Presenting a live 110-minute teleconference with interactive Q&A

ASC 740 Income Tax

Accounting Challenges in 2013
Tackling Valuations of Deferred Tax Assets, Tax Expense and UTP Reporting, and Other Issues

TUESDAY, MAY 28, 2013

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Today’s faculty features:

Douglas Sayuk, Partner, Clifton Douglas, San Jose, Calif.

Cindy Frank, Senior Director, Tax Process Efficiency and Technology, BDO USA, Phoenix
Jeffrey Zawada, Director, FreedMaxick CPAs, Buffalo, N.Y.

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 ASC 740 Income Tax Accounting
Challenges in 2013 Seminar
May 28, 2013

Cindy Frank, BDO USA Douglas Sayuk, Clifton Douglas

cfrank@bdo.com douglas@cliftondouglas.com

Jeffrey Zawada, FreedMaxick CPAs

jeff.zawada@freedmaxick.com
Today’s Program

Overview Of ASC 740 And Related Guidance Slide 8 – Slide 26

[Cindy Frank]

Specific Income Tax Accounting Issues, Best Slide 27 – Slide 96

Practices
[Douglas Sayuk, Cindy Frank and Jeffrey
Zawada]
 Notice
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY
THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY
OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT
MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR
RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,
without limitation, the tax treatment or tax structure, or both, of any transaction
described in the associated materials we provide to you, including, but not limited to,
any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are
subject to change. Applicability of the information to specific situations should be
determined through consultation with your tax adviser.
Cindy Frank, BDO USA

OVERVIEW OF ASC 740 AND

RELATED GUIDANCE
 FAS 109/ASC 740 Objectives

Recognize:

1. The amount of taxes payable or refundable for the current year

2. Deferred tax liabilities and assets for the future tax consequences

9
 Basic Principles
• A current tax liability or asset is recognized for the estimated
taxes payable or refundable on tax returns for the current year.

• A deferred tax liability or asset is recognized for estimated

future taxes created by temporary differences.

• The measurement of current and deferred taxes is based on the

provisions of the enacted tax law.

• Measurement of deferred tax assets is reduced if they will not be

recognized.

• These principles apply to domestic federal income taxes, and

foreign and state and local taxes that are based on income.

10
 Components Of Income Tax Expense

Current income tax expense (benefit)

+/- Deferred income tax expense (benefit)
= Total income tax expense (benefit)

11
 Current Income Tax Expense
Item Amount
Pre-tax book income $1,000,000
Permanent differences 100,000
Financial taxable income $1,100,000
Temporary differences 200,000
Taxable income per return $1,300,000
Tax rate 40%
Tax liability (current portion of tax expense) $520,000

This example replicates a typical tax return expense calculation and

represents only the current portion of income tax expense.
Without FAS 109/ASC 740 principles, our tax expense would be $520,000.

12
 Deferred Tax Expense

• SFAS 109 requires the balance sheet approach to compute

deferred taxes.

• To compute the deferred expense, you must compare the

beginning balance of temporary differences to their ending
balance.

• Temporary difference treatment in FAS 109/ASC 740 smoothens

out the rate; there is no impact on book tax expense.

13
 Components Of Total Expense
Permanent differences:

• Arise from income that is permanently non-taxable and

expense items are permanently non-deductible

• Affect either the financial statements or the tax

return, but not both

• Will always increase or decrease your effective tax rate

• Will either cost tax dollars or save tax dollars

14
 Current Income Tax Expense

Item Amount
Pre-tax book income $1,000,000

Permanent differences 100,000

Financial taxable income $1,100,000
Temporary differences 200,000
Taxable income per return $1,300,000
Tax rate 40%
Tax liability (current portion of tax expense) $520,000

15
 Permanent Differences

Item Amount
Pre-tax book income $1,000,000
Permanent differences
• Meals and entertainment 50,000
• Fines and penalties 40,000
• Lobbying expenses 10,000
Total permanent differences $100,000

Financial taxable income $1,100,000

16
 Permanent Differences (Cont.)

Item Amount
Permanent differences
• Meals and entertainment 50,000
• Fines and penalties 40,000
• Lobbying expenses 10,000
Total permanent differences $100,000
Tax rate 40%

Tax impact of permanent items $40,000

17
 Permanent Differences (Cont.)
Permanent differences will always affect your rate.
Item Amount
Pre-tax book income $1,000,000

Tax rate 40%

Expected tax expense $400,000

Tax related to permanent items 40,000

Total expected tax expense $440,000

Effective tax rate = 440,000/1,000,000 = 44%

(this is a short method of testing the rate)
18
 Components Of Total Expense

Temporary differences:

• Will generally have no impact on your effective tax rate

• Are book/tax differences that will be deductible or

taxable in one or more future years

• Will either cost tax dollars or save tax dollars in the

current year, and will have the opposite effect in a future
year

19
Current Income Tax Expense, Revisited

Item Amount
Pre-tax book income $1,000,000
Permanent differences 100,000
Financial taxable income $1,100,000
Temporary differences 200,000
Taxable income per return $1,300,000
Tax rate 40%
Tax liability (current portion of tax expense) $520,000

