Income Tax Accounting

SFAS 109 (ASC 740-10)

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

Objectives of ASC 740-10

Recognize:
1. The amount of taxes payable or refundable for the current year

2. Deferred tax liabilities and assets for the future tax

consequences of events that have been recognized in a
companys financial statements or tax returns

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

Components of Income Tax Expense

Current income tax expense (benefit)

+ Deferred income tax expense (benefit)

Total income tax expense (benefit)

Balance Sheet Approach

SFAS 109 requires the balance sheet approach to compute
deferred taxes

To compute the expense you must compare the beginning

balance to the ending balance

Balance Sheet Approach

Beg of Year

End of Year

Expense/
Benefit

Effect on Net
Income

Net DTA

Larger DTA

Benefit

Increase

Net DTA

Smaller DTA

Expense

Decrease

Net DTA

DTL

Expense

Decrease

Net DTL

Larger DTL

Expense

Decrease

Net DTL

Smaller DTL

Benefit

Increase

Net DTL

DTA

Benefit

Increase

ASC 740-10 Applicability

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

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

History of Accounting for Income Taxes

The basic formula under APB 11 was:
Pretax income
+/- Permanent Differences
Taxable Income
X Tax Rate
Tax Provision

10

History of Accounting for Income Taxes

FASB 96
Issued in 1996
Used the Liability Method
Required extensive scheduling
Assumed co. would have not future income
11

History of Accounting for Income Taxes

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

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

13

Types of Temporary Differences

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

Types of Temporary Differences

ASSETS

LIABILITIES

AssetsLiabilitiesTaxab Book carrying value >

le temporary
tax basis
difference (TTD)

Tax basis > book

carrying value

Deductible temporary
difference (DTD)

Book carrying value >

tax basis

15

Tax basis > book

carrying value

Types of Temporary Differences

Current / Prior Periods Future Periods
(Generally)
Taxable temporary
difference (TTD)

Book income > taxable

income

Taxable income > book

income

Deductible temporary
difference (DTD)

Taxable income > book

income

Book income > taxable

income

16

Types of Taxable Temporary Differences

Revenue or gain that are taxable after they are
recognized in book income.
Ex. Installment Sales
Expenses or losses that are deductible before they are
recognized in book income.
Ex. Depreciation

17

Types of Deductible Temporary

Differences
Revenue or gains that are taxable before they are
recognized in book income.
Ex. Prepaid Income

Expenses or losses that are deductible after they are

recognized in book income.
Ex. Reserves
NOLs and credit carryforwards
18

Calculation of the Balance of a

Temporary Difference
Calculation of Temporary Difference:
Calculated Book Basis
- Calculated Tax Basis
Total Temporary Difference

19

Deferred Tax Provision Five Step

Process
1. Estimate the applicable tax rate
2. Determine the gross deferred tax liability
3. Determine the gross deferred tax asset
4. Determine the gross deferred tax asset for credit
carryforwards
5. Record a valuation allowance, if necessary

20

Tax Rates Used

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

21

Deferred Tax Liability

DTL = Taxable temporary differences X applicable tax rate

22

Deferred Tax Asset

DTA = [(Deductible temporary differences + loss and

deduction carryforwards) X applicable federal rate] +
tax credit carryforwards.

23

Deferred Tax Expense/Benefit

Net DTA or DTL at end of year

Less: Net DTA or DTL at beginning of year
Deferred income tax expense (benefit)

24

Effect of Change in Net DTA or DTL

Change in Net DTA / DTL

Result

Decrease in net DTA

Deferred income tax expense

Increase in net DTL

Deferred income tax expense

Increase in net DTA

Deferred income tax benefit

Decrease in net DTL

Deferred income tax benefit

25

Exception to the General Rule

APB 23 Permanently reinvested earnings in a

foreign subsidiary

26

Valuation Allowance
Impairment Approach
A valuation allowance is required if the deferred tax
asset is impaired

Realization Test
A probability level of more than 50%
A single criterion more likely than not

Future Taxable Income is Required

27

Future Taxable Income

Future reversals of existing taxable temporary

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

28

Tax Planning Strategies

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

Tax Planning Strategies

Sale of operating assets
Change of inventory method
Elect out of the installment method
Elect the alternative depreciation system

