Accounting for Income Taxes

Accounting for Income Taxes
DETROIT TEI CONFERENCE JUNE 5, 2013

Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG 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.

Tax Executives Institute, Inc
Tax Executives Institute, Inc. – Detroit Chapter Accounting for Income Taxes Forum June 5, 2013 Presenters: KPMG LLP Ashby Corum, Jenna Summer, MC: Michelle Weil Time Topic CPE 8:00 a.m. – 8:10 a.m. Introduction and Objectives 10 Min 8:10 a.m. – 8:40 a.m. Accounting for Income Taxes – An Overview 30 Min 8:40 a.m. – 10:00 a.m. Accounting for Uncertainty in Income Taxes – FIN 48 (FASB ASC ) 80 Min 10:00 a.m. – 10:20 a.m. Break 10:20 a.m. – 11:00 a.m. (FASB ASC ), continued 40 Min 11:00 a.m. – 12:00 p.m. Business Combinations 60 Min 12:00 p.m. – 12:45 p.m. Lunch 12:45 p.m. – 1:45 p.m. Outbound Focus: Investment in Subsidiaries (Breakout Option 1) Inbound Focus: IFRS – High Level Overview (Breakout Option 2) 1:45 p.m. – 2:35 p.m. Accounting for Income Taxes in Interim Periods 50 Min 2:35 p.m.– 2:55 p.m. 2:55 p.m. – 3:25 p.m. Valuation Allowance Considerations 3:25 p.m. – 4:15 p.m. Intraperiod Allocations and Disclosures Total CPE 410 Min 4:15 p.m. – 6:00 p.m. Reception – Hosted by KPMG

Accounting for Income Taxes - Overview

Overview of Accounting for Income Taxes
Income Tax Provision Current Tax Provision Deferred Tax Provision +/ = Current Income Tax Expense/Benefit Deferred Income Tax Expense/Benefit Total Income Tax Expense/Benefit Based on Tax Return (Amount owed to Government) Based on Change in Deferred Tax Assets and Liabilities (BOY to EOY) 5

Current Tax Provision Pretax financial (book) income + Nondeductible items - Nontaxable items +/- Temporary differences Current taxable income x Enacted tax rate Current income tax expense

Permanent Differences
Common examples (not all inclusive) Items recognized for financial reporting purposes but not for tax purposes: Interest received on state and municipal obligations Life insurance premiums and proceeds Compensation expense for certain employee stock options Fines and expenses from violations of law 50% of meals & entertainment expenses Items recognized for tax purposes but not for financial reporting purposes: Deduction for dividends received from domestic corporations (generally 80% of these dividends are non-taxable) “Percentage depletion” of natural resources in excess of their cost

Temporary Differences – Example 1
Deductible Deductible Taxable Allowance for uncollectible accounts receivable If Not allowed for tax purposes until charged-off

Deductible Taxable Taxable Property, plant, and equipment If Straight line depreciation method for books and accelerated depreciation method for tax return (NBV exceeds NTV)

Deductible Deductible Taxable Property, plant, and equipment If Impairment recognized in books on assets not disposed

Deductible Taxable Taxable Property, plant, and equipment If Recorded at FV and FV > original cost

Deductible Deductible Taxable Accrued compensation If Such accruals are not deductible for tax purposes until paid

Deductible Deductible Taxable Deferred revenue If Can’t be deferred for tax purposes

Temporary Differences – Specific Application
Exceptions to the Recognition of Temporary Differences Investment in Domestic and Foreign Subsidiaries (upon meeting specific criteria) Excess Book Goodwill Intercompany Transactions CHANGES FROM TMS VERSION: - Included “Exceptions to the Recognition of Temporary Differences” instead of “Reminder from the Overview of ASC 740 pre-requisite” and updated the listing from the following to that included: Investment in subsidiaries Equity method investments Intercompany transactions

Recognition of Deferred Taxes
Deferred Tax Assets The deferred tax consequences attributable to deductible temporary differences Deferred Tax Liabilities The deferred tax consequences attributable to taxable temporary differences Deferred tax assets and liabilities are measured by applying to the corresponding deductible or taxable temporary differences the applicable enacted tax rate and provisions of the enacted tax law.

Measurement of Deferred Taxes
Basic roll-forward schedule of deferred taxes Beginning Current Ending Tax DTA/(DTL) Assets and Liabilities – U.S. Taxes Balances Activity Balance Rate S/T L/T Deferred tax assets Allowance for uncollectible A/R 350 150 500 35% 175 - Inventory valuation allowance 125 25 53 Accrued vacation 650 55 705 247 Impairment - Building 400 20% 80 Sub-total 1,525 230 1,755 474 Deferred tax liabilities Prepaid pension cost (1,250) 250 (1,000) (52) (298) Net 422 (218) CHANGES FROM TMS VERSION: Changed the title of “What a basic roll-forward schedule of deferred taxes might look like?” to “Basic roll-forward schedule of deferred taxes”

Balance Sheet Presentation
DTA/(DTL) Assets and Liabilities – U.S. Taxes S/T L/T Deferred tax assets Allowance for uncollectible A/R 175 - Inventory valuation allowance 53 Accrued vacation 247 Impairment - Building 80 Sub-total 474 Deferred tax liabilities Prepaid pension cost (52) (298) Net DTL Long-Term 422 (218) DTA/(DTL) Assets and Liabilities S/T L/T Deferred tax assets Allowance for uncollectible A/R 175 - Inventory valuation allowance 53 Accrued vacation 247 Impairment - Building 80 Sub-total 474 Deferred tax liabilities Prepaid pension cost (53) (298) Net DTA Current 422 (218) Beginning Current Ending Tax DTA/(DTL) Assets and Liabilities Balances Activity Balance Rate S/T L/T Deferred tax assets Allowance for uncollectible A/R 350 150 500 35% 175 - Inventory valuation allowance 125 25 53 Accrued vacation 650 55 705 247 Impairment - Building 400 20% 80 Sub-total 1,525 230 1,755 474 Deferred tax liabilities Prepaid pension cost (1,250) 250 (1,000) (52) (298) Net 422 (218)

Tax Rate Reconciliation
Temporary differences do not result in reconciling items in this analysis. Profit Before Tax Income Tax Expense Rate CONSOLIDATED INCOME BEFORE TAXES 117,715,457 41,200,410 35.00% PERMANENT DIFFERENCES Meals & entertainment 567,450 198,608 0.17% Other (club dues, luxury suites) 54,284 19,000 0.01% FOREIGN TAX DIFFERENTIAL 504,736 0.43% STATE TAXES NET OF FEDERAL BENEFIT 2,803,961 2.38% RETURN TO PROVISION RECONCILIATION (25,578) (0.02%) TAX EXPOSURES 250,000 0.21% TOTAL TAX EXPENSE AND EFFECTIVE RATE 44,951,136 38.19% ACTUAL EFFECTIVE RATE: TOTAL TAX EXPENSE EFFECTIVE TAX RATE

Accounting for Uncertainty in Income Taxes

Definition of a Tax Position
ASC defines a tax position as: “A position in a previously filed tax return or a position expected to be taken in a future tax return that is reflected in measuring current or deferred income tax assets and liabilities for interim or annual periods.”

Definition of a Tax Position (continued)
Possible tax positions Deduction taken on the tax return for a current expenditure that the taxing authority may assert should be capitalized/amortized over future periods; Acceleration of a deduction that otherwise would be available in a later period; Decision that certain income is nontaxable under the tax law; Determination of the amount of deductions/taxable income to report on intercompany transfers between entities in different tax jurisdictions; Calculation of the amount of a research and experimentation credit; Determination whether a spin-off transaction is taxable or nontaxable; Determination as to whether an entity qualifies as a REIT or regulated investment company; Determination whether an entity is subject to tax in a jurisdiction (Note: This does not represent a complete list) CHANGES FROM TMS VERSION: Changed the title from “What are possible tax positions” to “Possible tax positions”

Accounting for Uncertainty in Income Taxes
ASC Topic : Establishes the threshold for recognizing the benefits of tax-return positions in the financial statements as “more likely than not” to be sustained by the taxing authority Prescribes a measurement methodology for those positions meeting the recognition threshold as largest amount of benefit that is greater than 50% likely of being sustained Does not require a specific manner for the analysis related to either recognition or measurement

Accounting for Uncertainty in Income Taxes Eight Steps
Identify tax positions Step 2: Determine the appropriate unit of account Step 3: Determine if each tax position meets the recognition thresholds Step 4: Measurement Step 5: Recognize liability (or reduce asset) Step 6: Determine balance sheet classification Step 7: Calculate interest and penalties Step 8: Disclosures 23

Categories of Identified Tax Positions
Evaluation of the tax position may be grouped into the following categories: Highly certain positions No reason to believe 100% of the benefit will not be sustained No further evaluation of these positions is required Positions that meet the MLTN recognition threshold Have greater than a 50% likelihood of being sustained but are not highly certain Measurement of these positions is addressed in Step 4 Positions that do not meet the MLTN recognition threshold No benefit of the position is recognized Evaluation of these positions is continued in Step 5

Unit of Account The unit of account used to identify an individual tax position is a matter of judgment that should consider: Manner in which an entity prepares and supports its income tax returns (disaggregation should be consistent); Approach to be taken by taxing authorities It may be appropriate to define the unit of account at the lowest level necessary to ensure that benefits with widely varying levels of uncertainty or issues that may be treated differently under the tax law are not included in the same unit of account

Scenario: Unit of Account
Example Pharma Corp., a pharmaceutical company, claims a research and experimentation credit for a qualifying research project that contains both expenditures that are highly certain and expenditures that could be disallowed. Based on this scenario, what is a possible unit of account and what is the possible impact to recognition of the benefit? Providing the project qualifies, it may be appropriate to separate the expenditures into two units of account, especially if likely to be reviewed by the taxing authority in that manner

Recognition In determining whether it is MLTN that a tax position will be sustained, an entity must assume the taxing authority will examine the position and have full knowledge of all relevant information CHANGES FROM TMS VERSION: Removed “Audit considerations” section.

Recognition: Administrative Practices and Precedents
An entity may be able to conclude that a tax position meets the MLTN threshold based on administrative practices and precedents even though the tax position may be considered technical violations of the tax law For example, the tax law in ABC Inc.’s particular jurisdiction does not establish a capitalization threshold below which fixed-asset expenditures may be considered deductions in the period they are incurred. Based on widely understood precedence, the taxing authority has not historically disallowed current deductions for individual fixed-asset purchases below a specific dollar amount. Based on this scenario, is it possible for this tax position meet the MLTN recognition threshold?

Recognition: Administrative Practices and Precedents (continued)
For example, the tax law in ABC Inc.’s particular jurisdiction does not establish a capitalization threshold below which fixed-asset expenditures may be considered deductions in the period they are incurred. Based on previous experience, the taxing authority has not historically disallowed current deductions for individual fixed-asset purchases below a specific dollar amount. Based on this scenario, is it possible for this tax position meet the MLTN recognition threshold? Yes, because it is well understood by taxpayers that the taxing authority has not historically disallowed current deductions for individual fixed-asset purchases below a specific dollar amount.

Measurement The measurement process is applied only to tax positions that meet the MLTN recognition threshold. The benefit recognized for a tax position meeting the MLTN criterion is measured based on the largest benefit that is more than 50% likely to be realized. When multiple settlement outcomes are possible, management should evaluate the likelihood of the largest possible benefit that is more than 50% likely to be realized Aggregation or offset with indirect effects not appropriate

Measurement (continued)
Measurement should consider all facts (positive and negative) as of the reporting date including: History of negotiating and settling similar positions with the taxing authority (the entity’s history or available history of other entities) Guidance from appropriately qualified tax advisors Other available information Must assume taxing authority has full knowledge of position

Measurement: Scenario
An entity has determined that a tax position resulting in a benefit of $100 qualifies for recognition and should be measured. The entity has considered the amounts and probabilities of the possible estimated outcomes as follows: Possible Benefit Outcome Probability of Outcome Cumulative Probability of Outcome $100 (complete success in litigation, or settlement with IRS) 10% $80 (very favorable compromise) 20% 30% $60 (fair compromise) 25% 55% $40 (unfavorable compromise) 85% $0 (total loss) 15% 100% Based on this scenario, what is the amount of tax benefit that should be recognized?

Measurement: Scenario Debrief
An entity has determined that a tax position resulting in a benefit of $100 qualifies for recognition and should be measured. The entity has considered the amounts and probabilities of the possible estimated outcomes as follows: Possible Benefit Outcome Probability of Successful Cumulative Probability of Success $100 (complete success in litigation, or settlement with IRS) 10% $80 (very favorable compromise) 20% 30% $60 (fair compromise) 25% 55% $40 (unfavorable compromise) 85% $0 (total loss) 15% 100% $60 is the amount of tax benefit that would be recognized in the because it represents the largest cumulative amount of benefit that is MLTN.

Measurement: Availability of Information

Availability of Information
An entity needs to be cautious in distinguishing between: information that is available as of the reporting date but analyzed after period end, (should be considered in recognizing and measuring the entity’s tax positions) facts that arise and become available after the reporting date (should not be considered in recognizing and measuring the entity’s tax positions in the current period, although disclosure of the potential effects may be required) CHANGES FROM TMS VERSION: Removed “Audit Considerations” text box.

Availability of Information: Example Background
Lucky Charms, Inc. (LC), a national jewelry distributor, has employment agreements with certain executives that allow for payment of incentive compensation upon attainment of a goal or voluntary retirement. LC believes that these compensation arrangements are fully deductible and LC has recognized the tax benefit related to the executive compensation accruals.

Availability of Information: Example 1
On January 25, the IRS held in a Private Letter Ruling (PLR) that certain provisions in an individual's employment agreement prevented incentive compensation from being treated as performance based compensation. February 21, the IRS released a separate Revenue Ruling that supports the PLR. However, the Revenue Ruling states it will not disallow a deduction for compensation arrangements similar to that of LC, Inc. Explain to participants that the information available at the reporting date (January 31) was that the compensation under the current executive compensation agreements was not fully deductible. Therefore, the Company derecognized the tax benefit for the portion of the compensation that would not be deductible as of January 31. Because the unrecognized tax benefit is considered material to the financial statements and the Company is aware that the unrecognized tax benefit will meet the more-likely-than-not threshold as of February 21 (the date additional information is available), LC Inc. will disclose the Revenue Ruling as a subsequent event (non-recognized) in its January 31 financial statements. Based on this scenario, what is the impact to the financial statements assuming a January 31st reporting date?

Availability of Information: Example 2
On January 25, the IRS held in a Private Letter Ruling (PLR) that certain provisions in an individual's employment agreement prevented incentive compensation from being treated as performance based compensation. February 21, the IRS released a separate Revenue Ruling that supports the PLR. However, the Revenue Ruling states it will not disallow a deduction for compensation arrangements similar to that of LC, Inc. Explain to participants that the information available at the reporting date (February 28) was that the compensation under the current executive compensation agreements was fully deductible because the arrangements were in place as of February 21. Therefore, there is no effect on the Company’s February 28 financial statements. Based on this scenario, what is the impact to the financial statements assuming a February 28th reporting date?

Measurement: Reevaluation of the Tax Position

Reevaluation of the Tax Position
New information about the recognition and measurement of a tax position should trigger a reevaluation. The reevaluation could lead an entity to: derecognize a previously recognized tax position, recognize a previously unrecognized tax position, or remeasure a previously recognized tax position What new information may result in derecognition of a previously recognized tax position, recognition a previously unrecognized tax position, or remeasurement a previously recognized tax position?

Reevaluation of the Tax Position (continued)
New information may include, but is not limited to: changes in the tax law, developments in relevant case law, interactions with the taxing authority, and recent rulings by the taxing authority. Consider whether new information for an existing tax position at the reporting date triggers reevaluation of the measurement of a previously recognized tax position. CHANGES FROM TMS VERSION: Removed “Audit Considerations” text box.

Derecognition of Tax Positions
Based on new information, a tax position is no longer MLTN of being sustained, it should be derecognized in the first period in which it no longer meets the MLTN recognition threshold. The tax position must be derecognized in its entirety by either: increasing income taxes payable, decreasing income taxes receivable, or adjusting a deferred tax asset or liability. Use of a valuation allowance to derecognize a tax position is not permitted.

