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Income Tax Accounting

SFAS 109 (ASC 740-10)

Course Objectives
Understand and apply basic concepts and procedures of SFAS 109
Understand the how to identify temporary differences
Understand how to calculate the current and deferred tax provisions
Understand the basics of the valuation allowance
Understand how the tax provision affects financial statements and its
role in the audit
Ensure client compliance with financial statement disclosure
requirements

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Objectives of ASC 740-10
Recognize:
1. The amount of taxes payable or refundable for the current year

2. Deferred tax liabilities and assets for the future tax
consequences of events that have been recognized in a
company’s financial statements or tax returns

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4 .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.

Components of Income Tax Expense Current income tax expense (benefit) + Deferred income tax expense (benefit) Total income tax expense (benefit) 5 .

Balance Sheet Approach SFAS 109 requires the balance sheet approach to compute deferred taxes To compute the expense you must compare the beginning balance to the ending balance 6 .

Balance Sheet Approach Beg of Year End of Year Expense/ Benefit 7 Effect on Net Income Net DTA Larger DTA Benefit Increase Net DTA Smaller DTA Expense Decrease Net DTA DTL Expense Decrease Net DTL Larger DTL Expense Decrease Net DTL Smaller DTL Benefit Increase Net DTL DTA Benefit Increase .

state and local taxes based on income • Domestic and foreign operations that are consolidated. combined or accounted for by the equity method • Foreign enterprises in preparing financial statements under US GAAP 8 .ASC 740-10 Applicability • Domestic federal income taxes • Foreign.

Hi Course History of Accounting Objectives story for Income Taxes • APB 11 – Issued in 1967 – Used the Deferred Method – Calculation was a “with” and without” method 9 .

History of Accounting for Income Taxes The basic formula under APB 11 was: Pretax income +/.Permanent Differences Taxable Income X Tax Rate Tax Provision 10 .

would have not future income 11 .History of Accounting for Income Taxes •FASB 96 – Issued in 1996 – Used the Liability Method – Required extensive scheduling – Assumed co.

History of Accounting for Income Taxes •FASB 109 – Issued in 1992 – Maintained liability method – Simplified the scheduling requirement – Required all deferred assets to be recorded – Introduced the concept of a valuation allowance 12 .

Temporary Differences The difference between the tax basis of an asset or liability and its reported amount in the financial statements that will result in taxable or deductible amounts in future years when the reported amount of the asset or liability is recovered or settled. 13 . respectively.

Deductible Temporary Differences Differences that will result in deductible amounts in future years when the related asset or liability is recovered or settled 14 .Types of Temporary Differences Taxable Temporary Differences Differences that will result in taxable amounts in future years when the related asset or liability is recovered or settled.

Types of Temporary Differences ASSETS LIABILITIES AssetsLiabilitiesTaxab Book carrying value > le temporary tax basis difference (TTD) Tax basis > book carrying value Deductible temporary difference (DTD) Book carrying value > tax basis 15 Tax basis > book carrying value .

Types of Temporary Differences Current / Prior Periods Future Periods (Generally) Taxable temporary difference (TTD) Book income > taxable income Taxable income > book income Deductible temporary difference (DTD) Taxable income > book income Book income > taxable income 16 .

Ex. Depreciation 17 . Installment Sales Expenses or losses that are deductible before they are recognized in book income.Types of Taxable Temporary Differences Revenue or gain that are taxable after they are recognized in book income. Ex.

Ex. Ex. Reserves NOLs and credit carryforwards 18 . Prepaid Income Expenses or losses that are deductible after they are recognized in book income.Types of Deductible Temporary Differences Revenue or gains that are taxable before they are recognized in book income.

Calculation of the Balance of a Temporary Difference Calculation of Temporary Difference: Calculated Book Basis .Calculated Tax Basis Total Temporary Difference 19 .

Estimate the applicable tax rate 2. Determine the gross deferred tax asset 4.Deferred Tax Provision – “Five Step Process” 1. Record a valuation allowance. Determine the gross deferred tax asset for credit carryforwards 5. if necessary 20 . Determine the gross deferred tax liability 3.

S. Federal Income Tax Rate – Regular – AMT • State Income Taxes – Blended Tax Rate • Foreign Income Taxes 21 .Tax Rates Used •U.

Deferred Tax Liability DTL = Taxable temporary differences X applicable tax rate 22 .