30

Positive and Negative Evidence

Negative Evidence
Cumulative losses
History of expiring tax
benefits
Expectation of future losses
Unsettled circumstances
Brief carryback or
carryforward period
31

Positive Evidence
Existing contracts or
sales backlog
Appreciated asset
value over tax basis
Strong earnings
history

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

32

Valuation Allowance - Change

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

33

Valuation Allowance - Change

CHANGE IN JUDGMENT ABOUT REALIZABILITY

Affects Current Quarter If For Future Years

Affects Remaining Interim Periods If For Future

Interim Periods

34

Valuation Allowance Change at

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

Tax Effect of a Change in Tax Law

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

36

Change in Tax Law or Tax Rate

CURRENT

TAX EXPENSE
Calculate New ETR
Apply New ETR To Year-To-Date Income
Cumulative Catch-Up Adjustment

DEFERRED

37

TAX EXPENSE
Apply New Tax Rate to Deferred Tax Accounts
Impact of Change in Deferred Taxes Affects Quarter of
Enactment

Current Tax liability

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

38

Expected Current Tax Provision

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

Permanent Differences
Permanent Differences arise from income that is
permanently nontaxable and expense items are
permanently nondeductible.

Another way of saying it:

Permanent differences are items that impact either the
financial statements or the tax return but not the other

40

Examples of Permanent Differences

50% of Meal and Entertainment
Fines and Penalties
Officers Life Insurance Premiums and Proceeds
Municipal Bond Interest
Dividends Received Deduction

41

Cases

42

Cases Deferred Tax Calculation

Net Deferred Tax (Liability) Asset:
Net taxable temporary differences- state
State Rate

2008
(294,000)
8%

2009
(163,000)
8%

Net state deferred tax liability

(23,520)

(13,040)

Net taxable temporary differences - federal

(294,000)

(163,000)

23,520

13,040

(270,480)

(149,960)

Less state deferred tax

Federal Rate
Net Federal deferred tax (liability) asset
43

28%

26%

(75,734)

(38,990)

Cases Current Provision

State
Pretax Income

3,200,000

Less State Taxes

Federal
3,200,000
(134,480)

Schedule M-1 adjustments:

Key-Man Life Insurance
Tax-Exempt Interest

(1,500,000)

(1,500,000)

(150,000)

(150,000)

Dividends Received Deduction

Change in Temporary Differences
Taxable Income
Tax Rate
Current Tax Expense
44

(40,000)
131,000

131,000

1,681,000

1,506,520

8%
134,480

26%
391,695

Cases - Provision
Summary of Total Tax Provision (Benefit)
Current Tax Provision
Federal

391,695

State

134,480

Total

526,175

Deferred Tax Provision

Federal

(36,744)

State

(10,480)

Total
Total Tax Provision
45

(47,224)
478,951

Cases Rate Reconciliation

The reasons for the difference between income taxes
computed by applying the statutory federal income tax rate
and income tax expense in the financial statements are:
Statutory Rate

832,000

26.00%

State taxes, net of federal tax benefit

91,760

2.87%

Key-man life insurance

(390,000)

(12.19)%

Tax-exempt interest

( 39,000)

(1.22)%

Dividends Received Deduction

( 10,400)

( .32)%

Change in of tax rate

( 5,409)

( .17)%

Effective tax rate

478,951

14.97%

46

Cases Balance Sheet Presentation

Deferred income tax assets and liabilities consist of the following:
Deferred income tax assets:
Inventories

17,000

Bad Debts

73,100

Pension Costs

35,700

Restructuring Reserve

39,100

Deferred Compensation

17,000

Provincial Taxes

3,390

Gross Deferred Tax Asset

185,290

Deferred income tax liabilities:

Depreciation
Deferred
Tax Liability
47

237,320
52,030

True-Ups
During the provision work, a comparison is
performed to identify any differences between the
numbers used in last years tax provision and the
amounts used on the tax return.

