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I've been looking at some companies that have posted very large increases in Deferred Tax Assets that have resulted from newly created NOLs, themselves the product of new practices of expensing stock options in the past couple of years. While I understand the mechanics and the GAAP involved, I'm concerned that the very large increase in Investment in DTA is biasing the income tax charges way upward for both Defensive Earnings and Enterprising Earnings relative to the Accrual Earnings. Ultimately showing much lower Def. and Ent. relative to Accr. and perhaps making a seemingly "good" company look worse than it is. Thoughts?

Jeff
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Jeff,

A real-life example would make it easier to answer this interesting question.


Hewitt
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Hi Hewitt, good to be chatting with you again...it's been a while.

On the NOL, one example came up while analyzing ADSK from 2004-2006. They posted such a charge in '04. This is the most recent one I've come up against but there have been others.

Look forward to hearing back.
Jeff
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Hi Jeff

Not Hewitt and I can't answer your question regarding earnings. But I would very much like to understand the question. I have read through it a half dozen times and don't know what it asks

Are you saying you are finding companies with losses on EBIT from expensing options? And that is creating deferred tax assets?How are deferred assets increasing provision for taxes? Don't deferred liabilities increase provision for taxes? Are you considering provisional vs cash taxes? If you are looking at cash taxes wouldn't they be less if the company is claiming dtas and greater if the company includes dtls?

maybe if you gave an example of a specific company with the actual numbers it would help the discusiion

>^..^<
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Jeff -

I agree with KitKat...please flesh the question out a little more.

Hewitt
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Hi Jeff,

Looking at Autodesk for last fiscal year reported the tax deferred assets (net of changes in tax deferred liabilities) increased by 74.2 million. There was also a decrease in accrued income taxes of 30.8 million. By this method the cash taxes paid would increase by 105.0 million. I believe this is the concern you are bringing up.

Consider that Autodesk only paid 44.2 million in actual taxes (disclosed in the footnotes) which was 9.9 million less than the provision for income taxes of 54.1 million.

Looking at the operating cash flow reconciliation we see that adjustments to the provision of taxes was 124 million in tax benefit from stock options, an outflow of 87.8 million in Deferred Income Taxes, and a drop of 27.3 million in accrued income taxes. Adjusting:

Provision: 54.1 million
add: 124 million Tax Benefit from Stock Options
less: 87.8 Deferred Income Taxes
less: 27.3 Accrued Income Taxes
Taxes Paid: 45.2 million

(vs reported 44.2 million ?don't know where the 1 million went)

So do we reduce cash taxes by 9.9 million or add 105 million. My answer is stick with the cash flow statement and cash taxes paid of 44.2 million. I don't think the balance sheet includes enough information to get us in the ball park of the actual cash taxes paid. I personally have gone after the balance sheet method but this is a perfect example of the cash flow statements and footnotes being of help and giving a more clear picture. Don't know if this was of any help but maybe it will stimulate some more discussion - I am curious as to other's thoughts on this issue and finding out where I am confusing things.

Snippit from 10-K

Cash payments (refunds) for income taxes were approximately $44.2 million in fiscal 2006, $16.5 million in fiscal 2005, and ($19.3) million in fiscal 2004.


The tax benefit recognized associated with dispositions from employee stock plans was $124.0 million in fiscal 2006, $116.9 million in fiscal 2005, and zero in fiscal 2004. Foreign pretax income was $276.2 million in fiscal 2006, $183.5 million in fiscal 2005, and $126.7 million in fiscal 2004.

Matthew
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Hi Matthew

Glad to have your help here. Difficult topic

hard following your numbers

drop of 27.3 million in accrued income taxes.

decrease in accrued income taxes of 30.8 million.


Why two different numbers?


Provision: 54.1 million
add: 124 million Tax Benefit from Stock Options
less: 87.8 Deferred Income Taxes
less: 27.3 Accrued Income Taxes
Taxes Paid: 45.2 million


Can you translate what you did here and why

Accrued taxes are what the company owes but hasn't paid--thats why you subtracted it from provisional--
Added back the tax benefit from options because it reduces provisional?

From there I can't tell what you did.

And from Mulford's book it appears that you treat deferrals as a subtraction from provisional whether you end up with a net asset or liability. Does that sound right?

