Wall Street Prep: Advanced Accounting Questions And
Answers With Verified Solutions 100% Correct (GRADED
A+) Latest Update 2024/2025.
How would raising capital through share issuances affect earnings per share (EPS)? - ANSWER
The impact on EPS is that the share count increases, which decreases EPS. But there can be an impact on
net income, assuming the share issuances generate cash because there would be higher interest income,
which increases net income and EPS. However, most companies' returns on excess cash are low, so this
doesn't offset the negative dilutive impact on EPS from the increased share count.
Alternatively, share issuances might affect EPS in an acquisition where stock is the form of consideration.
The amount of net income the acquired company generates will be added to the acquirer's existing net
income, which could have a net positive (accretive) or negative (dilutive) impact on EPS.
How would a share repurchase impact earnings per share (EPS)? - ANSWER The impact on EPS
following a share repurchase is a reduced share count, which increases EPS. However, there would be an
impact on net income, assuming the share repurchase was funded using excess cash. The interest
income that would have otherwise been generated on that cash is no longer available, causing net
income and EPS to decrease.
But the impact would be minor since the returns on excess cash are low, and would not offset the
positive impact the repurchase had on EPS from the reduced share count.
What is the difference between the effective and marginal tax rates? - ANSWER Effective tax
rate: % corporations must by in taxes
Effective tax rate = Taxes paid / earnings before tax
Marginal tax rate: % on the last dollar of a company's taxable income.
Why is the effective and marginal tax rate often different? - ANSWER Effective and marginal tax
rates differ because the effective tax rate calculation uses pre-tax income from the accrual-based income
statement. Since there's a difference between the taxable income on the income statement and taxable
income shown on the tax filing, the tax rates will nearly always be different. Thus, the "Tax Provision" line
item on the income statement rarely matches the actual cash taxes paid to the IRS.
Could you give specific examples of why the effective and marginal tax rates might differ? - ANSWER
Under GAAP, many companies follow different accounting standards and rules for tax and financial
reporting.
, i. Most companies use straight-line depreciation (i.e., equal allocation of the expenditure over the useful
life) for reporting purposes, but the IRS requires accelerated depreciation for tax purposes - meaning,
book depreciation is lower than tax depreciation for earlier periods until the DTLs reverse.
ii. Companies that incurred substantial losses in earlier years could apply tax credits (i.e., NOL
carryforwards) to reduce the amount of taxes due in later periods.
iii. When debt or accounts receivable is determined to be uncollectible (i.e., "Bad Debt" and "Bad AR"),
this can create DTAs and tax differences. The expense can be reflected on the income statement as a
write-off but not be deducted in the tax returns.
What are deferred tax liabilities (DTLs)? - ANSWER Deferred tax liabilities ("DTLs") are created
when a company recognizes a tax expense on its GAAP income statement that, because of a temporary
timing difference between GAAP and IRS accounting, is not actually paid to the IRS that period but is
expected to be paid in the future.
DTLs are often related to depreciation. Companies can use accelerated depreciation methods for tax
purposes but elect to use straight-line depreciation for GAAP reporting. This means that for a given
depreciable asset, the amount of depreciation recognized in the earlier years for tax purposes will be
greater than under GAAP.
Those temporary timing differences are recognized as DTLs. Since these differences are just temporary -
under both book and tax reporting, the same cumulative depreciation will be recognized over the life of
the asset - at a certain point into the asset 's useful life, an inflection point will be reached where the
depreciation expense for tax reporting will become lower than for GAAP.
What are deferred tax assets (DTAs)? - ANSWER Deferred tax assets ("DTAs") are created when a
company recognizes a tax expense on its GAAP income statement that, due to a temporary timing
difference between GAAP and IRS accounting rules, is lower than what must be paid to the IRS for that
period. These net operating losses ("NOLs") that a company can carry forward against future income
create DTAs.
For example, a company that reported a pre-tax loss of $10 million will not get an immediate tax refund.
Instead, it'll carry forward these losses and apply them against future profits.
However, under GAAP, the tax benefit will be recognized from a presumed future tax refund immediately
on the income statement, and this difference gets captured in DTAs. As the company generates future
profits and uses those NOLs to reduce future tax liabilities, the DTAs gradually reverse.
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