Determine The Projected Income Tax Expense

Determine the projected amount of income tax expense that would be reported if Whitley waits until next year to purchase the equipment

The Whitley Corporation, with its fiscal year ending on December 31, 2013, faces strategic financial decision-making regarding a planned equipment purchase. As of October 1, 2013, management is evaluating the implications of delaying this purchase until next year, primarily to influence the current year's financial statements and reported income tax expense. To accurately determine the projected income tax expense under this scenario, it is essential to analyze the impact of the deferred tax assets and liabilities, current pretax income, and the future taxable implications associated with the equipment purchase.

Analysis of Tax Implications if Equipment Purchase Is Deferred

Under the scenario where Whitley postpones the equipment purchase until after the year-end, the company's 2013 taxable income remains unaffected by the upcoming capital investment. The pretax financial income, anticipated at $200,000, and the corresponding deferred tax balances at the start of 2013—specifically, a deferred tax asset of $15,000 and a deferred tax liability of $70,000—serve as foundational components of the tax expense calculation.

Deferred taxes arise due to temporary differences, primarily depreciation in this case. The deferred tax asset related to a temporary difference of $37,500, which is expected to fully reverse by year's end, along with the deferred tax liability of $70,000 stemming from depreciation discrepancies, influence the tax expense calculation. The reversal of the deferred tax assets and liabilities during 2013 directly impacts the current tax expense.

Since the purchase is deferred, the future taxable amount of $50,000 resulting from the equipment purchase will not be recognized in 2013 tax calculations. Therefore, the tax expense calculation for 2013 excludes this future taxable event, focusing only on the existing temporary differences and the current pretax income.

Calculation of Income Tax Expense When Equipment Purchase Is Deferred

The current deferred tax liability of $70,000 results from temporary depreciation differences with a reversal expected in 2013. Given a reversal of $42,500 during 2013, the associated deferred tax liability adjustment is:

• Deferred tax liability reversal: $42,500 × 40% = $17,000

Similarly, the deferred tax asset of $15,000, associated with temporary differences expected to fully reverse by year-end, will reverse accordingly, leading to a reduction in deferred tax assets:

• Deferred tax asset reversal: $37,500 × 40% = $15,000

Adjusting the recorded deferred taxes, the tax expense attributable to these temporary differences can be summarized as follows:

Taking these adjustments into account, the projected income tax expense for 2013 if Whitley delays the equipment purchase is computed as:

Tax expense = (Pre-tax income) × (Tax rate) - (Deferred tax liabilities reversal) + (Deferred tax assets reversal)

Applying the numbers:

Tax expense = $200,000 × 40% - $17,000 + $15,000 = $80,000 - $17,000 + $15,000 = $78,000

Thus, the projected income tax expense if Whitley waits until next year to purchase the equipment is approximately $78,000. This calculation assumes that the reversal of temporary differences occurs evenly and that no additional temporary differences arise before year-end.

Analysis of Tax Implications if Equipment Is Purchased in 2013

If Whitley proceeds with purchasing the equipment in 2013, the company's taxable income will incorporate the future taxable event of $50,000. This will impact the income statement as well as deferred tax calculations, leading to a different tax expense figure for the current year.

Calculation of Income Tax Expense When Equipment Is Purchased in 2013

The $50,000 future taxable amount will increase current taxable income, thereby increasing tax liability. The pre-tax income remains $200,000, but the additional taxable event adjusts taxable income upward by $50,000, resulting in a new taxable income of $250,000 for 2013.

Therefore, the initial tax expense on this basis becomes:

Tax on adjusted income = $250,000 × 40% = $100,000

However, we must account for the deferred tax implications associated with the temporary differences. The existing deferred tax liabilities and assets will now be affected by the purchase, as the $50,000 taxable amount will realize a tax payable of:

• $50,000 × 40% = $20,000

Because the temporary depreciation difference results in a deferred tax liability of $70,000, and $42,500 of this reverses during 2013, the net change is a reduction of the deferred tax liability by $17,000, as previously calculated. The deferred tax asset remains at $15,000, reversing as planned at year-end.

Combining these factors, the tax expense for 2013 if the equipment purchase occurs is calculated as follows:

• Current tax on the adjusted income: $250,000 × 40% = $100,000
• Minus deferred tax effects: ($17,000 due to liability reversal) and ($15,000 due to asset reversal)

The total projected tax expense thus becomes:

Tax expense = $100,000 - $17,000 + $15,000 = $98,000

In this scenario, the immediate tax expense rises to approximately $98,000, reflecting the impact of the equipment purchase on taxable income and the associated deferred tax adjustments.

Financial Statement Effects and Impact on EPS

The decision to delay or proceed with the equipment purchase significantly influences Whitley's short-term financial statements. Waiting until next year to purchase the equipment results in a lower current tax expense—approximately $78,000—compared to $98,000 if purchased this year. This difference enhances net income and consequently boosts earnings per share (EPS).

Assuming the number of shares is 55,500, the impact on EPS can be computed as:

• EPS when delaying purchase: (Pre-tax income - tax expense) / Shares = ($200,000 - $78,000) / 55,500 ≈ $2.503
• EPS when purchasing in 2013: ($200,000 - $98,000) / 55,500 ≈ $2.198

Thus, postponing the equipment purchase marginally improves EPS, which can be advantageous for management's financial reporting and investor perception. However, this strategy may conflict with operational needs and long-term growth plans, particularly considering the need for new equipment in the plant.

Strategic and Ethical Considerations

Beyond the numerical analysis, several ethical considerations arise regarding Whitley's decision to delay or accelerate the equipment purchase. From an ethical standpoint, management should prioritize transparency and integrity in financial reporting. Manipulating the timing of expenditures solely to influence earnings or tax liabilities can be viewed as window dressing, potentially misleading investors and other stakeholders.

Deliberately deferring expenses to improve current profit figures without genuine operational justification skirts ethical boundaries, risking loss of trust and potential regulatory scrutiny. Alternatively, making purchase decisions based solely on strategic, operational, and financial necessity—while maintaining accurate disclosures—upholds ethical standards and aligns with good corporate governance practices (Laux, 2017).

Furthermore, the ethical obligation extends to fair representation of the company's financial health, avoiding favoritism or manipulation that could distort the true economic position of Whitley. Transparency about the timing and nature of the equipment purchase, along with clear disclosure of deferred tax considerations, underpins ethical financial management.

Conclusion

In conclusion, delaying the equipment purchase until next year results in a projected income tax expense of approximately $78,000, leading to higher net income and EPS in 2013. Conversely, purchasing the equipment this year increases the tax expense to about $98,000, reducing net income slightly but aligning operational and strategic goals with fiscal obligations. From an ethical perspective, management must prioritize truthful and transparent financial reporting, avoiding manipulative practices that could undermine stakeholder trust. Ultimately, the decision should balance financial benefits, operational needs, and ethical standards to ensure sustainable corporate governance and long-term value creation (Gibson, 2018).

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