The formulas
- Tax effect = net pre-tax effect x tax rate
- After-tax effect = net pre-tax effect - tax effect
- Adjusted pre-tax income = reported + net pre-tax effect
How it works
Audit differences are usually listed and evaluated pre-tax, because materiality is often set on a pre-tax benchmark. Net income and equity, though, move by the after-tax amount, and the tax effect is itself a misstatement of income tax expense and the tax liability or deferred tax balance.
Use the rate that applies to the items: the statutory combined rate for ordinary items, zero for permanent differences such as nondeductible penalties, and the deferred rate for items that only change timing. Mixed items are best split and run separately.
Illustrative figures only. Check the result against your firm's methodology before relying on it.
Common questions
Should I compare the pre-tax or after-tax amount with materiality?
Compare the amount on the same basis as the benchmark. Pre-tax income benchmarks call for the pre-tax effect.
Does an entity with a full valuation allowance get a tax effect?
Usually not. The change in the deferred tax asset is offset by the allowance, so enter a zero rate.
What about balance sheet only reclassifications?
They have no income or tax effect. Evaluate them against the line items they move.
Formulas on this page are the standard definitions.
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