The question appears to be ralated to companies with negative EBIT due to the impact of options expense

Can this create an NOL that causes current taxes to be punitive and show a business with poor defensive and enterprising earnings? Seems to me the negative EBIT would be the bigger concern, not the taxes
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Hi Jean,

Ok here's a cleaner version with the help of the spreadsheet:
AutoDesk                                 ADSK

Selected Balance Sheet Items
Plus information from Note 5
(in millions)
Deferred Tax Calculation: 01/31/05 01/31/06
Assets
Deferred income taxes 223.50 285.50
Liabilities
Deferred income taxes (104.10) (91.90)

Net deferred tax assets 119.40 193.60
Investment in net deferred tax assets 74.20

Accrued Income Taxes*** 41.6 10.6
(31.00)


Accrual taxes** (54.10)
Change in Accrued Income Taxes** (31.00)
Investment in net deferred tax assets** (74.20)
(159.30)
<Additional adjustment?>
Tax Benefit from Stock Option*^ 124.00
Cash Income Taxes (35.30)

<<Actual Cash Taxes Paid>> (44.20)
Error 8.90

*** Not part of Hewitt's calculations
** Its negative because its an outflow
* Its positive because ita an inflow
^ Not so sure about this adjustment

So as you can see the investment is rather high if you don't consider the tax benefit of stock options and the inflation that I thought Jeff was talking about. Autodesk hasn't had any negative EBIT and I believe this is all IRS related for tax return purposes - not financial statements. As for that level of detail only the CFO could help us out.

And my point was that the statement of cash flows actually gives us the amount handed over. And that the statement of cash flows does come closer to the actual paid - all considering the tax benefit for stock options.
Cash Flow Version                         01/31/06

Accrual Taxes (54.10)
Tax benefits from employee stock plans 124.00
Deferred income taxes (87.80)
Accrued income taxes (27.30)

Adjusted Taxes (45.20)
<<Actual Cash Taxes Paid>> (44.20)
Error (1.00)

So I am not sure what to do but at least hopefully the data is easier to read :)

Matthew
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A blurb from FASB 123 paragraph 44 under the section "Accounting for Tax Consequences of Equity Instruments Awarded to Employees"

Paragraph 44:


44. If a deduction reported on a tax return for a stock-based award exceeds the cumulative compensation cost for that award recognized for financial reporting, the tax benefit for that excess deduction shall be recognized as additional paid-in capital. If the deduction reported on a tax return is less than the cumulative compensation cost recognized for financial reporting, the write-off of a related deferred tax asset in excess of the benefits of the tax deduction, net of the related valuation allowance, if any, shall be recognized in the income statement except to the extent that there is remaining additional paid-in capital from excess tax deductions from previous stock-based employee compensation awards accounted for in accordance with the fair value based method in this Statement. In that situation, the amount of the write-off shall be charged against that additional paid-in capital.

Matthew
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Hi Matthew

Day job interfering with my education here. Not ignoring the conversation--need some uninterrupted time to look at it so check back :)
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So we have to look for tax benefit both on the statement of equity and the balance sheet. Perhaps this goes some distance into answering the original question. But I am not sure how
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Hi Matthew

On your cash flow version, what is the definition for accrual taxes as opposed to accrued taxes?

Here is a cash flow statement from Stryker. They do not use either term but just use income taxes.Is this accrued, accrual or cash taxes? And if it is just cash taxes and that's what is usually on cash flow statement where are you finding accrued and accrual?

Thanks



Years ended December 31
2004 2003 2002
Operating Activities
Net earnings $465.7 $453.5 $345.6
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Depreciation 102.7 97.2 86.3
Amortization 148.2 132.5 99.8
Income tax benefit from exercise of stock options 39.8 35.7 22.5
Purchased in-process research and development 120.8 -- --
Restructuring and acquisition-related items -- -- 17.2
Payments of restructuring and acquisition-related liabilities (3.8) (14.7) (4.9)
Provision for losses on accounts receivable 18.4 15.9 16.0
Deferred income tax credit (65.5) (32.9) (1.8)
Other 10.2 8.7 1.9
Changes in operating assets and liabilities, net of
effects of acquisitions:
Proceeds from (reductions of) accounts receivable securitization (150.0) 20.0 --
Accounts receivable (93.5) (75.9) (64.4)
Inventories (63.0) (5.8) 7.0
Loaner instrumentation (161.4) (90.3) (84.6)
Accounts payable 68.3 24.6 (3.2)
Payments of acquisition purchase liabilities (0.2) (0.8) (3.5)
Accrued expenses 139.0 77.3 65.4

Income taxes 40.0 3.9 26.9

Other (22.4) (0.4) (10.0)
Net cash provided by operating activities 593.3 648.5 516.2

Sorry about the sideways scroll but it would have been time consuming to fix
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Thoughts?------

Duh?Took me a week but........

