1. September 29, 20061 Five Things Non-Accountants Should Know about Accounting Lillian F. Mills Associate Professor in Accounting, University of Texas

2. September 29, 20062 1: Book income matters Public companies prefer to report high net earnings. –Contracts based on book income induce preferences. –Capital markets may also be short-term inefficient. Only rate decreases, credits, and permanent deductions increase book income. –Accelerating deductions don’t. SO: Doesn’t everyone want a rate cut?

3. September 29, 20063 2. Tax rate changes affect accumulated deferred taxes Deferred tax liability = tax owed later. –e.g., Tax effect of accelerated depreciation Deferred tax asset = future refund. –e.g., Tax effect of NOL carryforward If statutory rate decreases: –Firms with a net liability position have a gain –Firms with a net asset position have a loss Thus, firms with net tax assets lobby against rate cuts and prefer permanent deductions (Sec 199)

4. September 29, 20064 3. Tax expense not  taxes paid Total tax expense = current + deferred Current tax expense differs from tax paid: –Stock options –Tax cushion –Prior/future effects of NOLs, etc. Media should especially guard against labeling corporations as “high” or “low” taxpayers based on hasty inspection.

5. September 29, 20065 4. Accounting mixes valuation methods and permits discretion Accounting concepts attempt to balance: –“relevance” (fair values more informative) VS. –“reliability” (can we audit the number?) –Thus, accounting mixes different valuation methods. Accounting requires estimation; hence permits management discretion –Caution against using book income for tax base.

6. September 29, 20066 5. Consolidation rules differ book v. tax Financial statement = worldwide-controlled corporations (>50 percent) U.S. tax return = domestic affiliates (80 percent) Cross-border accounting critical for tax, less so for book. –Hence, complex regs needed transfer-pricing. –Schedule M-3 helps IRS see entity differences.

7. September 29, 20067 Conclusions Corporations care about book income and lobby to avoid losses and increase income –Rate changes affect deferred tax assets and liabilities Caveats in using financial statement data to assess tax policy –Accounting mixes methods and allows discretion –Hard to tell how much U.S. tax is paid –Hard to tell what income is subject to U.S. tax Continued cross-education among disciplines improves policy.