23 .Deferred Tax Asset DTA = [(Deductible temporary differences + loss and deduction carryforwards) X applicable federal rate] + tax credit carryforwards.

Deferred Tax Expense/Benefit Net DTA or DTL at end of year Less: Net DTA or DTL at beginning of year Deferred income tax expense (benefit) 24 .

Effect of Change in Net DTA or DTL Change in Net DTA / DTL Result Decrease in net DTA Deferred income tax expense Increase in net DTL Deferred income tax expense Increase in net DTA Deferred income tax benefit Decrease in net DTL Deferred income tax benefit 25 .

Exception to the General Rule APB 23 – Permanently reinvested earnings in a foreign subsidiary 26 .

Valuation Allowance Impairment Approach A valuation allowance is required if the deferred tax asset is “impaired” Realization Test A probability level of more than 50% A single criterion “more likely than not” Future Taxable Income is Required 27 .

Future Taxable Income • Future reversals of existing taxable temporary differences • Taxable income in carryback years • Tax-planning strategies • Future taxable income (exclusive of reversing temporary differences and carryforwards) 28 .

Tax-planning strategies must be prudent and feasible.Tax Planning Strategies Tax-planning strategies will accelerate income so that the company can take advantage of future deductible differences. The company does not have to actually implement the strategy. 29 .

Tax Planning Strategies Sale of operating assets Change of inventory method Elect out of the installment method Elect the alternative depreciation system 30 .

Positive and Negative Evidence Negative Evidence • Cumulative losses • History of expiring tax benefits • Expectation of future losses • Unsettled circumstances • Brief carryback or carryforward period 31 Positive Evidence • Existing contracts or sales backlog • Appreciated asset value over tax basis • Strong earnings history .

Valuation Allowance RECOGNITION OF AN OPERATING LOSS OR ADJUSTMENTS TO BEGINNING-OF-YEAR VALUATION ALLOWANCE • When incurred .source of loss • Subsequently – Operations if based on future income – Source of income if based solely on current year income 32 .

Change EFFECT OF A CHANGE IN THE VALUATION ALLOWANCE THAT RESULTS FROM A CHANGE IN CIRCUMSTANCES MUST BE INCLUDED IN INCOME FROM CONTINUING OPERATIONS.Valuation Allowance . 33 .

Valuation Allowance .Change CHANGE IN JUDGMENT ABOUT REALIZABILITY • Affects Current Quarter If For Future Years • Affects Remaining Interim Periods If For Future Interim Periods 34 .

Valuation Allowance – Change at Interim Date DECREASE IN VALUATION ALLOWANCE IS SEGREGATED INTO TWO COMPONENTS • Portion related to a change in estimate regarding the current year's income – Taken into income by prospectively adjusting effective tax rate for current year • Portion related to a change in estimate about future years' income – Taken into income as a discrete event in the quarter of the change in estimate 35 .

operations.EITF ISSUE 93-13 – Impact on disc. extraordinary and cumulative effect items REQUIRED DISCLOSURES 36 .Tax Effect of a Change in Tax Law MEASURED AND RECORDED ON THE ENACTMENT DATE – May be necessary to estimate temporary difference at interim dates RETROACTIVE APPLICATION .

Change in Tax Law or Tax Rate CURRENT – – – TAX EXPENSE Calculate New ETR Apply New ETR To Year-To-Date Income Cumulative Catch-Up Adjustment DEFERRED – – 37 TAX EXPENSE Apply New Tax Rate to Deferred Tax Accounts Impact of Change in Deferred Taxes Affects Quarter of Enactment .

Current Tax liability The amount of income taxes paid or payable (or refundable) for a year as determined by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues for that year. 38 .

Expected Current Tax Provision Pretax Income +/.Schedule M-1 adjustments Taxable Income Before NOL Carryforward .NOL Carryforward Taxable Income x Applicable Tax Rate Current Tax Provision before Credits .Applicable Tax Credits Expected Current Tax Provision 39 .

Permanent Differences Permanent Differences arise from income that is permanently nontaxable and expense items are permanently nondeductible. Another way of saying it: Permanent differences are items that impact either the financial statements or the tax return but not the other 40 .

Examples of Permanent Differences 50% of Meal and Entertainment Fines and Penalties Officers’ Life Insurance Premiums and Proceeds Municipal Bond Interest Dividends Received Deduction 41 .