20
 Temporary Differences

Year-End Current Year Year-End

12/31/2011 Activity 12/31/2012

Bad debt reserve $300,000 $250,000 $550,000

Accrued bonus 200,000 (50,000) 150,000

Total change in temp $500,000 $200,000 $700,000

differences

Tax rate 40% 40% 40%

Tax impact of $200,000 $80,000 $280,000
temporary differences

21
 Temporary Differences (Cont.)

Entry to record impact of temporary differences

Debit Credit
Deferred tax asset $80,000
Income tax expense $80,000

22
 Remember Current Expense?

Item Amount
Pre-tax book income $1,000,000
Permanent differences 100,000
Financial taxable income $1,100,000
Temporary differences 200,000
Taxable income per return $1,300,000
Tax rate 40%
Tax liability (current portion of tax expense) $520,000

23
 Journal Entries

Entries to record tax provision

Debit Credit
Deferred tax asset $80,000
Income tax expense $80,000
Income tax expense $520,000
Current tax payable $520,000

24
 Income Tax Expense

Income statement looks like:

Item Amount
Deferred tax benefit (reduces tax $(80,000)
expense
Current income tax expense 520,000
Total income tax expense $440,000

25
Remember This Shortcut Method?

Item Amount

Pre-tax book income $1,000,000

Tax rate 40%

Expected tax expense $400,000

Tax related to permanent items 40,000

Total expected tax expense $440,000

Effective tax rate = 440,000/1,000,000 = 44%

(this is a short method of testing the rate)

26
Douglas Sayuk, Clifton Douglas
Cindy Frank, BDO USA
Jeffrey Zawada, FreedMaxick CPAs

SPECIFIC INCOME TAX

ACCOUNTING ISSUES, BEST
PRACTICES
VALUING AND REPORTING
DEFERRED TAX ASSETS
 Calculating The Deferred Tax Asset

Deferred Tax Assets – General Approach Example

Step 1: Identify temporary differences $3,000,000
Step 2: Identify NOL carryovers 7,000,000
Cumulative timing differences $10,000,000
Step 3: Determine applicable tax rate 40.00%
Deferred tax asset before credits $4,000,000
Step 4: Identify tax credits 500,000
Step 5: Calculate gross deferred tax assets $4,500,000
Step 6: Value the deferred tax assets (2,500,000)
Step 7: Calculate net deferred tax assets $2,000,000

In steps 5-7, current deferred tax assets/liabilities and non-current deferred tax assets/liabilities should
be aggregated, for balance sheet presentation purposes.

29
 Deferred Tax Assets: Specific Issues
I. Applicable tax rate
A. Use enacted tax rate applicable when differences are expected to affect the
taxes payable
B. Consider effect of federal deductions for state taxes
1. Generally, this has the effect of reducing the state rate to 65% of the full
amount (100% – 35% federal rate).
2. A few states permit a deduction for other state income taxes.
C. Always use the regular tax rate, even when in an AMT situation
D. Understand implications of tax holidays with limited durations
II. Foreign branches
A. Foreign DTAs result in a reduction to the future U.S. foreign tax credit.
B. Thus, a DTL must be established for the future reduction to the FTC.
C. This has the effect of eliminating a double-counting of branch DTAs.
30
 Valuing The Deferred Tax Assets
I. Consider other DTA reductions prior to valuation allowance
A. Worthless DTAs – Sect. 382
B. ASC 740-10 (FIN 48) DTA reductions (e.g., R&D credit reserves)
II. Valuation allowance
A. Remaining gross DTA subject to VA under more-likely-than-not standard
B. While not a bright-line test, the prior three years of cumulative financial
operations (pre-tax income +/- permanent items) is often considered strong
objective evidence.
C. Partial VAs based on forecasted future taxable income are not uncommon, but
these can appear to distort the tax rate if sustained for multiple years.
D. VA should be allocated pro rata between current and non-current DTAs
(without netting of DTLs), regardless of the specific asset to which it is related.

31
Slide Intentionally Left Blank
 Valuation Allowance Allocation
DTA/(DTL) DTA Ratio VA VA Allocated Classified

Current DTA A $2,000,000 A/(A+B) 20.00% x $9,000,000 = $1,800,000

Current DTL -0- n/a

Total current DTA $2,000,000 $(1,800,000) $200,000

Non-current DTA B $8,000,000 B/(A+B) 80.00% x $9,000,000 = $7,200,000

Non-current DTL C $(1,000,000)

Total non-current DTA $7,000,000 $(7,200,000) $(200,000)

Total gross DTA A+B+C $9,000,000
Valuation allowance (9,000,000)

Net DTA $- 0 - 100.00% $- 0 -

General rules for classification:

