1. FAS 109 and the International Financial Reporting Rules
Chicago Tax Club
June 26, 2008

2. Presenters Rick Bodnum – Partner, Deloitte Tax LLP, Chicago
Maggie Zellers – Partner, Deloitte Tax LLP, Chicago
Jon Oleksyk – Partner, Deloitte Tax LLP, Chicago
Joe Fahndrich – Manager, Deloitte Tax LLP, Chicago

3. Keep in Mind
The views expressed do not necessarily represent Deloitte & Touche LLP or Deloitte Tax LLP policy
The outcome of any specific matter depends upon the specific facts and circumstances in which the matter arises
The views expressed cannot be relied upon as accounting or tax advice
Check with a qualified advisor before taking any action
Standard caveat slide. The goal of this session is not to provide you with accounting advice but to help you identify issues.
Financial Statements are the responsibility of management and we want to help you be in a position to identify issues and talk them through.

4. FAS 109: A Reminder on Why it Matters

5. Why it Matters – Example (Facts)
Mr. Bigbucks wants to purchase Without 109 Corporation.
He reviews the balance sheet of Without 109 Corporation and offers to purchase the company from Mr. Seller for its net book value of $400.
The offer is accepted.
Without 109 Corporation never implemented FAS 109.
Fixed Assets
$1,000
Bank Loan
$ 600
______
Equity
400
Total
$ 1,000
Additional Facts:
Assume the tax rate is 40%
The tax basis of fixed assets if $0 due to accelerated depreciation.

6. Why it Matters – Example (Facts – cont.)
The day after the purchase is complete, Mr. Bigbucks decides to sell all the fixed assets for $1,000 (the net book value).
He expects to use the proceeds to repay the bank loan and have $400 to buy inventory.
His accountant informs him he will need to use the remaining $400 to pay the taxes resulting from the $1,000 gain on sale of the fixed assets.
Mr. Bigbucks calls Mr. Seller and claims that the financial statements of Without 109 Corporation were incorrect and he will be hearing from his attorney, F. Lee Fasbey.
He believes he should have been able to sell all the assets of the company at book value, pay all the liabilities and have cash remaining after the sale equal to equity.
Instead, all the assets are sold and no net cash is remaining.
You are Mr. Bigbuck’s consultant.
Briefly explain what is missing from the financial statements.

7. Why it Matters – Example (Basis Difference)
Book
Tax
Book > Tax
Fixed assets
$1,000
$ 0
Tax rate
40%
Deferred tax liability required, not recorded
$ 400
Journal Entry:
Deferred Tax Expense $ 400
Deferred Tax Liability $ 400

8. Why it matters – Example (Solution)
The book basis of the fixed assets of Without 109 Corporation are $1,000 higher than the tax basis.
The financial statements of Without 109 Corporation are missing deferred taxes.
The future tax liability of $400 associated with the tax gain in excess of the book gain needs to be recorded on the financial statements, and equity needs to be reduced to zero. This liability should have been accrued as the accelerated depreciation was taken with the offsetting debits to deferred tax expense.
The revised balance sheet is shown below:
Fixed Assets
$ 1,000
Bank Loan
$ 600
Deferred Taxes
400
Equity
Total
$ 1,000

9. FAS 141(R)

10. Considerations – Business Combinations
When does it matter?
When you acquire a business
What matters?
Is the acquisition taxable or non-taxable
Why does it matter?
To correctly state the company’s deferred balances

11. General Accounting Rules
APB No. 16, Business Combinations
SFAS No. 109, Accounting for Income Taxes
SFAS No. 141, Business Combinations
SFAS No. 141R, Business Combinations
effective for years beginning after 12/15/2008
SFAS No. 142, Goodwill and Other Intangible Assets

12. SFAS 109 Guidance Business Combinations – ¶30 Appendix A – ¶127- ¶138
Appendix B
Business Combinations – ¶259
Nontaxable Business Combinations – ¶260
Taxable Business Combination – ¶261 and ¶262
Carryforwards – Purchase Method – ¶264 – ¶267
Subsequent Recognition of Carryforward Benefits – Purchase Method – ¶268 and ¶269
Exceptions – ¶9(d)