Cases 42 .

state State Rate 2008 (294.000) 8% 2009 (163.520) (13.000) (163.960) Less state deferred tax Federal Rate Net Federal deferred tax (liability) asset 43 28% 26% (75.000) 8% Net state deferred tax liability (23.734) (38.520 13.federal (294.Cases – Deferred Tax Calculation Net Deferred Tax (Liability) Asset: Net taxable temporary differences.000) 23.040 (270.480) (149.040) Net taxable temporary differences .990) .

500.000 1.480) Schedule M-1 adjustments: Key-Man Life Insurance Tax-Exempt Interest (1.500.000) (150.000 131.520 8% 134.000 Less State Taxes Federal 3.Cases – Current Provision State Pretax Income 3.000) (150.000 (134.000) (1.506.681.000) 131.200.000) Dividends Received Deduction Change in Temporary Differences Taxable Income Tax Rate Current Tax Expense 44 (40.695 .200.000 1.480 26% 391.

695 State 134.951 .744) State (10.224) 478.175 Deferred Tax Provision Federal (36.480 Total 526.480) Total Total Tax Provision 45 (47.Provision Summary of Total Tax Provision (Benefit) Current Tax Provision Federal 391.Cases .

409) ( .00% State taxes.951 14.000) (1.760 2.Cases – Rate Reconciliation The reasons for the difference between income taxes computed by applying the statutory federal income tax rate and income tax expense in the financial statements are: Statutory Rate 832. net of federal tax benefit 91.32)% Change in of tax rate ( 5.97% 46 .22)% Dividends Received Deduction ( 10.000 26.17)% Effective tax rate 478.400) ( .19)% Tax-exempt interest ( 39.87% Key-man life insurance (390.000) (12.

030 .320 52.Cases – Balance Sheet Presentation Deferred income tax assets and liabilities consist of the following: Deferred income tax assets: Inventories 17.390 Gross Deferred Tax Asset 185.000 Provincial Taxes 3.700 Restructuring Reserve 39.100 Pension Costs 35.100 Deferred Compensation 17.000 Bad Debts 73.290 Deferred income tax liabilities: Depreciation Deferred Tax Liability 47 237.

True-Ups During the provision work. 48 . 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. The differences are “trued up” as part of the tax provision preparation process for the succeeding year.

True Up Process 49 Type of Difference True-Up Process Permanent Adjust current income tax expense in succeeding year to reflect impact of discrepancy on amount of tax paid in prior year Temporary Adjust deferred income tax asset/liability in succeeding year to reflect impact of discrepancy on amount of tax paid in prior year .

True Up Process Temporary Difference 50 End of Year 20X1 True Up Beginning Year 20X2 .

Gamma Corporation reported current income tax expense of $358..000. (A 40% tax rate was used in all computations.True Up Process .000 and deferred income tax expense of $62.e. its initial year of operations.Example For 20X9.000.) A reconciliation of Gamma’s 20X9 tax provision to its 20X9 income tax return is as follows: 51 . i. total income tax expense of $420.

000 35.000 $850.000 10.Example Per Provision Pre-Tax Book Income Per Return Difference $1.0000 10.000 50.000) (50.000) Excess Tax Depreciation Taxable Income What is the adjustment that is needed? 52 .000 $1.True Up Process .000 75.000) $895.000 Bad Debt Allowance 80.000 (10.000 Meals & Entertainment 50.000 40.000) Accrued Liabilities 40.000) (350.000) UNICAP Adjustment 25.000.000 $(45.000.000 (5.000 $0 (300.

000 $14.Example What is the adjustment that is needed? Dr Cr Cr 53 Income taxes payable $18.000 Current income tax expense Deferred income tax liability $ 4.000 .True Up Process .

Uncertain Tax Positions Tax issues created the most problems found under Sarbanes-Oxley and 404 Numerous restatements were required because of the tax provision In response FASB undertook a project to govern how uncertain tax positions would be reported 54 .

Former Practices Tax Contingencies or cushion were hid and not disclosed in detail Tax Directors were very proprietary with the calculation and were reluctant to discuss with the auditors Concern that if the information was included in the audit workpapers the IRS would have access to them 55 .

