We've only got an hour. It's not a massive amount of time, so we're gonna get going pretty quickly.

Right, so we want to talk about, we're gonna talk about deferred tax.

And really the kind of, the thing you, you need to think about for deferred tax is, is why deferred tax assets and liabilities get created.

And, and the kind of one of the main reasons for this is we're gonna think about the matching principle in accounting.

I want to think about the effective tax rate.

So when we create deferred tax assets and deferred tax liabilities, what that seeks to do is to smooth out the effective tax rate.

And so probably the first thing that it would be appropriate for us to talk about would be, okay, so what is the effective tax rate? What's the marginal tax rate? And why do those two things diverge? So I've got a actually pretty simple little example here.

We've got a company that is apparently a highly leveraged business and it's got the following characteristics.

We've got operating profit and a tax expense.

We've got profit before tax.

We've got some net income and we've got statutory tax rate.

And the first question is, well, what, what is the what is the effective tax rate? So a good way to describe the effective tax rate is to refer to it as the average tax rate.

So if I said, because I'm gonna go up to the face of the income statement and I'm gonna go and grab the tax expense, and I'm gonna divide that by the profit for tax.

So on average, this business is paying 40 or has a 40.3% tax rate. And you say, well, why is that? Because I thought the statutory rate was 25%. So how do we get to the 40.3? The marginal tax rate is really the the statutory tax rate at 25%. So what, why is there a difference between the two? If we read a little bit further down, it says 17% of the interest expense is from a shareholder loan.

So let's just think a little bit about what that really means.

For the most part, a company can go and borrow from a bank and it will occur interest.

And as I think we all know, interest is a tax deductible item.

And so that interest will reduce the profit for tax and it will also reduce the tax expense.

But this business has within its capital structure, it's got a shareholder loan.

So a shareholder said to the business, which is a related party, it said to the business, Hey, you know, I could lend you some money.

Now that's not necessarily an arm's length transaction.

So to an extent the shareholder that's lending that money could play around with the tax rate.

And if it decided spuriously to increase the tax rate, then the tax expense would increase. And the company might say, oh, amazing.

You know, I've got lower profit before tax, I'm gonna pay less tax.

The tax authority or any tax authority is never gonna let that happen. They're never gonna put that power in the hands of that, of that shareholder for the business.

So we are being told that in the jurisdiction that the company operates, the interest on the shareholder loan is not tax deductible. And that would be a very common thing in really every tax, every tax jurisdiction I'm familiar with.

So let's just play around with the numbers below that.

The profit before tax from above is 14,400.

And the non-deductible to tax expense is 17%.

I'm being told that it's 17, 17% of the interest expense. So if I multiply that by the interest expense we've been given, 17% of that i.e. 8,840 is non-tax deductible.

So the next line item is the profit subject to tax at the statutory rate.

If we add those two together, 23,240 is subject to tax at the statutory rate.

And that means that if we go and grab the statutory tax rate, which is also the marginal tax rate, and we multiply it by 23,240, we can get back to 5,810.

Now, interestingly, if we look at that number, that number is the tax expense.

So to get to the tax expense in the income statement, we've said, look the interest on shareholder loan is not tax deductible.

Let's add that back. That increases the profit subject to tax at the statutory rate, and that means that we have slightly more tax.

Now that's still a legitimate accounting expense, so it's still gonna factor into the profit before tax, but it's not a tax deductible expense. So we've got a difference between the two, and that is what is referred to as a permanent difference.

So it's always gonna be the case that the, that for in this jurisdiction that the interest on shareholder loan is not tax deductible. And that's kind of the end of the, you know, the end of discussion.

So if you said, well, you know, in the accounting, what would it look like? Asset, asset equals liability plus equity.

Let's just move that out to the side a little bit.

So you'd be saying, okay our tax payable to the tax authorities is 5,810.

So tax payable is gonna go up by 5,810.

And in our income statement, our tax expense is also gonna be 5,810.

So retained earnings is gonna go down by 5,810, and that is our tax expense.

That's our tax expense.

So, so those two match off and there's just no more action to take.

But we might have a different situation.

So we might have a situation whereby we have an item that is, is not tax deductible, but in place of the accounting expense, we have a tax expense and the tax expense and the accounting expense might diverge and then converge.

And what am I talking about here? I'm talking about depreciation.

