1. Income Tax Accounting SFAS 109 (ASC 740-10)

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

3. Objectives of ASC 740-10 Recognize:
The amount of taxes payable or refundable for the current year
2. Deferred tax liabilities and assets for the future tax consequences of events that have been recognized in a company’s financial statements or tax returns

4. Basic Principles
A current tax liability or asset is recognized for the estimated taxes payable or refundable on tax returns for the current year
A deferred tax liability or asset is recognized for estimated future taxes created by temporary differences
The measurement of current and deferred taxes is based on the provisions of the enacted tax law
Measurement of deferred tax assets is reduced if they will not be recognized.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

42. Cases

43. Cases – Deferred Tax Calculation
Net Deferred Tax (Liability) Asset: Net taxable temporary differences- state (294,000) (163,000) State Rate 8% 8% Net state deferred tax liability (23,520) (13,040) Net taxable temporary differences - federal (294,000) (163,000) Less state deferred tax 23,520 13,040 (270,480) (149,960) Federal Rate 28% 26% Net Federal deferred tax (liability) asset (75,734) (38,990)

44. Cases – Current Provision
State Federal
Pretax Income 3,200, ,200,000
Less State Taxes (134,480)
Schedule M-1 adjustments:
Key-Man Life Insurance (1,500,000) (1,500,000)
Tax-Exempt Interest (150,000) (150,000)
Dividends Received Deduction (40,000)
Change in Temporary Differences 131, ,000
Taxable Income ,681, ,506,520
Tax Rate % % Current Tax Expense , ,695

45. Cases - Provision
Summary of Total Tax Provision (Benefit) Current Tax Provision Federal 391,695 State 134,480 Total 526,175 Deferred Tax Provision Federal (36,744) State (10,480) Total (47,224) Total Tax Provision 478,951

46. Cases – Rate Reconciliation
The reasons for the difference between income taxes computed by applying the statutory federal income tax rate and income tax expense in the financial statements are:
Statutory Rate , %
State taxes, net of federal tax benefit 91, %
Key-man life insurance (390,000) (12.19)%
Tax-exempt interest ( 39,000) (1.22)%
Dividends Received Deduction ( 10,400) ( .32)%
Change in of tax rate ( 5,409) ( .17)%
Effective tax rate , %

47. Cases – Balance Sheet Presentation
Deferred income tax assets and liabilities consist of the following: Deferred income tax assets: Inventories 17,000 Bad Debts 73,100 Pension Costs 35,700 Restructuring Reserve 39,100 Deferred Compensation 17,000 Provincial Taxes 3,390 Gross Deferred Tax Asset 185,290 Deferred income tax liabilities: Depreciation 237,320 Deferred Tax Liability 52,030

48. True-Ups
During the provision work, a comparison is performed to identify any differences between the numbers used in last year’s tax provision and the amounts used on the tax return. The differences are “trued up” as part of the tax provision preparation process for the succeeding year.

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

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

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

52. True Up Process - Example
Per Provision
Per Return
Difference
Pre-Tax Book Income
$1,000,000 $0
Excess Tax Depreciation
(300,000)
(350,000)
(50,000)
Accrued Liabilities
40,000
50,0000
10,000
Bad Debt Allowance
80,000
75,000
(5,000)
UNICAP Adjustment
25,000
35,000
Meals & Entertainment
50,000
(10,000)
Taxable Income
$895,000
$850,000
$(45,000)
What is the adjustment that is needed?

53. True Up Process - Example
What is the adjustment that is needed?
Dr Income taxes payable $18,000
Cr Current income tax expense $ 4,000
Cr Deferred income tax liability $14,000 53 53

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

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

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

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

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

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

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

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

62. Scope of FIN 48 (ASC 740-10) Applies to all income tax positions
A tax position is defined as a position taken in a previously filed return or expected to be taken in a future return
A position can result in a permanent reduction of taxes (permanent differences), a deferral of taxes (temporary differences), or a change in the expected realizability of deferred tax assets
FIN 48 also encompasses decisions not to file an income tax return, jurisdictional allocations (i.e., transfer pricing) and characterization of income

63. FIN 48 (ASC )
Recognition criteria focuses primarily on technical tax law
“Widely understood” administrative procedures considered
Each position assessed separately
Detection risk not considered

64. Highly Certain Tax Positions
FIN 48 applies to all income tax positions
Distinguishes between “highly certain” and “uncertain” tax positions
Highly certain tax positions
Clearly meets the MLTN recognition standard and greater than 50% likely that 100% of benefit will be sustained based on clear and unambiguous tax law

65. FIN 48 (ASC 740-10) Introduces concept of “Unit of Account”
Based on facts and circumstances
Aggregate or
Separate each project

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

84. Changes Caused by FIN 48 (ASC 740-10)
Must reexamine:
Non-income based taxes
Planning and controls
Regulations S-K and MD & A disclosures
Implementation of other new accounting standards 84 84

85. Interest and Penalties
Interest is a period cost
Interest accrual is based upon the difference between the amount of tax benefit recognized in the financial statements and the amount recognized in the tax return
Accrue statutory penalties when a tax position does not meet the minimum statutory threshold required to avoid penalties
Consider administrative practices and precedents of the tax authority 85 85

86. Interest and Penalties
Tax law provisions that address interest and penalties may vary between jurisdictions, periods
Classification of interest and penalties is an accounting policy election 86 86

87. Other Related Topics

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

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

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

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

92. Methods Of Accounting For Investments
COST
EQUITY
CONSOLIDATION

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

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

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

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

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

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

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

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

101. SFAS 123R
SFAS 123R applies to all transactions involving the issuance by a company of its own equity in exchange for goods or services
Currently SFAS 123R does not apply to share- based payment transactions with non- employees or ESOPs.

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

103. Compensation Expense
Compensation expense will be recognized over the requisite service period
How the compensation is recorded depends on the vesting schedule
Cliff Vesting
Graded Vesting

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

132. Cases – Rate Reconciliation
The reasons for the difference between income taxes computed by applying the statutory federal income tax rate and income tax expense in the financial statements are:
Statutory Rate , %
State taxes, net of federal tax benefit 91, %
Key-man life insurance (390,000) (12.19)%
Tax-exempt interest ( 39,000) (1.22)%
Dividends Received Deduction ( 10,400) ( .32)%
Change in of tax rate ( 5,409) ( .17)%
Effective tax rate , %
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