1. Tracks balance sheet classification of underlying asset/liability (e.g., fixed asset DTAs are non-current)
2. Where not tied to an actual balance sheet account, based on when DTA is expected to reverse (i.e.,
less than one year is current, greater than one year is non-current)

33
 DTA Movement Reconciliation: NOL Position

Gross Amount Applicable Rate DTA

Pre-tax book loss $(10,000,000) n/a
Perm differences 2,000,000 n/a
Temp differences 3,000,000 40.00% 1,200,000
Taxable loss $(5,000,000) -40.00% 2,000,000
Tax credits 500,000 100% 500,000
Change to DTA $3,700,000

Gross Amount Applicable Rate DTA

Pre-tax book loss $(10,000,000) -40.00% $4,000,000
Perm differences 2,000,000 -40.00% (800,000)
Tax credits 500,000 100% 500,000
Change to DTA $3,700,000
34
Return To Provision (RTP) Adjustment

• During the provision preparation, a comparison is performed to

identify any differences between the numbers used in last year’s tax
provision and the amounts used on the tax return.
• Generally computed during Q3

• The differences are “trued up” as part of the tax provision

preparation process for the succeeding year.

35
Return To Provision (RTP) Adjustment

Adjustment resulting from the comparison of individual items

included in the prior year provision to the final income tax returns
• Adjustments related to permanent items impact the current income
tax expense on the income statement
• Adjust deferred income tax asset/liability in succeeding year to reflect
impact of discrepancy on amount of tax paid in prior year

Change in Estimate Error

• Change in estimate when new
information ,not available when
the provision was prepared,
becomes available after the
provision is completed.
• Change can be attributed to
facts known or knowable at the
time the provision was prepared.
• Incorrect computation
• Incorrect information used
during provision preparation

36
 Return To Provision (RTP) Adjustment

Return Provision *
12/31/2011 12/31/2011 Difference Tax Effected

Pre-tax book income $1,000,000 $1,000,000 $0 $0

Meals and 50,000 40,000 10,000 4,000
entertainment
Allowance for bad debts 60,000 80,000 (20,000) (8,000)

Tax depreciation (300,000) (400,000) 100,000 40,000

Taxable income $810,000 $720,000 $90,000 $36,000

* Assume 40% federal and state statutory rate

37
Return To Provision (RTP) Adjustment

Entries to record tax provision true-up

Debit Credit
Current income tax expense $ 4,000
Deferred income tax expense 32,000
Income taxes payable $36,000

38
ANALYZING AND REPORTING
UNCERTAIN TAX POSITIONS
 Uncertain Tax Positions: Brief Overview

I. Recognition: Determine whether position is sustainable on a more-likely-

than-not basis (“on-off” switch)
A. Based on technical merits
B. Administrative practices and precedents
II. Measurement: Calculate the expected benefit of the position, based on
cumulative probability approach
A. Benefit greater than 50% of being realized upon settlement
B. Assume taxing authority has full knowledge of facts
III. Unrecognized tax benefits (UTBs): Tax effect of UTPs
A. FIN 48 liabilities recorded on balance sheets
B. Reduction of DTA (whether or not valuation allowance in recorded)
C. Excludes interest and penalties and well as “indirect benefits”
40
 Change In Recognition And Measurement

I. A change in recognition or measurement may occur when:

A. Management changes its judgment on the position.
B. The statute of limitations tolls.
C. The position is effectively settled.
II. Change in judgment
A. Critical issue: Was there a change in fact or authority?
B. A simple reassessment of existing facts can result in a restatement issue.
C. Consistency must be maintained; significant consideration should be
given to when establishing a methodology.
III. Statute of limitations
A. Net operating loss and tax credit carrybacks/carryforwards
B. Jurisdictional differences
41
 Change In Recognition And Measurement (Cont.)

IV. Effective settlement

A. A tax position is considered “effectively settled” when:
1. The taxing authority has completed its examination procedures.
2. The company does not intend to appeal or litigate any aspect of the tax
position.
3. Possibility is remote that the taxing authority would examine or reexamine
the tax position, assuming it has full knowledge of all relevant information.
B. Examination closure: Key considerations
1. A tax position does not need to be legally extinguished, and its resolution
need not be certain, in order to re-measure a tax reserve.
2. Consider whether the issue was specifically reviewed or examined
3. If not, is it remote the tax period will be re-examined?
4. Effective settlement may not affect the tax position in other years, especially
where the issue was not reviewed or “horse-trading” occurred.
42
 Common Unrecognized Tax Benefits

I. Transfer pricing
A. Benefits and limitations of contemporaneous documentation
B. Potential indirect effects – competent authority and withholding taxes
II. State nexus/permanent establishment
A. Consider taxing authorities’ administrative policies and practices on SOL
B. Potential indirect effects – throwback and FTCs
III. Foreign withholding taxes
A. Who is liable? Joint vs. separate liability
B. Potential indirect effects – FTC (or deductions)
IV. R&D credits
V. Anti-deferral provisions (Subpart F, Sect. 956, etc.)