So you might have a situation whereby the accounting depreciation schedule is different from the tax depreciation schedule.

We've got an asset and we're gonna depreciate it down to maybe 0 over its life.

But the way in which we phase that depreciation from an accounting point of view and a tax point of view can vary.

And that would be referred to not as a permanent difference, but as a temporary difference.

So when we're thinking about tax, we're thinking about permanent differences.

So non-tax deductible items, end of discussion and temporary differences where the tax deductibility might change versus the accounting deductibility over the, over the life of, of that asset.

And that's what we need to think about deferred tax.

And we're, we're gonna explain that in a bit of detail.

So let's scroll down.

I'm going to scroll a little further down these workouts and, uh, I'm looking at workout 11.

So let's scroll down. I'm look at workout 11.

Just a narrative question.

I'm not gonna write anything here, I'm just gonna talk about it.

The question says, explain the following variations between the marginal tax rate and the effective tax rate.

Now, this situation I've highlighted for business one is exactly the same as the situation we've looked at in the previous workout in workout five.

So the effective tax rate is greater than the marginal tax rate.

How come the effective tax rate is higher? What pushing it up, well, we'll have some non-tax deductible items that will create permanent differences.

And in the previous example, we looked at the interest on a shareholder loan, but there are other items that are non-tax deductible.

So for example, maybe some litigation expenses, some fines, but employee entertainment can be non-tax deductible to a certain degree.

And so they'll create this separation between the two.

Now we've also got business two.

So in business two, you'll notice that the effective tax rate is lower than the marginal tax rate.

So what has caused that? Well, typically that lower rate is caused by something quite different.

So it's usually caused by foreign rate, a foreign rate differential.

So if you go back a couple of years and, uh, not very far back in, in time, and you look at the corporate tax rate in the United States.

So it used to be for a long time, 35%, which is pretty high globally.

So companies like Coca-Cola or Nike, if they were doing business internationally, which of course they are, then they would be subject to tax in various different tax jurisdictions that have a lower rate than the us.

So those earnings would be taxed at lower rates.

And when you put everything together, the average tax rate, or I might say the effective tax rate, the average tax rate or the ETR would be lower because of that foreign rate differential.

So there are a number of reasons, and of course they could all exist at the same time.

That can cause the effective tax rate to diverge from a marginal tax rate.

But I'm actually not really that interested in that divergence. What I'm interested in, and I've only already seen setting here, is there a mechanism by which we can keep the effective tax rates stable? So I don't really want that divergence.

And, and there is and that is a useful approach when we are when we're looking at what I'm gonna call temporary differences.

So let's scroll down and look at out 12.

And out 12 says, hey Jonathan, can you calculate the tax liability, the tax expense, and the effective tax rate for Alamda using the following information given below? Now, let's look at what we've been given here.

We've got profit for tax from the income statement non-deductible expenses.

And we've got the statutory tax rate.

So really, you know, the same sort of situation.

So let's just show the formulas there. So you can see this.

So the profit before tax and the income statement is 13,773.

We've got some non-deductible expenses we're gonna add back.

We add those together. The tax due at the STA rate is 8.5%.

So we've got 4,489.

The tax expense is also 4,489.

We've equalized those because we've got a permanent difference.

And so the effective tax rate would be the tax expense over the profit before tax.

So we've got that lower rate of we've got that lower rate, oh, sorry, let me actually go grab the right number.

Tax expense over the profit for tax on the income statements. Sorry, we've got that higher rate of 32 point 6%.

If we look now as a compare and contrast, if we now go down and look at out 13, we are being asked, can you calculate the tax liability, the deferred tax liability, the tax expense, and the ETR for this business? And the kind of interesting thing we're looking at here will be the deferred tax liability and its impact on the effective tax rate.

So we've got for tax from the income statement, depreciation expense in operating costs and tax deductible depreciation expense.

So I'm noticing that these two numbers are different.

So we haven't got multi period information, but it would be reasonable to make assumption that probably we've got an asset we're gonna depreciate on a straight line basis.

So let's imagine that the, whatever this asset is, it's gonna be depreciated at 2,500 every period, okay? For a number of periods.

Now, from a tax point of view, the tax authorities are gonna say, accounting depreciation isn't tax deductible.

And I might say, well, why not? The tax authorities would say, look, when you think about accounting depreciation, an accountant has some reasonable amount of control to determine how the asset is depreciated.