13. SFAS 141(R) Fundamental principles of the acquisition method
Recognition principle - The acquirer recognizes all of the assets acquired and all of the liabilities assumed
Measurement principle - The acquirer measures each recognized asset acquired and each liability assumed and any non-controlling interest at its acquisition date fair value
Notable exceptions include deferred tax assets and liabilities, unrecognized tax benefits and related indemnities
Effective date
Fiscal years beginning after December 15, 2008
Transition
Prospective application for transactions consummated after the effective date, with an exception for two of the several changes related to income taxes
Future adjustments to income tax recognition, measurement, and changes in valuation allowances include amounts related to transactions consummated before the adoption of Statement 141(R) 13

14. New FAS 109 ¶30
The effect of a change in a valuation allowance for an acquired entity’s deferred tax asset shall be recognized as follows:
a. Changes within the measurement period that result from new information about facts and circumstances that existed at the acquisition date shall be recognized through a corresponding adjustment to goodwill. However, once goodwill is reduced to zero, an acquirer shall recognize any additional decrease in the valuation allowance as a bargain purchase in accordance with paragraphs 36–38 of Statement 141(R).
b. All other changes shall be reported as a reduction or increase to income tax expense (or a direct adjustment to contributed capital as required by paragraph 26).

15. FAS 141(R) – Business Combinations

16. Measurement Period

17. FAS 141(R) – Tax Basis Uncertainties and Release of VA
77. For business combinations in which the acquisition date was before the effective date of this Statement, the acquirer shall apply the requirements of Statement 109, as amended by this Statement, prospectively. That is, the acquirer shall not adjust the accounting for prior business combinations for previously recognized changes in acquired tax uncertainties or previously recognized changes in the valuation allowance for acquired deferred tax assets. However, after the effective date of this Statement:
The acquirer shall recognize, as an adjustment to income tax expense (or a direct adjustment to contributed capital in accordance with paragraph 26 of Statement 109), changes in the valuation allowance for acquired deferred tax assets. 1
b. The acquirer shall recognize changes in the acquired income tax positions in accordance with Interpretation 48, as amended by this Statement. 2
1 Par. 30/37/268/43 of FAS 109 modified
2 EITF 93-7 nullified

18. Valuation Allowances Under SFAS 141(R)
Current GAAP
Increases to valuation allowances after acquisition are generally charged to tax expense
Decreases to valuation allowances after acquisition (or actual usage on tax return):
First, reduce goodwill to zero
Second, reduce other intangible assets to zero
Third, reduce income tax expense
SFAS 141(R)
Increases to valuation allowances treated the same as under current GAAP
Decreases to valuation allowances after acquisition are now recorded as a reduction to tax expense
Changes in tax uncertainties and valuation allowances are recorded in the income statement (discrete items for interim reporting purposes)

19. Example - Valuation Allowances
Assumptions
Company A acquires Company Z in 2005
At the date of acquisition, a $100,000 valuation allowance is established for an acquired entity’s tax benefits
Goodwill of $200,000 is also recorded at acquisition
The following changes in the valuation allowance are reported:
$40,000 reduction in 2006
$30,000 increase in 2007
Questions:
#1 What is the entry to record the change in 2006?
#2 What is the entry to record the change in 2007?
#3 How would this change under FAS 141R?

20. Example – Valuation Allowances (Solution)
Question #1 – Journal Entry:
DR Valuation Allowance
$ 40,000
CR Goodwill
Question #2 – Journal Entry:
DR Income Tax Expense
$ 30,000
CR Valuation Allowance

21. Example – Valuation Allowances (Solution)
Question #3 – Journal Entry:
DR Valuation Allowance
$ 40,000
CR Income Tax Expense
DR Income Tax Expense
$ 30,000
CR Valuation Allowance

22. Uncertain Tax Positions – Prior to FAS 141(R)
Uncertain tax positions are accrued as part of opening balance sheet (under FIN 48) and must be specifically tracked
Increases after acquisition date go to goodwill
Decreases:
Reduce goodwill to zero
Reduce other noncurrent intangibles recorded in acquisition to zero
Finally, go to income statement
Changes should not impact tax expense

