accounting for income taxes detroit tei conference june 5, 2013

Accounting for Income Taxes

DETROIT TEI CONFERENCEJUNE 5, 2013

© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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.

2


Tax Executives Institute, Inc. – Detroit ChapterAccounting for Income Taxes ForumJune 5, 2013

3

Presenters: KPMG LLPAshby Corum,Jenna Summer,MC: Michelle Weil

Time Topic CPE 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 740-10-25)

80 Min

10:00 a.m. – 10:20 a.m. Break

10:20 a.m. – 11:00 a.m.Accounting for Uncertainty in Income Taxes – FIN 48(FASB ASC 740-10-25), 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)

60 Min

Inbound Focus:

IFRS – High Level Overview

(Breakout Option 2)

60 Min

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. Break

2:55 p.m. – 3:25 p.m. Valuation Allowance Considerations 30 Min

3:25 p.m. – 4:15 p.m. Intraperiod Allocations and Disclosures 40 Min

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

Current Tax Provision Deferred Tax Provision

+/- =Based on Tax Return

(Amount owed to Government)

Current Income Tax Expense/Benefit

Based on Change in Deferred Tax Assets

and Liabilities (BOY to EOY)

Deferred Income Tax Expense/Benefit

Total Income Tax Expense/Benefit

Income Tax Provision

5

© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 6

Current Tax Provision

Pretax financial (book) income+ Nondeductible items- Nontaxable items+/- Temporary differencesCurrent taxable incomex Enacted tax rate

Current income tax expense


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

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

Permanent Differences

7

Common examples (not all inclusive)


Temporary Differences – Example 1

Deductible Taxable

Allowance for uncollectible accounts receivableIf

Not allowed for tax purposes until charged-off

8



Deductible Taxable

Property, plant, and equipmentIf

Straight line depreciation method for books and accelerated depreciation method for tax return

(NBV exceeds NTV)

9



Deductible Taxable


Impairment recognized in books on assets not disposed

10



Deductible Taxable


Recorded at FV and FV > original cost

11



Deductible Taxable

Accrued compensationIf

Such accruals are not deductible for tax purposes until paid

12



Deductible Taxable

Deferred revenueIf

Can’t be deferred for tax purposes

13


Temporary Differences – Specific Application

14

Exceptions to the Recognition of Temporary Differences

• Investment in Domestic and Foreign Subsidiaries (upon meeting specific criteria)

• Excess Book Goodwill• Intercompany Transactions


Recognition of Deferred Taxes

15

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.

Deferred Tax Assets

The deferred tax consequences attributable

to deductible temporary differences

Deferred Tax Liabilities

The deferred tax consequences attributable

to taxable temporary differences


Beginning Current Ending Tax DTA/(DTL)Assets and Liabilities – U.S. Taxes Balances Activity Balance Rate S/T L/T

Deferred tax assetsAllowance for uncollectible A/R 350 150 500 35% 175 - Inventory valuation allowance 125 25 150 35% 53 - Accrued vacation 650 55 705 35% 247 - Impairment - Building 400 - 400 20% - 80

Sub-total 1,525 230 1,755 474 80

Deferred tax liabilitiesPrepaid pension cost (1,250) 250 (1,000) 35% (52) (298)

Net 422 (218)

Measurement of Deferred Taxes

16

Basic roll-forward schedule of deferred taxes


Beginning Current Ending Tax DTA/(DTL)Assets and Liabilities Balances Activity Balance Rate S/T L/T

Deferred tax assetsAllowance for uncollectible A/R 350 150 500 35% 175 - Inventory valuation allowance 125 25 150 35% 53 - Accrued vacation 650 55 705 35% 247 - Impairment - Building 400 - 400 20% - 80

Sub-total 1,525 230 1,755 474 80

Deferred tax liabilitiesPrepaid pension cost (1,250) 250 (1,000) 35% (52) (298)

Net 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 80

Deferred tax liabilities

Prepaid pension cost (53) (298)

Net DTA Current 422 (218)

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 80

Deferred tax liabilities

Prepaid pension cost (52) (298)

Net DTL Long-Term 422 (218)

Balance Sheet Presentation

17


Tax Rate Reconciliation

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:

CONSOLIDATED INCOME BEFORE TAXES 117,715,457

TOTAL TAX EXPENSE 44,951,136

EFFECTIVE TAX RATE 38.19%

Temporary differences do not result in reconciling items in

this analysis.