So it might be depreciated over a three year period, it might depre be depreciated over a five year period.

It might be depreciated using straight line depreciation or reducing balance depreciation.

So the issue is, as an accountant, you could say, oh my goodness, we wanna pay less tax this year.

How can we manipulate these numbers? Let's use reducing balance depreciation and we'll take a big, you know, depreciation hit early on and that will reduce our profit and we'll pay less tax.

Now, clearly the tax authorities is not good, are not gonna allow the accountant to have that level of control.

So they'll say, no.

Accounting depreciation is a non-tax deductible item.

And the accountant might say, well, what does that mean? We can't deduct depreciation to, you know to arrive at our, our tax numbers and the tax authorities to say, oh no, you can deduct depreciation, but just not depreciation of your choosing.

So as the tax authority, we will decide how that depreciation is phased.

Now, if you look at this example, this is very much in the company's favor.

So the tax deductible depreciation is greater than the accounting depreciation.

And it might be that the, the government and through the tax authority is looking to incentivize a business to acquire a certain asset by offering generous depreciation.

So it might say, we'd really love you to invest in electric vehicles.

And if you invest in electric vehicles rather than from an accounting point of view, depreciate the, the electric vehicles on a straight line basis over five years, we might let you take 50% of the depreciation in year one and 50% of the tax depreciation in year two.

Now, the company would say, well, hang on a minute.

I don't want, I don't wanna depreciate it over just a two year period because we're gonna use the asset for five years.

And the tax authorities will say, no, no, that's not what we mean.

So you as a, as an accountant, you depreciate it over five years, a tax point of view, you can kind of front load that depreciation and recognize 50% in year one and 50% in year two.

What's worth thinking about is the, the accountant under accounting depreciation will fully depreciate over five years.

And from a tax point of view will also fully depreciate over five years.

It's just, it'll be phased differently, it'll be front loaded.

So what we are not doing is we're not recognizing any more or less depreciation in total over the life of the asset.

We're just recognizing it a different point in time.

So let's have a think numerically about how these numbers might work.

The profit before tax on the income statement is given us, given to us above it's 19,196 and the we're gonna add back the non-deductible tax depreciation of 10,500.

And then we're gonna recognize the non-deductible accounting depreciation of 2,500.

And then we're gonna recognize the tax deductible depreciation of 3,250.

And let's just make that bold.

The profits subject to tax for the period would be the profit on the income statement before tax on the income statement, add back the tax depreciation, subtract the add back, the accounting depreciation, subtract the tax depreciation so that number's lower, right, it's lower than the accounting taxable profit number.

Now we're gonna pick up the tax due at the statutory rate for the period.

So we've given a statutory tax rate, and if I multiply that by that number, I get 6545.6.

And if we go to the side and do some accounting asset equals liability plus equity, you might say, right? So I think the, the tax due at the statute rate for the period, so that's the tax I'm gonna pay over to the tax authority.

I'm gonna say tax payable up by 6,545.6.

And you might say retained earnings and this would be wrong.

Okay, so we we're not gonna do this next bit, but just, just for the sake of argument, you might say, retained earnings down by 6,545.6.

That's correct, that 0.6.

Now, if we did that, thinking about the last examples we've looked at, so if we did that, that would affect the effective tax rates, the effective tax rate would go down.

But the thing is, because we're depreciating an asset, it might be the case in this period that the depreciation or tax depreciation is a little higher.

So that might you know, affect, affect the effective tax rate in this period, in the next period that situation might reverse.

So it create, it can create quite a lot of volatility in the effective tax rate.

And given that this will all net out to zero ultimately anyway, that's kind of a suboptimal solution.

So let's not do that bit, okay? It's probably not a great idea to say we'll have the tax expense at 6,545.6, let's delete that, get rid of that.

I wanna keep the tax expense at 35%, 35.4% of the profit before tax and the income statement.

So we're gonna keep it at 6,795.4.

Now, if I put that into the accounting equation, so retained earnings down by 6,795.4, and I'm gonna say in brackets tax expense, then that clearly doesn't work.

Okay? So the liabilities are going up by 6,545.6 and equity is going down by 6,795.4, If you look at the, the difference between the two, so one minus the other, there's a difference of 249.8 here.

So what are we gonna do with that? Well, I'm gonna think about this as an accrual. Really.