43
 Example Of Indirect Effects
Facts: A U.S. company determines that $100 of foreign taxes should have been withheld on
royalty payment made to it by a foreign customer. The company determines that it has
joint liability for payment of the tax in the foreign jurisdiction and that a reserve is
required for this amount. However, the company concludes that it will also receive a $100
foreign tax credit for the taxes withheld, which it can use to offset U.S. taxes.

Conclusion: Ignoring potential interest and penalties, this has no potential future net cash impact to
the company, as the FTC will fully offset the foreign taxes paid. However, this must still be
disclosed as a $100 UTB. The journal entries would be as follows:

Dr. tax expense $100

Cr. FIN 48 reserve $100
To record withholding tax reserve

Dr. DTA $100

Cr. tax expense $100
To record FTC DTA

44
 Uncertain Tax Positions: Required Disclosures

I. All entities
A. Interest and penalties
1. Classification
2. Current and cumulative amounts
B. Reasonably possible increases or decreases in UTBs within next 12 months
1. Nature of uncertainty and potential event causing the change
2. Estimate of amount (or statement that cannot be reasonably estimated)
C. Tax years that remain open to examination in major jurisdictions
II. Public companies
A. Tabular reconciliation of UTBs
1. Increases: Current year and prior year
2. Decreases: Settlements, tolling of statutes, changes in judgment
B. Total amount of UTBs, if recognized, would affect the ETR.
45
FINANCIAL STATEMENT
DISCLOSURES:
OVERVIEW, ISSUES AND SEC
COMMENTS
Reported, Discussed And Disclosed

Reported amounts
• Balance sheet presentation
• Income statement presentation
• Statement of cash flows (SFAS No. 95)
• Changes in equity, net of taxes

47
 Reported, Discussed And Disclosed
(Cont.)

Discussions
• MD&A (management discussions and analysis)
• Commission guidance regarding management’s discussion and analysis of
financial condition and results of operations:
• MD&A should be a discussion and analysis of a company’s business as
seen through the eyes of those who manage that business.
Management has a unique perspective on its business that only it can
present. As such, MD&A should not be a recitation of financial
statements in narrative form or otherwise uninformative series of
technical responses to MD&S requirements, neither of which provides
this important management perspective.

48
 Reported, Discussed And Disclosed
(Cont.)

Discussions (Cont.)
• Effective tax rate
• Forecasted rate for following year
• Critical accounting policies
• Liquidity
• Contractual obligations

49
 Reported, Discussed And Disclosed
(Cont.)

Disclosed
• Significant accounting policies
• Income taxes including, but not limited to:
• Components of income before taxes
• Income tax expense (domestic and/or foreign)
• Rate reconciliation (for public enterprise)
• Individual items in excess of 5%
• Components of net deferred tax asset/liability, valuation
allowances
• Certain information related to FIN 48 amounts

50
 Disclosure Requirements

Financial statement presentation

• Classification
• Entities
• Jurisdictions

51
 Disclosure Requirements (Cont.)

Financial statement disclosure

• Components of the net deferred tax asset or liability
• Information for certain deferred tax liabilities not recognized
• Components of income tax expense (continuing operations)
• Income tax expense or benefit allocated to continuing
operations and separately allocated to other items
• Rate reconciliation (public enterprise)
• Certain carryforwards and certain valuation allowances
• Certain disclosures for members of a consolidated group

52
 Disclosure Requirements (Cont.)
FIN 48 disclosure
• Policy on interest and penalty classification
• Tabular reconciliation
• Unrecognized tax benefit that, if recognized, would affect the effective
tax rate
• Total interest and penalties
• Unrecognized tax benefits – reasonable possible of significant change
in the next 12 months
• Nature of uncertainty
• Nature of even that could occur
• Estimate of range of possible change or a statement that an
estimate cannot be made
• Tax years open to examination

53
 Disclosure Requirements (Cont.)
What to remember:
• Understand the netting rules when it comes to current and non-current
deferred tax assets and liabilities
• Understand how amounts are compiled and reported from different
jurisdictions
• Significant accounting policies related to tax should be disclosed (SFAS 109,
FIN 48, policies on interest and penalties).
• Components of income (from different jurisdictions)
• Components of expense (by jurisdiction, by classification)
• Rate reconciliation (dollars or percentages)
• Details for amounts > 5% of total for public companies
• Robust disclosures for estimates and changes in estimates (valuation
allowances, uncertain tax positions)
54
 SEC Comments: Areas Of Focus
Management estimates and judgments
• Valuation allowances
• Basis for having or not having a VA
• Timing of recording changes
• Consistency with other forward-looking information
• FIN 48-related items
• Paragraph 21 disclosures
• Interest and penalty policy disclosures
• Disclosures and adjustments on adoption
• Timing of recording changes

55
SEC Comments: Areas Of Focus (Cont.)

Management estimates and judgments (Cont.)