Subsequent Recognition
If subsequent recognition of the benefit of a tax position occurs in the first interim period that: MLTN threshold is subsequently met Tax position is “effectively settled” with tax authority; or Expiration of the statute of limitations

Settlement Requirements for “effectively settled:”
The taxing authority has completed its examination procedures The enterprise does not intend to appeal or litigate any aspect of the tax position included in the completed examination It is remote that the taxing authority would examine or reexamine any aspect of the tax position. Management should consider: the taxing authority’s policy on reopening closed examinations the specific facts and circumstances of the tax position

Settlement (continued)
Tax position by tax position analysis A tax position does not need to be specifically reviewed to meet these criteria Similar or identical tax positions in different years are different tax positions Effective settlement in and of itself does not change technical merits Effectively settled is an ongoing assertion—if circumstances change settlement accounting may need to be reversed!

Interim Period Changes in Judgment
Changes in judgment that result in subsequent recognition, derecognition, or remeasurement of tax positions taken in prior annual periods should be recognized entirely in the interim period in which the change in judgment occurs as a discrete item Changes to positions taken in an earlier interim period within that same annual period are reflected as adjustments to the annual effective rate

Measurement: Timing Uncertainties

Timing Uncertainties: Temporary Differences
If the uncertainty is a temporary difference: Recognition of current benefit is only appropriate if benefit is > 50% likely of being ultimately realized in the current year or a future year tax return Related deferred tax effects should be calculated based on the difference between the carrying amounts of assets and liabilities for financial-reporting purposes and their implied MLTN tax bases as measured in accordance with FASB ASC CHANGES FROM TMS VERSION: Removed “V of Deferred Tax Assets” text box.

Example: Timing Uncertainties
An enterprise incurs costs of $1 million to repair equipment on January 1 and recognizes the entire deduction on its current-year tax return. While it is highly certain that the $1 million will ultimately be deductible, the MLTN tax position is to capitalize the expenditure and amortize it over 4 years. Based on this scenario, what is the impact to income taxes payable and deferred tax assets in the current period?

Example Debrief: Timing Uncertainties
An increase in taxes payable is required for the deduction that is not greater than 50% likely in the current period ($750K) A deferred tax asset for future deductible amounts of $750K is also required as it is MLTN of being sustained in a future year

Recognize Liability (or Reduce Asset)
Recognizing a benefit from a tax position that is smaller than the tax effect of the related deduction reported in the company’s tax return creates a tax liability or reduces the amount of a NOL carryforward or amount refundable from the taxing authority. CHANGES FROM TMS VERSION: Removed “What substantive audit procedures may be performed ” text box.

Recognize liability (or reduce asset): Indirect Effects

Indirect Effects A FASB ASC (FIN 48) credit can result in indirect effects which require consideration Benefits in another jurisdiction For example, if an entity recognized a liability due to a state tax issue, a deferred tax asset would need to be established for the related federal benefit if that deferred benefit was more likely than not of being sustained CHANGES FROM TMS VERSION: Separated slide into two separate slides, one on indirect effects and another on NOLs (see following slide)

Presentation A FASB ASC (FIN 48) credit can result in indirect effects which require consideration Utilization of existing operating loss carryforwards Net presentation FASB ASC liabilities directly related to a position taken in a tax year that results in a NOL carryforward for that year should be presented as a reduction of the related DTA (net presentation), if such deferred tax has not been utilized Gross presentation Required when an enterprise has a DTA for a NOL carryforward and in a subsequent or PY records a liability for an unrelated unrecognized tax benefit associated with a different tax position CHANGES FROM TMS VERSION: Separated slide into two separate slides, one on indirect effects and another on NOLs (see following slide) Title changed from “Indirect Effects” to “Presentation”

Presentation: Example #1
OJ Inc., a juice company, has a 2009 book net loss of $100 (includes $100 charge for certain permanent expenses) 2009 tax return reflects same $100 net loss resulting in NOL carryforward 60% chance that if challenged by the taxing authority the $100 deduction would be disallowed Company operates in a single tax jurisdiction How would the net loss be presented? CHANGES FROM TMS VERSION: Title changed from “Indirect Effects” to “Presentation” Net presentation: Since the unrecognized tax benefit is directly related to a position taken in a year that an NOL carryforward was generated, it would be presented as a reduction of the DTA for the NOL.

Presentation: Example #2
OJ Inc., a juice company, has a 2008 book net loss of $100 (includes $100 charge for certain permanent expenses) 2008 tax return reflects same $100 net loss resulting in NOL carryforward It is MLTN that the $100 deduction would be allowed 2009 taxable income of zero (includes $80 charge for certain other permanent expenses unrelated to the deduction) CHANGES FROM TMS VERSION: Title changed from “Indirect Effects” to “Presentation”

Presentation: Example #2 (continued)
30% chance that if challenged by the taxing authority the $80 deduction taken in 2009 (position #2) would be allowed If position #2 is disallowed, $80 of the $100 NOL generated in 2008 would be utilized to settle the taxes payable Company operates in a single tax jurisdiction How would position 2 be presented? Gross presentation: As position #2 is not directly associated with a tax position taken in the year the NOL carryforward was generated, the unrecognized tax position is presented on the balance sheet as a liability and is NOT netted against the DTA for the 2008 NOL. CHANGES FROM TMS VERSION: Title changed from “Indirect Effects” to “Presentation”

EITF Issue 13-C, Presentation of a Liability for an Unrecognized Tax Benefit When a Net Operating Loss or Tax Credit Carryforward Exists Task Force Discussion The following alternatives were discussed by the EITF in considering how an entity should present the liability for an unrecognized tax benefit when an NOL or tax credit carryforward exists: View A: Present an unrecognized tax benefit as a reduction of a deferred tax asset for an NOL or tax credit carryforward (rather than as a liability) when the uncertain tax position would reduce the NOL or tax credit carryforward under the provisions of the tax law. View B: Present an unrecognized tax benefit as a liability in the statement of financial position unless the unrecognized tax benefit is directly associated with a tax position taken in a tax year that results in or that resulted in the recognition of an NOL carryforward for that year (and such an NOL carryforward has not yet been utilized). View C: An entity shall make an accounting policy election to apply either View A or View B. The Task Force reached Consensus-for-Exposure on View A. ASU – February 21, 2013 Current KPMG guidance is View B, based discussions with FASB staff. See of our book. This has a result of presenting a liability when there is no risk of a cash payment, and, for valuation allowance companies, a DTA with no VA when they may not otherwise recognize a DTAs. SLIDES ADDED FROM US SUMMIT PRESENTATION

EITF Issue 13-C, Presentation of a Liability for an Unrecognized Tax Benefit When a Net Operating Loss or Tax Credit Carryforward Exists (continued) Example Rich Industries has taken a position in its U.S. tax return that resulted in a reduction of taxable income of $250. The Company has concluded the tax position taken is less than 50% likely of being sustained, resulting in an unrecognized tax benefit of $100 given a 40% tax rate. The Company suffered losses in recent years resulting in an NOL carryforward of $500 that can be used to offset future U.S. income taxes. The Company’s deferred tax assets are expected to be realized. In calculating deferred taxes, $250 of the NOL carryforward would be used to offset the additional taxable income resulting from the uncertain tax position, thereby reducing the deferred tax asset for the NOL by $100. From CFO Financial Forum – Slightly modified wording.

There are no incremental disclosures proposed in the Draft Abstract.
EITF Issue 13-C, Presentation of a Liability for an Unrecognized Tax Benefit When a Net Operating Loss or Tax Credit Carryforward Exists (continued) Disclosure There are no incremental disclosures proposed in the Draft Abstract. However, entities should apply the disclosure requirements from ASC for changes in the method of applying an accounting principle, if applicable. Transition The Draft Abstract for exposure proposes retrospective application, and requests comments from constituents to specifically address the difficulty of applying the guidance retrospectively. Effective Date The effective date of the proposed guidance was not addressed by the EITF. ASC provides: 50-1 An entity shall disclose all of the following in the fiscal period in which a change in accounting principle is made: -- a The nature of and reason for the change in accounting principle, including an explanation of why the newly adopted accounting principle is preferable. -- b The method of applying the change, including all of the following: -- 1 A description of the prior-period information that has been retrospectively adjusted, if any. -- 2 The effect of the change on income from continuing operations, net income (or other appropriate captions of changes in the applicable net assets or performance indicator), any other affected financial statement line item, and any affected per-share amounts for the current period and any prior periods retrospectively adjusted. Presentation of the effect on financial statement subtotals and totals other than income from continuing operations and net income (or other appropriate captions of changes in the applicable net assets or performance indicator) is not required. -- 3 The cumulative effect of the change on retained earnings or other components of equity or net assets in the statement of financial position as of the beginning of the earliest period presented. -- 4 If retrospective application to all prior periods is impracticable, disclosure of the reasons therefore, and a description of the alternative method used to report the change (see paragraphs through 45-7). -- c If indirect effects of a change in accounting principle are recognized both of the following shall be disclosed: -- 1 A description of the indirect effects of a change in accounting principle, including the amounts that have been recognized in the current period, and the related per-share amounts, if applicable -- 2 Unless impracticable, the amount of the total recognized indirect effects of the accounting change and the related per-share amounts, if applicable, that are attributable to each prior period presented. Compliance with this disclosure requirement is practicable unless an entity cannot comply with it after making every reasonable effort to do so. Financial statements of subsequent periods need not repeat the disclosures required by this paragraph. If a change in accounting principle has no material effect in the period of change but is reasonably certain to have a material effect in later periods, the disclosures required by (a) shall be provided whenever the financial statements of the period of change are presented. An entity that issues interim financial statements shall provide the required disclosures in the financial statements of both the interim period of the change and the annual period of the change. In the fiscal year in which a new accounting principle is adopted, financial information reported for interim periods after the date of adoption shall disclose the effect of the change on income from continuing operations, net income (or other appropriate captions of changes in the applicable net assets or performance indicator), and related per-share amounts, if applicable, for those post-change interim periods.

Classification Classification of the resulting exposure liability is based on the expected timing of cash payments Current liability if payment of cash is expected within one year (or operating cycle, if longer) Liability remains noncurrent if it is not expected to be settled in cash within one year If the liability is expected to be settled upon the expiration of statute or otherwise released such that no cash payment will be made, it is noncurrent Factor in all “real world” considerations

Interest and Penalties
Interest accrual computations under the tax law can be complex The rate at which interest is accrued may depend on the amount of underpayment and the effect of offsetting overpayments of tax (or prepayment of tax obligations) Interest rate on overpayments of income tax may be different than the rate on underpayments of income tax Companies must make a reasonable effort to estimate the amount of interest that may be assessed Consultation with experts on this subject may be appropriate

Interest and Penalties: Classification
Classification of interest and penalties on the income statement is an accounting policy decision Interest expense/SG&A Income tax expense CHANGES FROM TMS VERSION: Removed “Audit Considerations” text box.

Disclosure Requirements Quantitative (Required for public entities only)
Rollforward of unrecognized tax benefits (on a worldwide aggregate basis), including (at a minimum): The gross amounts of increases and decreases in unrecognized tax benefits for tax positions taken during a previous annual period The gross amounts of increases in unrecognized tax benefits for tax positions taken during the current annual period Decreases in unrecognized tax benefits related to settlements Reductions in unrecognized tax benefits due to lapse of statute of limitations Disclosure of the amount of unrecognized tax benefits that, if recognized, would impact the effective rate

Disclosure Requirements Qualitative (Required for all entities)
Classification of interest and penalties as well as the amount of interest and penalties in the income statement and accrued on the balance sheet. For positions in which it is reasonably possible that the total amount of unrecognized tax benefits will significantly change in the next 12 months disclose: Nature of the uncertainty Nature of event that could cause a change An estimate of the range of possible change or a statement that estimates cannot be made Description of open tax years by major jurisdiction. CHANGES FROM TMS VERSION: Removed “Audit Considerations” text box.

Accounting for Tax Effects: Business Combinations
THIS SECTION WAS PULLED FROM THE 2011 TMS COURSE AS IT HAS BEEN EXCLUDED FROM THE 2012 VERSION

Acquisition Accounting
Recognize fair values of identifiable assets acquired and liabilities assumed Identify tax basis of assets acquired and liabilities assumed and compare to recognized fair values Recognize deferred taxes on temporary differences Recognize deferred taxes on acquired NOL and tax credit carry-forwards Recognize valuation allowance on DTAs (acquired and existing) with changes in valuation allowances to acquirer’s existing DTAs recognized outside of acquisition accounting Recognize goodwill for residual Recognize a DTA and an adjustment to goodwill for excess deductible tax goodwill Recognize fair values (ignoring the tax bases) to identifiable assets acquired and liabilities assumed in accordance with the provisions of ASC 805 (Statement 141R). Identify the tax basis of identifiable assets acquired and liabilities assumed based on enacted tax laws and regulations (for nontaxable transactions the tax bases generally will be the carryover bases; for taxable transactions the tax bases will be the stepped-up bases). Compare the recognized values of the identifiable assets acquired and liabilities assumed with the tax bases to determine temporary differences. Recognize deferred tax assets and liabilities for the future tax consequences of the deductible and taxable temporary differences between the recognized values and the tax bases. Recognize a deferred tax asset for the tax benefits of operating loss and tax credit carryforwards acquired in the combination. Recognize a valuation allowance, to the extent necessary, to reduce the acquired deferred tax asset to an amount that more likely than not will be realized in the future by the combined enterprise. Necessary changes in the acquirer's existing valuation allowance are also evaluated at this time but are not accounted for in applying the acquisition method. Recognize goodwill as the residual difference between (a) the sum of (i) the consideration transferred, (ii) the fair value of any noncontrolling interest and (iii) the acquisition-date fair value of the acquirer's previously held equity interest in the acquiree (for business combinations achieved in stages), and (b) the acquisition-date amounts of the identifiable assets acquired and liabilities assumed measured in accordance with the provisions of ASC 805 (Statement 141R), including the deferred tax assets, net of any valuation allowance, and deferred tax liabilities. Recognize a deferred tax asset and an adjustment to goodwill for second component tax goodwill, if any. Taxable business combinations would be recorded in the same manner, however the book and tax basis of assets acquired generally will be the same. Deferred tax assets and liabilities may arise for basis differences in assets and liabilities, and NOL and tax credit carryforwards. 74

Acquisition Accounting (Cont’d)
Assumptions Company A, a calendar year corporation, acquires Company B on January 1, 2010, for $1,000,000 in a nontaxable transaction that is accounted for as a purchase Company A has no temporary differences or carry forwards prior to the acquisition The enacted tax rate for 2010 and all future years is 40 Identifiable assets acquired and liabilities assumed have the following fair values and tax bases All deductible temporary differences reverse in the same periods as at least an equivalent amount of taxable temporary differences. The current asset temporary difference results from a higher tax basis for the LIFO inventory. Company B has no net operating loss or tax credit carry forwards. Fair Value Tax Basis Taxable (Deductible) Temporary Difference Current assets $300,000 $350,000 $(50,000) Property, plant, and equipment 800,000 400,000 Liabilities, excluding warranty reserve and deferred taxes (200,000) Warranty reserve (100,000) Identifiable net assets acquired $800,000 $550,000 $250,000 CHANGES FROM TMS VERSION: Included example from TSS II Course

Acquisition Accounting (Cont'd)
Final allocation: The deferred tax liability of $160,000 results from the $400,000 taxable temporary difference between the assigned value and the tax basis of the property, plant, and equipment, multiplied by the enacted tax rate of 40 percent. The deferred tax asset of $60,000 is the result of the enacted tax rate multiplied by the sum of the deductible temporary differences - $50,000 attributable to inventory and $100,000 of warranty reserve. No valuation allowance is required since deductible temporary differences will offset taxable temporary differences. No deferred taxes are recorded for the goodwill as ASC 740 specifically excludes nondeductible goodwill from deferred tax recognition. Current assets $300,000 Property, plant, and equipment 800,000 Deferred tax asset 60,000 Goodwill 300,000 Warranty reserve (100,000) Other liabilities (200,000) Deferred tax liability1 (160,000) Purchase price $1,000,000 CHANGES FROM TMS VERSION: Included example from TSS II course 76

Acquisition Accounting (Cont'd)
When determining the measurement of the acquiree’s deferred taxes, the acquirer considers its attributes on the measurement of the deferred tax assets and liabilities For example, an acquirer may not be able to assert the indefinite reversal criteria of ASC for its acquired subsidiary. Although the acquiree may have previously been able to make such an assertion, deferred taxes related to outside basis differences of acquired investments should be recorded as part of the acquisition accounting CHANGES FROM TMS VERSION: Included slide from TSS II course