It's an accrual, right? So if you think about generally how an accrual works, if you recognize an expense in your income statement, but you don't recognize the liability in your, in your balance sheet, then you would accrue for it.

So if you think about like a payable, I've got rent, uh, that we haven't received an invoice for.

So retained earnings is gonna go down by whatever that rent expense is.

We can't say accounts payable up because we haven't received the invoice.

So we're gonna say accruals up, we're gonna accrue for it.

And it's very similar here, right? We're saying retained earnings is gonna go down by 6,795.4 and we haven't received an invoice as such, but we're gonna declare to the tax authority that we owe them 6,545.6.

So the amount by which the income statement is going down is different from the liability we're reporting to the tax authority.

So what are we going to do there? We need to accrue the difference, and that is referred to as a deferred tax liability.

So a deferred tax liability is effectively like, you know, accruing some tax that's gonna happen that's gonna occur in the future.

So I'm gonna say deferred tax liability up by 249.8 and we're talking deferred tax liability.

But clearly on the other side you can have a deferred tax asset and a deferred tax asset is like a prepayment.

So you might have a situation where you have to pay more tax over to the tax authority in a given period than you're declaring in your income statement.

So if you are paying more to the tax authority than you're declaring in your income statement, then that must mean that you are prepaying that tax and that's a deferred tax asset.

Okay? If we, I've done the accounting equation already, but if we scoot a bit further down the question.

There is a bit of space available to, punch in some numbers here.

So really, you know, just, just in summary of what we said, the income tax for the period, if, if I scroll up the income tax for the period, here is 6,795.4.

So that's, that's the expense.

The income tax liability for the period is the amount we're gonna pay to the tax authorities is 6,545.6.

And so the difference between the two, which is a number I've already calculated up here, so one minus the other is 249. That's the deferred tax liability says deferred tax.

Is the tax on temporary differences? Because ultimately for any asset, the tax depreciation and the accounting depreciation over the life of the asset will be the same number.

It's just phased differently.

But in this period, the depreciation expense in operating costs i.e. in the income statement was 2,500.

And the tax deductible depreciation, which just sits directly below that is 3,205.7.

So the temporary difference for the period would be the difference between the 2, 705.7, you could say, well I thought, you know, I thought we were looking for a deferred tax liability of 249.

Yeah, we are. So if we look at the difference in the depreciation and we multiply that by the tax rate above 35.4, there is your 249.8 and it's probably useful if I show you my formula's there.

Just so you can see what I'm doing in the accounting. So we've got the accounting to the side, as we'd said previously, the retained earnings goes down by 6,795.4, the accrued taxes.

And what we mean there is the tax payable to the tax authorities goes up by 6,545.6.

And we recognize the deferred tax liability of 249.

So the accounting equation balances, reliability and equity side, we've got zero on the asset side, there's just nothing there is there.

So we've also got zero and it's in balance. Okay? So, I think one of the issues with the example is that it's only looking at a single period.

So to get a, you know, more complete picture, it would be useful if we could look more broadly, what might happen, over the entire life of an asset.

And in order to do that, I'm going to just scoot down a couple of rows and go down to workout 15.

So work out 15 is really the the last workout that we're gonna look at here.

And then we're gonna move on to the, looking at the valuation of the deferred tax deferred tax losses net operating losses, sorry.

Okay, so Huelva brought some PP&E for 100,00 and it's depreciation is straight line over five years.

The salvage values estimated to be 0, so that means they're gonna depreciate it at a hundred thousand a year, right? So let's not read any further.

We've got a little table to fill in here and it says, what's the gross amount of the PP&E the gross amount is 100,000 It's not the net book value, it's the gross amount.

So that's unchanging throughout the entire life of the asset.

It's gonna be 100,000.

The depreciation expense would be a hundred thousand divided by five years.

So it'll be 20,000 a year.

So you might say, well, what's the net book value? The net book amount for that asset at the end of the first year, it's 100,000, minus 20,000, it's 80,000.

And in year two it's 80,000 minus a further 20,000, 60,000, 40,000, 20,000, 0.

Okay? So ultimately we're gonna depreciate the asset down to 0.

There's nothing fancy there, we're not even talked about tax yet. We're just saying we've got an asset, we're 80 over a five year period, it's 20,000 a year.

Okay, let's review that from a tax perspective.