Former Practices Tax Contingencies are reported using either: “Loss Contingency” approach – SFAS 5 “Best Estimate” approach – 50/50 “Tax Advantaged Transaction” approach – reverse SFAS 5 56 .

Former Practices Had to use a consistent approach The likelihood of a taxing authority discovering the issue on examination should not be considered Support for each reserve amount and any change was required 57 .

FASB’s Concerns Diversity of reporting of tax contingencies Felt the standards needed strengthening Use of tax contingencies had become too flexible and used to manipulate income Reporting and disclosure lacked transparency 58 .

SEC’s Position SEC also concerned about the reporting of tax contingencies Many SEC letters were been issued on this matter in the 6 to 9 months prior to the issuance of FIN 48 (ASC 740-10) Dealing with the SEC very different than FASB and IRS 59 .

2006 “Benefit Recognition” Approach “More likely than not” threshold “Cumulative Probability” 60 .FIN 48 (ASC 740-10) Released July 13.

derecognize.Objectives of FIN 48 (ASC 740-10) Clarify accounting for income taxes Provide greater consistency in criteria used to recognize. thereby improving relevance and comparability of financial statement reporting 61 . and measure benefits related to income taxes Establish consistent thresholds.

Scope of FIN 48 (ASC 740-10)
Applies to all income tax positions
A tax position is defined as a position taken in a previously filed
return or expected to be taken in a future return
A position can result in a permanent reduction of taxes
(permanent differences), a deferral of taxes (temporary
differences), or a change in the expected realizability of
deferred tax assets
FIN 48 also encompasses decisions not to file an income tax
return, jurisdictional allocations (i.e., transfer pricing) and
characterization
of income
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FIN 48 (ASC 740-10)
Recognition criteria focuses primarily on
technical tax law
“Widely understood” administrative
procedures considered
Each position assessed separately
Detection risk not considered
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Highly Certain Tax Positions
• FIN 48 applies to all income tax positions
Distinguishes between “highly certain” and
“uncertain” tax positions

Highly certain tax positions
Clearly meets the MLTN recognition standard
and greater than 50% likely that 100% of benefit
will be sustained based on clear and
unambiguous tax law
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FIN 48 (ASC 740-10) Introduces concept of “Unit of Account” Based on facts and circumstances • Aggregate or • Separate each project 65 .

should be consistently applied to similar positions from period to period unless change in facts and circumstances indicates that a different unit of account is more appropriate 66 .Unit of Account The appropriate unit of account for a tax position is a matter of judgment and requires consideration of • The manner in which the enterprise prepares and supports its income tax return. and • The approach the enterprise anticipates the taxing authority will take during an examination Once established.

Two Step Process The application of FIN 48 to an uncertain tax position (UTP) requires a two-step process that separates recognition from measurement Step 1: Recognition Threshold Step 2: Measurement of the Benefit 67 .

Step 1: Initial Recognition A tax benefit is recognized when it is “more likely than not” to be sustained based on the technical merits of the position • Conclusion regarding financial statement recognition takes into account technical merits and facts and circumstances • Assumes that tax position will be examined by the taxing authority • Each position must stand on its own merits • Administrative practices and precedents deal with limited technical violations of the tax law • Authority will not take issue with the tax position • Broad understanding in practice 68 .

Step 2: Measurement A tax position that meets the MLTN recognition threshold shall initially and subsequently be measured as the largest amount of tax benefit that is greater than 50% likely of being realized (cumulative probability concept) • 69 Based upon facts and circumstances determined at the reporting date .

Step 2: Measurement Differences related to timing (deduction itself is not in question) • Recognition threshold is achieved Not all tax positions require detailed consideration of possible outcome amounts and percentage likelihood associated with each amount (cumulative probability approach) 70 .

Example – Step 1 A company takes a deduction that creates a tax benefit of $100. The amount that should be recognized will depend on the cumulative probability in the second step. How likely of being sustained on technical merit must the deduction be before the company can record the benefit? 71 Under the first step the position must be more than 50% likely of being sustained on its technical merit to take the benefit. .

How much should be deducted? 72 .Example – Step 2 From the previous example if the cumulative probability the position will be sustained is 30% for a $100 deduction. 40% for an $80 deduction. 55% for a $60 deduction and 80% for a $30 deduction.