In-process R&D ASC 805 requires in-process R&D to be measured at fair value and recognized as an indefinite lived intangible until the project is completed or abandoned A related deferred tax liability would be recognized in a non-taxable business combination Timing of reversal of any deferred tax liabilities associated with indefinite lived in-process R&D intangibles ASC 805 (FASB Statement 141R Business Combinations: a replacement of FASB Statement No. 141) requires that the acquiree’s in-process research and development projects would be measured at fair value and recognized as an asset rather than immediately expensed (as previously required under SFAS 141). The capitalized in-process research and development asset would be accounted for as an indefinite-lived intangible asset until the project is completed or abandoned. When the project is completed, a useful life would need to be determined for amortization purposes. As a result, tax basis differences related to IPR&D are now recognized under ASC 740 (SFAS 109) and recorded as part of the acquisition accounting. After initial recognition, acquired IPR&D is classified as an indefinite-lived intangible asset and it is subject to annual impairment testing until development is completed or abandoned. While the IPR&D is still being developed and considered to be an indefinite-lived intangible asset, the related deferred tax liability may not be a future source of taxable income for the realization of deferred tax assets since the timing of the reversal of the related deferred tax liability may be difficult to predict. If, however, the reversal period of the deferred tax liability related to the IPR&D can be determined with sufficient reliability, the resulting source of income would be considered in assessing the realization of deferred tax asset. (Source: paragraph of the KPMG publication, Accounting for Business Combinations and Noncontrolling Interests) Note to instructors: This is different than under Statement Previous guidance is included below if questions arise, not necessary to present old accounting FAS 141 The portion of the cost of the acquired enterprise that is allocated to in-process research and development (IPR&D) projects that have no alternative future use are charged immediately to income. EITF Issue No. 96-7, Accounting for Deferred Taxes on In-Process Research and Development Activities acquired in a Purchase Business Combination, addresses deferred taxes related to IPR&D in connection with a nontaxable business combination. In nontaxable business combinations deferred taxes are not provided on the initial differences between the amounts assigned for financial reporting and tax purposes, for IPR&D accordingly IPR&D is charged to expense on a gross basis at acquisition. In a taxable business combination a deferred tax asset is recognized upon the write-off of the financial statement IPR&D only if the amount related to the book IPR&D is classified as an identifiable intangible asset for tax purposes, not as tax goodwill. If the tax basis of the book IPR&D is assigned to an identifiable intangible asset for tax purpose, a deferred tax asset would be established (with a corresponding tax benefit) upon the write-off of the book IPR&D. If the tax IPR&D is classified as tax goodwill, tax goodwill would exceed the financial statement amount of goodwill and there would not be a tax basis for IPR&D. With no tax basis for IPR&D when the financial statement carrying amount is written-off a temporary difference is not created because the financial statement and tax basis of IPR&D both would be zero. Tax basis of goodwill would exceed the financial statement basis of goodwill and the tax benefits of the deduction of the excess of the tax goodwill over the book goodwill generally would be recognized as a reduction of book goodwill when those excess deductions are taken on the tax return. Note: FAS 141 was not included in the FASB’s codification. Therefore, related EITF’s such as EITF 96-7 were also not codified. The legacy standards, if applicable, are the authoritative GAAP in those cases. 78

Acquirer’s Existing Deferred Taxes
If an acquirer determines that as a result of a business combination its valuation for deferred tax assets should be changed (increase/decrease), that change is recognized in earnings (or credited directly to contributed capital) rather than as part of the business combination This guidance applies to all the acquirer’s pre-existing deferred tax balances. For example, if the tax rate will change as a result of the acquirer including the acquired entity in its consolidated tax return, then and changes in the deferred tax balances as a result of a change in the tax rate will be recognized in the income statement rather than as part of the business combination. Note to instructors: This is different than under Previous guidance is included below if questions arise, not necessary to present old accounting A reduction in the acquirer’s valuation allowance on its existing deferred tax assets was recognized as part of the business combination.

Subsequent Changes in a Valuation Allowance
Change in valuation allowance of an acquired DTA is recognized as follows: Changes in the measurement period that results from new information about facts existing at the acquisition date is recognized as part of acquisition accounting All other changes are reported in earnings (or as direct adjustment to contributed capital) After the measurement period, changes to DTA valuation allowances and acquired tax uncertainties are recognized in earnings or contributed capital Notes to instructors: 1. This is different than under Previous guidance is included below if questions arise, not necessary to present old accounting An initial reduction in an acquired deferred tax asset’s valuation allowance was recognized (a) first to reduce to zero goodwill, (2) second to reduce to zero other noncurrent intangible assets and (3) third to reduce income tax expense. 2. The new guidance (on this slide) also applies to business combinations accounted for prior to the adoption of Statement 141R.

Subsequent Changes in a Valuation Allowance (pre 141R acquisitions)
Changes in DTA valuation allowances and tax uncertainties acquired in pre-141R business combinations occurring after the adoption/effective date of FASB ASC 805 (FAS 141R) are recognized in earnings or contributed capital NOTE: This provision applies not only to business combinations accounted for under ASC Topic 805 (FAS 141R) but to acquisitions accounted for under previous standards.

Subsequent Changes in an Acquired Uncertain Tax Position
Existing tax uncertainties of an acquiree or that arise as a result of the acquisition are accounted for under FASB ASC 740 Under FASB ASC 740, changes in recognition and measurement of tax uncertainties are recognized following intraperiod allocation in FASB ASC 740 As a result any subsequent changes in tax uncertainties that are not measurement period changes are recognized outside of the acquisition accounting (including pre-141R acquisitions) Existing tax uncertainties of an acquiree or that arise as a result of the acquisition are accounted for under FASB ASC 740 and not their acquisition date fair value. Highlight that ASC (FIN 48) considers information that is available as of the acquisition date and that information that becomes available after the acquisition date is recognized outside of the acquisition accounting even if it becomes available during the measurement period. Information that is obtained during the measurement period that was available as of the acquisition date is recognized in acquisition accounting. Note to instructors: A difference exists between FAS 141 and FAS 141R (ASC 805). Previous guidance is included below if questions arise, not necessary to present old accounting. Under FAS 141, changes in an acquired uncertain tax position were recognized as an increase or decrease to goodwill. If goodwill is reduced to zero the remaining would be first applied to reduce to zero other noncurrent intangible assets and second to reduce income tax expense.

Goodwill and Deferred Taxes
No deferred taxes recognized for nondeductible goodwill Two components of tax deductible goodwill: Component 1: Lesser of financial reporting or tax goodwill Component 2: Excess financial reporting or tax goodwill Preliminary Temporary Difference Table* Book Tax Component 1 $ 600 600 Recognize no deferred taxes at date of acquisition, but may subsequently recognize deferred taxes, as temporary differences arise Component 2 - 200 Recognize DTA at date of acquisition for excess tax goodwill; do not recognize DTL for excess financial reporting goodwill Total Goodwill 800 Explain that non‑deductible goodwill arises in non‑taxable business combinations and in tax jurisdictions where the amortization of goodwill is not deductible. In nontaxable transactions, goodwill is generally not deductible because there is no goodwill for tax purposes (although it is possible there may be deductible goodwill from previous acquisitions by the acquiree). No deferred taxes are recorded for non‑deductible goodwill established in a business combination at the date of acquisition. State that in tax jurisdictions where amortization of goodwill is deductible for tax purposes, ASC and 25-9 (paragraph 262 of FAS 109), requires that the amount of goodwill recognized for financial reporting and tax goodwill is separated into two components for taxable business combinations or where previous acquisitions by the target result in acquired deductible goodwill: Component 1: The first component is the lesser of goodwill for financial reporting or tax deductible goodwill (an amount common to both, which, again, is frequently zero for nontaxable business combinations). Tax deductible goodwill refers to the amount of goodwill for which amortization is deductible for tax purposes. Recognize no deferred taxes at date of acquisition on Component 1. However, deferred taxes are recognized for temporary differences arising subsequent to the acquisition in the first component which may result from differing amortization periods or impairment for tax and book purposes. Component 2: The second component (again, frequently the full amount of the financial reporting goodwill for nontaxable business combinations) is the remaining goodwill for financial reporting or tax deductible goodwill. Recognize a deferred tax asset at date of acquisition for excess tax goodwill (i.e., Component 2), but do not recognize anything for any excess book goodwill. The “Day 1” and “Day 2” accounting for the tax effects of Component 2 goodwill will be addressed in the next series of slides. Walk through the example on the slide. Highlight that the example depicts excess tax deductible goodwill, meaning that a deferred tax asset (DTA) would be recognized for Component 2 goodwill at the date of the business combination. Also, highlight that the example represents the preliminary temporary difference calculation before taking into consideration any tax benefits. The table on the next slide summarizes the final Component 1 and Component 2 financial reporting and tax goodwill for purposes of Day 2 accounting. * The excess of tax goodwill over financial reporting goodwill before taking into consideration the tax benefit associated with goodwill 83

Excess Tax Goodwill Under FASB ASC 805 (FAS 141R) recognize DTA for any excess of tax goodwill (i.e., Component 2) over financial reporting goodwill Apply simultaneous equation to determine the DTA: [Tax Goodwill – Book Goodwill] x [Tax Rate/(1 – Tax Rate)] In the previous example, if the tax rate is 40%, DTA to be recognized at date of acquisition would be $133 [$800 – $600] x [40%/(1 – 40%)] Financial reporting goodwill is reduced to $467 ($600 – $133) Journal entry at acquisition date: Dr. DTA $133 Cr. Goodwill $133 Final Goodwill Table Book Tax Component 1 $ 467 467 Component 2 – 333 Total Goodwill 800 Explain that a deferred tax asset must be recognized for Component 2 excess tax goodwill at the acquisition date. The amount to be recognized is based on a simultaneous equation. This is because as DTAs are recognized, book goodwill diminishes, resulting in another difference between tax goodwill and book goodwill. A simultaneous equation addresses this circularity. Walk through the example on the screen to demonstrate the concepts just discussed.

Amortization of Tax Goodwill
There is no guidance in FASB ASC 805 or FASB ASC 740 that discusses whether amortization of tax goodwill should be attributed to Component 1 or Component 2 goodwill There are two alternatives… Alternative A: Assume tax amortization starts with Component 2 tax goodwill Reverse the deferred tax asset first until it is reduced to zero Then begin to recognize a deferred tax liability for Component 1 goodwill Alternative B: Another alternative is to allocate the tax goodwill amortization on a pro rata basis between Component 1 and Component 2 This would result in any DTA recognized for Component 2 goodwill being reduced, simultaneous with a DTL being recognized for Component 1 goodwill Alternatives A and B are policy elections that once made would be consistently applied to subsequent acquisitions Note that ASC Topic 805 (FAS 141R) amended paragraphs 262 and 263 of FAS 109 (ASC and 25-9 and ASC through 55-13)). As a result of the amendments, there is no longer any guidance on whether tax goodwill amortization is required to be allocated between Component 1 and Component 2. Indicate that as the entity amortizes tax goodwill, is may elect an accounting policy to: Assume tax amortization starts with Component 2 tax goodwill and thus reverse the deferred tax asset first until it is reduced to zero and then begin to recognize a deferred tax liability; or Continue to allocate the tax goodwill amortization on a pro rata basis between Component 1 and Component 2 and thus reverse the deferred tax asset (related to Component 2) and recognize a deferred tax liability (related to Component 1). Mention that this is a policy election that once made would be consistently applied to subsequent acquisitions. 85

Transition Issue: Pre-141R (FASB ASC 805) Component 2 Tax Goodwill
Specific guidance on day 2 accounting related to pre-FAS 141R (FASB ASC 805) combinations has been formally superseded Nevertheless, entities should continue to apply the superseded guidance in paragraphs 262 and 263 of SFAS 109 (FASB ASC and 25-9 and ASC through 55-13) for Component 2 tax goodwill arising from pre-141R (FASB ASC 805) acquisitions for which no deferred tax asset exists Remind participants that for business combination transactions accounted for under pre-141R (ASC 805), a deferred tax asset was not recognized for the excess of tax-deductible goodwill over the financial reporting goodwill (i.e., Component 2). Instead, the tax benefit for the excess was recognized when realized subsequent to the business combination. Explain that, as a result of amendments to paragraphs 262 and 263 of FAS 109 (ASC and 25-9 and ASC through 55-13) (as mentioned on the previous slide), there is no guidance on the Day 2 accounting for realization of Component 2 tax goodwill associated with pre-141R acquisitions for which no deferred tax asset exists. State that under ASC Topic 805 (FAS 141R), entities are not permitted to adjust their previous accounting for past acquisitions (i.e., entities may not retrospectively apply FAS 141R). Accordingly, KPMG believes that the entity should continue to apply the guidance in paragraphs 262 and 263 of FAS 109 for past acquisitions, even though this guidance is now superseded. Therefore, when the tax benefit for second component tax goodwill for which a deferred tax asset was not recognized under Statement 141 is realized on the tax return, the tax benefit is applied first to reduce to zero any first component of goodwill for financial statement purposes related to that acquisition; second, to reduce to zero other noncurrent intangible asset related to that acquisition; and third, to reduce income tax expense. (Source: paragraph of the KPMG publication, Accounting for Business Combinations and Noncontrolling Interests). Also, paragraph of the KPMG publication, Accounting for Business Combinations and Noncontrolling Interests provides guidance about situations when an entity does not generate sufficient taxable income to offset the amortization of second component tax goodwill for which a deferred tax asset was not recognized under Statement 141.

Deferred Taxes and Acquisition Costs in Pre-Combination Period
Under FASB ASC 805, acquisition costs are expensed as incurred for book purposes Tax treatment of the costs will depend on: Whether the business combination is taxable, and Whether the business combination is ultimately consummated Two alternatives to account for deferred tax effects of acquisition costs incurred in the pre-combination period (see next slides) Recall that, under FASB ASC 805, acquisition related costs are expensed as incurred. However, for tax purposes, these costs may be immediately deductible, capitalizable, included as part of tax-deductible goodwill or included in the basis of the stock acquired. The ultimate tax treatment will depend the whether the business combination is taxable and if the business combination is ultimately consummated. Acquisition-related costs in a non‑taxable business combination will increase the outside tax basis in the investment once the business combination is consummated. Generally, acquisition-related costs are tax deductible if the business combination is ultimately not consummated. State that KPMG believes there are two alternatives to accounting for the deferred tax effects of acquisition-related costs incurred in the pre‑combination period. We will walk through these alternatives in the following slides.

Pre-Combination Period
Deferred Taxes and Acquisition Costs in Pre-Combination Period (Cont’d) View A Reporting entity must consider: The likelihood that the business combination will be consummated Whether the business combination will be treated as taxable or nontaxable Pre-Combination Period Likelihood of consummation Expected Not-Expected Taxable Recognized a DTA Non-Taxable Recognize a DTA only if expected to be recognized in the foreseeable future (outside tax basis) (presuming the costs will be deductible if the transaction isn’t consummated) Walk through View A: If it is expected that a taxable business combination will be consummated, then a deferred tax asset should be established for the acquisition-related costs incurred during the pre‑combination period. If it is expected that a non‑taxable business combination will be consummated, then the acquisition-related costs would result in outside tax basis. Therefore, the reporting entity would not establish a deferred tax asset for the acquisition-related costs unless the deferred tax asset is expected to be recognized in the foreseeable future (generally interpreted as being within 12 months of the balance sheet date). If it is not expected that an acquisition will be consummated, then the entity should record the related DTA (provided that the taxing jurisdiction will permit the deduction for the costs of the failed transaction).

Deferred Taxes and Acquisition Costs in Pre-Combination Period (Cont’d)
View B In the pre-combination period, cannot assume a business combination will be consummated Therefore, recognize a deferred tax asset for all costs incurred in the pre-combination period (assuming they would be deductible if the business combination failed) Upon Consummation Taxable DTA recognized in pre-combination period remains on the books Non-Taxable Write-off DTA recognized in pre-combination period, unless DTA is expected to be recognized in the foreseeable future (outside tax basis) Walk through View B: Under this view, it cannot be assumed that a business combination will be consummated because this is not something generally within the control of the reporting entity. Since acquisition-related costs generally will be deductible if the business combination is not consummated, an entity should recognize a deferred tax asset for those costs in the pre-combination period if they will be deductible if the acquisition is not successful. If the business combination is ultimately consummated, to the extent the business combination is taxable the deferred tax asset would not be immediately written off as the related amounts would be expected to be included in the amortizable purchase consideration for tax. If the business combination is ultimately consummated as a nontaxable business combination, the deferred tax asset would be written off upon consummation of the business combination unless the deferred tax asset is expected to be recognized in the foreseeable future (again, generally within 12 months of the reporting date).

