Question

A company's effective tax rate can best be described as:

Multiple Choice

• The company's cash taxes paid divided by taxable income.

• The company's cash taxes paid divided by net income from continuing operations.

• The company's financial statement income tax provision divided by taxable income.

• The company's financial statement income tax provision divided by net income from continuing operations.

Answer 1

Tax expenses are the liabilities which are payable to the revenue department/ federal /state etc. It is charged on the Income generated from the operations at an effective rate.

Now effective tax rate is the average rate which a company is taxed on its net income/taxable income. It is calculated as a ratio of all the income and taxes combined.

for example, Let income from operations = $ 20000 and for income upto $ 10000, tax rate is 10% , and upto $20000 tax rate is 20% ,Thus effective tax rate will be tax on income / total income ( so for 1st 10,000 it will be 10% and for remaining it will be 20% )= ( 10000 *10% ) + (10000*20% ) / 20000

so effective tax rate = ( 1000+2000) /20000 = 3000/20000 = 15%.

This effective tax rate if multiplied with the income from continuing operations will give the income tax provision which is payable by the company.

The effective rate does not consider the cash paid but takes in account the income tax provision and income from operations.

Thus the correct option is -------------D i.e The company's financial statement income tax provision divided by net income from continuing operations.