23. EITF 93-7
Under existing rules, changes in an acquired entity’s deferred tax assets and uncertain tax position balances are generally recorded through goodwill, regardless of whether such changes occur during the allocation period or thereafter. For example:
On January 15, 2007, Company X acquired 100 percent of Company Y. As part of the purchase accounting, X recognized a liability associated with an uncertain tax position.
DR Goodwill
$ 2,000
CR FIN 48 Payable
On February 2, 2008, X increased the liability to reflect a change in its best estimate of the ultimate settlement with the taxing authority. In accordance with EITF 93-7, X recorded this adjustment as an increase to goodwill.
$ 800

24. SFAS 141(R)
Statement 141(R) requires that any adjustments to an acquired entity’s deferred tax assets and uncertain tax position balances that occur after the initial determination to be recorded as a component of income tax expense.
On January 15, 2007, Company X acquired 100 percent of Company Y. As part of the purchase accounting, X recognized a liability associated with an uncertain tax position.
DR Goodwill
$ 2,000
CR FIN 48 Payable
On February 2, 2009 (assumed post-measurement period under SFAS 141(R)), X increased the liability to reflect a additional change in its best estimate of the ultimate settlement with the taxing authority. In accordance with SFAS 141(R), X recorded this adjustment as a component of income tax expense.
DR Income Tax Expense
$ 800

25. Components of Goodwill
If there are differences between the book and tax basis of the first component of goodwill in future years, a temporary difference is created and a deferred tax liability or asset is recognized
However, no deferred tax asset or liability is created for the second or “remainder” component (¶262)
If the remainder component is tax deductible in future periods (i.e., tax deductible goodwill > book goodwill), when the tax benefit is realized on tax return it:
First, reduces financial reporting goodwill to zero
Second, reduces other noncurrent intangible assets to zero
Third, reduces income tax expense

26. Purchase Accounting

27. Goodwill DTA – FAS 141(R)
Deferred tax assets should be recognized as part of the acquisition accounting if tax deductible goodwill exceeds goodwill recorded as part of the acquisition accounting.
Setting up DTA requires a simultaneous equation because goodwill is a residual asset for financial reporting (example in ¶263)

28. Business Combinations - Transaction Costs
Transaction Costs Capitalized Expensed
Under FAS 141, there commonly was a purchase accounting question related to “what to do” with the tax benefit related to transaction costs deducted for tax but capitalized for book (with tax usually being able to deduct a subset of the total).
Under FAS 141(R), purchase accounting question will be how to do tax accounting for amounts expensed for book but potentially capitalized for tax into either Section 197 or stock basis – (the problem is the opposite of the historical problem)

29. Business Combinations – Transaction Costs: Initial Thought
Prior to Closing
DTA is recognized in periods prior to close since the closing of a transaction should not be contemplated (no transaction = “busted transaction” = full deduction)
At Closing
Bad perm (DTA w/o) if carryover basis transaction for tax (Par. 34 is the issue with “retaining” DTA since it now pertains to an outside basis difference)
No provision consequence from “closing” if a transaction results in a step-up for tax – the DTA would “attach” to corresponding Section 197 cost that would be treated as having an origin related to continuing operations (vs. being an acquired basis difference affecting G/W)

30. Best Practices and Challenges

31. Computing the Provision – 10 Steps
Identify permanent and temporary differences
Compute current payable or receivable
Compute return to accrual adjustments
Analyze deferred taxes and compute deferred tax expense or benefit
Account for uncertainties
Analyze the need for valuation allowances
Compute total income tax expense or benefit
Reconcile tax accounts and record journal entries
Prepare rate reconciliation
Prepare financial statement disclosures
Note: The 10-steps are on a jurisdiction-by-jurisdiction basis.

32. Fundamentals to Remember
Accounting for the tax consequences of a transaction or event in the same period that it is recognized in the enterprise’s financial statements
Compute the tax provision by enterprise and by jurisdiction
Jurisdictions include federal, state and international or non-US
Assess recognition and measurement of FIN 48 uncertain tax positions (FIN 48)
Current provision is the liability expected on the current year tax return adjusted for any return to accrual adjustment and the impact of FIN 48
Deferred provision is the change in deferred tax assets and liabilities
Not necessarily able to measure change based on the balances shown on the balance sheet
The deferred provision in continuing operations is not exactly as simple as the change in deferred tax items due to intra-period allocations of expense to equity or OCI.