Contingent Consideration— Taxable Business Combination
Characterize contingent consideration as tax-deductible goodwill when determining the amount of the Component 1 tax goodwill and Component 2 tax goodwill Regardless of whether contingent consideration payments are goodwill for tax purposes Record DTA related to Component 2 tax goodwill, if any Subsequent increases are recognized outside of acquisition accounting (recognize a DTA) Subsequent decreases are also recognized outside of acquisition accounting: If contingent consideration resulted in Component 2 tax goodwill, reduce related DTA first and then set up DTL If contingent consideration resulted in Component 1 tax goodwill, treat as amortization of tax-goodwill and set up DTL State that, in a taxable business combination, KPMG believes contingent consideration payments generally should be characterized as tax-deductible goodwill for purposes of determining the amounts of Component 1 and Component 2 goodwill, notwithstanding that these deductions may not be characterized as goodwill for tax purposes. This concept will be demonstrated in an example on the following two slides. State that subsequent increases in the value of contingent consideration are recognized outside of acquisition accounting (recognize a DTA). Indicate that for subsequent decreases in the value of contingent consideration: If contingent consideration resulted in a deferred tax asset for Component 2 goodwill, reduce the related DTA first and then set up a DTL. If contingent consideration resulted in Component 1 goodwill, treat as amortization of tax goodwill and set up a DTL.

Example: Contingent Consideration— Taxable Business Combination
Parent acquires Subsidiary in a taxable business combination A $50 earn-out is payable to the seller on March 31, 20X0 if Subsidiary meets its EBITDA target for the year ended December 31, 20X9 The acquisition date fair value of the earn-out amounts to $8 Book goodwill is preliminarily calculated at $70 before taking into account any tax implications of the earn-out Tax deductible goodwill, excluding the earn-out, amounts to $100 Parent’s tax rate is 40% Walk through the case facts on the slide. Transition to the next screen to walk through the calculation of the DTA attributable to the Component 2 goodwill

Example: Contingent Consideration— Taxable Business Combination (Cont’d)
Adjust tax deductible goodwill to include fair value of contingent consideration: Excess of tax goodwill over book goodwill is $38 ($108 – $70) Deferred tax asset on excess tax goodwill is $25 [$38 x (40%/(1 – 40%))] Financial reporting goodwill is reduced to $45 ($70 – $25) Journal entry at Acquisition Date: Tax goodwill $100 Earn-out 8 Adjusted tax goodwill $108 Explain that, since this is a taxable business combination, a deferred tax asset should be recognized based on the excess of Component 2 tax goodwill over book goodwill. However, the amount of tax goodwill must first be adjusted to include the fair value of contingent consideration: The adjusted amount of tax goodwill is $108 ($100 tax goodwill + $8 fair value of earn-out). The excess of adjusted tax goodwill over book goodwill is calculated at $38 ($108 adjusted tax goodwill – $70 book goodwill) The deferred tax asset is calculated` using the simultaneous equation method as follows: $25 DTA = $38 excess tax goodwill x [40% tax rate/(1 – 40%)] Accordingly, the final amount of goodwill is recorded at $45 ($70 preliminary goodwill – $25 DTA arising from excess tax goodwill). DR. DTA $25 CR. Goodwill $25

Contingent Consideration— Nontaxable Business Combination
Do not characterize contingent consideration as tax-deductible goodwill Contingent consideration does not increase tax basis of acquired net assets, since business combination is nontaxable Instead, contingent consideration impacts tax basis of investment when settlement occurs Record deferred taxes on outside basis differences unless: Exceptions to recognition of deferred taxes on taxable outside basis differences for investments in subsidiaries apply, or Future deductible temporary basis differences related to the outside basis differences in investments in subsidiaries will not be realized in the foreseeable future Explain that, in non‑taxable business combinations, the contingent consideration recognized at the acquisition date is not characterized as tax-deductible goodwill because it does not increase the tax basis of the assets and liabilities acquired. Rather, the settlement of the contingent consideration increases the tax basis of the investment itself. Note that since the contingent consideration affects the outside tax basis of the investment, deferred taxes should be recorded unless: The outside basis difference qualifies for an exception to recognizing deferred taxes (e.g., the outside basis difference relates to a foreign subsidiary whose earnings are expected to permanently reinvested) or Future deductible temporary basis differences related to the outside basis differences in investments in subsidiaries will not be realized in the foreseeable future

Tax Deductible Share Based Payments
For equity-classified replacement awards that ordinarily result in post-combination tax deductions under the current law, the acquirer will recognize a DTA for the deductible temporary difference that relates to the portion of the award attributed to pre-combination employee service ISOs—no DTA recognized (similar to prior practice) Nonstatutory stock options, nonvested shares—DTA is recognized FASB ASC Previously, the acquirer did not recognize a DTA for tax deductible awards at the acquisition date. Rather, subsequent tax deductions realized related to replacement share based payment awards would be recognized as adjustments to goodwill. Under FASB ASC 805, the acquirer recognizes a DTA for the portion of the tax deductible replacement share based payment awards related to pre-combination employee services. If an enterprise issues an equity classified replacement award that will become deductible at the date of exercise (for share options) or at the vesting date (nonvested stock) a deferred tax asset is recognized for the deductible temporary difference that relates to the portion of the award attributed to precombination employee service. For portions of the award attributed to postcombination employee service, a deferred tax asset is recognized in the period that the compensation cost is reported for financial reporting purposes. Subsequent to the acquisition any future tax deduction reported on the tax return for these awards may result in a related tax benefit that exceeds the deferred tax asset recognized for the replacement award for both precombination and postcombination service (the excess tax benefit). This excess tax benefit should be recognized as additional paid-in-capital in the period the benefit is realized. When the tax benefit for the replacement award is less than the deferred tax asset recognized for the replacement award for both precombination and postcombination service, the write-off of the deferred tax asset related to the tax deficiency is first offset against any existing additional paid in capital that resulted from previously realized excess tax benefits from previous awards. However, if that existing balance in additional paid-in-capital is not sufficient to absorb the full amount of the tax deficiency the remaining shortfall amount is recognized as a charge to tax expense.

Accounting for Income Taxes: Investments in Subsidiaries

Topic Overview Inside/outside basis differences
Investment in Subsidiaries and equity method investments Exceptions to Income Tax Recognition Domestic Outside Basis Differences Outside basis differences: Exceptions to Income Tax Recognition Equity Method Investments Deferred taxes for investment in foreign subsidiary CHANGES FROM TMS VERSION: Updated listing below “Investment in Subsidiaries and equity method investments” to reflect modifications to items included wtihin the presentation

Inside/Outside Basis Differences

Inside Basis vs. Outside Basis
Represents temporary differences for which deferred taxes should be recognized. Inside Basis Differences: Arise from differences between the financial statement carrying amounts and tax basis of a subsidiary’s (both domestic and foreign) assets and liabilities. Outside Basis Differences: Arise from difference between the financial statement carrying amount and the tax basis of the parent company’s basis of the investment in the stock of the subsidiary May represent a temporary difference even though that investment account is eliminated in consolidation. The exceptions to recognition of deferred taxes for investments in subsidiaries apply only to outside basis differences

Outside Basis Differences Investments in Subsidiaries
Basis differences related to a parent company’s investment in the stock of a subsidiary may be created by: undistributed earnings of the subsidiary, accumulated subsidiary losses, foreign currency translation gains and losses included in equity (for foreign operations only), business combinations, or adjustments recognized in equity on the issuance of stock by the subsidiary which cause a parent to deconsolidate the subsidiary. When may these basis differences result in future taxable or deductible amounts?

Outside Basis Differences Investments in Subsidiaries (continued)
Those basis differences may result in future taxable or deductible amounts when: dividends are paid to the parent company by the subsidiary; the parent company sells the stock of the subsidiary; the subsidiary is liquidated; or the subsidiary is merged into the parent company.

Investment in Subsidiaries and Equity Method Investments

Investments in Subsidiaries Exceptions to Income Tax Recognition
There are certain exceptions to the recognition of deferred taxes for taxable outside basis differences related to investments in subsidiaries. The availability of these exceptions may depend on Whether the subsidiary is domestic or foreign, The provisions of the applicable tax law, and The parent company’s plans for reinvestment of undistributed earnings of the subsidiary. These exceptions generally are not available for investments in partnerships (or other pass-through entities) or 50%-or-less-owned investees (equity method investees).

Investments in Subsidiaries Determining Whether a Subsidiary Is Foreign or Domestic
The determination as to whether a subsidiary is domestic or foreign generally should be based on the treatment in the parent company’s tax jurisdiction. For example, a subsidiary or corporate joint venture that is not incorporated in the US generally is a foreign entity, from the perspective of a U.S.-based parent company. The assessment as to whether a subsidiary is domestic or foreign should be determined at each subsidiary level by reference to the subsidiary’s immediate parent.

Tiered Subsidiaries: Scenario 1
US Parent German Subsidiary French Subsidiary 1 French Subsidiary 2 U.S. Parent owns German Subsidiary, German Subsidiary owns French Subsidiary 1 and French Subsidiary 1 owns French Subsidiary 2. Is the German subsidiary considered to be a foreign or domestic subsidiary to US Parent? German Subsidiary is a foreign subsidiary to U.S. Parent. Accordingly, the provisions of ASC Topic 740 and ASC Subtopic , should be considered to determine whether deferred taxes in the U.S. should be recognized on the outside basis difference of U.S. Parent’s investment in German Subsidiary.

US Parent German Subsidiary French Subsidiary 1 French Subsidiary 2 Is the French subsidiary 1 considered to be a foreign or domestic subsidiary to German subsidiary? French Subsidiary 1 is a foreign subsidiary to German Subsidiary The provisions of ASC Topic 740 and ASC Subtopic on investments in foreign subsidiaries also would be considered in determining whether deferred taxes should be recognized in Germany for the outside basis difference in German Subsidiary’s investment in French Subsidiary 1.

US Parent German Subsidiary French Subsidiary 1 French Subsidiary 2 Is the French subsidiary 2 considered to be a foreign or domestic subsidiary to the French subsidiary 2? French Subsidiary 2 is a domestic subsidiary of French Subsidiary 1 and thus the exceptions to the application of ASC Topic 740 included in ASC Subtopic for investments in foreign subsidiaries cannot be applied. Therefore, the provisions of ASC Topic 740 related to investments in domestic subsidiaries would apply to French Subsidiary 1’s investment in French Subsidiary 2.

Investments in Subsidiaries Domestic Outside Basis Differences
No taxable temporary difference should be recorded if: Law provides a means by which the subsidiary may be recovered tax-free, and The company expects it will ultimately use that means If no tax-free options exist due to current ownership percentage, assess intent, ability and cost with respect to timing of settlement of minority interest

Investments in Subsidiaries Domestic Outside Basis Differences Scenario
Current U.S. federal tax law allows a tax-free liquidation or statutory merger of a subsidiary into its parent entity if certain requirements under the tax law are met. The parent entity expects to recover its excess financial reporting basis investment in its subsidiary in a tax-free manner under current provisions of the tax law. In this scenario, should a deferred tax liability be recognized for the outside basis difference?

Investments in Subsidiaries Domestic Outside Basis Differences Scenario Debrief
The outside basis difference is not a taxable temporary difference and a deferred tax liability should not be recognized for that basis difference. Deferred taxes would however be recognized in accordance with ASC Topic 740 on basis differences related to the underlying assets and liabilities of the domestic subsidiary (inside basis differences).

Investments in Foreign Subsidiaries Outside Basis Differences
Exceptions to the recognition of a deferred tax liability for a taxable outside basis difference, include: A basis difference associated with investments in the stock of foreign subsidiaries and certain foreign corporate JVs that are essentially permanent in duration. Not applicable to inside basis differences A taxable outside basis difference associated with a foreign subsidiary is essentially permanent in duration if the indefinite reversal criterion of ASC paragraph is met. Criterion includes: Plan to re-invest indefinitely Remitted in a tax free manner Will not reverse in foreseeable future

Investments in Foreign Subsidiaries Outside Basis Differences
The exception does not apply to investments accounted for under the equity method unless the investee meets the definition of a foreign corporate JV. Consolidated Variable Interest Entities (VIEs) Consider whether the primary beneficiary (parent entity) can control the decision of whether or not to distribute earnings. If the primary beneficiary (parent) can control how and when earnings are distributed (and the other ASC paragraph conditions are met) then the ASC paragraph exception may apply to investments in foreign VIEs. CHANGES FROM TMS VERSION: Deleted Question regarding “clients” at the top of the TMS slide.

ASC 740-30-25-17 Considerations
Meeting the indefinite reversal criterion is not an all-or-nothing test. An entity may conclude: Indefinite reversal criterion may apply to some, but not all, foreign subsidiaries. Taxes should be recognized on earnings deemed distributed under Section 951 of the IRC as Subpart F income. May continue to apply the criterion even if there is a plan to repatriate future earnings from the foreign subsidiary if the parent entity has specific plans to continue reinvestment of the foreign subsidiary’s existing undistributed earnings.

ASC 740-30-25-17 Considerations (continued)
Meeting the indefinite reversal criterion is not an all-or-nothing test. An entity may conclude (continued): Planned payment of fixed dividends may preclude the application of the criterion as an entity would be unable to support an assertion of permanent reinvestment Criterion generally does not apply to basis differences associated with a foreign branch or other pass-through entity The indefinite reversal criterion is not limited to the U.S. tax jurisdiction or to the tax jurisdiction of the ultimate parent entity.

Investments in Subsidiaries Excess Tax Basis
Excess tax basis related to outside basis difference for both domestic and foreign subsidiaries No deferred tax asset unless basis difference reverses in foreseeable future Generally recognize deferred tax liabilities In practice, foreseeable future interpreted to be within one year

Outside Basis Differences—Summary
Taxable Temp Diff Deductible Domestic Foreign Temp Diff Subsidiary Tax free recovery exception – FASB ASC (b) Essentially permanent in duration exception – FASB ASC (a) DTA prohibited, unless “apparent” test met. (FASB ASC ) Corporate joint venture Same rules as a subsidiary Other equity methods General rules of ASC 740; no exceptions VIEs Same rules as a subsidiary (control of how and when earnings are distributed must be considered)

Equity Method Investments
Investments accounted for under the equity method (ASC Topic 323) generally are accounted for using the cost method for tax purposes and give rise to the following differences: Inside Basis Allocation of cost of investment (similar to purchase accounting), including deferred taxes Impact on equity in earnings of investee Outside Basis Dividend received deduction Tax is recognized by the investor

Changes in Equity Method Investment Interests
Changes in ownership interests Consolidated to equity method Domestic (recognize DTL at time of sale) Foreign (the exception in ASC and 25-18a. (APB Opinion 23) does not apply to differences to the extent arising after sale and would only continue to apply to pre-sale earnings if the investor continued to control distributions) Equity method to consolidated Foreign (do not reverse DTL previously recorded) Domestic (reverse DTL if appropriate as additional purchase consideration; not income) impact recorded through P&L if investment is recoverable tax-free CHANGES FROM TMS VERSION: Within the “Consolidated to Equity method” section, removed “not previously recognized” within the foreign tab Within the “Equity method to consolidated” section, under the domestic bullet, added the last part of the sentence that the “Impact recorded through P&L”

Example —Deferred taxes for investment in foreign subsidiary
On January 1, 20X6, Parent Company, a U.S. company, acquired all of the common stock of Company ABC Corp. for $1,000 in cash. ABC operates in a foreign tax jurisdiction; its functional currency is the local foreign currency. Parent Company’s tax basis of the investment in the stock of ABC was $1,000 on January 1, 20X6. On January 1, 20X6, the exchange rate was FC 1 = U.S. $1. The average exchange rate for the year ended December 31, 20X6 and the exchange rate at December 31, 20X6 were FC 1 = U.S. $1.10 and FC 1 = U.S. $1.15, respectively. A summary of Company FS’s balance sheet at December 31, 20X6 in the foreign currency and in U.S. dollars is presented below: FC $ Assets 2,000 2,300 Liabilities 800 920 Stockholders’ equity: Common stock 1,000 Retained earnings 200 220 Cumulative translation adjustment 160 Total equity 1,200 1,380 Total liabilities and equity Example 7.3 from book CHANGES FROM TMS VERSION: Added example from TSS II Course

Example —Deferred taxes for investment in foreign subsidiary (Cont’d)
At December 31, 20X6, there is a taxable temporary difference in the U.S. tax jurisdiction of $380 between Parent Company’s financial statement carrying amount of $1,380 and tax basis of $1,000 of the investment in the stock of ABC due to an increase in assets represented by undistributed earnings of $220 and the effect of the translation adjustment of $160 If the indefinite reversal criterion does not apply, the deferred tax liability on the basis difference would be recognized. Assume Parent Company has a 40 percent U.S. tax rate and ABC has generated $20 of foreign tax ASC paragraph provides an example of the recognition of deferred taxes on unremitted earnings and translation adjustments. In that example, deferred taxes for both the unremitted earnings and the translation adjustments are measured using a net tax rate that reflects foreign tax credits. It may also be acceptable to allocate foreign tax credits only to the unremitted earnings and to use the gross rate for measuring deferred taxes on the translation adjustments CHANGES FROM TMS VERSION: Added example from TSS II course 119

Example —Deferred taxes for investment in foreign subsidiary (Cont’d)
Parent company would make one of the following entries to recognize the deferred tax liability on its outside basis difference, based on company policy. ASC approach: Allocating foreign tax credits only to unremitted earnings: Income tax expense ($220 x 36.84%)1 81 Cumulative translation adjustment ($160 x 36.84%) 59 Deferred tax liability (($380+$20) x 40% – $20) 140 Income tax expense (($220+20) x 40% – $20) 76 Cumulative translation adjustment (residual) 64 Deferred tax liability (($380+20) x 40% – $20) 140 CHANGES FROM TMS VERSION: Added Example from TSS II course 1 Represents the effective rate net of foreign tax credits. Computed as total tax of $140 divided by the outside basis difference of $380. 120

Accounting for Income Taxes under IFRS
THE IFRS SLIDES INCLUDED HAVE BEEN TAKEN FROM A PRESENTATION IN TAIWAN DURING 2012.