So from a tax perspective, they would, the tax authorities would see the asset, again, being 100,000 in its gross value, the depreciation expense from a tax perspective is different.

So let me grab a highlighter.

The tax authorities have allowed tax depreciation of 40%, 30%, 20%, and 10%, and then 0% in the fifth year.

'cause if you notice, the asset is fully depreciated.

So 40% plus 30% plus 20%, 10% is a hundred percent.

It's fully depreciated over a five year period.

So my conclusion would be that the tax authorities wanna incentivize people to buy this asset.

They're gonna let them recognize quite aggressive tax depreciation early on in the life of the asset that's gonna reduce the taxable profits and reduce the tax expenses early on.

It does mean that the tax expense will be higher, sorry, tax payable. It does mean that tax payable will be higher further on in the life of the asset.

But if you think about the time value of money, it's kind of a nice thing to not have to pay so much tax early on over the, you know, over the next few years. And we'll just figure out that we're gonna pay some more, extra tax further on the life of the asset. We'll figure that out when we get there. Okay? So the, the tax depreciation expense, and this would just be a bit manual to insert, would be 100,000 multiplied by 40% because that's the first year of depreciation we're gonna recognize.

And then it would be 100,000 multiplied by 30% because that's the next amount we're gonna recognize.

And then following, following that, a hundred thousand multiplied by 20% and 100,000 multiplied by 10%.

And then just for completeness, 100,000 multiplied by 0%.

Okay? So there's no depreciation in the final year.

So the net book amount would be 100,000 minus 40.

So the tax depreciation is more aggressive, so it's falling in value quite quickly.

For the second year, it'd be that 60,000 and we're gonna deduct a further 30,000 of depreciation.

So it's 30,000, 10,000, 0 and 0.

So it's worth saying that under both the accounting depreciation approach and the tax depreciation approach, both under both situations, the asset reduces to 0.

And in fact just, it's just worth saying that if we add together the sum of the accounting depreciation, we're gonna highlight that in the yellow, the sum of the accounting depreciation is 100, we're depreciating it by 100,000 And of course if we look at the tax depreciation, we're also depreciating it by 100,000.

We're just depreciating it faster from a tax perspective.

So I'm gonna come back to that idea of a temporary difference.

There is a temporary difference in the depreciation we are charging, but that irons out by the time we get to the end of the life of the asset.

If we scroll down and kind of keep going with the table, you might say, well what is the difference in the what is the difference in the amount to the, life of the asset? So the net book amount is 20,000 ahead of the net book amount under tax.

So if I take the, the tax value of the asset and I subtract the accounting value of the asset, that's like 20,000 different, 30, 30,000 different, okay? In total. Or what we could do is look at the depreciation that we're charging.

So we could say the depreciation expense is 20,000 when accounting point of view in the first year, and it's 40,000 for a tax point of view in the first year.

So there's a 20,000 difference in that given year.

There's a 10,000 difference. There's no difference.

Is that right? Yeah, it's right.

In the third year, the depreciation charge from an accounting perspective is 20, and from a tax point of view is also 20.

As we continue through the life of the asset, the difference in the year minus 20, minus 10, 0 positive 10,000, positive 20,000.

And actually if you add those together, you can see that those differences net to 0.

Okay? I'm gonna highlight that in green, they net to 0 the difference in the year.

So, if we wanted to look at the difference in the year, we could make this cumulative.

So we could say you've got 20,000 in year two, you've got 20,000 plus a further 10,000, 30,000, which I calculated earlier.

And if I copy that out to the right, the difference in the year ultimately equalizes to 0.

So the point is that these are just temporary differences.

Now what I'd quite like to do is think about the accounting for this.

And in order to do that, I'm going to do extra little bit of work to the side.

So I'm gonna scoot over to the side of the workout and I'm gonna go and grab some years.

So if we say, cause I'm gonna go and grab year one, let's copy this out to the right.

2, 3, 4, and 5. And then I want an EBIT number.

Now to be clear, I am making this number up.

It's just useful to look at the slightly broader picture to think about how the income statement works.

So I am absolutely, if you think, where's Jonathan getting this number from? I'm making this number up.

Let's imagine that we've got EBIT of 60,000.

So you might say, well, where's that in the question? It's not in the question. Okay, I've just made that up, right, 60,000.