33. Fundamentals to Remember (cont.)
Deferred tax assets and liabilities
Recognize a deferred tax asset for future deductible amounts and loss or credit carryforwards
Recognize a deferred tax liability for future taxable amounts
Measure deferred tax assets and liabilities using the applicable enacted tax rates
Measure at the rate expected to apply when the temporary difference reverses
Effects of future changes in tax laws or rates are not considered
Reduce deferred tax assets to the amount “more likely than not” to be realized with a valuation allowance (contra-asset account)
Assume all temporary differences result in a deferred tax asset or liability and then determine if an exception applies
Income Tax is key to remember.
Maryland – Enacted new rate last year applicable to next year. My current taxes will be based on current rates and deferred taxes based on future rates enacted today.
US - The president signs it and you are done.
Mexico – Be careful because in other countries the president’s signature doesn’t necessarily cause an “enactment” there are other events that have to occur.

34. FAS 109: The Balance Sheet Approach
Compute the current tax asset or liability (estimating the current year tax return)
Same process as preparing the tax return
Compute the deferred tax asset or liability on the difference between the book and tax basis of assets and liabilities and tax attributes and carryforwards
Deferred tax is the future expected tax effect of temporary differences and carry forwards
Adjust the general ledger accounts to computed balances
Analyze the existing tax accounts, compute the total provision and adjust balances in all accounts to provision calculations
Measurement is based upon enacted tax laws and rates
Comprehensive liability approach considering future operations
The tax rate used is the statutory tax rate for the period expected to turn. It has to be enacted, but based on enacted rates you do look to future tax rates. We have seen a lot of foreign rate changes in the past year for which this impacts registrants. 34

35. Balance Sheet Approach to Tax Provision
Current Taxes
Deferred Taxes
Tax Provision
Rec’vble
Payable
Asset
Liability
Current
Deferred
Beginning
Ending
…get the balance sheet correct and …..
Reiterate - FAS 109 is a balance sheet approach. Get away from the tax return P&L approach to a balance sheet approach. First get your current payable/receivable, then based on book/tax basis differences get your deferred items right and the tax expense/benefits falls out.
…. the P&L falls out 35

36. Tax Software Objectives
Streamline the tax provision process
Strengthen controls and reporting
Plan for changes in accounting regulations and ease their impact on your organization
Reallocate resources to tax matters strategic to your business
Integrate finance, provision, and compliance systems
Improve tax risk management procedures

37. FAS 109 Process Implementation/Process
While a provision software system is designed to provide better functionality, a company will still need to make sure of the following:
Implementation
Data Collection Process is efficient/complete
Validate Data/Prior year data is input correctly
System/report functions are designed specifically for the company
Controls
Company has process to identify and obtain necessary information that will be input into system.
Current year data is input correctly.
Failure to do this will result in a company that will continue to have difficulty with their provision process.

38. Software Selection FAS109 software selection
While a majority of companies use Excel, there has been a large shift to Provision software systems.
TaxStream is the leader in the provision software system market at approximately 20% of the market.
Key Driver (besides Market Ownership) – Tax Return System

39. IFRS Tax Update

40. Agenda IFRS overview Overview of IFRS/US GAAP accounting differences
IFRS/FAS 109 differences

41. IFRS Overview

42. IFRS – Overview
IFRS (International Financial Reporting Standards) is a set of established accounting standards promulgated by the London-based International Accounting Standards Board (IASB) that is gaining accelerated use on a worldwide basis
Key characteristics of IFRS:
Principals-based approach that places greater emphasis on interpretation and application of principles, with a particular focus on the spirit of the principle being applied
The standards necessitate the assessment of the substance of transactions and an evaluation of whether the accounting presentation reflects the economic reality
There is renewed focus on the need for professional judgment in arriving at accounting conclusions
Greater use of fair value as a measurement basis placing emphasis on obtaining reliable measurements

43. The SEC and FASB initiated a process that will likely culminate in the transition from US GAAP to IFRS
Global Fortune 500
IFRS is quickly gaining worldwide acceptance
as a global standard for financial reporting
Today
Used in over 100 countries and by approximately 40% of the Global Fortune 500
Required for listing companies across all EU countries, starting in 2005
Adoption date announced by large countries like Brazil, Canada, and India
Tomorrow
Expected that all major countries will have adopted IFRS to some extent by 2011
Convergence of Japan will be substantially completed
Substantial majority of Global Fortune 500 will report under IFRS
U.S. public companies will likely have the option of using either IFRS or US GAAP by 2011
As this graph illustrates, migration to IFRS is much more prominent than to US GAAP 43 43

