Overview

Deferred tax assets and liabilities can be significant amounts on a company's financial statements. Understanding what these numbers mean, how they occurred, and their implications for the future is very important for users of financial statements. We need to be aware of the professional responsibilities of a company's accountant to both the company and other users in a variety of situations.

Instructions

Frank Jurgenson, CPA, is a newly employed by Hightower, Inc., a publicly traded corporation, as controller. He has been reviewing the company's deferred income taxes, and notices that there is a large deferred tax liability on the balance sheet due to differences between book and tax depreciation methods. As a result, the amount of income taxes actual paid by Hightower in recent years is very small.

Frank also noted that Hightower has an explicit policy of selling off certain property, plant and equipment items before these assets would cause a reversal in the deferred tax liability account. In addition, the company has recently acquired a large number of new fixed assets. Despite paying very little in income taxes, the company has always reported positive earnings and an increasing EPS. Frank has verified that these policies are legal, but he's uncomfortable with the ethics of them.

Answer the following questions:

Why would Hightower's management have an explicit policy of selling plant assets before the temporary differences reversed in the deferred tax liability account? How would acquiring a large number of new plant assets affect the company's income tax situation?

Are there ethical implications of Hightower's policies? If so, clearly describe what they are and who could be harmed by Hightower's policies, despite positive earnings. If not, clearly explain your position.

In a situation such as this, what (if any) are Frank's professional responsibilities as a CPA?