Example – Step 2 Amount of tax benefit 73 % Likelihood will be sustained Cumulative Probability $100 30% 30% $80 10% 40% $60 15% 55% $30 25% 80% $20 20% 100% .

new evaluation •Reporting date vs.Change in Judgment Subsequent recognition. financial statement issuance date •Change from rules under FAS 5 74 . derecognition or change in measurement • Requires new information vs.

negotiation or litigation • The statute of limitations expires 75 .Subsequent Recognition Subsequent recognition occurs when any of the following conditions are met: • The MLTN threshold is met by the reporting date • The tax matter is effectively settled through examination.

Subsequent Recognition Applies to those positions not initially recognized “Effectively settled” defined • Taxing authority completed all exam procedures • No appeal or litigation is intended • Enterprise considers it remote that the tax position would be subsequently examined or reexamined • Presume taxing authority has full knowledge of all relevant information 76 .

Sources of New Information • Developments in the audit • Revenue Agent’s report • Changes in the law • Notice of Proposed Adjustment • Experience in prior audits • APA • Taxing authority program changes • Public statements by tax authority 77 .

78 .Balance Sheet Presentation Tax contingencies should be included in the current income tax payable for amounts expected to be paid within 12 months. Amounts that are expected to be paid after 12 months should be in a long-term payable. FIN 48 does not allow tax contingencies to be part of the deferred tax accounts or the valuation allowance.

Effective for annual periods beginning after December 15. 2006 for public companies. 2008 for private companies Same rules apply for public and nonpublic companies One-time disclosure of cumulative effect 79 .Effective Date FIN 48 applies to annual periods beginning after December 15.

If the adjustment relates to a business combination. the effect requires an adjustment to goodwill.Cumulative Effect The cumulative effect of the change in net assets requires an adjustment to beginning retained earnings. 80 .

Disclosure Requirements FIN 48 requires additional footnote disclosure including: 81 • An annual reconciliation of “unrecognized tax benefits” on an aggregated world-wise basis • Gross amount of increases or decreases relating to prior period positions • Gross amount of increases or decreases relating to the current period • Amounts of decreases relating to settlements with taxing authorities • Reductions due to expiration of statute of limitations .

Disclosure Requirements FIN 48 requires additional footnote disclosure including: Amount of unrecognized tax benefits that if recognized would impact the ETR Open years by jurisdiction Total amounts of interest and penalties Policy election on classification of interest and penalties 82 .

Disclosure Requirements FIN 48 requires additional footnote disclosure including: “Reasonably possible” significant changes in recognized tax benefits over the next 12 months Qualitative and quantitative disclosure Nature of the uncertainty Events that could cause a change 83 Estimate of the range of the change .

Changes Caused by FIN 48 (ASC 74010) Must reexamine: Non-income based taxes Planning and controls Regulations S-K and MD & A disclosures Implementation of other new accounting standards 84 .

Interest and Penalties
• Interest is a period cost
• Interest accrual is based upon the difference
between the amount of tax benefit recognized in the
financial statements and the amount recognized in
the tax return
• Accrue statutory penalties when a tax position does
not meet the minimum statutory threshold required to
avoid penalties

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• Consider administrative practices and
precedents of the tax authority

Interest and Penalties
Tax law provisions that address interest and
penalties may vary between jurisdictions, periods
Classification of interest and penalties is an
accounting policy election

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Other Related Topics

Application of ASC 740-10 to Foreign Subsidiaries • MEASURE TEMPORARY DIFFERENCES SEPARATELY FOR EACH FOREIGN SUBSIDIARY • U. TAX BASIS UNDER FOREIGN LAW • VALUATION ALLOWANCES DETERMINED IN LIGHT OF FOREIGN LAW • REVIEW UNCERTAIN FOREIGN TAX POSITIONS .S. GAAP v.

Application of ASC 740-10 to Foreign Branches  BRANCH INCOME SUBJECT TO BOTH FOREIGN AND US TAX  ADDITIONAL • SET OF TEMPORARY DIFFERENCES US GAAP vs. US Tax  US TAX RECORDED NET OF US FOREIGN TAX CREDIT  TAX POSTURE OF US HEAD OFFICE RELEVANT IN DETERMINING NEED FOR VALUATION ALLOWANCE .

