Generations of accountants were indoctrinated in the concept of conservatism, which is essentially the need to record anticipated losses, but not expected profits. So when did this guiding caution get thrown out the window? With minor exceptions, the past 10 years of Canadian financial reporting sounded the death knell for much of conservatism. In its place, we see a fatten-the-balance-sheet philosophy, with goodwill being the principal tenet. Another increasingly popular means of beefing up the bottom line is called "future income tax assets."
In 2001 and 2002, many Canadian corporations will be reporting operating losses. Investors will therefore have to heighten their awareness of the income and income tax implications of these losses. Operating losses before income taxes can be reduced by recording previously paid, or perhaps hoped-for, income tax refunds. That is, Canadian companies can use their 2001 operating losses to offset income taxes paid in the past three years. Thus, at a 40% tax rate, a $20-million operating loss (before income taxes) in 2001 could result in a tax refund of $8 million if carried back into previous years.
But what happens when a Canadian corporation's taxable loss in 2001 exceeds the combined taxable incomes of 2000, 1999 and 1998? The company is allowed to use the balance of the 2001 operating loss to offset potential income taxes payable over the next seven years. So the unused portion of the 2001 operating loss is like a benefit waiting to be used. Suppose that the "taxable" loss in 2001 is $60 million (before income tax) and the combined operating profits in 2000, 1999 and 1998 were only $20 million. Can a $24-million tax effect be recorded on the income statement, in order to reduce the net loss to $36 million (i.e., a $60-million loss minus $24 million in tax equals a $36-million net loss)? The $24-million "tax reduction" in 2001 would be made up of the $8 million of taxes paid for 2000, 1999 and 1998, and $16 million that would otherwise constitute taxes on future profits. But who can guarantee that the corporation will have taxable operating profits during 2002 to 2008? In the absence of some reasonable guarantee of profits, the $24-million tax reduction could be partially bogus, and the 2001 net loss of $36 million could be understated by as much as $16 million.
New Canadian accounting rules, introduced as early as 1999 by some companies, allow the $16-million "future tax" portion from our example above to be recorded when the amount "is more likely than not to be realized." How's that for giving management considerable freedom in accounting for profits and losses?
So far, the new tax accounting rules have produced a hodgepodge of financial results. A sampling of Canadian companies shows that the "future tax asset" category can include a variety of items, beyond operating-loss tax effects, which serve to add to interpretation difficulties.
The financial reporting range includes, but is not restricted to:
Al Rosen is the founder of Rosen & Associates Limited.