Overview of current standards
IAS 12 and ASC 740 are founded on similar principles: Balance sheet approach Current tax payable (or receivable) Arising from current taxable income Deferred (future) taxes payable (or receivable) Differences between financial statement carrying amount and tax bases of assets and liabilities Differences between IFRS and U.S. GAAP are generally the result of: Tax-effects of pre-tax adjustments to the Financial Statements Differences in exceptions to general principles between IAS 12 and ASC 740 Scope Recognition and measurement differences Presentation and disclosure differences The scope of ASC 740 and IAS 12 are limited to income taxes, which are taxes based on taxable profits, as well as taxes that are payable by a subsidiary, associate or joint venture upon distribution to the investor. The objective of accounting for income taxes are (1) to recognize the amount of taxes payable or refundable for current-year operations and (2) to recognize deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the financial statements or tax returns. That is deferred tax assets and liabilities represent the amounts of taxes that will be recovered or paid upon recovery of assets and settlement of liabilities recorded in the financial statements.

Exceptions to recognition of deferred taxes
IAS 12 Basis differences that will not result in taxable or deductible amounts (permanent items) Deferred tax assets subject to recoverability test Specific rules for investments in subs, JVs and associates Initial recognition of goodwill ASC 740 Basis differences that will not result in taxable or deductible amounts (permanent items) Valuation allowance for deferred tax assets subject to recoverability test Specific rules for investments in subs and corporate JVs Initial recognition of goodwill There are several exceptions to recognition of deferred taxes in U.S. GAAP and IFRS, many of which are similar, but not necessarily identical, between the two standards. Certain specific exceptions will be discussed in length later in the course. It should be noted that the above exceptions appear to be the same but in reality there are differences between IFRS and U.S. GAAP which will be discussed.

Exceptions to recognition of deferred taxes (continued)
IAS 12 Initial recognition of assets/liabilities in a transaction that is not a business combination and does not affect accounting profit or taxable profit (loss) (Initial Recognition Exemption) ASC 740 Excess of tax-deductible goodwill acquired in fiscal years beginning before December 15, 2008 Intercompany transfers of assets Foreign nonmonetary assets and liabilities Leveraged leases Statutory reserve funds of U.S. steamship enterprises Bad debt reserves Policyholders’ surplus Under US GAAP, companies that had an excess of tax basis in goodwill over goodwill for financial reporting purposes (component two tax goodwill) that arose in a business combination prior to the adoption of ASC 805 did not recognize a deferred tax asset related to goodwill. The specific guidance on day two accounting related to FAS 141 combinations has been formerly superseded. Nevertheless, entities should continue to apply the superseded guidance in FAS 109, paragraph 263. IFRS does not have a similar prohibition on the recognition of deferred tax assets related to goodwill. Leveraged leases will not be discussed any further – it is a U.S. GAAP exception and IFRS does not have leveraged leases. Similarly, ASC has a policy choice for Qualified Affordable Housing Project Investments that integrates the pre-tax and income tax accounting. That exception will not be further discussed in this class.

Initial recognition exception
In our view, the non-recognition of temporary differences for certain assets and liabilities that are integrally linked is not appropriate Upon initial recognition, we believe that the asset and liability that arise for accounting purposes are integrally linked giving a net temporary difference of zero In later periods, a deferred tax asset or liability should be recognized for the net temporary difference This may include: Finance leases Decommissioning provisions See Insights ; and

Measurement of deferred taxes – IFRS
Measured at the tax rates expected to apply when the underlying asset (liability) is recovered (settled), based on rates which are enacted or substantively enacted at the reporting date Measured using the tax rate and the tax base that reflect the expected manner of recovery (asset) or settlement (liability) Consideration of management intent Non-depreciable asset measured using the revaluation model in IAS 16 Investment property measured using the fair value model in IAS 40 Assume no distribution Discounting not permitted Reviewed at each period end Tax rate – Like U.S. GAAP, the rate of tax that is expected to apply is based on the statutory tax rate and not an entity’s effective tax rate. “Substantively enacted” – Current and deferred tax assets and liabilities are usually measured using the tax rates (and tax laws) that have been enacted. However, in some jurisdictions, announcements of new tax rates (and tax laws) have the substantive effect of actual enactment, which may follow the announcement by the government by a period of several months. In these circumstances, tax assets and liabilities are measured using the announced tax rate (and tax laws). This might be important if a U.S. team is reporting on consolidated statements that include a foreign subsidiary because that subsidiary may have measured their deferred tax assets and liabilities at a substantively enacted rate if substantive enactment has the effect of actual enactment in that jurisdiction and therefore the deferred taxes would need to be remeasured to the enacted rate for U.S. GAAP reporting. However, in the U.S., tax laws are only considered after signed by the President (i.e. enacted) under IFRS or U.S. GAAP. Management Intent – In some tax jurisdictions the tax rate depends on the manner of recovery (e.g. sale vs. use, capital gains tax rate vs. an income tax rate). In such cases management’s intentions are key in determining the amount of deferred tax to recognize. Under U.S. GAAP, the expected manner of recovery or settlement of an asset or liability is not taken into account in the measurement of deferred tax assets and deferred tax liabilities. IAS 12.51B applies to assets which have been revalued and which are not being depreciated because it is assumed that there is an indefinite useful life (e.g. land, and applied to non-amortizable intangibles by analogy), there is a presumption that because the UEL is indefinite management will always intend to recover such assets eventually through sale, as there is no depreciation, no part of its carrying amount is expected to be recovered (consumed) through use and therefore deferred taxes associated with the revalued portion of the non-depreciable asset reflect the tax consequences of sale. Insights also states that IAS 12.51B can be applied by analogy to non-amortizable intangible assets which have been acquired at fair value in a business combination. Beginning in 2012, an exception applies that creates a rebuttable presumption that the carrying amount of investment property measured using the fair value model in IAS 40, will be recovered through sale. Undistributed Rate – we will talk about this a few slides later. Discounting – neither IAS 12 or ASC 740 permit the use of discounting of deferred tax assets or liabilities, some assets and liabilities are already recorded at discounted amounts under IFRS (e.g. provisions, pension liabilities/assets, certain financial assets and liabilities, etc) also the use of discounting would require detailed scheduling of the timing of reversals of DTAs and DTLs and this is not required under IAS 12 or ASC 740.

Measurement of deferred taxes
IAS 12 Deferred tax assets and liabilities are measured based on: The expected manner of recovery (asset) or settlement (liability); A rebuttable presumption that investment property will be recovered through sale, and Enacted or substantively enacted tax rates and laws at the reporting date ASC 740 Deferred tax assets and liabilities are measured based on: An assumption that the underlying asset or liability will be settled or recovered in a manner consistent with its current use in business; and Enacted tax rates and laws at the reporting date In some tax jurisdictions the applicable tax rate depends on how the carrying amount of an asset or liability is recovered or settled. In such cases management’s intentions are key in determining the amount of deferred tax to recognize. Management Intent Example (Insights ): Entity V owns an operating plant that it intends to continue using in its operations. If the plant was sold, then any gain would be taxed at the capital gains rate of 20%. The normal income tax rate is 30%. The deferred tax should be measured using a 30% tax rate because the carrying amount will be recovered through use and not sale. Under U.S. GAAP, the realization of the deferred tax assumes it is settled in a manner consistent with the normal business. For example, it would be assumed that assets used in a manufacturing plant would be realized as a result of normal depreciation, regardless of management’s intention. The deferred tax would be set up using the normal tax rates, rather than a capital gain tax rate that might apply if management’s intention was to recover the asset through sale versus use.

Measurement of deferred taxes (continued)
IAS 12 IAS 12.52B provides the income tax consequences of dividends are recognized when a liability to pay the dividend is recognized IAS 12.52A provides current and deferred tax assets and liabilities are measured at the tax rate applicable to undistributed profits ASC 740 In situations where the undistributed tax rate is higher than the distributed tax rate, ASC provides in the separate financial statements of an entity that pays dividends subject to the tax credit to its shareholders, a deferred tax asset shall not be recognized for the tax benefits of future tax credits that will be realized when the previously taxed income is distributed; rather, those tax benefits shall be recognized as a reduction of income tax expense in the period that the tax credits are included in the entity's tax return ASC provides that under the circumstances in ASC , the entity shall measure the tax effects of temporary differences using the undistributed rate IPTF – Indicated – “period in which the distribution plan becomes final” The accounting required in the preceding paragraph may differ in the consolidated financial statements of a parent that includes a foreign subsidiary that receives a tax credit for dividends paid, if the parent expects to remit the subsidiary’s earnings. Assume that the parent has not availed itself of the exception for foreign unremitted earnings that may be available under paragraph In that case, in the consolidated financial statements of a parent, the future tax credit that will be received when dividends are paid and the deferred tax effects related to the operations of the foreign subsidiary shall be recognized based on the distributed rate because, as assumed in that case, the parent is not applying the indefinite reversal criteria exception that may be available under that paragraph. However, the undistributed rate shall be used in the consolidated financial statements to the extent that the parent has not provided for deferred taxes on the unremitted earnings of the foreign subsidiary as a result of applying the indefinite reversal criteria recognition exception.

Intercompany transactions

Intercompany transactions
Intercompany transfer of assets between tax jurisdictions Taxable event that establishes a new tax basis measured at the buyer’s tax rate Intra-group transactions are eliminated upon consolidation for financial accounting The guidance in Topic 810 and IAS 12 on accounting for the tax effects of intercompany transactions applies to all intercompany sales, not just sales of inventory. This guidance applies to the accounting in the consolidated financial statements. Taxable events sometimes occur between companies within the consolidated group. Recognition in the financial statements of the difference in the buyer’s tax jurisdiction and the seller’s tax jurisdiction and the intercompany profit is generally deferred. This applies not only to intercompany transactions with foreign subsidiaries, but also entities that have different tax jurisdictions (i.e. state and local). Treatment applies to the consolidated financial statements, not necessarily the separate financial statements of the subsidiaries. Examples would include the transfer of inventory, fixed assets or intellectual property.

ASC 740 Income taxes paid by seller are deferred
The deferred amount should not be adjusted for any subsequent changes in tax rates/laws Buyer is prohibited from recording deferred tax asset for the excess of new tax basis No assessment of recoverability on the deferred charge, not a deferred tax asset. However, the deferred charge should be included with the financial statement carrying amount of the transferred asset for purposes of any impairment evaluation The income taxes paid related to the intercompany transfer of assets, and the related deferred tax affects, are deferred in a separate account in the financial statements (separate from deferred taxes). The deferred amount should not be adjusted for changes in tax rates and will be reversed to income when the intercompany asset is sold outside the group or when it effects income (i.e. through depreciation/amortization, etc.).

IAS 12 Any related deferred tax effects are measured based on the tax rate of the purchaser The tax effects are generally not eliminated Subject to general deferred tax asset recognition requirements Deferred tax recognized on intra-group transfer of an asset to an entity that is not wholly owned if there is a change in tax base Unlike U.S. GAAP, the purchaser recognizes deferred taxes related to intercompany transactions. Insights ( ) The tax effects are not eliminated unless the transacting entities are subject to the same tax rate. Insights ( ) In some jurisdictions, an intra-group transfer of an asset to an entity that is not wholly owned by the group may result in a change in tax base. Insights ( ) “In our view it may be appropriate to apply the IAS 12 guidance on tax revaluations by analogy to other situations in which the tax base of an asset changes but its carrying amount remains the same. In some jurisdictions the tax base of an asset may be changed if the asset is transferred from a wholly owned group entity to another group entity that is not wholly owned, to the extent of the minority interest in the receiving entity.” Utilize the flipchart while going through this example: Insights For example, entity V sells inventory to fellow subsidiary W for 300, giving rise to a profit of 50 in V's separate financial statements. V pays current tax of 15 on the profit. Upon consolidation the profit of 50 is reversed against the carrying amount of the inventory of 300. Therefore the carrying amount of the inventory on consolidation is 250. However, the carrying amount of the inventory for tax purposes will depend on the legislation in W's jurisdiction. Assuming that the carrying amount of the inventory for tax purposes is 300, a deductible temporary difference of 50 arises, which should be recognized on consolidation at W's tax rate, subject to the general asset recognition requirements

Outside Basis Differences

ASC 740 A deferred tax liability is recognized for investments in foreign subsidiaries and foreign corporate joint ventures unless evidence overcomes the presumption that one is needed (indefinite reversal criteria ASC ). There is no exception for other equity method investments The exception for recognizing a liability related to domestic subsidiaries and domestic corporate joint ventures only applies to undistributed earnings that are essentially permanent in duration that arose in fiscal years beginning on or before December 15, 1992 A deferred tax asset is only recognized for an investment in a subsidiary or corporate joint venture that is essentially permanent in duration if it is apparent that the temporary difference will reverse in the foreseeable future

IAS 12—Overview IAS 12.39—An entity should recognize a deferred tax liability for all taxable temporary differences associated with investments in subsidiaries, branches, associates and JVs, except to the extent that both of the following conditions are satisfied: The parent, investor or venturer is able to control the timing of the reversal of the temporary difference, and It is probable that the temporary difference will not reverse in the foreseeable future No distinction between foreign and domestic entities Similar to ASC 740 there is a potential exception for the recognition of DTLs in relation to outside basis differences (i.e. those arising on the net investment created by undistributed profits). Under IFRS there is no distinction between whether the investee/sub is foreign or domestic. Also the potential exception under IFRS also includes equity method investments (Associates) and not just corporate joint ventures therefore there is a potential for some differences to arise. The two conditions which must be met for non-recognition of a DTL are: The investor must be able to control the timing of the reversal – it is unlikely that the investor would be able to control the timing of the reversal (e.g. the dividend policy) of an equity method investee (unless an agreement exists requiring that the profits will not be distributed in the near future [IAS 12.42]) because the investor does not control that entity and only has significant influence, therefore in practice a DTL arising on the carrying value of an associate would be recognized. However, as a parent is able to control the dividend policy of its subsidiary, it is also able to control the reversal of the temporary differences therefore when a parent has determined that those profits will not be distributed in the foreseeable future there is no need to recognize the DTL. It must be probable that the temporary difference will not reverse in the foreseeable future.

Deferred tax assets IAS 12.44—Similarly a deferred tax asset arising from investments in subsidiaries, branches and associates, and interests in joint ventures, would only be recognized to the extent it is probable that: The temporary differences will reverse in the foreseeable future; and Taxable profit will be available against which the deductible temporary differences can be utilized The requirements under IAS 12 are similar to ASC 740. Under ASC 740, a DTA would be recognized only if it is apparent that the temporary difference will reverse in the foreseeable future. Once recognized, the need for a valuation allowance must be assessed (similar to criteria 2 above).