44. Regulatory Developments
Considerable movement towards mutual recognition of financial reporting frameworks between the US and the EU
Recent SEC developments
Elimination of US GAAP reconciliation for Foreign Private Issuers using IFRS effective 12/31/07 year ends
Concept release allowing US companies a choice of IFRS is gathering support

45. IFRS Hierarchy
In absence of a Standard or Interpretation that specifically applies to a transactions management should use its judgment and consider the applicability of the following sources in descending order
IASB Standards and Interpretations
IASB Framework
Other standard setting bodies with similar conceptual framework (e.g. U.S. GAAP)

46. A “Principle-Based” Approach
No longer simply understanding the “rules”
Will need to focus more on…
The “substance” of transactions
Evaluate whether the accounting presentation reflects the “economic reality”
Renewed focus on use of professional judgment
Comparability versus uniformity

47. Differences between IFRS
and FAS 109

48. IFRS Tax Literature IAS 12, Income Taxes
Originally effective 1 January 1998
Revised in 1999 and 2000
Amended by IFRS 2, Share-based payments
To be amended further to reflect convergence issues
SIC 21, Income Taxes – Recovery of Revalued Non-Depreciable Assets
SIC 25, Income Taxes – Changes in the Tax Status of an Enterprise or its Shareholders
There is significantly more guidance on accounting for income taxes under US GAAP than IFRS

49. Tax Accounting Convergence Key Concepts
Approach between the two accounting standards is similar
Comprehensive asset/liability approach
Deferred tax provided on all temporary differences
Measured at enacted tax rates
Tax assets reduced to ‘more likely than not’ recoverable
Many differences come from differences in underlying accounting – not tax accounting
e.g. Share-based payments
Some differences appear minor and only realised in careful reading of the applicable pronouncements

50. Tax Accounting Convergence
Tax accounting convergence – latest news:
The FASB is still grappling with a decision on the planned August exposure draft and the decision of whether to issue a revised SFAS 109 or an amended form of IAS 12.
It also remains uncertain how FIN 48 will factor into the new guidance. Currently, it appears, FIN 48 will remain in US GAAP and the IASB plans to amend IAS 37 soon to provide rules regarding the disclosure of uncertainties relating to income tax.

51. IFRS Uncertain Tax Positions
IFRS currently:
IAS 37 requires accrual where liability is “probable” and “quantifiable”
Interest and penalties are excluded from income tax expense
IFRS may not go to a FIN 48 model…
Wait and see mode until exposure draft is released

52. Tax Accounting Convergence Enacted vs Substantively Enacted Tax Rates
Which tax rate?
SFAS 109: Enacted tax rate
IAS 12: Enacted or “substantively” enacted
Substantively enacted would be the stage of passing law where further stages are administrative (eg in the UK, this would be passing of a bill in parliament rather than signing by the Queen)
Convergence:
Both boards have agreed that substantial enactment for operations in non-US jurisdictions but “enacted” for operations within the USA. IASB will clarify that “substantial enactment” means that future steps in the enactment process will not change the outcome

53. Tax Accounting Convergence Intercompany Transfers of Assets
The sale of an asset between tax jurisdictions is a taxable event that establishes a new tax base for the asset in the buyer’s tax jurisdiction. The new tax base is deductible on the buyer’s tax return as the asset is sold outside the group or consumed.
Difference
IFRS
Provide tax on temporary difference (i.e. at buyer’s tax rate)
US GAAP
follows ARB 51
Can apply to intra-group sales, transfers and distribution whereby tax basis of the asset changes as a result of the transfer
Defer all tax paid by seller and reverse any deferred tax consequences
Prohibits recognition of a deferred tax asset for tax base difference between the jurisdictions
Result is that deferred taxes are recognised at seller’s tax rate on temporary difference before sale (as if sale had not occurred)
Boards’ decision
FASB has agreed to amend SFAS 109 to eliminate this exception.