• Adequacy of disclosure
• Rate reconciliation items
• Deferred tax assets and liabilities
• Uncertain tax positions
• Timing of reversal
• Expiration of NOLs in various jurisdictions
• Other
• Contingency obligations table

56
SEC Comments: Areas Of Focus (Cont.)
What to remember – SEC Comments
• SEC may ask for clarification related to management’s material
estimates and/or judgments.
• Changes in estimates should be well-documented.
• Responses to SEC comment letters are easier if the company has
documentation related to:
• Alternative views considered
• Company policies that provide guidance on estimates
• Criteria used in evaluation
• Consider information that could be important to the user of the
financial statements

57
Slide Intentionally Left Blank
DECIDING ON APPROPRIATE
INTRA-PERIOD ALLOCATIONS
 Intraperiod Tax Allocations
I. Income tax expense or benefit should be allocated among:
A. Continuing operations
B. Other components
1. Discontinued operations
2. Extraordinary items
3. Other comprehensive income
4. Items charged or credited directly to shareholders’ equity
II. Steps in allocation process
A. Step 1 - Calculate total tax expense
B. Step 2 - Determine tax related to continuing operations
C. Step 3 - Allocate remainder to other components (disc. ops, OCI, etc.)
60
 Intraperiod Tax Allocations: Example
NOL Carryover w/ No NOL Carryover NOL Carryover
VA No VA No VA
Pre-tax Income – cont. ops $3,000,000 $3,000,000 $3,000,000
Pre-tax Income – disc. ops (1,000,000) (1,000,000) (1,000,000)
Pre-tax income $2,000,000 $2,000,000 $2,000,000
NOL carryover (2,000,000) -0- -0-
Taxable income $- 0 - $2,000,000 $2,000,000
Tax rate 40.00% 40.00% 40.00%
Total tax expense A $- 0 - $800,000 $800,000
Related to continuing ops B -0- $3MM x 40%= 1,200,000 1,200,000
Current Deferred
Allocated to disc. ops A-B -0- benefit (400,000) benefit (400,000)

Note: Net operating losses and other deferred tax assets are utilized before the impact of other
components are considered.

61
 Application Of ASC 740-20-45-7
Under this exception to the general rules, all components should be considered in
determining the tax benefit resulting from continuing operations losses.
NOL Carryovers/Full Valuation
Allowance Year X1 Year X2
Pre-tax income – cont. ops $(2,000,000) $2,000,000
Pre-tax gain/(loss) – OCI (AFS) 2,000,000 (2,000,000)
Pre-tax income $-0- $-0-
Tax rate 40.00% 40.00%
Total tax expense $-0- No tax expense due to NOL $-0-
C/F and valuation allowance
Related to continuing ops $(2MM) x 40%= (800,000) -0-
Allocated to disc. ops $2MM x 40%= 800,000 -0-

Note: Even though the two-year impact of the OCI gain/loss is $nil, the tax effect of the Year X1
application of this rule does not reverse out in Year X2. Rather, the disproportionate tax effects
become lodged in OCI and only reverse under very limited circumstances.

62
INTERIM PERIOD TAX
COMPUTATION CALCULATIONS
 Interim Period Tax Computation
I. Guidance
A. ASC 740-270-25-2
1. The tax (or benefit) related to ordinary income (or loss) shall be
computed at an estimated annual effective tax rate, and the
tax (or benefit) related to all other items shall be individually
computed and recognized when the items occur.
2. Ordinary income or loss
a. Includes continuing operations before income taxes or
benefit
b. Excludes significant unusal or infrequently occuring items
(rare)
c. Excludes extraordinary items, cumulative effects of
changes in accounting principles and discontinued
operations
64
 Interim Period Tax Computation (Cont.)

I. Calculation
A. Caluclate estimated effective tax rate
1. Forecast annual pre-tax income by entity/tax filing
jurisdiction
2. Calculate current and deferred provisions
3. Consider federal, state and foreign
B. Apply estimated effective tax rate
1. Multiply estimated effective tax rate by actual year-
to-date worldwide pre-tax income
C. Layer on items recorded discretely

65
 Interim Period Tax Computation (Cont.)

I. Items recorded discretely in the interim period

A. Prior-year uncertain tax positions
B. Current-year uncertain tax positions related to income excluded
from the effective tax rate calculation
C. Interest and penalties related to uncertain tax positions
D. Change in tax law
E. Change in tax status
F. Changes in realizability of deferred tax assets
G. Changes in judgment regarding APB 23 items (unremitted earnings of
foreign subsidiaries and other outside basis items)
H. Changes in estimates from prior-year provisions (provision to return
adjustments)

66
 Interim Period Tax Computation (Cont.)
I. Modification to estimated effective tax rate approach (ASC 740-270-
30-30 through ASC 740-270-30-34)
A. Loss limitation (year-to-date loss exceeds the full-year expected
loss, and full realization of tax benefit is assured, i.e. no need
for a valuation allowance)
A. Recalculate tax based on year-to-date results
B. Good example: ASC 740-270-55-16
B. Loss limitation (year-to-date loss exceeds the full year expected
loss, and partial realization of tax benefit is assured)
A. Calculate estimated effective tax rate based on amount of
tax benefit assured
B. Recalculate tax based on year-to-date results
C. Good example: ASC 740-270-55-20
67
 Interim Period Tax Computation (Cont.)