Deferred tax assets

Recognition Recognition of Deferred Tax Assets
Under IAS 12, a deferred tax asset is not recognized unless it is probable that it will be realized Probable is not currently defined in IAS 12 but in practice “more likely than not” is used No valuation allowance concept Under ASC 740, all deferred tax assets are recognized (unless an exception applies) and a valuation allowance is recognized to the extent that it is “more likely than not” that the deferred tax assets will not be realized Probable is not defined in IAS 12. IN PRACTICE – “PROBABLE” IN IAS 12 = “MORE LIKELY THAN NOT” IN ASC 740. Insights ( ): Although an entity is required to consider the probability of realizing the benefit of deductible temporary differences, “probable” is not defined in IAS 12. In our experience, entities often use a working definition of “more likely than not,” which is consistent with the definition of probable in respect of provisions (see Insights ). However, IAS 12 does not preclude a higher threshold from being used. In our view, a single definition of “probable” should be developed and applied throughout a group for the purpose of recognizing deferred tax assets (e.g., more likely than not, or more than 60 percent likely). However, in our view, a threshold approaching 95 percent could not be used, as that would be more consistent with the “virtually certain” test for contingent assets (see Insights ). In an ED expected in December 2010, the IASB is expected to propose recognizing DTAs in full with an offsetting valuation allowance along with adopting some of ASC 740’s guidance.

Reversal of taxable temporary differences
IAS 12, par 28 It is probable that taxable profit will be available against which a deductible temporary difference can be utilized when there are sufficient taxable temporary differences relating to the same taxation authority and the same taxable entity which are expected to reverse: In the same period as the expected reversal of the deductible temporary difference; or In periods into which a tax loss arising from the deferred tax asset can be carried back or forward Same concept under IAS 12 and ASC 740 Insights ( ) Example: Utilize the flipchart when working through this example: Entity N has a possible DTA of $100 related to an employee benefit liability. For tax purposes the expenditure is deducted as incurred which is expected to be in 2 years time. N has a DTL for PPE of $300 of which $150 will reverse in the next 2 years, and the remaining $150 in four years. The $150 reversal of the DTL will create sufficient taxable income to support the realization of the DTA.

Future anticipated taxable income
IAS 12, par 29 When there are insufficient taxable temporary differences relating to the same taxation authority and the same taxable entity, the deferred tax asset is recognized to the extent that: It is probable that the entity will have sufficient taxable profit relating to the same taxation authority and the same taxable entity in the same period as the reversal of the deductible temporary difference (or in the periods into which a tax loss arising from the deferred tax asset can be carried back or forward); or Tax planning opportunities are available to the entity that will create taxable profit in appropriate periods Assessment of whether a deferred tax asset should be recognized on the basis of the availability of future taxable profits should take into account all factors concerning the entity’s expected future profitability, both favourable and unfavourable. See for specific indicators. Utilize the flipchart when working through this example: Insights – Entity P has a deductible temporary difference in respect of a liability for employee benefits, the majority of which is expected to reverse in 20 years’ time. P has a history of being profitable and there is no reason to believe that it will not be profitable in the future. P prepared budgets and forecast for a period of only two years into the future. A deferred tax asset should be recognized notwithstanding the limited period for which budget and forecasts are available. The criteria for recognizing a DTA under IAS 12 is similar to ASC 740.

Tax loss carryforwards and credits
IAS 12, par 35 The criteria for the recognition of DTA in respect of loss carry forwards and tax credits are the same as the criteria for the recognition of DTA resulting from deductible temporary differences The existence of unused tax losses is strong evidence that future taxable profit may not be available When an entity has a history of recent losses, the entity recognizes a deferred tax asset arising from unused tax losses or tax credits only to the extent that the entity has sufficient taxable temporary differences or there is convincing other evidence that sufficient taxable profit will be available to offset the deferred tax assets Compare “history of recent losses” under IFRS to “cumulative losses in recent years” under U.S. GAAP. Compare “convincing other evidence” under IFRS to “objectively verified” under U.S. GAAP. Insights ( ) The probability threshold is applied to portions of the total amount of unused tax losses or tax credits, rather than to the entire amount when determining whether probable future taxable profits are available. Utilize the flipchart when working through this example: Example: Entity R has a $1,000 tax loss carryforward at December 31, Tax rate is 30%. R expects to utilize a portion of the loss carryforward in 2013 due to a new contract. It is unclear whether the new contract will extend beyond R believes it is highly probable that it will generate $400 taxable profit in 2013, but not certain about 2014 and beyond. DTA = $300; estimated DTA supported by taxable profit in 2008 based on new contract = $120. In determining whether it should recognize a deferred tax asset, R should assess whether any portion of the tax losses carried forward is recoverable through probable future taxable profits. At December 31, 2012, a DTA of $120 should be recognized because only 2013 is expected to have future profit. Insights ( ) T was established one year ago and is in its “start up “ phase. In the first year of operations it had a loss of $500. T expects to be profitable by its third year of operations and expects all tax losses to be utilized by the end of its fourth year of operations. T should not recognize any DTA in respect of the tax losses since it is not appropriate to forecast profits when a business is in a start up phase, unless there is convincing evidence that future taxable profits will be available.

Accounting for uncertainty in income taxes

U.S. GAAP—Accounting for uncertainty in income taxes
Establishes the threshold for recognizing the benefits of tax-return positions in the financial statements as “more likely than not” to be sustained by the taxing authority Prescribes a measurement methodology for those positions meeting the recognition threshold as the largest amount of benefit that is greater than 50% likely of being sustained Significant disclosures required (although fewer for private entities) Provides that recognition and measurement should be based on all information available at the reporting date Uncertainty exists about how tax positions will be treated under the tax law. This uncertainty leads to questions about whether tax positions taken or to be taken on a tax return should be reflected in the financial statements before the uncertainty is resolved with the taxing authority. ASC 740 establishes the threshold for recognizing the benefits of tax-return positions in the financial statements as “more likely than not” to be sustained by the taxing authority, and prescribes a measurement methodology for those positions meeting the recognition threshold. The Interpretation does not require a specific manner for the analysis related to either recognition or measurement. Further, because the nature and level of uncertainty of individual tax positions will vary, we believe the extent of the analyses required to conclude on measurement will also vary.

IFRS—Income tax exposures
No specific definition or explicit guidance for “income tax exposures” provided in IAS 12 Accounting for interest and penalties related to income tax exposures addressed by IAS 12 or IAS 37 No “reporting date” guidance exists Accounting is subject to the normal subsequent events guidance under IAS 10 Tax related contingent liabilities and contingent assets are disclosed in accordance with IAS 12 and IAS 37 IAS 12.5 – Income tax exposures not defined Insights a) IAS – Current tax liabilities (assets) for the current and prior periods shall be measured at the amount expected to be paid to (recovered from) the taxation authorities, using the tax rates (and tax laws) that have been enacted or substantively enacted by the balance sheet date. b) IAS 12.5 – Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences. IAS – An entity discloses any tax-related contingent liabilities and contingent assets in accordance with IAS 37: Unless the possibility of any outflow in settlement is remote, disclosure of each class of contingent liability at the balance sheet date a brief description of the nature of the contingent liability and where practicable: an estimate of its financial effect an indication of the uncertainties relating to the amount or timing of any outflow; and the possibility of any reimbursement Where an inflow of economic benefits is probable, disclose a brief description of the nature of the contingent assets at the balance sheet date, and where practicable, an estimate of their financial effect. If the information is not disclosed because it is not practicable, this fact needs to be disclosed. If the disclosure of the information can be expected to prejudice seriously the position of the entity in a dispute with other parties on the subject matter of the contingent liability or contingent asset, an entity need not disclose the information, but discloses the general nature of the dispute, together with the fact that, and reason why, the information has not been disclosed. This exception will be rare and should not be used as a reason to avoid disclosing uncertain tax positions.

Guidance—Income tax exposures
KPMG’s Guidance Assess each tax exposure item individually The amount provided for is the best estimate of the tax amount expected to be paid Two common approaches include: Single point best estimate Probability weighted amount The definition of “probable” should be assessed in the context of IAS 12 (“more-likely-than-not”) Insights ( ) Potential tax exposures are analyzed individually and separately from the calculation of income tax, and the amount of tax provided for should be determined in accordance with IAS 12. Consistent with the definition of a current tax liability (or asset), the amount to be provided for is the best estimate of the tax amount expected to be paid. See also, of KPMG’s Accounting for Income Taxes, An Analysis of FASB Statement 109 (ASC Topic 740), which provides enterprises may adopt policies consistent with ASC as permitted by IAS 8.12. Insights provides (in the guidance on provisions): - If there is a large population…then the provision is measured at its expected value. - If there is a single item, then the most likely outcome usually is the best estimate. There is diversity in practice in determining the best estimate in accounting for income tax uncertainties under IFRS. We understand that in countries with less developed tax structures, detection risk may be considered in determining the best estimate. In countries with more developed tax structures, detection risk is generally not considered. For U.S. entities reporting under IFRS, we do not believe it would be appropriate to consider detection risk when determining the best estimate of income tax uncertainties. (Q&A ) Silent on: - Criteria for recognizing indirect effects - Consideration of detection risk - Subsequent recognition / remeasurement

Measurement of tax benefits
Possible outcome of benefits Individual probability (%) Cumulative probability (%) Weighted average $1,000 35 350 800 20 55 160 100 30 85 15 Probability weighted amount $540 Single point best estimate 1,000 U.S. GAAP cumulative probability 800

Guidance—Interest and penalties
KPMG’s Guidance If, and only if an income tax exposure is present, accounting policy election whether a company accounts for interest and penalties under IAS 12 or under IAS 37 If uncertainties are not present or are insignificant, interest and penalties that relate to income tax obligations should be presented according to the underlying nature If IAS 37 is elected, a provision for the best estimate related to previous tax years, if there is a probable outflow of resources and the amount can be estimated reliably Presentation of interest and penalties in the statements of financial position and comprehensive income should be consistent with accounting policy election Insights Insights ( ) Interest and penalties arising from income tax exposures, although not covered by the definition of income taxes, are amounts due to the tax authorities that are closely related to income taxes. In the absence of clear guidance, if and only if an income tax exposure is present, an entity should make an accounting policy election as to whether it accounts for such interest and penalties under IAS 12 or under IAS 37. IAS 12 – interest and penalties will be presented in the balance sheet and income statement as a current/deferred tax payable and as income tax expense. IAS 37 – interest and penalties will be presented in the balance sheet and the income statement as another provision/liability and as operating expense and interest expense, respectively. Accounting policy election only applies to income tax exposures – if income tax uncertainties are not present or are insignificant, then interest and penalties are accounted for under IAS 37 (Insights ). Does not apply to non-income based tax exposures (i.e. sales tax, VAT, social security taxes, etc.).

Share-based payments

Overview Equity classified share based payments
Measurement of deferred tax asset differs between U.S. GAAP and IFRS: U.S. GAAP—The deferred tax asset is based on the amount of cumulative compensation cost recognized in profit or loss IFRS—The deferred tax asset is based on the share price at each reporting date Stock option deduction in excess of compensation expense included in equity (Windfall) Stock option deduction is less than compensation expense (Shortfall) We will discuss in the later slides for Windfall and Shortfall situations. U.S. GAAP: Tax benefit and credit to APIC for excess tax benefit is recognized in the period that deduction reduces taxes payable. Reduction of taxes payable may occur in period subsequent to period in which amount is deductible. For example, a company may have a net operating loss carry-forward in the period of the tax deduction.

U.S. GAAP ASC provides guidance on tax effects of share-based compensation awards Cumulative compensation cost recognized for instruments that ordinarily would result in a future tax deduction is a deductible temporary difference when applying U.S. GAAP Amount of tax benefits and date of tax benefits are received depends on nature and terms of the award Deferred taxes are recorded based on recognition of compensation cost in the income statement ASC 718 (revised 2004), Share Based Payments, December 2004 requires companies to recognize in the income statement the grant-date fair value of equity-classified stock options and other equity-based compensation issued to employees. This slide provides general information on the tax effects of the accounting treatment required for companies after adopting ASC 718. Prior to adoption of ASC 718, many companies applied APB 25, Accounting for Stock Issued to Employees which did not require companies to record compensation expense for financial reporting purposes associated with stock awards that had an intrinsic value of zero at the date of grant (stock price and exercise price on date of grant were the same) when other conditions were met. Section provides the pre-tax expense is considered a deductible temporary difference.

U.S. GAAP (continued) Tax benefits realized:
In excess of the amount recognized for financial reporting purposes are recorded as additional paid-in capital (APIC) at the time the benefit is realized For less than the amount recognized for financial reporting purposes, the tax effect of the deficiency is recognized in the income statement except to the extent that there is remaining APIC from excess tax benefits from previous exercises of share-based payment awards (APIC pool concept) This results in a portfolio approach for determining excess tax benefits The tax benefit is not recognized until the related deduction reduces taxes payable Portfolio approach – FAS 123R, B210

IFRS IFRS Deferred tax assets measured based on amount for which deduction is expected (intrinsic value of awards under U.S. tax law) Re-measure deferred tax asset based on share price (intrinsic value) at each reporting date as this amount is deemed to represent the “expected deduction” Cumulative tax benefit recognized is based on intrinsic value (if this is basis for tax deduction) No APIC pool concept IAS 12.68B: The differences between the tax base of the employee services received to date (being the amount the taxation authorities will permit as a deduction in future periods) and the carrying amount of nil, is a deductible temporary difference. A deferred tax asset is recognized only if and when the share options have intrinsic value that could be deductible for tax purposes. An entity that grants at-the-money share option to an employee in exchange for services would not recognize tax effects until that award was in-the-money.

IFRS (continued) Tax deduction (estimated future tax deduction) exceeds related cumulative share-based expense: Indication that tax deduction relates to not only remuneration expense, but also an equity item Excess of the associated income tax should be recognized directly in equity IFRS does not specifically address the situation in which the amount of the tax deduction is less than the related cumulative remuneration expense, but no APIC pool concept under IFRS The determination of excess benefits should be based on an individual instrument approach, however, it is a policy election whether this would be by individual award or tranche of awards Insights U.S. GAAP uses a portfolio approach to determining excess benefits while IFRS uses an individual instrument approach. See B269 of Stmt 123(R). U.S. GAAP enterprises should have experience determining excess tax benefits on an individual award basis as part of computing the tax benefit to recognize as a cash flow from financing activities.

Intraperiod allocation

Intraperiod tax allocation—U.S. GAAP
Generally, income tax is allocated among continuing operations, discontinued operations, other comprehensive income, and directly to shareholders’ equity under a with and without approach Items specifically allocated to continuing operations include: Changes in circumstances that change the judgment about realization of deferred tax assets in future years Changes in tax rates or laws on all deferred tax assets and deferred tax liabilities (even those that relate to other comprehensive income) Changes in tax status Tax-deductible dividends paid to shareholders (except for those dividends paid on unallocated shares held by ESOP or other stock compensation arrangement) See Chapter 8 in the KPMG Guide and ASC Income tax expense from continuing operations includes the tax effect of pretax income/loss from continuing operations plus/minus: Changes in circumstances that change the judgment about realization of deferred tax assets in future years. Changes in tax rates or laws on all deferred tax assets and deferred tax liabilities (even those that relate to other comprehensive income) Changes in tax status. Tax-deductible dividends paid to shareholders (except for those dividends paid on unallocated shares held by ESOP or other stock compensation arrangement). There is no backwards tracing concept in U.S. GAAP. Paragraph provides an exception to this general approach by requiring all components, including discontinued operations, extraordinary items, and items charged or credited directly to equity, be considered when determining the tax benefit from a loss from continuing operations. Provide the participants with the information that the FAS 109 Guide is located in a pdf format on ARO.

Intraperiod tax allocation—IFRS
Generally, income tax is recognized in profit or loss except to the extent the tax arises from: A transaction or event recognized either in other comprehensive income or directly to equity (backwards tracing), or A business combination. See the next slide for discussion of backwards tracing.