54. Tax Accounting Convergence Foreign Non-Monetary Assets and Liabilities
Difference
US GAAP exempts deferred tax arising from retranslation of assets and liabilities from local currency to functional currency as a result of changes in exchange rates
No exemption under IAS 12
Boards’ decision
FASB will remove exemption

55. Tax Accounting Convergence Definition of Tax Base
Difference
No definition of tax base in US GAAP
Dependent on the expected manner of recovery under IFRS
Boards’ decision
Both boards are proposing to adopt a new joint definition of tax base
Tax base of an asset determined as amount deductible if asset were to be sold for carrying value at balance sheet date
‘Management intention’ principle to be removed

56. Tax Accounting Convergence Balance Sheet Classifications
Difference
IFRS
DTAs not recognised unless ‘probable’ that they will be realized
All deferred tax assets and liabilities classified as non-current under IAS 12
US GAAP
Recognise all DTAs and record valuation allowance if more likely than not that DTA will not be recognised
DTA/DTLs must be split between current and non-current
Boards’ decision
IASB will adopt SFAS109 reporting requirements and asset recognition approach
IASB has agreed that “probable” means “more likely than not” and will add explanation to IAS 12
Considerations
May require changes to process, software, and general ledger accounts

57. Tax Accounting Convergence ‘Unremitted Earnings’
More correctly – Investments in subsidiaries, branches and associates, and interests in joint ventures…
Differences
Exemption under IAS 12 from recognizing deferred tax on temporary differences on unremitted earnings if parent can control timing of reversal and probable that difference will not reverse in foreseeable future
SFAS109 prohibits recognition of a DTL for excess of financial reporting over tax base that is ‘permanent’ in nature
Boards’ decision
IASB to move to US GAAP wording for exemption

58. Tax Accounting Convergence Changes to Disclosure Requirements
Disclosures required by one standard and not the other will be adopted by both, including:
Separate disclosure in tax charge for adjustments in respect of prior year items (SFAS 109 will adopt)
Disclosure of amounts and basis for allocation of DTA/DTLs between members of a group that files a consolidated tax return (IAS 12 will adopt)
Disclosure of income tax consequences of payment of a dividend where income is taxed differently if distributed
Additional new disclosures to be adopted by both, including:
Disclosures relating to intercompany transfers of assets
Considerations
May require changes to process, software, and general ledger accounts

59. Tax Accounting Convergence Initial Recognition Exemption
Difference
IAS 12 prohibits recognition of deferred tax arising on initial acquisition of an asset or liability in certain circumstances
Under IAS 12 no subsequent movements in these positions are recognised
No equivalent under SFAS109
Boards’ decision
IASB will eliminate exemption
All assets fair valued on initial recognition and deferred tax recognized on differences between FV and tax base
Resulting DTA/DTL included in calculation of purchase discount allowance

60. Tax Accounting Convergence Intra-period Allocations / Backwards Tracing
Both IAS 12 and FAS 109 require tax on items taken to equity in the current year to be allocated to equity. However, standards differ on current year deferred tax related to an item taken to equity in an earlier period
SFAS 109: Changes to DTAs/DTLs originally recorded in equity may be allocated to income from continuing operations subject to intraperiod tax allocation rules
Changes to VA due to change in circumstance about realizability
Changes in tax law/rate
IAS 12: Any changes to a DTA/DTL originally recorded in equity are also recorded to equity except in exceptional circumstances.
Convergence: IASB will amend IAS 12 to adopt the intraperiod allocation requirements similar to those contained in SFAS 109.

61. Convergence Decisions - Summary US GAAP Changes
Intra-group transfers to buyer’s tax rate
Measurement of deferred tax on translation of foreign non-monetary assets and liabilities
Additional disclosure requirements
Substantively enacted tax rates in foreign jurisdictions

62. Convergence Decisions - Summary IFRS Changes
Adopt SFAS 109 approach to deferred tax assets
Define probable as more likely than not
Record valuation allowance when not realisable
B/S classification – current vs non-current
Define tax base – amount that would be realised on sale/disposition
Delete initial recognition exemption for asset acquisition
Exemptions from recognizing deferred tax on unremitted earnings
Allocation of tax to P&L vs equity
Additional disclosure requirements