I. Example – ASC 740-270-55-16

Ordinary Income Tax

Overall
Estimated
Annual Year-to- Year-to- Less
Reporting Reporting Year-to- Effective Date - Date - Previously Reporting
Period Period Date Tax Rate Computed Limited Reported Period
First Qtr 20,000 20,000 60% 12,000 - 12,000
Second Qtr (80,000) (60,000) 60% (36,000) 12,000 (48,000)
Third Qtr (80,000) (140,000) 60% (84,000) (80,000) (36,000) (44,000)
Fourth Qtr 40,000 (100,000) 60% (60,000) (80,000) 20,000
Fiscal Year (100,000) (60,000)

Year to date ordinary loss ($140,000 X 50%) (70,000)

Estimated Tax Credits (10,000)
(80,000)

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 Interim Period Tax Computation (Cont.)

I. Example – ASC 740-270-55-20 (overall ETR limited to partial unrealizable

losses)
Ordinary Income Tax

Overall
Estimated
Annual Year-to- Year-to- Less
Reporting Reporting Year-to- Effective Date - Date - Previously Reporting
Period Period Date Tax Rate Computed Limited Reported Period
First Qtr 20,000 20,000 20% 4,000 - 4,000
Second Qtr (80,000) (60,000) 20% (12,000) 4,000 (16,000)
Third Qtr (80,000) (140,000) 20% (28,000) (20,000) (12,000) (8,000)
Fourth Qtr 40,000 (100,000) 20% (20,000) (20,000) -
Fiscal Year (100,000) (20,000)

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Interim Period Tax Computation (Cont.)

C. ASC 740-270-30-36(a) – If a separate jurisdiction has year-

to-date ordinary loss or anticipates ordinary loss for the
year, and no tax benefit can be recognized, then that
entity should be excluded from the estimated effective
tax rate calculation.

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 Interim Period Tax Computation (Cont.)

I. Example – ASC 740-270-55-39

Anticipated ordinary income for the fiscal year:

In the United States $ 60,000
In Country A 40,000
Total $ 100,000

Anticipated tax for the fiscal year:

In the United States ($60,000 at 50% statutory rate) $ 30,000
In Country A ($40,000 at 20% statutory rate) 8,000
Total $ 38,000

Overall estimated annual effective tax rate ($38,000 / $100,000) 38%

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 Interim Period Tax Computation (Cont.)

I. Example – ASC 740-270-55-40 – quarterly tax computation

Ordinary Income Tax

Overall
Estimated
Annual Less
Reporting United Year-to- Effective Year-to- Previously Reporting
Period States Country A Total Date Tax Rate Date Reported Period
First Qtr 5,000 15,000 20,000 20,000 38% 7,600 - 7,600
Second Qtr 10,000 10,000 20,000 40,000 38% 15,200 7,600 7,600
Third Qtr 10,000 10,000 20,000 60,000 38% 22,800 15,200 7,600
Fourth Qtr 35,000 5,000 40,000 100,000 38% 38,000 22,800 15,200
Fiscal Year 60,000 40,000 100,000 38,000

72
 Interim Period Tax Computation (Cont.)

I. Example – ASC 740-270-55-41 – ordinary loss; realization not MLTN

I. Country B history of losses, 40% rate, expected tax benefit will not be
realized on these losses

Ordinary Income Tax

Overall
Estimated Year-to-
Annual Date - Less
Reporting United Year-to- Effective Excluding Previously Reporting
Period States Country A Country B Total Date Tax Rate Country B Reported Period
First Qtr 5,000 15,000 (5,000) 15,000 15,000 38% 7,600 - 7,600
Second Qtr 10,000 10,000 (25,000) (5,000) 10,000 38% 15,200 7,600 7,600
Third Qtr 10,000 10,000 (5,000) 15,000 25,000 38% 22,800 15,200 7,600
Fourth Qtr 35,000 5,000 (5,000) 35,000 60,000 38% 38,000 22,800 15,200
Fiscal Year 60,000 40,000 (40,000) 60,000 38,000

Note: Format above different than actual ASC 740-270-55-41 example

73
 Interim Period Tax Computation (Cont.)

I. Example – ASC 740-270-55-41 – what if country B was included

Anticipated ordinary income for the fiscal year:

In the United States $ 60,000
In Country A 40,000
In Country B (40,000)
Total $ 60,000

Anticipated tax for the fiscal year:

In the United States ($60,000 at 50% statutory rate) $ 30,000
In Country A ($40,000 at 20% statutory rate) 8,000
Total $ 38,000

Overall estimated annual effective tax rate ($38,000 / $60,000) 63.33%

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 Interim Period Tax Computation (Cont.)