Backwards tracing—IFRS
The carrying amount of deferred tax assets and liabilities may change even though there is no change in the amount of the related temporary differences. This can result, for example, from: A change in tax rates or tax laws; A re-assessment of the recoverability of deferred tax assets; or A change in the expected manner of recovery of an asset The resulting deferred tax is recognized in profit or loss, except to the extent that it relates to items previously charged or credited to equity (backwards traced) In exceptional circumstances, where it is not possible to determine the amount of current and deferred tax that relates to items credited or charged to equity, a pro-rata allocation should be utilized or other method that achieves a more appropriate allocation in the circumstances (see IAS for examples) Backwards Tracing – IAS Consistent with the initial treatment, IAS 12 requires a change in deferred taxes due to a change in tax rates, or laws, change in assessment of future recoverability, or a change in the expected manner of recovery of the asset (sale vs. depreciation) be charged or credited directly to equity to the extent such items were previously recognized in equity. ASC 740 requires these changes be included in income tax from continuing operations. IAS – In exceptional circumstances it may be difficult to determine the amount of current and deferred tax that relates to items credited or charged to equity. This may be the case, for example, when: There are graduated rates of income tax and it is impossible to determine the rate at which a specific component of taxable profit (tax loss) has been taxed; A change in the tax rate or other tax rules affects a deferred tax asset or liability relating (in whole or in part) to an item that was previously charged or credited to equity; or An entity determines that a deferred tax asset should be recognized, or should no longer be recognized in full, and the deferred tax asset relates (in whole or in part) to an item that was previously charged or credited to equity. In such cases, the current and deferred tax related to items that are credited or charged to equity are based on a reasonable pro rata allocation of the current and deferred tax of the entity in the tax jurisdiction concerned, or other method that achieves a more appropriate allocation in the circumstances.

Other issues

Investment tax credits
ITCs are excluded from the scope of both IAS 12 and IAS 20 and are not defined by IFRS In our view, management needs to choose an approach that best reflects the economic substance of the specific ITC In practice entities generally account for ITCs using one of the two following approaches: If more akin to a government grant, following IAS 20 by analogy, ITCs are presented in other income or a reduction of expense over periods to match them with the related cost that they intend to compensate. Amounts are presented in the statement of financial position as either deferred income or as a deduction from an asset If more akin to a tax allowance, following IAS 12, ITCs are presented as a reduction of income tax expense when it reduces current tax or is recognizable as a deferred tax asset IAS 20: The amount of tax incentive is independent of the amount of taxable profit or tax liability. For example, a government provides an ITC to entities that invest in retirement homes for the elderly. An eligible entity is required to first carry forward and offset the ITC against its income tax liability for a specified period; if there is insufficient income tax liability to offset the ITC after the specified period, then any excess ITC is paid by the government in cash at the end of the period. In such a situation, the ITC incentivises an entity to invest in retirement homes. Therefore, the benefit may not be akin to a tax allowance. • As well as the condition that expenditure is made on a particular asset or activity, there are other substantive conditions attached to an ITC that relate to the operating activity of an entity. This may be the case when, for example, as well as the condition that expenditure is incurred on a particular asset, an ITC stipulates another condition such as requiring that a certain number of local workers are employed to operate the asset. Therefore, if other substantive conditions are attached to an ITC, then these conditions may indicate that the benefit is more akin to a government grant. IAS 12: For example, under a general R&D tax incentive scheme, which is available to all taxable entities, a government allows entities to claim an additional 15% tax deduction for a broad range of generic R&D expenditures in the period in which the expenditure is incurred. If the additional deduction exceeds taxable income, then the resulting tax loss can be carried forward and utilised in a future period of up to three years. If any part of the ITC remains unclaimed after three years, then the ITC expires. In this case, in the absence of any other pertinent indicators, we believe that the economic substance of the ITC is more akin to a tax allowance and should be accounted for by analogy to IAS 12 Note that certain property that received pre-1987 U.S. federal ITCs may still be in existence and are being depreciated for financial accounting.

Accounting for Income Taxes in Interim Periods

General Rule and Overview of Interim Period Calculations

Overview of Interim Reporting Tax Calculations
Recognizing income tax expense for interim periods is based on an estimated effective tax rate for the year The complexity of the estimated annual effective tax rate calculation will depend upon: The number of tax jurisdictions in which the company operates; The nature and extent of the “permanent difference” items; and The ability to make reliable estimates.

Applying the Estimated Annual Tax Rate to Interim Period Ordinary Income

What is the estimated annual effective tax rate?
Extraordinary items The estimated annual effective tax rate is the ratio of estimated annual income tax expense to estimated pretax ordinary income and thus excludes: Discontinued operations Cumulative effects of changes in accounting principles Significant unusual or infrequent items reported separately or reported net of their related tax effect Overview Can you identify what items are excluded in the calculation?

Estimated Annual Effective Tax Rate
Calculating the estimated annual effective tax rate requires an entity to estimate both annual income tax expense (current and deferred) and annual ordinary income: Estimated Current Tax Expense – estimate of income taxes payable by applying provisions of the tax law to estimated “ordinary” taxable income. Estimated Deferred Tax Expense – requires an estimate of net deferred tax asset or liability at the end of the year including necessary valuation allowance.

Estimated Annual Effective Tax Rate Scenario
What if you can not reliably estimate ordinary income (or loss)? FaceSpace is the latest social networking website. In the current year, FaceSpace expects near break-even operations. Answer: The actual effective tax rate for the year-to-date period may be the best estimate of the annual effective tax rate

Inability to make reliable estimates
OVERALL FORECAST V COMPONENTS OF FORECASTS What are some other instances in which income can not be reliably estimated? Translating foreign currency financial statements For example, depreciation may be translated at historical rates while transactions in income are translated at current period average rates. Warrant liabilities recorded at fair value For example, future increases in stock price will result in losses while future declines will result in gains. Stock price is unpredictable. Need to update design document for these additional items from Pauline. For example, we should discuss whether foreign currency gains and losses is part of ordinary income or if it should be excluded from determination of ordinary income (with the tax effect separately calculated on a discrete basis), particularly when the functional currency of the reporting entity is in US dollars. Second example, book gain/loss from warrant liability or equity instruments subject to fair value adjustments (typically nontaxable) may be unpredictable and would cause large fluctuation on the ETR if included. Rec’d from Pauline on August 15th Generally, the tax (or benefit) applicable to ordinary income (or loss) shall be recognized in the interim period in which the ordinary income (or loss) is reported.

Consideration of Future Events
Future events, such as tax-planning strategies that are not primarily within management’s control and changes in tax laws and rates, generally should not be anticipated when determining the estimated annual effective tax rate.

Operations Taxable in Multiple Jurisdictions
An entity subject to tax in multiple jurisdictions should generally compute one overall effective tax rate related to consolidated ordinary income Exceptions apply: Ordinary loss is anticipated in a jurisdiction for the fiscal year Ordinary loss YTD in a jurisdiction where no tax benefit can be recognized. Entity is unable to estimate an annual effective tax rate in a foreign jurisdiction This is not in the design document but it was in prior year therefore kept in the materials. Should be added to design document for consistency.

Application of Estimated Annual Effective Tax Rate
Calculated YTD tax expense Tax expense recorded in prior interim periods Current Quarter Tax Expense The estimated annual effective tax rate is applied to year to date (YTD) income to arrive at YTD tax expense. The estimated rate is reviewed and/or revised each quarter. Add something to this slide

Estimated Annual Effective Tax Rate Scenario
Answer: $610 Pretax income plus political contributions and reserves, less tax exempt income and depreciation expense multiplied by the tax rate. The tax credits are subtracted from tax expense to arrive at net current tax of $610. Wetzel’s Windmills specializes in wind energy and has shown consistent 5% growth each year. The Companies tax rate is 40%. Pretax income $1,000 Permanent differences: Political contributions $500 Tax exempt income $100 Temporary differences: Depreciation expense $100 Reserves $300 Tax credits $30 In this scenario, what would net current tax (for purposes of calculating the estimated annual effective tax rate) be?

Application of Estimated Annual Effective Tax Rate Scenario
Wetzel’s Windmills estimated current tax is $610. Pretax income $1,000 Permanent differences: Political contributions $500 Tax exempt income $100 Temporary differences: Depreciation expense $100 Reserves $300 Tax credits $30 In this scenario, what is the estimated current tax rate? Answer: $610 estimated current tax / pretax income of $1,000 = 61% In this scenario, what is the estimated deferred tax rate? Estimated Annual Effective Rate is 53% Answer: Net timing difference of $200 ($300-$100) multiplied by 40% = $80 tax effected net timing difference Divided by pretax income of $1,000 Estimated deferred tax rate of 8.0%

Application of Estimated Annual Effective Tax Rate Scenario continued
Pretax income $1,000 Permanent differences: Political contributions $500 Tax exempt income $100 Temporary differences: Depreciation expense $100 Reserves $300 Tax credits $30 If Q1 income is $200, what is the tax provision? Answer: $200 X 53% = $106 If Q2 income is $300, what is the Q2 tax provision? Answer: YTD Income of $500 X 53% = $265 Less: tax expense recorded in Q1 $106 Q2 tax expense $159 Example: Assuming the estimated pretax income is 1,000, the estimated annual effective tax rate would be computed as follows: Est. Current Tax Rate (610/1,000) = 61% Est. Def Tax Rate [($80 net timing difference = = 200*40%)/1,000) = (8.0)% 61% less 8.0% = 53.0% Therefore, if actual 1Q income was $200, the 1Q tax provision would be $106 (200 x 53%). If the actual 2Q income was $300, the 2Q tax provision would be determined as follows: YTD Income ($500) x 53% is $265 Less tax exp recorded in 1st qtr 2nd qtr tax expense $ 159 Note to instructor: In this example there were no revisions to the estimated annual tax rate during 2Q therefore if the 53% tax rate was applied to the $300 2Q income the tax expense would have been $159. However, if the annual effective tax rate was revised in 2Q it would be necessary to calculate 2Q tax expense as noted above.

Tax Effect of Losses on the Interim Period Calculation

Tax Effect of Losses The tax effects of losses that arise in early interim periods should be recognized only if: The tax benefits are more likely than not of being realized during the year and/or In a future year. A historical pattern of losses in early interim periods offset by income in later interim periods may provide sufficient evidence If tax effect of losses are not recognized in early interim periods, tax effects of income in later interim periods should not be recognized until tax effects of previous interim losses are utilized

Tax Effect of Losses Scenario
What if Wetzel’s Windmills had a Q1 loss of $100 and losses are common in early interim periods? Answer: A tax benefit of $53 would be recognized at the end of Q1. Q1 loss of $100 multiplied by the estimated tax rate of 53% = $53 benefit If a loss was expected for the full fiscal year, the effect of the necessary valuation allowance expected at the end of the year should be considered. CHANGES FROM TMS VERSION: Within the explanation, changed “expected that the end…” to “expected at the end….”

Tax Effect of Losses Scenario
What if a loss was expected for the full fiscal year? Answer: The effect of the necessary valuation allowance expected at the end of the year should be considered in determining: The estimated tax benefit of the expected ordinary loss for the year The estimated annual effective tax rate and The year-to-date tax benefit of a loss in an interim period.

Impact of Changes in Valuation Allowance on Interim Period Calculations

Changes in Valuation Allowance
Changes in circumstances can cause a change in judgment about the future realizability of a deferred tax asset and result in a revision to the valuation allowance For interim reporting purposes, the accounting recognition for changes in the valuation allowance will depend upon when realization is expected

Types of Changes in Valuation Allowance
Change originating in the current year Recognize as part of the estimated annual effective tax rate in the period the event occurs Change as a result of ordinary income in current year Change affecting future periods Recognize the entire amount of the change in the interim period the event occurs

Interim Effect of a Change in Valuation Allowance
Answer: MIAA would record a tax benefit in Q2 (as a discrete item) to reduce the valuation allowance related to the $8,000 DTA expected to be realized in the future. The release of the $2,000 valuation allowance will be recognized as an adjustment to the annual effective income tax rate used to calculated income tax expense for the year. Deferred tax asset (DTA) $10,000 Valuation allowance $10,000 Made in America Auto Co. (MIAA) During Q2 MIAA, signed a major contract with the City of New York to replace all of their police vehicles over the next few years. MIAA expects that $2,000 of the DTA will be used to reduce current year income tax. It is more likely than not that the remaining $8,000 will be realized in future periods. Pauline would like to add numerical examples per her August 15th How should MIAA account for this change in valuation allowance?

Examples of discrete and non-discrete items
Disqualifying dispositions of incentive stock options Changes in prior period uncertain tax positions Non-discrete item Significant incentive payment to a new executive which is non-deductible under Section 162(m)* of the IRS Code (the Code) Rec’d from Pauline on August 15 * Section 162(m) pertains to employee compensation at publicly held companies.

Changes in Tax Laws or Rates

Changes in Tax Laws or Rates
The effects of these changes on taxes currently payable and deferred tax assets and liabilities should be recognized as a discrete item in income from continuing operations in the interim period that includes the enactment date of the changes Effect of these changes should not be allocated to subsequent interim periods by an adjustment of the estimate annual effective tax rate for the remainder of the year. Treatment of a retroactive change is similar Slide/Topic is not in the design document but it is in the prior year materials. Need to update design document if keeping all prior year materials as discussed.

Changes in Tax Laws or Rates Scenario
A federal income tax rate change was enacted in Q2: Answer: A catch up adjustment of $50 (benefit) would be recorded in Q2 as part of the deferred tax provision along with any impact on current taxes payable. Old tax Law New tax law Net taxable temporary difference $1,000 Tax rate 40% 35% Deferred tax liability $400 $350 How would the change in the income tax rate be accounted for in Q2?

Accounting for Income Taxes: Valuation Allowances

Assessing the Need for a Valuation Allowance

Recognition of a Valuation Allowance
When is a valuation allowance recognized? A valuation allowance is recognized when it is more likely than not (MLTN) that, based on available evidence, all or a portion of the deferred tax asset will not be realized.

More Likely than Not (MLTN) Criteria
+ Historical evidence of timely use of NOLs Long carry back/forward periods - Insignificant backlog on existing contracts Loss of a significant customer Recent Cumulative losses All available evidence, both positive and negative, that may affect the realizability of deferred tax assets should be identified and considered in determining the need for a valuation allowance.

How Much Valuation Allowance is Required

Sufficiency of the Valuation Allowance
How much valuation allowance is required? Deferred tax assets are realized by an entity by having sufficient taxable income to allow the related tax benefits to reduce taxes otherwise payable. Accordingly, the taxable income must be both of an appropriate character (e.g., capital versus ordinary) and within the carryback and carryforward periods permitted by law.

Possible Sources of Taxable Income
Future reversals of existing taxable temporary differences Taxable income in prior carryback years if carryback is permitted by the tax law Future taxable income exclusive of reversing temporary differences and carryforwards Tax-planning strategies ASC paragraph

Future Reversals of Existing Taxable Temporary Differences
What is the most common form of management documentation of reversals of existing taxable temporary differences? Which of the following procedures is purely subject to judgment? Determining the extent of scheduling required Selecting the scheduling method Determining the period in which the temporary differences reverse. A is the correct answer.

Future taxable income exclusive of reversing temporary differences and carryforwards
Not subject to the professional standard requirements on prospective information Consider future originating temporary differences Number of years to include in the estimate The least reliable source of evidence CHANGES FROM TMS VERSION: Removed text box asking “What substantive audit procedures would you perform to test the schedule of future taxable income?”

Taxable Income in Prior Carryback Years if Carryback Is Permitted by the Tax Law
Zero pretax book income in the future period in which the deferred tax asset reverses Allowed on the relevant jurisdiction’s tax law Consideration of dislodged credits Consideration of uncertain tax positions CHANGES FROM TMS VERSION: Removed the text box asking “What substantive audit procedures would you perform to test the realizability of deferred tax assets in carryback years?”

Tax-Planning Strategies
How can a tax-planning strategy be a source of taxable income? Examples: Accelerating, delaying or offsetting temporary differences Actions that impact future taxable income estimates

Tax-Planning Strategies (continued)
What is a qualifying tax- planning strategy? Is an action that: is prudent and feasible an entity ordinarily might not take, but has the intent and ability to take to prevent an operating loss or tax credit carryforward or other tax benefit from expiring unused, and would result in realization of deferred tax assets. CHANGES FROM TMS VERSION: Changed the text box asking “Does the entity have control over the actions that are necessary to implement the strategy?” to “Is there control over the actions that are necessary to implement the strategy?” Is there control over the actions that are necessary to implement the strategy?

Tax-Planning Strategies (continued)
+ Approach sustained in previous government audits The character of the offsetting amounts are similar Enables the realization of a tax benefit - The temporary difference may expire unused soon Not a popular approach within the industry Measurement The recognized tax benefit of a qualifying tax-planning strategy should be measured in accordance with the guidance for uncertain tax positions.