Accounting for Uncertainty in Income

Taxes


Definition of a Tax Position

ASC 740-10-20 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)


Accounting for Uncertainty in Income Taxes

ASC Topic 740-10:− 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

23

• Identify tax positionsStep 1:

• Determine the appropriate unit of accountStep 2:

• Determine if each tax position meets the recognition thresholdsStep 3:

• MeasurementStep 4:

• Recognize liability (or reduce asset)Step 5:

• Determine balance sheet classification Step 6:

• Calculate interest and penaltiesStep 7:

• DisclosuresStep 8:


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



25










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.

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

Based on this scenario, what is a possible unit of account and what is the possible impact to recognition of the

benefit?



28










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


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

Based on this scenario, is it possible for this tax position meet the MLTN recognition threshold?

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.


Recognition: Administrative Practices and Precedents (continued)

Based on this scenario, is it possible for this tax position meet the MLTN recognition threshold?

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.

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.



32










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

Possible Benefit Outcome Probability of Outcome

Cumulative Probability of

Outcome

$100 (complete success in litigation, or settlement with IRS) 10% 10%

$80 (very favorable compromise) 20% 30%$60 (fair compromise) 25% 55%$40 (unfavorable compromise) 30% 85%$0 (total loss) 15% 100%

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:

Based on this scenario, what is the amount of tax benefit that should be recognized?


Measurement: Scenario Debrief

Possible Benefit OutcomeProbability

of Successful

Cumulative Probability of

Success

$100 (complete success in litigation, or settlement with IRS) 10% 10%

$80 (very favorable compromise) 20% 30%

$60 (fair compromise) 25% 55%

$40 (unfavorable compromise) 30% 85%

$0 (total loss) 15% 100%

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:

$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)


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.

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.

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.


Derecognition of Tax PositionsBased 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 meritsEffectively 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 740-10


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



54










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.

Recognize liability (or reduce asset): Indirect

Effects


Indirect Effects

A FASB ASC 740-10 (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


Presentation

A FASB ASC 740-10 (FIN 48) credit can result in indirect effects which require consideration− Utilization of existing operating loss carryforwards

Net presentation

FASB ASC 740-10 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


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?

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 2008 deduction)


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 jurisdictionHow 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.


62

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 2013-01 – February 21, 2013

EITF Issue 13-C, Presentation of a Liability for an Unrecognized Tax Benefit When a Net Operating Loss or Tax Credit Carryforward Exists


63

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.

EITF Issue 13-C, Presentation of a Liability for an Unrecognized Tax Benefit When a Net Operating Loss or Tax Credit Carryforward Exists (continued)


64

Disclosure There are no incremental disclosures proposed in the Draft

Abstract. However, entities should apply the disclosure requirements from

ASC 250-10-50 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.

EITF Issue 13-C, Presentation of a Liability for an Unrecognized Tax Benefit When a Net Operating Loss or Tax Credit Carryforward Exists (continued)



65










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



67










Interest and Penalties

Consultation with experts on this subject may be appropriate

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


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



70










Disclosure RequirementsQuantitative (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 RequirementsQualitative (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 madeDescription of open tax years by major jurisdiction.

Accounting for Tax Effects:Business Combinations


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

7474


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 BasisTaxable (Deductible)

Temporary DifferenceCurrent assets $300,000 $350,000 $(50,000)

Property, plant, and equipment 800,000 400,000 400,000

Liabilities, excluding warranty reserve and deferred taxes

(200,000) (200,000) 0

Warranty reserve (100,000) 0 (100,000)

Identifiable net assets acquired $800,000 $550,000 $250,000

75


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

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 740-30 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

77


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

7878


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

79


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

80


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

81


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)

82


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 $ 600 800

Goodwill and Deferred Taxes

8383

* The excess of tax goodwill over financial reporting goodwill before taking into consideration the tax benefit associated with goodwill

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


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

84

Final Goodwill TableBook Tax

Component 1 $ 467 467Component 2 – 333Total Goodwill $ 467 800


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

8585


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 805-740-25-8 and 25-9 and ASC 805-740-55-9 through 55-13) for Component 2 tax goodwill arising from pre-141R (FASB ASC 805) acquisitions for which no deferred tax asset exists

86


Deferred Taxes and Acquisition Costsin 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

consummatedTwo alternatives to account for deferred tax effects of

acquisition costs incurred in the pre-combination period (see next slides)

87


Deferred Taxes and Acquisition Costsin 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

88

Pre-Combination PeriodLikelihood of consummation Expected Not-ExpectedTaxable Recognized a DTA Recognized a DTANon-Taxable Recognize a DTA only if

expected to be recognized in the foreseeable future (outside tax basis)

Recognized a DTA (presuming the costs will be deductible if the transaction isn’t consummated)