I. Example – ASC 740-270-55-41 – what if country B was included (Cont.)

I. Country B history of losses, 40% rate, expected tax benefit will not be
realized on these losses

Ordinary Income Tax

Overall
Estimated Year-to-
Annual Date - Less
Reporting United Year-to- Effective Including Previously Reporting
Period States Country A Country B Total Date Tax Rate Country B Reported Period
First Qtr 5,000 15,000 (5,000) 15,000 15,000 63.33% 9,500 - 9,500
Second Qtr 10,000 10,000 (25,000) (5,000) 10,000 63.33% 6,333 9,500 (3,167)
Third Qtr 10,000 10,000 (5,000) 15,000 25,000 63.33% 15,833 6,333 9,500
Fourth Qtr 35,000 5,000 (5,000) 35,000 60,000 63.33% 37,998 15,833 22,166
Fiscal Year 60,000 40,000 (40,000) 60,000 37,998

Note: Format above different than actual ASC 740-270-55-41 example

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Slide Intentionally Left Blank
MERGER AND ACQUISITION
TOPICS
 Business Combinations: Key Steps
Step 1: Determine transaction structure (stock vs. asset acquisition)
• Stock – historical tax basis carryover; can lead to significant DTA/DTLs
• Asset – tax basis stepped up to FMV; DTA/DTL may be minimal
Step 2: Identify existing deferred tax assets and liabilities
• Typically, a short period cut-off provision is calculated.
• Consider the impact of stock awards and other non-recurring charges.
• When combined returns will be filed with the acquirer, the applicable tax rate
in valuing DTA/DTLs should be reassessed.
Step 3: Calculate DTA/DTL from purchase accounting fair value adjustments
• In a stock transaction, every FV adjustment will result in a DTA/DTL. Non-
goodwill intangibles often result in a significant DTL.
• Consider the impact of an acquired DTL on the acquirer’s VA, as the benefit of
any release will be recorded to P&L.

78
 Business Combinations: Key Steps (Cont.)

Step 4: Evaluate deferred tax asset valuation

• Consider whether the combined operation’s financial position changes
the assessment of deferred tax asset utilization
• Changes to the acquired company’s VA are recorded in purchase
accounting, while the acquirer’s VA is recorded outside of purchase
accounting.
• Also consider the need to write-off DTAs due to Sect. 382, SRLY or other
acquisition related limitations
Step 5: Consider tax reserve needs
• Leverage off of conclusions reached in due diligence
• Consider the impact of indemnifications
• Continue to evaluate information available at the acquisition date during
the one-year measurment period
79
STOCK AWARD ISSUES
 Stock Awards
I. Guidance
A. When the settlement of an award creates or increases a net
operating loss
A. This provides that the excess tax benefit and the credit to
APIC (and our APIC pool) for the windfall should not be
recorded until the deduction reduces income taxes payable.
B. ASC 718-740-25-10
A. A share option exercise may result in a tax deduction before
the actual realization of the related tax benefit because the
entity, for example, has a net operating loss carryforward.
In that situation, a tax benefit and a credit to additional
paid-in capital for the excess deduction would not be
recognized until that deduction reduces taxes payable.
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 Stock Awards (Cont.)
I. Result
A. Net operating losses
A. The deferred tax asset on the company’s net operating
losses will differ from the net operating losses actually
on its tax return.
B. The net operating losses relating to this windfall tax
benefit will have to be tracked separately.
C. The net operating losses disclosed in the footnote should
be the actual net operating losses per the tax return.
D. The footnote should also disclose the amount of benefit
still to be recorded in additional paid-in capital once the
net operating loss carryforward is realized.
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 Stock Awards (Cont.)
I. Accounting policy
A. Generally two approaches allowed:
A. With and without – results in windfall tax benefits
being realized last
B. Tax law ordering – results in windfall tax benefit being
realized first (should be less complex)
B. Election of method is an accounting policy that must be
applied consistently.

83
 Stock Awards (Cont.)
I. Examples
I. Facts:

NOL carryforward from prior years – actual per $500,000

tax return
Deferred tax asset on NOL at 40% $200,000
Current-year taxable income (before excess tax $600,000
deduction for stock-based comp)
Current-year excess tax deduction for stock $250,000
based compensation

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 Stock Awards (Cont.)
Example 1: No valuation allowance

With and Tax Law

Without Without With Ordering

Taxable income before NOL and excess tax deduction $ 600,000 $ 600,000 $ 600,000 $ 600,000

Current year excess tax deduction for stock based compensation $ (250,000) $ - $ (100,000) $ (250,000)
NOL Carryforward from prior years $ (500,000) $ (500,000) $ (500,000) $ (350,000)

Taxable Income or NOL carryforward to next year $ (150,000) $ 100,000 $ - $ -

Journal Entry
Income Taxes Payable $ - $ -
Current Tax Expense $ 40,000 $ 100,000
Deferred Tax Expense $ 200,000 $ 140,000
Deferred Tax Asset $ (200,000) $ (140,000)
Additional Paid-in Capital $ (40,000) $ (100,000)