Accounting for Income Taxes: Intraperiod Allocations

What is Intraperiod Allocation of Income Taxes?
Continuing operations Intraperiod allocation is the process of allocating tax expense (benefit) to the following: Discontinued operations Extraordinary items Items recorded directly to shareholders equity Items recorded directly to other comprehensive income Overview Can you identify what items tax expense is allocated to?

General Rule and Exceptions to the General Rule

General Rule Step 1: Determine total income tax expense or benefit
Determine the income tax expense or benefit allocated to continuing operations Step 3: Allocate the remainder to the components other than continuing operations (discontinued operations, other comprehensive income, equity, etc.)

Continuing Operations
Tax effect of pretax income/loss from continuing operations +/- tax effects of: Changes in BOY valuation allowance (due to changes in expectations about realization in future years) Changes in tax laws or rates Changes in tax status Tax-deductible dividends paid to shareholders

Remaining Components Total tax expense Expense allocated to continuing operations Expense allocated to remaining components If two or more components, allocate to each item in proportion to their individual tax effects on total income tax expense or benefit. Use with-and-without approach where the tax effect is difference between total tax expense calculated without item and with the item. Guidelines apply when the sum of the tax effect of each item as computed using the with-and-without approach may not equal remaining amount of income tax expense or benefit after allocation of continuing operations.

Allocations When There Are Income And Loss Components
Step 1: Determine the total effect on income tax expense or benefit for all net loss items Step 2: Allocate the tax benefit determined in Step 1 ratably to each loss item Step 3: Calculate the difference between the amount allocated to all items other than continuing operations and remaining tax expense Step 4: Allocate the remaining tax expense determined in Step 3 above ratably to each net gain item

Exceptions to the General Rule
Change in tax status (ASC c) Tax deductible dividends paid to shareholders (ASC d) Change in tax law or rates (ASC b) Valuation assessment of losses from continuing operations (ASC ) Tax uncertainties acquired in a business combination. Changes in circumstances that cause a change in judgment about the realization of DTA’s in future years (ASC a)

Exercise 4-1 – Extraordinary Loss
Tax benefit allocated to continuing operations ($400) Tax benefit allocated to extraordinary loss ($400) Columbeana Coffee Roasters Balance sheet – 12/31/XX Deferred tax assets $0 Deferred tax liability $0 Income statement – 12/31/XX Loss from continuing operations $1,000 Extraordinary loss $1,000 Determine total tax expense and allocation of tax expense to continuing operations and the extraordinary loss.

Exercise 4-2 – Tax effect of change in tax rates
Dr. Deferred tax expense $10 Cr. Deferred tax liability $10 Made in China Clothing Corp– In an effort to discourage offshore manufacturing, an increased tax rate was passed for the retail industry. 1/1/XX unrealized gain on AFS securities $100 1/1/XX related deferred tax liability (40) Net of tax amount in OCI (equity) During the year, the tax rate increased from 40 to 50 percent! Determine the entry necessary to adjust the deferred tax liability for the change in tax rates.

Residual tax effects Arises when the effects of changes in tax laws or rates on DTA/DTL’s that were originally established in OCI causes the deferred tax effects residing in OCI to be different from the financial statement carrying amount of the related DTA/DTL. The method to release should be systematic, rational and consistently applied.

Other Matters

Interaction Between Intraperiod Tax Allocation and a Valuation Allowance
The intraperiod tax allocation of changes in the valuation allowance, as a result of current year operations, generally should follow the step-by-step approach. The effect of changes in BOY valuation allowance, which leads to a change in judgment about the realization of deferred tax assets in future years, should be included in income tax expense from continuing operations. Exceptions may apply CHANGES FROM TMS VERSION: Removed reference to KPMG’s Accounting for Income Taxes publication in last bullet

Exercise 4-3- Allocating a change in valuation allowance for existing deferred tax assets
Tax expense allocated to continuing operations $400 Tax benefit allocated to discontinued operations ($400) Jilly’s Jellybeans Tax expense on continuing operations generally determined without regard to other items Tax allocated to continuing operations $0 Tax allocated to discontinued operations $0 Assume the tax rate is 40% Balance sheet – 01/01/XX Deferred tax asset $800 Valuation allowance ($800) NOL carryforward at 1/1/XX $2,000 Income statement– 12/31/XX Inc. from cont. ops $1,000 Loss from disc. ops (1,000) Net income 0 Balance sheet – 12/31/XX Deferred tax asset $800 Valuation allowance ($800) CHANGES FROM TMS VERSION: Removed “audit consideration reminder” fly-over What would the allocation have been if there had been no valuation allowance at the beginning of the year? Determine total tax expense and allocation of tax expense to continuing operations and discontinued operations.

Exercise 4-4 Pharma Corp:
Year 1 tax expense: Inc. from continuing operations $1,000 Use of BOY carry forward ($1,000) No tax expense is allocated to continuing operations. The carryforward at the end of Year 1 now includes stock option deductions of $1,000. The tax benefit of those deductions should be credited to equity when realized through reduction of taxes payable. Pharma Corp: Stock option deductions in carryforwards generally the last benefits recognized Balance sheet – 1/1/X1 Deferred tax asset $800 Valuation allowance ($800) NOL carryforward at 1/1/X1 $2,000 NOL carryforward at 12/31/X1 $2,000 Stock option deductions in excess of book expense (1,000) Balance sheet – 12/31/X1 Deferred tax asset $400 Valuation allowance ($400) Income statement– 12/31/X1 Inc. from cont. ops $1,000 Determine tax expense and related journal entries for Year 1. (Refer to FASB for further guidance.)

Exercise 4-4 Pharma Corp:
Year 2 tax expense: Inc. from continuing operations $1,500 Use of remaining carry forward from operating loss ($1,000) Use of carryforward for stock option deductions ($500) Dr. Charge in lieu of taxes (expense) $200 Cr. Equity (APIC) $200 All of the remaining carryforward at the end of Year 2 relates to the stock option deductions and will be credited to equity when realized through reduction of taxes payable. Pharma Corp: Balance sheet – 1/1/X2 Deferred tax asset $400 Valuation allowance ($400) NOL carryforward at 1/1/X2 $2,000 NOL carryforward at 12/31/XX2 $500 Balance sheet – 12/31/X2 Deferred tax asset $0 Valuation allowance $0 Income statement– 12/31/X2 Inc. from cont. ops $1,500 Determine tax expense and related journal entries for Year 2. (Refer to FASB for further guidance.)

Exercise 4-5 – Release of valuation allowance
Dr. Valuation allowance $40 Cr. Deferred tax benefit (continuing operations) $40 Underwater Airlines (UA) – Projecting record profits and has determined a valuation allowance is no longer necessary. 1/1/XX unrealized loss on available for sale securities ($100) Related deferred tax asset $40 Valuation allowance ($40) Net tax amount in OCI (equity) ($100) Prepare an entry to reduce the valuation allowance.

Accounting for Income Taxes: Financial Statement Disclosures

Required Disclosures Accounting policy The total of:
All deferred tax liabilities and assets Any valuation allowance Nature of significant temporary differences Public companies required to include tax effect Tax refunds receivable and amounts currently payable Change in valuation allowance Facts and circumstances supporting realizability of deferred tax assets Investments in foreign subsidiaries Significant components of income tax expense allocated to continuing operations The disclosure of deferred tax assets or liabilities shall include total of all deferred tax liabilities, all deferred tax assets, and total valuation allowance recognized for the deferred tax assets. The net change in valuation allowance for the year also shall be disclosed. A public enterprise shall disclose the approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liability and deferred tax assets (before valuation allowance). A non public enterprise shall disclose the types of significant temporary differences and carryforwards but may omit the disclosure of the tax effects of each type. If an enterprise is not subject to income taxes because its income is taxed directly to its owners, that fact and the net difference between the tax basis and the reported amounts of the enterprise’s assets and liabilities shall be disclosed. When ever a deferred tax liability is not recognized because of an exception, for example areas addressed by APB Opinion 23, the enterprise shall disclose (1) a general description of the unrecognized deferred tax liability, (2) the types of events that would cause those temporary differences to become taxable, (3) the cumulative amount of each type of temporary difference not recognized, (4) the amount of the unrecognized deferred tax liability for foreign subsidiaries and foreign corporate joint ventures that are essentially permanent, and (5) the amount of the deferred tax liabilities for temporary differences not recognized because of other exceptions. The significant components of income tax expense attributable to continuing operations for each year presented shall be disclosed in the financial statements or the notes. Those components are listed in FASB ASC and include: current and deferred tax expense or benefit; benefits from NOLs; tax expense resulting from allocating tax benefits directly to equity or to goodwill or other noncurrent intangible assets; impact of a change in tax rates, law, or status; and adjustments to the beginning-of-the-year balance of a valuation allowance related to deferred tax assets expected to be utilized in future years.

Required Disclosures (Cont’d)
Amount of income tax expense or benefit allocated to continuing operations and other items Tax rate reconciliation Non-public companies a narrative of nature of significant reconciling items Amounts and expiration dates for NOL and other tax credit carryforwards Portion of valuation allowance for which subsequent recognition will result in an adjustment directly recorded to equity (Continued from previous slide) The amount of the income tax expense or benefit allocated to continuing operations and the amounts separately allocated to other items (such as equity, discontinued operations, etc.) shall be disclosed. A public enterprise shall disclose a reconciliation using percentage or dollar amounts of (a) the reported amount of income tax expense attributable to continuing operations for the year (b) the amount of income tax expense that would result from applying the domestic federal statutory tax rate to pretax income from continuing operations. A non public company shall disclosure the nature of the significant reconciling items but may omit a numerical reconciliation. An enterprise shall disclose the amounts and expiration dates of operating loss and tax credit carryforwards for tax purposes. Separately, the portion of the valuation allowance that will not be credited to income shall be disclosed. The valuation allowances being traced forward include those that if released will result in an adjustment to the purchase price allocation of a prior acquisition (by reducing goodwill or other noncurrent assets), or an adjustment to contributed capital (e.g. increases or decreases in contributed capital e.g. deductible expenses reported as reduction of proceeds from issuing capital). CHANGES FROM TMS VERSION: Within the last bullet, removed “to goodwill or other noncurrent intangible assets”

Required Disclosures (Cont’d)
Amount of investment tax credits and accounting policy Certain matters specific to stand-alone financial statement of an enterprise Cash paid for income taxes FASB ASC and 50-15A (FIN 48) disclosures Additional disclosures for public companies (Continued from previous slide) For the stand-alone financial statements of an enterprise that is a member of a consolidated group, disclosures include (a) the aggregate amount of current and deferred tax expense for each statement of earnings presented and the amount of any tax-related balances due to or from affiliates as of the date of each statement of financial position presented, and (b) the principal provisions of the method by which the consolidated amount of current and deferred tax expense is allocated to members of the group and the nature and effect of any changes in the method during the years for which the disclosures in (a) above are presented. Additional disclosures for public companies include: (a) nature of significant temporary differences, and (b) tax rate reconciliation as noted on previous slides. Plus (a) assumptions leading to the conclusion that deferred tax assets would be realized, (b) domestic and foreign components of pre-tax income (loss), (c) quantitative disclosure of uncertain tax positions and (d) other disclosures required by Regulation S-X, SAB’s, etc. Uncertain tax position disclosures were discussed earlier. Note public and non-public entities may have differences in uncertain tax position disclosures given the effective date deferral for non-public entities (FSP FIN 48-3) and the proposed relief for non-public entities of tabular reconciliation of unreconciled tax benefits and the effect the unrecognized tax benefits would have on the effective tax rate if they were recognized (as proposed in the FSP FIN 48-d). Refer to FASB ASC and 50-15A for disclosure requirements.

Financial Statement Presentation
Classification of current vs. noncurrent deferred tax assets and liabilities Allocation of valuation allowance on pro rata gross current and noncurrent deferred tax asset basis by jurisdiction Net presentation within a particular jurisdiction: Current deferred tax assets and liabilities Noncurrent deferred tax assets and liabilities Interest and penalties on uncertain tax positions Accounting policy decision Policy for interest may differ from penalties Interest income and expense policy must be same Balance sheet and cash flow presentation should be consistent Per FASB ASC and an enterprise shall separate deferred tax liabilities and assets into a current amount and noncurrent amount. The basis for classifying the DTL or DTA as current vs. noncurrent is determined by the related asset or liability for financial reporting unless there is no related asset or liability. If there is no related asset or liability, including deferred tax assets related to carryforwards, classification is according to the expected reversal date of the temporary difference. The valuation allowance for a particular tax jurisdiction shall be allocated on a pro rata basis between current and noncurrent deferred tax assets Per FASB ASC for a particular tax-paying component of an enterprise and within a particular tax jurisdiction (a) all current deferred tax liabilities and assets should be offset and presented as a single amount and (b) all noncurrent deferred tax liabilities and assets shall be offset and presented as a single amount. However, an enterprise shall not offset deferred tax liabilities and assets attributable to different tax-paying components of the enterprise or to different tax jurisdictions. Classification of Interest and Penalties on Uncertain Tax Positions. Classification of interest and penalties on the income statement represents an accounting policy decision that should be consistently applied. Interest may be classified as either income tax expense or interest expense; while penalties may be classified as either income tax expense or another appropriate expense classification (such as SG&A). While an enterprise may have differing policies for interest and penalties (for example, interest above the line and penalties below the line), an enterprise's classification policy for interest income (or the reversal of interest expense) on uncertain tax positions should be consistent with its policy for interest expense. If an enterprise's policy is to classify interest expense in tax expense, interest income should likewise be classified as part of tax expense. If an enterprise's policy is to classify interest on tax settlements in interest expense, interest income on tax settlements should likewise be classified as a reduction of interest expense or as interest income. Further, classification of interest and penalties on the balance sheet and the cash flow statement generally should be consistent with an enterprise's classification of interest and penalties on the income statement.

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Ashby T. Corum Partner Ashby T. Corum Partner Background
Ashby is the Partner-in-Charge of the Accounting for Income Tax group for KPMG’s Washington National Tax Practice. For over twelve years, Ashby has been devoted to resolving accounting for income tax and uncertainty in income tax issues for multinational companies. Professional and Industry Experience As the Partner-in-Charge of the Accounting for Income Tax group, Ashby oversees KPMG’s Washington National Tax Practice’s support of local office engagement teams, knowledge sharing around emerging issues, and the enhancement of firm training and external presentations on accounting for income taxes. Ashby also serves as the partner for selected tax review teams that assist KPMG’s audit practice. In addition, Ashby has lead income tax provision outsourcings and advised clients on GAAP conversions. Ashby has experience in accounting for income taxes under US GAAP, IFRS, and various other accounting standards. Ashby speaks frequently on accounting for income tax related topics. Prior to relocating to our Detroit office in 2003, Ashby was a member of KPMG’s International FAS 109 Group based in Paris, France. As a member of the group, he provided technical support regarding accounting for income tax and related SEC filing issues for non-North American SEC registrants. Ashby T. Corum Partner KPMG LLP 150 W. Jefferson Suite 1900 Detroit, MI Tel Cell Function and Specialization Partner-in-Charge of the Accounting for Income Tax Group in KPMG’s Washington National Tax Practice. Education, Licenses & Certifications BS, University of Kentucky Certified Public Accountant, Kentucky & Michigan

Jenna L. Summer Tax Senior Manager
Background Jenna Summer is a senior manager in KPMG’s Tax Services practice in Detroit. Jenna has been with KPMG over eight years and specializes in accounting for income taxes under both US GAAP and IFRS in addition to general tax compliance and consulting. Professional and Industry Experience Jenna provides services to public and non-public domestic and multinational clients in a variety of industries, including, but not limited to, the following activities: Income Tax Provision Preparation and Review under both US GAAP and IFRS Accounting for Income Taxes on Carve-out Financial Statements Accounting for Income Taxes on IFRS Conversions Federal Income Tax Compliance including taxable and nontaxable entities and foreign informational returns Federal Income Tax Consulting including transaction tax issues and business restructuring Jenna L. Summer Senior Manager KPMG LLP 150 W. Jefferson Suite 1900 Detroit, MI Tel Cell Function and Specialization Jenna is a member of the tax practice with a technical focus on accounting for income taxes Education, Licenses & Certifications BS in BA in Accounting, Central Michigan University Masters of Science in Taxation, Grand Valley State University Certified Public Accountant

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