But what does come from the question is the depreciation expense.

So the depreciation expense from an accounting point of view is 20,000.

I'm gonna multiple that by minus 1 every year from an accounting perspective, the depreciation expense is 20,000.

That means that the profit before tax Is 40,000, 40,000, 40,000, 40,000 every year.

The accounting profit for tax is 40,000.

And the tax expense, if we assume that the earnings before interest in tax, assume there's no interest, that the profitable tax number is 60,000.

Then yeah, the EBIT number, sorry 60,000 and the depreciation expense is 20,000.

The profitable tax is 40,000.

If we go and grab the tax rate, which if we scoot over to the question being told is 35%, so if I go and grab 35% and multiply it by 40,000 and multiply it, I guess by minus 1, then we've got a tax expense every single year of 14,000.

And now if we look at the tax that we're actually gonna pay, so not the tax expense, but the tax payable, I'm gonna start with the profit before tax from above.

So PBT from above was 40,000.

And I'm gonna add back the accounting depreciation, add back the accounting depreciation, which is 20,000.

I'm gonna multiply it by minus one to add that back because that's not a tax deductible item.

And then I'm gonna charge, I'm gonna subtract the tax depreciation.

Do we have that number? I don't think I want this to be bold. Really? Yeah, the tax depreciation we've got on the left, remember that tax depreciation varies each year because it's phased differently. It's not a straight line.

So I'm gonna multiply that by minus 1, copy it out to the site.

So now we've got the taxable profit.

I might have this in bold, the taxable profit profit before tax of 40,000, add back the accounting depreciation, charged the tax depreciation.

I've got 20,000 in the first year, 30,000, 40,000, 50,000, and 60,000.

And so the tax payable on that taxable profit would be 35% we said multiplied by the taxable profit, maybe multiplied by minus one just to make the sign consistent with the tax expense.

So I've got 7,000, 10,514,000, 17,521,000.

So you can see in the early years of the life of the asset, the tax expense is 14,000.

But we're only being asked to pay 7,000 because that's, that's because we've got quite aggressive tax depreciation we're allowed to recognize, which is a really good thing.

But because ultimately the total tax depreciation, the total accounting depreciation has to be the same.

Because the asset has to get down to 0.

If you look at the end in year end of the schedule in year five, the tax expense is still 14,000, but now the tax payable is 21,000.

So the tax authorities like clawed back the extra tax effectively.

And again, you'd refer to it as a, as a temporary difference, might be useful to have a look at the difference between the two.

So the tax difference between the two would be the 14,000 tax expense minus the negative tax payable.

So it's worth noting that you've got a difference of 7,000 negative 3,500 negative, a difference of 0, and then a difference of 3,500 positive and 7,000 positive.

So they, those differences net off to 0.

What I'd quite like to do is maybe just think about that.

I'm gonna zoom out a little bit here.

I'd like to think about what the accounting equation looks like for that.

And so if I say asset equals liability plus equity and I'm looking at year one and what I'm gonna do is just chuck in some numbers for the first year.

So I'm seeing in the first year that the tax payable is 7,000.

So I'm gonna say tax payable up 7,000.

And I'm seeing if I scoot down a couple of lines, I'm seeing that retained earnings is gonna go down by the tax expense and the tax expense looks like it's 14,000, say tax expense, 14,000.

And those, you know, they don't balance, right? So there, there's a difference we need to fix.

And that difference is 7,000.

So I'm gonna create a deferred tax liability, it's gonna go up by 7,000.

Make that balance. Now every year we're, you know, we're gonna need to think about this and how this is gonna work.

I'm gonna, just for ease, I'm gonna copy this and I'm gonna paste this year two, I'm do some adjustments in a minute.

Year three, year four, and year five.

So I'm just gonna amend this.

For year one I'm gonna press F2.

I'm gonna say that's year two year, year three in year four and year five.

And if we just look at the numbers, because they're, they're gonna change a little bit.

Try and keep that on the screen.

Let's try and keep that on the screen. You'll notice that the tax expense is 14,000, although throughout the forecast.

So that's not gonna change.

But the tax payable does change in year two.

We've got tax payable going up by 10,500 and we're gonna need this to balance.

So if tax payable is going up by 10,500, retained earnings going down by 14,000 to make that balance, we've got a difference of 3,500.

So our deferred tax liability is gonna go up by 3,500.