Deferred Taxes and Acquisition Costsin 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)

89

Upon ConsummationTaxable DTA recognized in pre-combination period remains on the

booksNon-Taxable Write-off DTA recognized in pre-combination period,

unless DTA is expected to be recognized in the foreseeable future (outside tax basis)


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

90


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%

91


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:

Example: Contingent Consideration—Taxable Business Combination (Cont’d)

92

DR. DTA $25CR. Goodwill$25

Tax goodwill $100Earn-out 8Adjusted tax goodwill $108


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

93


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

recognizedFASB ASC 805-740-25-10

94

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

Inside/Outside Basis Differences


Inside Basis vs. Outside Basis

Inside Basis Differences

: Arise from

differences between the financi

al statem

ent carryin

g amounts and

tax basis of a

subsidiary’s (both domestic and foreign

) assets

and liabiliti

es.

Outside

Basis Differences

: Arise from

difference

between the financi

al statem

ent carryin

g amount and

the tax basis of the parent compa

ny’s basis of the investment in the stock of the

subsidiary

Represents temporary differences for which

deferred taxes should be recognized.

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 DifferencesInvestments 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 DifferencesInvestments in Subsidiaries (continued)

Those basis differences may result in future taxable or deductible amounts when:1. dividends are paid to the parent company by the

subsidiary; 2. the parent company sells the stock of the subsidiary; 3. the subsidiary is liquidated; or 4. the subsidiary is merged into the parent company.

Investment in Subsidiaries and Equity

Method Investments


Investments in SubsidiariesExceptions 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 1. Whether the subsidiary is domestic or foreign, 2. The provisions of the applicable tax law, and 3. 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 SubsidiariesDetermining 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

U.S. Parent owns German Subsidiary, German Subsidiary owns French Subsidiary 1 and French Subsidiary 1 owns French Subsidiary 2.

US Parent

German Subsidiary

French Subsidiary

1

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 740-30, 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.



French Subsidiary 1 is a foreign subsidiary to German Subsidiary

The provisions of ASC Topic 740 and ASC Subtopic 740-30 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.

Is the French subsidiary 1 considered to be a foreign or domestic subsidiary to German

subsidiary?US Parent

German Subsidiary

French Subsidiary

1

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 740-30 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.

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?


Investments in SubsidiariesDomestic 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 SubsidiariesDomestic 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 SubsidiariesDomestic 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 SubsidiariesOutside 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 differencesA taxable outside basis difference associated with a foreign subsidiary is essentially permanent in duration if the indefinite reversal criterion of ASC paragraph 740-30-25-17 is met. Criterion includes:• Plan to re-invest indefinitely• Remitted in a tax free manner• Will not reverse in foreseeable future


Investments in Foreign SubsidiariesOutside 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. •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 740-30-25-17 conditions are met) then the ASC paragraph 740-30-25-17 exception may apply to investments in foreign VIEs.

Consolidated Variable Interest Entities (VIEs)


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 SubsidiariesExcess 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 740-30-25-18(b)

Essentially permanent in duration exception – FASB ASC 740-30-25-18(a)

DTA prohibited, unless “apparent” test met. (FASB ASC 740-30-25-9)

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 investeeOutside 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 740-30-25-17 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


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 2,300Liabilities 800 920

Stockholders’ equity:

Common stock 1,000 1,000

Retained earnings 200 220

Cumulative translation adjustment 0 160

Total equity 1,200 1,380

Total liabilities and equity 2,000 2,300

118


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 740-20-55-18 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

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 740-20-55-18 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

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


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


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


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


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


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


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


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 740-10-25-40 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 740-10-30-14 provides that under the circumstances in ASC 740-10-25-40, the entity shall measure the tax effects of temporary differences using the undistributed rate

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


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


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

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 740-30-25-18). 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


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

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


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


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


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

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


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


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”)


Measurement of tax benefitsPossible outcome

of benefitsIndividual

probability (%)Cumulative

probability (%) Weighted average$1,000 35 35 350

800 20 55 160

100 30 85 30

0 15 100 0

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

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)


U.S. GAAP

− ASC 718-740 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


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


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


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

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 740-20


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.


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 12.63 for examples)

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

Accounting for Income Taxes in Interim

Periods

General Rule and Overview of Interim Period Calculations

161


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

163


What is the estimated annual effective tax rate?

Can you identify what items are excluded in the calculation?

The estimated annual effective tax rate is the

ratio of estimated annual income tax expense to

estimated pretax ordinary income and

thus excludes:

Extraordinary items

Discontinued operations

Cumulative effects of changes in accounting

principles

Significant unusual or infrequent items reported

separately or reported net of their related tax effect


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 FORECASTSWhat are some other instances in which income can not be

reliably estimated?