INSIDE BASIS)  MEASURE TEMPORARY DIFFERENCES SEPARATELY FOR EACH FOREIGN SUBSIDIARY  US GAAP vs..e.Inside Basis Temporary Difference  FAS 109 APPLIES TO DIFFERENCES IN FINANCIAL REPORTING CARRYING VALUE AND TAX BASIS OF FOREIGN SUBSIDIARIES’ ASSETS (i. TAX BASIS UNDER FOREIGN LAW  VALUATION LAW ALLOWANCES DETERMINED IN LIGHT OF FOREIGN .

“Outside” Basis Temporary Difference • THE DIFFERENCE BETWEEN THE FINANCIAL REPORTING AMOUNT AND THE TAX BASIS OF THE INVESTMENT ON THE INVESTOR’S FINANCIAL STATEMENTS. .

Methods Of Accounting For Investments • COST • EQUITY • CONSOLIDATION .

Cost Method Of Accounting • INVESTMENT RECORDED AT INITIAL COST • RECOGNIZE INCOME AS DIVIDENDS ARE RECEIVED • NET ACCUMULATED EARNINGS OF THE INVESTEE SUBSEQUENT TO THE DATE OF INVESTMENT ARE RECOGNIZED BY THE INVESTOR TO THE EXTENT DISTRIBUTED AS DIVIDENDS • DIVIDENDS RECEIVED IN EXCESS OF EARNINGS SUBSEQUENT TO THE DATE OF INVESTMENT ARE CONSIDERED A RETURN OF INVESTMENT AND ARE RECORDED AS REDUCTIONS OF THE COST OF THE INVESTMENT .

.Continued • A DEFERRED TAX LIABILITY IS RECOGNIZED FOR AN EXCESS OF THE AMOUNT FOR FINANCIAL REPORTING OVER THE TAX BASIS OF AN INVESTMENT IN A LESS-THAN-20-PERCENT-OWNED FOREIGN INVESTEE. • A DEFERRED TAX ASSET IS RECOGNIZED FOR AN EXCESS TAX BASIS OVER THE AMOUNT FOR FINANCIAL REPORTING OF AN INVESTMENT IN A LESS-THAN-20-PERCENT-OWNED FOREIGN INVESTEE.Cost Method Of Accounting .

• 20 PERCENT OR MORE OF THE VOTING STOCK LEADS TO THE PRESUMPTION THAT.Equity Method Of Accounting • ONE-LINE CONSOLIDATION CONCEPT • MUST BE FOLLOWED BY AN INVESTOR WHO HAS THE ABILITY TO EXERCISE SIGNIFICANT INFLUENCE OVER OPERATING AND FINANCIAL POLICIES OF AN INVESTEE EVEN THOUGH THE INVESTOR HOLDS 50 PERCENT OR LESS OF THE VOTING STOCK. IN ABSENCE OF EVIDENCE TO THE CONTRARY. AN INVESTOR HAS THE ABILITY TO EXERCISE SIGNIFICANT INFLUENCE OVER AN INVESTEE. .

Continued • INVESTMENT ORIGINALLY RECORDED AT THE COST OF SHARES ACQUIRED.Equity Method . . • REVENUE CONSISTS OF THE INVESTOR’S PROPORTIONATE SHARE OF EARNINGS AND AMORTIZATION OF ANY PURCHASED PREMIUM. • INVESTMENT’S CARRYING AMOUNT IS INCREASED OR DECREASED BY THE INVESTOR’S PROPORTIONATE SHARE OF EARNINGS OR LOSSES AND DECREASED BY ALL DIVIDENDS RECEIVED.

INCOME TAXES SHOULD BE ACCRUED AT THE APPROPRIATE RATES (CAPITAL GAIN RATES. • IF EQUITY IS TO BE REALIZED IN THE FORM OF A DISPOSITION. INCOME TAXES SHOULD BE RECOGNIZED AS IF THE EARNINGS WERE DISTRIBUTED AS A DIVIDEND. FOREIGN TAX CREDITS. IF APPLICABLE). ETC. . APPLYING ANY APPLICABLE DIVIDENDS RECEIVED DEDUCTIONS. TAXES TO BE WITHHELD.Equity Method .Continued • IF EQUITY IS TO BE REALIZED IN THE FORM OF DIVIDENDS.

