correct answer is 2. A decrease in the income tax rate will reduce the carrying amounts of deferred tax assets and liabilities and lower income tax expense, which in turn increases net profit after tax.\"\n    }\n  }\n}\n<\/script>\n\n\n\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/ZdGeNqOn7iA\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\n<p>Income tax rate changes can significantly impact a company\u2019s financial statements and the financial ratios which are derived from them. It is important, therefore, for an analyst to take note of any proposed changes to tax laws that may inform changes to the income tax rates and consequently have a material impact when enacted.<\/p>\n<h2><strong>Impact of Tax Rate Changes on a Company\u2019s Financial Statements and Ratios<\/strong><\/h2>\n<p>Any change in the income tax rate will result in adjustments being made to the carrying values of existing deferred tax assets and liabilities. Increments (decrements) in the tax rate will lead to increments (decrements) in reported amounts for deferred tax assets and liabilities.<\/p>\n<p>The effect of the change will also be reflected in the determination of the accounting profit in the period during which the change is enforced. This results from the fact that the changes in the income tax rate will also affect the measurement of income tax expense in the year under review.<\/p>\n<blockquote>\n<h3><strong>Question 1<\/strong><\/h3>\n<p>A new tax law results in the income tax rate decreasing from 30% to 25%. What effect is this <em>most likely<\/em> to have on a company\u2019s deferred taxes and net profit after tax?<\/p>\n<ol style=\"list-style-type: upper-alpha;\">\n<li data-tadv-p=\"keep\">Deferred taxes: Increase; Net profit: Increase<\/li>\n<li data-tadv-p=\"keep\">Deferred taxes: Decrease; Net profit: Increase<\/li>\n<li data-tadv-p=\"keep\">Deferred taxes: Increase; Net profit: Decrease<\/li>\n<\/ol>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is <strong>B<\/strong>.<\/p>\n<p>A decrease in the income tax rate will result in a decrease in both the company\u2019s deferred taxes and the income tax expense. A decrease in income tax expense will lead to an increase in net profit (after tax).<\/p>\n<h3><strong>Question 2<\/strong><\/h3>\n<p>All else being equal, a proposed increase in tax rates would affect a company that has a substantial amount of tax assets by:<\/p>\n<ol style=\"list-style-type: upper-alpha;\">\n<li data-tadv-p=\"keep\">Increasing the company\u2019s asset turnover ratio.<\/li>\n<li data-tadv-p=\"keep\">Decreasing the company\u2019s asset turnover ratio.<\/li>\n<li data-tadv-p=\"keep\">It wouldn\u2019t affect the company\u2019s asset turnover ratio.<\/li>\n<\/ol>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is <strong>B<\/strong>.<\/p>\n<p>An increase of the tax rate would increase the value of the company\u2019s tax assets. Since the Asset turnover ratio = Revenue\/Total assets, an increase in the company\u2019s assets would decrease this ratio.<\/p><\/blockquote>","protected":false},"excerpt":{"rendered":"<p>Income tax rate changes can significantly impact a company\u2019s financial statements and the financial ratios which are derived from them. It is important, therefore, for an analyst to take note of any proposed changes to tax laws that may inform&#8230;<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[5],"tags":[],"class_list":["post-4248","post","type-post","status-publish","format-standard","hentry","category-financial-reporting-and-analysis","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Impact of Tax Rate Changes | CFA Level 1<\/title>\n<meta name=\"description\" content=\"Learn how changes in tax rates affect deferred tax assets, liabilities, and financial statements, impacting a company&#039;s tax strategy.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, 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