If we look at year three, I can see we've got tax payable of 14,000 and we've always, always got this tax expense of 14,000.

So if I change that to 14,000, we actually don't need any deferred, any movement in deferred tax liability because they're the same.

So up, stroke, down, whichever direction, it's gonna be a zero.

When we look at year four, let's just try and keep that on the screen.

When we look at year four, the tax payable is gonna be 17,500 Retained earnings, it's still gonna be 14,000, it's gonna go down by 14,000.

So we need that to balance.

We're gonna have if you think that the liability, the tax payable is going up by 17,500, the equity's only going down by 14,000.

So we need to reduce the liability.

So the deferred tax liability in this instance is gonna go down by 3,500.

Make that balance. Okay, so liabilities are going up by 14,000 now and equity's going down by 14,000.

And then in year five, I can just see on the edge of the screen there, 21,000.

So the tax payable is gonna go up by 21,000.

Retained earnings is gonna go down by 14,000.

And that means to make this balance, the deferred tax liability needs to go down by 7,000.

If you look at what's happening here, and I'm gonna put a lasso around these deferred tax liability numbers, including the direction in which they're moving.

Because that's significant, let's gather all of these together.

So if we gather all of these together, you can see that the deferred tax liability has gone up by 7,000, up by 3,500, it's changed by zero and then it's gone down by 3,500 and down by 7,000.

You could say that these nets or nets off to zero.

And that just brings us back to the idea that this is a temporary difference.

Now what is this trying to achieve? I said to you early on that what we're trying to achieve here is some stability in our effective tax rate.

And if you grab a look at our tax expense, even though we've got some non-deductible tax expenses here, our effect, our tax expenses remaining constant. And it can only do that, it can only be constant the tax expense if we build up and then release away a deferred tax liability.

So it acts as like a cushion, smooth the numbers to achieve matching.

Yeah, in accounting you talk about matching.

If you wanted to calculate the effective tax rate the ETR, then you're clearly gonna see that the effective tax rate is the tax expense divided by the profitable tax.

And we've got 35% a copy of that out to the right.

We've got 35% every year so that, because the difference is only temporary in nature, we want to get stability in our effective tax rate and that's what the deferred tax liability is actually doing for us.

And I think a great way of thinking about the deferred tax liability is to think about it as an accrual.

Okay? And so, as I said, with an accrual, the amount we're expensing in the income statement for whatever it is you're looking at, it doesn't have to be tax or an accrual. The amount you're expensing is greater than the liability, that you are recognizing you're gonna pay over to another party.

And that's exactly what deferred tax liability is doing.

Okay, so for the session we were looking at deferred tax, but also I wanted to have a look at net operating losses.

There's a, there's a file here.

I'm just gonna copy this and paste this into the chat box.

So the file I've been working on, we haven't got uploaded and I'll, I'll make sure that gets, that gets uploaded.

But the file I'm about to look at is available here.

So we're gonna look at valuing deferred tax and net operating losses.

We're can look at this file if you wouldn't mind opening up if you want to work through it with me, that'd be useful.

And when you open it up, there's a welcome sheet, but you hit hit a, a model sheet.

And so we've got a situation here where it says, can you calculate the present value of tax losses and the value of the equity.

So let's just do a bit of a rewind here.

Our business historically has generated some losses and that's not great, okay? However, we can utilize those losses going forward.

If in the future the business generates profits, we can say to the tax authority, hang on a minute, I know that we're profitable in this year, but in previous years we've generated losses.

So can we set some of our historic losses against our future profits to reduce our tax burden? And the great news is, and there are different rules around the world, but the great news is for, for the most part we can do that.

Now we're interested in valuation.

So if I kind of just scribble out a fairly basic valuation bridge, if I said asset equals liability plus equity, you could say I have arrived at the value of the ev. So the enterprise value of the business I've arrived at.

And I don't know, maybe I've used a discounted cash flow to do that or, you know, or perhaps I've used multiples and and comps to do that, but I've got the value of the EV and there's some debt in the business and I'm just kinda making this up.

But well let's assume there's, maybe just a little bit actually of debt in the business and we can put some numbers in in a minute.

So there's some debt in the business and therefore I've got an equity value in the business that we've got an equity value.

So we're in fact gonna go over what we might refer to as the bridge from enterprise value To equity value in that direction.

