Medicis Explains Sudden Increase in Company's Deferred Tax Assets

(MoneyWatch)  A while ago, Medicis restated its numbers going back several quarters due to an accounting error. The mistake involved the company's "sales return reserve," a technical line on the company's financial statements that few understand. Medicis has since filed new statements and they contain a surprise: A massive accumulation of $119 million in its "Deferred Tax Assets," (if you add the current and long term assets together). Those assets were only $82 million on the original, Q2 2008 Medicis balance sheet. So what's going on?

BNET readers will remember that when Medicis announced it was re-doing its books, it said the move would be a purely technical one that did not affect its cashflows:

The restatement is not expected to have an impact on the Company's cash flows or Cash and Cash Equivalents balances for any of the affected periods.

I expressed some skepticism:

I will be extremely interested to see how Medicis recalculates its returns without changing its cashflow statement.

So, did the restatement -- and the new deferred tax asset -- change the company's cashflows? It turns out that both predictions came true. Medicis' overall cashflows remained the same, but the company did make changes on its cashflow statements. Among the lines being altered on the cashflow statements were "income taxes payable" and "deferred tax benefits."

At a glance, it appears to the casual reader that the changes Medicis made altered the timing of the way Medicis accounts for its tax obligations, resulting in a huge deferred tax asset -- as if the company had paid taxes ahead of time and would enjoy the benefit of that in the future. Accounting authorities define "deferred tax assets" this way:

A deferred tax asset is recognized in the current year for the reduction in taxes payable in future years.

But that's not exactly what's going on. COO Mark Prygocki went over it with me. (One of the things that sets Medicis apart from any other drug companies is that if you call with a question, a real executive with real knowledge and responsibilities -- not a pr flack -- calls you back.)

Prygocki reminded me that Generally Accepted Accounting Principles (which companies must follow) are different from the tax code (which companies must also follow), and the differences affect the way companies record tax levels on earnings. The restatement for the sales return reserve increased these differences, which are now represented as a deferred tax asset. Ultimately, the tax asset and actual taxes paid will equal each other out, just not all at once.

Prygocki said:

The deferred tax asset has no impact on cashflow or corporate earnings. It had no impact on tax per se, we won't be amending returns or anything like that.

Specifically, he said, that $119 million asset:

Represents the difference between what we're representing as tax income versus GAAP income. We handle it through a deferred tax asset.

That's pretty much it -- the solution is admittedly less interesting than the mystery, but that's accounting for you.