Translating foreign currency financial statements

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.

For example, depreciation may be translated at historical rates while transactions in income are translated at current period average rates.

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


Application of Estimated Annual Effective Tax Rate

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.

Calculated

YTD tax

expense

Tax expens

e recorde

d in prior

interim periods

Current Quarter

Tax Expens

e


Estimated Annual Effective Tax Rate Scenario

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 $500Tax exempt income $100

Temporary differences:Depreciation expense $100Reserves $300

Tax credits $30

In this scenario, what would net current tax (for purposes of calculating the estimated annual effective tax rate) be?

Answer: $610Pretax 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.


Application of Estimated AnnualEffective Tax Rate Scenario




Tax credits $30

Wetzel’s Windmills estimated current tax is $610.

In this scenario, what is the estimated current tax rate?

In this scenario, what is the estimated deferred tax rate?

Answer: $610 estimated current tax / pretax income of $1,000 = 61%

Answer: Net timing difference of $200 ($300-$100) multiplied by 40% = $80 tax effected net timing differenceDivided by pretax income of $1,000Estimated deferred tax rate of 8.0%

Estimated Annual

Effective Rate is

53%


Application of Estimated AnnualEffective Tax Rate Scenario continued




Tax credits $30

If Q1 income is $200, what is the tax provision?

If Q2 income is $300, what is the Q2 tax provision?

Answer: $200 X 53% = $106

Answer: YTD Income of $500 X 53% = $265Less: tax expense recorded in Q1 $106Q2 tax expense $159

Tax Effect of Losses on the Interim Period

Calculation

174


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.


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:A. The estimated tax benefit of the expected ordinary loss for

the yearB. The estimated annual effective tax rate andC. 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

• Recognize as part of the estimated annual effective tax rate in the period the event occurs

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

Made in America Auto Co. (MIAA)Deferred tax asset (DTA) $10,000Valuation allowance $10,000

How should MIAA account for this change in valuation allowance?

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.

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.


Examples of discrete and non-discrete items

Discrete itemsDisqualifying 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)

* 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


Changes in Tax Laws or Rates Scenario

Old tax Law

New tax law

Net taxable temporary difference

$1,000 $1,000

Tax rate 40% 35%Deferred tax liability $400 $350

A federal income tax rate change was enacted in Q2:

How would the change in the income tax rate be accounted for 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.

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

+ -

189

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

192

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 740-10-30-18


Future Reversals of Existing Taxable Temporary Differences

193

What is the most common form of management documentation of reversals of existing taxable

temporary differences?

A is the correct answer.

Which of the following procedures is purely subject to judgment?

A. Determining the extent of scheduling requiredB. Selecting the scheduling methodC. Determining the period in which the temporary

differences reverse.


Future taxable income exclusive of reversing temporary differences and carryforwards

194

Not subject to the professional standard requirements on prospective information

Consider future originating temporary differencesNumber of years to include in the estimate The least reliable source of evidence


Taxable Income in Prior Carryback Years if Carryback Is Permitted by the Tax Law

195

Zero pretax book income in the future period in which the deferred tax asset reverses

Allowed on the relevant jurisdiction’s tax lawConsideration of dislodged creditsConsideration of uncertain tax positions


Tax-Planning Strategies

196

Examples:Accelerating,

delaying or offsetting temporary differences

Actions that impact future taxable income estimates

How can a tax-planning strategy be a source of taxable income?


Tax-Planning Strategies (continued)

197

Is an action that:(a) is prudent and feasible(b) 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

(c) would result in realization of deferred tax assets.

What is a qualifying tax-planning strategy?

Is there control over the actions that are necessary to implement the strategy?


Tax-Planning Strategies (continued)

+ -

198

The recognized tax benefit of a qualifying tax-planning strategy should be measured in accordance with the guidance for uncertain tax positions.

Measurement

Accounting for Income Taxes: Intraperiod

Allocations


What is Intraperiod Allocation of Income Taxes?

Can you identify what items tax expense is allocated to?

Intraperiod allocation is the process of allocating tax expense (benefit) to

the following:

Continuing operations

Discontinued operations

Extraordinary items

Items recorded directly to shareholders equity

Items recorded directly to other comprehensive income

General Rule and Exceptions to the

General Rule


General Rule

Step 1:

• Determine total income tax expense or benefit

Step 2:

• 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

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.