Now, you know what have, so several businesses that you know, are all pretty similar operation in even have a similar capital structure and look like that you're looking at this business, you're saying, hang on a minute, they must be something that might make this business more valuable.

And I'd say, well what is it? Well, this business which is peculiar relative to the other businesses that we're comparing it to this business has some historic tax losses.

We'd say, well, losses doesn't sound great now nobody is because there, there's a benefit to that for us going forward and I think we should build that in.

So actually what I suggest we do is let's see if we can move that arrow up.

We try and somehow capture the value of these tax loss asset Capture the value of the tax loss asset in my valuation bridge.

And I put it to you that the value of the equity should reflect that this business' equity should be worth more if it's generated historic tax losses.

So let's try and chuck some numbers in, do we know what the enterprise value is for this business? Yes, we do. It's 500. Do we know what the debt value is? Yes, it's 20. Great.

So we can go over the bridge and figure out the value of the equity.

Well, not quite because we dunno what the value of the tax losses are yet.

And that's really what we wanna explore here.

So let's move this out the way, 'cause this is now sort of slightly in the way.

Let's cut this and move this over to the side.

So we're gonna do some numbers to try and figure out what we think the tax loss financial asset is worth.

I note in the question, and I'm gonna highlight this in purple because we've used purple for those tax losses.

I note that the ending tax loss is 400,000.

And so we're gonna do a little base analysis on that.

So the beginning tax loss is gonna be 400,000.

I'd love to utilize all of that right now in year one, but I can't, okay? And the reason I can't do that is we're generating EBIT.

So we're generating a profit number of 100,000, we've got 400,000, but we can't utilize it all yet.

What I wanna make sure as we go through the forecast here, I wanna make sure that although we've got 100,000 every year, I wanna make sure that we don't over utilize that.

So I've only got 400,000 available.

So the numbers are really simple.

I can utilize those tax losses in year one, year two, year three, and year four.

But by the time we get to the end of year four, they'll run out.

Okay? So to account for that, I'm gonna say pay Excel, we're gonna use equals min.

Why don't you choose the lower of the EBIT comma and the beginning tax loss available to be utilized.

Close bracket I think multiplied by minus 5 would be good.

So we've got our ending tax loss number and if we copy that out to the right, hopefully what we're seeing is we're utilizing that for five years.

By the time we get to the fifth year, there'd be no utilization because there's no tax loss remaining.

So you might say, great, are we gonna reduce the tax, by 100,000? No. If we got a profit of 100,000, we can neutralize that down to 0, okay? And if you had a profit of 100,000 you wouldn't be paying tax of 100,000 In fact, the tax rate's 30%.

So if you had a profit of 100,000 in year one, you'd be paying tax of 30 or 100 million, maybe 30, you'd be paying 30 million or, or 30,000 I guess whatever, whatever the numbers are.

And it's that, that we're gonna save.

So the tax benefit from the utilization is that 30% F four multiplied by the that utilization.

I think I might multiply that by minus 1 to show that positively.

So we've got this stream of cash flows that I'd like to capture the value of, and because they stretch out in time, we need to think about the time value of money.

So I want to discount those.

So maybe a good efficient way to do that in Excel would be to use the MPV function.

So I'm gonna say equals net present value tab and Excel says, Jonathan, give me a rate. We're gonna discount these at 5%.

Comma, give me some cash flows.

I'm gonna again, point at those cash flows.

So the present value of those cash flows is 106.4.

And if we go back into my valuation bridge, I'll just move that back below the question so we can better kind of see that over there.

So in my valuation bridge, the value of those, the present value of those tax losses is present value of the future.

Utilization of those tax losses I guess is 106.4, refactoring the debt that means their equity is worth for this business.

586.4 million.

Okay, and I think that probably brings us to the end of the, the content I wanted to cover.

I'm just gonna say again that there is a page that's got some let's try and copy this.

There's a page that's got some downloadable content in it and I was actually expecting to see both files in there.

I I don't see the first file, so I'll review that once the session finishes and I will make sure that both files are sitting there available to you.

I just wanna say a massive thanks to you guys for being dialed in.

It's really great. Thanks so much for attending.

I really appreciate your valuable time.

Hope you enjoyed the session, hope it was useful to you and really look forward to seeing you guys in a session in the future.

Thanks very much guys. Take care. Bye now.