Memo Entry - Debit / (Credit)

Deferred Tax Asset $ 60,000 $ -
Additional Paid-in Capital $ (60,000) $ -
- With and Without - memo entry to reflect the $150,000 excess tax deduction for which there has been no cash benefit yet received

Actual Remaining Net Operating Losses $ (150,000) $ (150,000)

Deferred Tax Asset $ - $ 60,000
0% 40%

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 Stock Awards (Cont.)
Example 2: Full valuation allowance

With and Tax Law

Without Without With Ordering

Taxable income before NOL and excess tax deduction $ 600,000 $ 600,000 $ 600,000 $ 600,000

Current year excess tax deduction for stock based compensation $ (250,000) $ - $ (100,000) $ (250,000)
NOL Carryforward from prior years $ (500,000) $ (500,000) $ (500,000) $ (350,000)

Taxable Income or NOL carryforward to next year $ (150,000) $ 100,000 $ - $ -

Journal Entry
Income Taxes Payable $ - $ -
Current Tax Expense $ 40,000 $ 100,000
Valuation Allowance $ 200,000 $ 140,000
Deferred Tax Asset $ (200,000) $ (140,000)
Additional Paid-in Capital $ (40,000) $ (100,000)

Memo Entry - Debit / (Credit)

Deferred Tax Asset $ 60,000 $ -
Additional Paid-in Capital $ (60,000) $ -
- With and Without - Memo entry to reflect the $150,000 excess tax deduction for which there has been no cash benefit yet received

Actual Remaining Net Operating Losses $ (150,000) $ (150,000)

Deferred Tax Asset $ - $ 60,000
Valuation Allowance $ - $ (60,000)

86
CURRENT AUDITOR RED
FLAGS
 Current Auditor Hot Topics
I. PCAOB materiality guidelines
II. Deferred tax asset disclosure
A. Classification – current vs. non-current
B. Stock-based compensation
1. Terminations and cancellations
2. Sect. 83(b) elections
C. Cost basis – fixed/intangible assets
D. “True-up” impact – estimate vs. error
III. Permanent reinvestment of foreign earnings rep under APB 23
A. Ability – sufficient cash to fund domestic operations
B. Intent – established company policy; earnings need to fund operations
C. Reasonable estimate of deferred taxes

88
Current Auditor Hot Topics (Cont.)
IV. Valuation allowance
A. Allocation between current and non-current assets
B. Jurisdictional issues (e.g., cost plus entities)

V. ASC 740-10 (FIN 48)

A. Statute of limitation periods
B. Disclosure regarding changes in next 12 months

VI. Intraperiod tax allocations to OCI

89
 Current Auditor Red Flags
I. Effective tax rate reconciliation
A. Foreign effective tax rate varies significantly from
statutory rate.
II. Business combinations
A. Contingent liabilities and consideration
III. Deferred tax roll
IV. Uncertain tax positions
A. Inter-company transactions/transfer pricing
B. Foreign audits

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Slide Intentionally Left Blank
RISK MITIGATION
 Risk Mitigation
I. Valuation allowance documentation

II. ASC 740-30-25-17 (APB 23) documentation

III. Tax provision software

IV. Department capability and internal controls

93
 Risk Mitigation (Cont.)
I. Valuation allowance documentation
I. Four sources of taxable income
A. Taxable income in carryback years
1. Consider character of income
B. Future reversal of existing temporary differences
1. Consider timing of future reversals
C. Tax planning strategies
1. Must be prudent and feasible
2. Must be something management wouldn’t ordinarily
take
3. Must prevent deferred tax asset from expiring unused
4. Must result in the realization of a deferred tax asset
94
 Risk Mitigation (Cont.)
I. Valuation allowance documentation (Cont.)
D. Future taxable income exclusive of reversing
temporary differences and carryforwards
1. Three-year cumulative pretax book earnings
2. Forecast accuracy!!!
3. How many years of forecasted pre-tax income
would be needed to realize all of the deferred tax
assets?
4. Document and consider company liquidity,
backlog, market trends, losses of significant
customers, forecast divestitures, and expected
restructuring or changes in operations.
95
 Risk Mitigation (Cont.)
I. ASC 740-30-25-17 (APB 23) documentation
A. Document policy of permanent reinvestment
B. Consider all aspects of outside basis differences (unremitted earnings,
cumulative translation adjustments, transactions with non-controlling
shareholders and other comprehensive income)
C. Document uses of excess cash at foreign subsidiary (working capital needs,
capital expenditures, acquisitions, repay inter-company obligations, loan to
other foreign entities, etc.
D. Document or forecast need or lack thereof of cash at the parent company
1. Operations, debt service, acquisitions, capital expenditures, inter-
company obligations
E. Consider history of earnings remittances
1. Consider policy of not remitting past earnings
F. Consider dispositions/available for sale entities

96