MBA in 2 minutes | Lesson 6: Strategies CEOs use for tax deferrals
Updated: Jan 8, 2021
We will be solving practical challenges through MBA concepts. No theory only applications !
As a non-finance professional, during most of the accounting classes I took during MBA- my takeaways ended up focusing on potential tax deferrals a founder of a venture could take. In my case I was planning GGI concurrently during ISB days. The 2 minutes today are focussed around the same.
Firms pay taxes on Profits i.e.Revenue-Costs. Thus, if you increase costs your firm's taxable income could go down.
1. Increase Depreciation costs today
Let's first define depreciation. Depreciated cost is the value of a fixed asset net of all depreciation that has been recorded. In a broader economic sense, the depreciated cost for industry is the aggregate amount of capital that is "used up" in a given period, such as a fiscal year.
Now, there are various methods to calculate depreciation costs such as intuitively meaning straight line, double declining rate.
The idea here is to use an accelerated method of calculating depreciation costs as the faster an asset is written off for tax purposes, the greater the tax deferral to future periods and more funds are available for operations immediately.
2. Leverage COGS accounting
Now let's first explain what is COGS ? It means Cost of Goods Sold. In many circumstances you could again defer taxes by determining which accounting method should be used for cost side of the equation.
In products industry, there can be 4 methods for accounting COGS. To stick with the Lesson goal, I'm comparing 2 methods here:
FIFO: First In product will go for Sale First Out
LIFO: Last In product will go for Sale First Out. Though this is usually rarely used but many times when FMCG firms run promotion offers they use this method for business as usual.
Assume a scenario when cost of procuring goods has decreased then one might want to use LIFO. LIFO will show lower profit as recent costs are matched to sales.
Note: Since LIFO ending inventories can be significantly lower than replacement costs, companies using LIFO are required to disclose the amount at which the inventories would have been had the company used FIFO method. The difference between these two methods is called LIFO reserve.
LIFO reserve can be viewed as an ‘unrealized holding gain’.
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