Judgment Case 16–10 Macy\'s debt to equity ratio for the year ended February 1,
ID: 2423176 • Letter: J
Question
Judgment Case 16–10
Macy's debt to equity ratio for the year ended February 1, 2014, was 2.46, calculated as ($21,634 - 6,249) ÷ 6,249. Some analysts argue that long-term deferred tax liabilities should be excluded from liabilities when computing the debt to equity ratio.
Required:
1.What is the rationale for the argument that long-term deferred tax liabilities should be excluded from liabilities when computing the debt to equity ratio?
2.What would be the effect on Macy's debt to equity ratio of excluding deferred tax liabilities from its calculation? What would be the percentage change?
3.What might be the rationale for not excluding long-term deferred tax liabilities from liabilities when computing the debt to equity ratio?
Explanation / Answer
1. The rationale for the argument that long-term deferred tax liabilities should be excluded from liabilities when computing the debt to equity ratio:
(i) Taxes are a function of government fiscal and monetary policies, and they are not functionally related to financial reporting of companies.
(ii) Deferred tax accounting is based on the concept that income taxes are expenses and not for redistribution of wealth.
(iii) The ratios including Debt to Equity ratio, are calculated for the analysis and comparison purpose, so it became in-comparison able if other comparative companies lacks deferred tax liability.
2. The effect on Macy's debt to equity ratio of excluding deferred tax liabilities from its calculation =
= (21634 - 6249 - 1673) / 6249 = $13712 / $6249 = 2.19
The percentage of change = 11%
3. The rationale for not excluding long-term deferred tax liabilities from liabilities when computing the debt to equity ratio:
A few analyst believe that taxes are a redistribution of wealth therefore included in long-term liabilities because while expenses measure the cost of generating revenue, income taxes generate no revenues. They are neither incurred in anticipation of future benefits nor are they expirations of costs. In addition, income taxes are not levied on individual items of revenue and expense. Therefore, there can be no temporary differences related to these items.
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