THE OUTSIDE BASIS DIFFERENCE). ..Foreign Subsidiaries • A DEFERRED TAX LIABILITY IS NOT RECOGNIZED FOR THE EXCESS OF THE AMOUNT FOR FINANCIAL REPORTING OVER THE TAX BASIS OF AN INVESTMENT IN A FOREIGN SUBSIDIARY OR A FOREIGN CORPORATE JOINT VENTURE THAT IS ESSENTIALLY PERMANENT IN DURATION (i.e.

Election • Not an election • Exception applies if the specific facts and circumstances warrant • Based on a company’s ability and intent to control the reversal of a taxable temporary difference (i.APB 23 (ASC 740-30) Exception vs. the outside basis difference in the stock of CFC due to unrepatriated earnings) .e.

APB 23 (ASC 740-30) Issues • FAS 109 INCORPORATES UNREMITTED EARNINGS IN THE “OUTSIDE BASIS” DIFFERENCE • The ”outside basis" also includes –SAB 51 gains –Currency translation adjustments .

SFAS 123R
• SFAS 123R applies to all transactions involving
the issuance by a company of its own equity in
exchange for goods or services

• Currently SFAS 123R does not apply to sharebased payment transactions with nonemployees or ESOPs.

SFAS 123R
• 123R requires all entities to recognize
compensation expense in an amount equal to
the fair value of share-based payments granted
to employees.

Compensation Expense
• Compensation expense will be recognized over
the requisite service period

• How the compensation is recorded depends on
the vesting schedule
– Cliff Vesting
– Graded Vesting

estimates can be adjusted • Changes in estimates will be a cumulative effect of a change in accounting estimate .Forfeitures • 123R requires companies to estimate forfeitures on the date of grant • In subsequent periods.

Stock Compensation • SFAS 123R requires companies to use fair value to measure share-based payments to employees • Fair Value is determined at date of grant • Value is never remeasured .

a valuation technique based on established financial economic theory should be used .Fair Value  If an observable market price exists for an option with the same or similar terms. companies should use that price  Otherwise.

Valuation Models • Must be consistent with the fair value measurement objective and • Capable of incorporating all the substantive characteristics unique to employee stock options .

Factors Considered in Fair Value • Exercise Price • The expected term of the award • Current Price • Expected Volatility • Expected Dividends • Risk Free Interest Rate .

Application of ASC 740-10 to Stock Options • The compensation deduction on the financial statements give rise to a deferred tax asset under SFAS 109. • The deferred tax is not remeasured for any future changes in the fair value before the tax deduction is taken • A need for a valuation allowance should be considered .

Effect on DTA – Tax Deduction • At the time of the tax deduction is taken the DTA is written off • If the tax deduction is larger than the book deduction the excess tax benefit is treated as an increase to paid-in capital • If there is a tax benefit deficiency it is recorded as a decrease in paid-in capital if excess tax benefits exist .

a company would only be allowed to credit APIC when a benefit is received. .SFAS 123R • A company should not recognize a credit to APIC for windfall tax benefits unless such windfall benefit reduces taxes payable. Therefore.

Effect of ASC 740-10 for ISOs • Companies should not record a deferred tax asset for ISO’s because they cannot assume that these awards will result in a tax deduction • A current tax benefit will result if there is a disqualifying dispostion .

Interim • FIN 18 “Accounting for Income Taxes in Interim Periods” amended APB 28 • Tackles how to measure the tax provision for interim reports when the actual tax expense is based on annual income. • Allows estimates and judgments to determine the interim tax provision .Accounting for Income Taxes .

Accounting for Income Taxes • Income taxes for interim reporting is divided into: 1. Those applicable to income from continuing operations 2. discontinued items and extraordinary items • Tax effect of the second set of items are calculated separately and added to tax expense for the quarter . Those applicable to significant. unusual or infrequently occurring items.

credits and carryforwards for the entire year 2. Calculate the tax liability for the year 3. Determine the projected income. and 4. Calculate the ETR for the year. all permanent and temporary differences.Annual Effective Rate Method • To calculate the provision under the annual effective rate method you must: 1. Apply the ETR to quarterly earnings .

Annual Effective Rate Method • Estimated ETR is applied to year-to-date income • Prior quarter income taxes are deducted to compute the current quarterly income tax expense .

Post Sarbanes-Oxley • Prior to Sarbanes-Oxley many companies did not separate the income tax provision into current and deferred – APB 11 approach • Currently. a complete tax provision that shows a breakdown of current and deferred taxes are required for public companies .