Total tax

expense

Expense

allocated to

remaining

components


Allocations When There Are Income And Loss Components

• Determine the total effect on income tax expense or benefit for all net loss items

Step 1:

• Allocate the tax benefit determined in Step 1 ratably to each loss item Step 2:

• Calculate the difference between the amount allocated to all items other than continuing operations and remaining tax expense

Step 3:

• Allocate the remaining tax expense determined in Step 3 above ratably to each net gain item

Step 4:


Exceptions to the General Rule

Change in tax status (ASC 740-20-45-8c)

Tax deductible dividends paid to shareholders (ASC 740-20-45-8d)

Change in tax law or rates (ASC 740-20-45-8b)

Valuation assessment of losses from continuing

operations (ASC 740-20-45-7)

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 740-20-45-8a)


Exercise 4-1 – Extraordinary Loss

Columbeana Coffee Roasters

Income statement – 12/31/XXLoss from continuing operations $1,000Extraordinary loss $1,000

Balance sheet – 12/31/XXDeferred tax assets $0Deferred tax liability $0

Determine total tax expense and allocation of tax expense to continuing operations and the extraordinary loss.

Tax benefit allocated to continuing operations ($400)

Tax benefit allocated to extraordinary loss ($400)


Exercise 4-2 – Tax effect of change in tax rates

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 $1001/1/XX related deferred tax liability (40)Net of tax amount in OCI (equity) 60

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.

Dr. Deferred tax expense $10 Cr. Deferred tax liability $10


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


Exercise 4-3- Allocating a change in valuation allowance for existing deferred tax assetsJilly’s Jellybeans

− Tax expense on continuing operations generally determined without regard to other items

Balance sheet – 01/01/XXDeferred tax asset $800Valuation allowance ($800)

Income statement– 12/31/XXInc. from cont. ops $1,000Loss from disc. ops (1,000)Net income 0

Balance sheet – 12/31/XXDeferred tax asset $800Valuation allowance ($800)

NOL carryforward at 1/1/XX$2,000

Determine total tax expense and allocation of tax expense to continuing operations and discontinued operations.

Assume the tax rate is 40%

Tax allocated to continuing operations $0Tax allocated to discontinued operations

$0

What would the allocation have been if there had been no valuation allowance at the beginning of the year?

Tax expense allocated to continuing operations $400

Tax benefit allocated to discontinued operations ($400)


Exercise 4-4

Pharma Corp:− Stock option deductions

in carryforwards generally the last benefits recognized

Balance sheet – 1/1/X1Deferred tax asset $800Valuation allowance ($800)


NOL carryforward at 1/1/X1 $2,000NOL carryforward at 12/31/X1 $2,000Stock option deductions in excess of book expense (1,000)

Income statement– 12/31/X1Inc. from cont. ops $1,000

Determine tax expense and related journal entries for Year 1.(Refer to FASB 718-740-25-10 for further guidance.)

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.


Exercise 4-4

Pharma Corp:


Balance sheet – 12/31/X2Deferred tax asset $0Valuation allowance $0

NOL carryforward at 1/1/X2 $2,000NOL carryforward at 12/31/XX2 $500

Income statement– 12/31/X2Inc. from cont. ops $1,500

Determine tax expense and related journal entries for Year 2.(Refer to FASB 718-740-25-10 for further guidance.)

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.


Exercise 4-5 – Release of valuation allowance

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.

Dr. Valuation allowance $40 Cr. Deferred tax benefit

(continuing operations) $40

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

217


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 itemsAmounts and expiration dates for NOL and other tax

credit carryforwardsPortion of valuation allowance for which subsequent

recognition will result in an adjustment directly recorded to equity

218


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 taxesFASB ASC 740-10-50-15 and 50-15A (FIN 48)

disclosuresAdditional disclosures for public companies

219


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

220

Questions?

Your KPMG LLPPresenters

© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.

Ashby T. CorumPartner

BackgroundAshby 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 ExperienceAs 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. CorumPartner

KPMG LLP150 W. JeffersonSuite 1900Detroit, MI 48226

Tel 313-230-3361Cell [email protected]

Function and SpecializationPartner-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

© 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.

Jenna L. SummerTax Senior Manager

BackgroundJenna 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 ExperienceJenna 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. SummerSenior Manager

KPMG LLP150 W. JeffersonSuite 1900Detroit, MI 48226

Tel 313-230-3345Cell [email protected]

Function and SpecializationJenna 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

Reception

accounting for income taxes detroit tei conference june 5, 2013

Documents

kpmg llpashby corum

income taxes fin

swiss entity

income taxes forumjune

tax treatment

tax adviser

tax analyses

tax opinions