Income taxes: analysis of disclosures I Sandvik is a large engineering company with headquarters in Sweden. Its high-speed steel tools and mining equipment have a high reputation. Only 5% of its 2001 sales of SEK 48.9 billion (A5.3 billion)

and one-third of its production that year were in its home market. Group profit before tax was SEK 5.6 billion in 2001 (2000: SEK 5.8 billion). Reported tax expense of SEK 1.7 billion in 2001 was broken down in the accounts as follows (negative sign indicates expense or debit):

In SEK million 2001 2000 Current taxes −1,555 −1,662 Adjustment of taxes attributable to prior years 103 −71 Total current tax expense −1,452 −1,733 Deferred tax expense −241 −137 Taxes on participation in associated companies −19 −11 Total reported tax expense −1,712 −1,881 In common with other Swedish multinationals, Sandvik provides detailed information about its current and deferred taxes in its consolidated accounts. (The company follows Swedish GAAP which is similar to IAS in this area.) Exhibit 17.16 contains extracts from the tax note in the consolidated accounts.

Required

(a) Investors use information in the analysis of a company’s effective tax rate to forecast tax expense – and therefore profits – in future years. With the information Sandvik provides, it’s possible to identify the recurring elements in the group’s effective tax rate. Assuming Sandvik’s weighted average (statutory) tax rate remains at 30.7%, estimate its effective tax rate for 2002. State any assumptions you have made.

(b) Sandvik reports a net deferred tax liability of SEK 852 million in its end-2001 consolidated balance sheet. There are four main sources of temporary difference. In addition to ‘Other’ (for which Sandvik provides an explanation), they are:
(i) tangible fixed assets;
(ii) inventories;
(iii) provisions.
Suggest an explanation for each of these three major sources of temporary difference (taxable in the case of tangible fixed assets, deductible in the case of inventories and provisions). Note that the company values its inventories in its published accounts at the lower of FIFO cost or market, an acceptable method of valuation for tax purposes. ‘Provisions’ are long-term in nature and relate mainly to pension benefits and warranties.

(c) Not all the change in the Sandvik’s net deferred tax liabilities in 2001 is reported in the income statement. Part relates to ‘Translation differences and other items reported in Shareholders’
equity’. Give examples of items reported directly in shareholders’ equity that may have a deferred tax effect (besides translation differences).AppenedixLO1

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Exhibit 17.16 Sandvik Group: selected tax disclosures in 2001 accounts Reconciliation of tax expense The Group's weighted average tax rate, based on the tax rate in each country, is 30.7%. The tax rate in Sweden is 28%. The weighted average tax rate in the foreign subsidiaries is 33.2%. The Group's weighted average tax rate is reconciled to its reported tax rate as follows: SEK m % Expected tax expense based on the Group's weighted average tax rate -1,721 -30.7 Tax effects of Goodwill amortization -114 -2.0 Non-deductible expenses -104 -1.8 Tax-exempt income 153 2.7 Overprovided in prior years 103 1.8 Effects of loss carryforwards, net -34 -0.6 Other 5 0.1 Total reported tax expense -1,712 -30.5 Out of the tax effect of tax-exempt income of SEK 153 m (2.7%), SEK 114 m (2.0%) pertains to non-recurring items. Deferred tax assets and liabilities The deferred tax assets and liabilities reported in the balance sheet are attributable to the following assets and liabilities, with liabilities shown with a minus sign. Group 2001 Deferred tax assets Deferred tax liabilities Net Intangible fixed assets 11 -3 B Tangible fixed assets 57 -1,612 -1,555 Financial fixed assets 36 -2 34 Inventories 519 -13 506 Receivables 82 -28 54 Provisions 621 0 621 Interest-bearing liabilities 4 0 4 Non-interest-bearing liabilities 139 -22 117 Other 12 -679 -667 Loss carryforwards 26 0 26 Total 1,507 -2,359 -852 Offsetting within companies -489 489 0 Total deferred tax assets and liabilities 1,018 -1,870 -852 Provisions within the 'Other' item pertain primarily to Swedish tax allocation reserves and similar untaxed reserves unrelated to specific assets or liabilities.... A reconciliation of the opening and closing balances of deferred taxes is presented below. Deferred tax liabilities, net, 1 January 2001 Acquisition of companies Reported in the income statement Translation differences and other items reported in Shareholders' equity Deferred tax liabilities, net, 31 December 2001 -789 -18 -241 196 -852