I see where you are going with this thought on deferred assets.

Since deferred assets are taxes paid that will be recouped in the future on IRS tax returns, you are concerned about the swelling asets that go into the invested capital that decreases free cash flow. Its a valid point
If you want to delete the DTA then you would also need to eliminate the DTL


Matthew (TMF Rivet) has suggested backing out all tax related items when looking at invested capital.

Huge amounts of deferred tax assets would make FCF lower
But you are still stuck with a company with decreased(even negative by your account) earnings due to options expense. Are you in favor of also taking that out of the free cash flow calculation?
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OT

Hi KitKat,

Do you mind much if I but in and ask a favor?

I was wondering if you still had a link to the Dam Seminar, to the excellent post you did on what goes into a P/E?

If it is any trouble at all, don't bother with it.

Thanks either way,

Chin
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Hi again KitKat,

Just thought I would let you know I found it.

Sorry for the interuption.

Chin
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Hey Chin

Where have you been? Glad to hear from you

The chapters in the book and the slides are vital for understanding the sketchy notes I took. I find as time goes by, those lectures become more and more valuable. Dam is a very gifted teacher

>^..^<
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I was wondering if you still had a link to the Dam Seminar, to the excellent post you did on what goes into a P/E?

Sounds interesting. You said in your next post that you found it ... may I take a look?

Thanks,

SonFool
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Hi SonFool

The following links to all the lectures
#14-#19 are relative valuation and very worthwhile
Supplementing with his lectures and book is a necessary component. He is the absolute best teacher(and cute too!)

http://boards.fool.com/Message.asp?mid=19958329&sort=whole#19981941
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Folks, I've been out for over a week and haven't kept track but having read through the threads I'm glad to see the DTA question sparked so much discussion. After reviewing the threads I have to say good job in carving this issue up. So it's with much added clarity on some of your approaches that I pose the original question once again...and we can use the 06 figures for specifics.

Given that the Accrual Inc Taxes are $54.1MM and the Investment in DTA is $74.2 (as noted above), the overall impact on Defensive Earnings is quite material even though it appears to me to be driven by the new treatment on the stock options and not real cash flows. My basic understanding of the new ruling is the company is taking a charge to income for the stock options and creating a DTA based on that value but I don't believe the ruling on its own now triggers a new, and actual cash payment for the taxes. Unless I'm wrong, these types of charges and the subsequent impact on our Defensive Earnings calcs, will put a negative bias on those calculations which aren't really reflecting reality (i.e. impacts to cashflows)...and ultimately biasing our investment decisions? Final thoughts?

Jeff
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Hi Jeff

Will start a new thread. this one has gotten buried and you may get better responses if we drag it forward

>^..^<
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Hi KitKat,

Say Hi, and don't even bother to check back, huh?

Sorry. I have been quite busy, and on top of that arguing the advantages (disadvantages in my view) of Shiller's PE10 which claims the market is extremely overvalued now over on the Morningstar boards;
http://socialize.morningstar.com/NewSocialize/asp/FullConv.asp?forumId=F100000015&convId=178844


You can find what you are looking for here;
http://boards.fool.com/Message.asp?mid=19408797

this in particular here;
kitkatklub continues on the journey with Damodaran to Chapter 18, Relative Valuations and Lectures; invites others to join. Bravo!
<http://fireboards.fool.com/Message.asp?mid=19063557&sort=whole>
D15-PE Ratios Thoroughly Dissected
<http://fireboards.fool.com/Message.asp?mid=19096658&sort=whole>
Lecture 16 – PEG
<http://fireboards.fool.com/Message.asp?mid=19122772&sort=whole>
Lecture 17 – Relative PE Evaluations
http://fireboards.fool.com/Message.asp?mid=19319539&sort=whole#19321341 <http://fireboards.fool.com/Message.asp?mid=19319539&sort=whole>
Lecture 18 – Relative Valuation
http://boards.fool.com/Message.asp?mid=19345856
http://boards.fool.com/Message.asp?mid=19345886

As Ro pointed out, “Bravo!”

You did an excellent job with the Dam Seminar, especially having to put up with us Spitballers. :o)

Chin
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Oh Geez,

Shouda read before posting, huh? :o)
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