Updating the Annual Estimate • A company must update its ETR each quarter • An accurate projection of ETR is very important • Because it is an estimate the amount may change during the year • If ETR is miscalculated early in the year it is better to overstate taxes in the earlier quarter .

Operating Losses in an Interim Period • SFAS 109 addresses the case where a company has an operating loss for a quarter • Under SFAS 109 realization of a tax benefit must be assured beyond a reasonable doubt before the benefit may be recognized in the financial statements .

Operating Losses in an Interim Period • A company can recognize a tax benefit of a to-date operating loss • Prior periods of income are present against which the current loss can be applied • Tax credits are available to offset the tax effect of the operating loss • The company has established seasonal patterns of income in subsequent interim periods .

Accounting Changes in Interim Periods • SFAS 3 deals with how to report accounting changes in interim reports • General recommendation is that changes should be made in the first quarter • Cumulative effect of change – if change is made any a subsequent quarter all prior quarters must be restated • Retroactive type change – if previous annual reports must be restates so do the interim reports .

Intraperiod Tax Allocations • Income tax expense or benefit must be allocated among – Continuing operations – Discontinued operations – Extraordinary items – Items charged or credited directly to shareholder’s equity .

Intraperiod Tax Allocations • The tax effects of the following items are charged or credited directly to equity: – Adjustments of opening RE for certain changes in accounting principles or a correction of an error – Gains and losses included in comprehensive income but excluded from net income – A change in contributed capital – Change in basis of tax assets in a pooling of interest – Dividends that are paid on unallocated shares held by an ESOP – Deductible temporary differences that existed at the date of a quasi reorganization .

Intraperiod Tax Allocations • Tax benefit of NOLs are reported in the same manner as the source of the income or loss in the current year • Exceptions to this rule are: • Tax effects of deductible temporary differences that existed at the date of a purchase business combination • Tax effects of deductible temporary differences that are allocated directly to stockholder’s equity .

the portion of income tax expense or benefit that remains after the allocation to continuing operations is allocated to that item. – Use a with and without calculation .Allocation Between Types of Income • If there is only one item other than continuing operations.

the amount of tax that remains after the allocation to continuing operations shall be allocated among the other items in proportion to their individual effect on income tax expense or benefit for the year.Allocation Between Types of Income • If there are two or more other items. • The sum of the separate tax effects may not equal the amount of income tax that remain to be allocated. .

Balance Sheet Presentation Classified Balance Sheet • Break out current and noncurrent portions Netting of Deferred Tax Assets and Liabilities of the Same Jurisdiction No Netting of Deferred Tax Assets and Liabilities from Different Jurisdictions 127 .

gross deferred tax assets.Financial Statement Disclosures Tax expense or benefit allocated to continuing operations and other categories Significant components of income tax Effective rate reconciliation Gross deferred tax liabilities. the valuation allowance and the net change in the valuation allowance 128 .

Financial Statement Disclosure Tax effect of each type of temporary difference and carryforward that gives rise to significant portions of the deferred tax liabilities or assets Significant matters affecting comparability of information for all periods presented Amounts and expiration dates of tax loss and credit carryforwards 129 .

Financial Statement Disclosure Any portion of the valuation allowance or deferred tax assets for which subsequent recognition would be used to reduce goodwill or other noncurrent intangible assets of an acquired entity or would be allocated directly to equity 130 .

Items that Impact the Effective Tax Rate State and foreign taxes (net of federal benefit) Permanent Differences Changes in the Valuation Allowance Income Tax Credits True Ups and changes in Cushion or change in prior year tax Changes in Tax Rates 131 .Rate Reconciliation The objective of the rate reconciliation is to reconcile the “expected” US federal statutory income tax rate of 34% or 35% with the company’s “actual” or “effective” tax rate.

Cases – Rate Reconciliation The reasons for the difference between income taxes computed by applying the statutory federal income tax rate and income tax expense in the financial statements are: Statutory Rate 832.951 14.87% Key-man life insurance (390.97% 132 .409) ( .19)% Tax-exempt interest ( 39. net of federal tax benefit 91.22)% Dividends Received Deduction ( 10.00% State taxes.400) ( .17)% Effective tax rate 478.000 26.000) (1.000) (12.32)% Change in of tax rate ( 5.760 2.