The differences are trued up as part of the tax

provision preparation process for the succeeding
year.
48

True Up Process

49

Type of Difference

True-Up Process

Permanent

Adjust current income tax expense in

succeeding year to reflect impact of
discrepancy on amount of tax paid in
prior year

Temporary

Adjust deferred income tax

asset/liability in succeeding year to
reflect impact of discrepancy on
amount of tax paid in prior year

True Up Process

Temporary
Difference

50

End of Year
20X1

True Up

Beginning
Year 20X2

True Up Process - Example

For 20X9, its initial year of operations, Gamma

Corporation reported current income tax expense
of $358,000 and deferred income tax expense of
$62,000, i.e., total income tax expense of
$420,000. (A 40% tax rate was used in all
computations.) A reconciliation of Gammas 20X9
tax provision to its 20X9 income tax return is as
follows:
51

True Up Process - Example

Per Provision
Pre-Tax Book Income

Per Return

Difference

$1,000,000

$1,000,000

$0

(300,000)

(350,000)

(50,000)

Accrued Liabilities

40,000

50,0000

10,000

Bad Debt Allowance

80,000

75,000

(5,000)

UNICAP Adjustment

25,000

35,000

10,000

Meals & Entertainment

50,000

40,000

(10,000)

$895,000

$850,000

$(45,000)

Excess Tax Depreciation

Taxable Income

What is the adjustment that is needed?

52

True Up Process - Example

What is the adjustment that is needed?
Dr
Cr
Cr

53

Income taxes payable

$18,000
Current income tax expense
Deferred income tax liability

$ 4,000
$14,000

Uncertain Tax Positions

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

54

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

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

56

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

57

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

58

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

FIN 48 (ASC 740-10)

Released July 13, 2006
Benefit Recognition Approach
More likely than not threshold
Cumulative Probability
60

Objectives of FIN 48 (ASC 740-10)

Clarify accounting for income taxes
Provide greater consistency in criteria used to
recognize, derecognize, and measure benefits
related to income taxes
Establish consistent thresholds, thereby improving
relevance and comparability of financial statement
reporting
61

Scope of FIN 48 (ASC 740-10)

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

FIN 48 (ASC 740-10)

Recognition criteria focuses primarily on
technical tax law
Widely understood administrative
procedures considered
Each position assessed separately
Detection risk not considered
63

Highly Certain Tax Positions

FIN 48 applies to all income tax positions
Distinguishes between highly certain and
uncertain tax positions

Highly certain tax positions

Clearly meets the MLTN recognition standard
and greater than 50% likely that 100% of benefit
will be sustained based on clear and
unambiguous tax law
64

FIN 48 (ASC 740-10)

Introduces concept of Unit of Account
Based on facts and circumstances
Aggregate or
Separate each project

65

Unit of Account
The appropriate unit of account for a tax position is a
matter of judgment and requires consideration of
The manner in which the enterprise prepares and
supports its income tax return, and
The approach the enterprise anticipates the taxing
authority will take during an examination

Once established, should be consistently applied to

similar positions from period to period unless change
in facts and circumstances indicates that a different
unit of account is more appropriate
66

Two Step Process

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

Step 1: Initial Recognition

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

Step 2: Measurement
A tax position that meets the MLTN recognition
threshold shall initially and subsequently be
measured as the largest amount of tax benefit that
is greater than 50% likely of being realized
(cumulative probability concept)

69

Based upon facts and circumstances determined at

the reporting date

Step 2: Measurement
Differences related to timing (deduction itself is not in
question)
Recognition threshold is achieved

Not all tax positions require detailed consideration of

possible outcome amounts and percentage
likelihood associated with each amount (cumulative
probability approach)
70

Example Step 1
A company takes a deduction that creates a tax
benefit of $100. How likely of being sustained on
technical merit must the deduction be before the
company can record the benefit?

71

Under the first step the position must be more

than 50% likely of being sustained on its
technical merit to take the benefit. The
amount that should be recognized will depend
on the cumulative probability in the second
step.

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

72

Example Step 2
Amount of tax benefit

73

% Likelihood will be
sustained

Cumulative
Probability

$100

30%

30%

$80

10%

40%

$60

15%

55%

$30

25%

80%

$20

20%

100%

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

74

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

75

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

Sources of New Information

Developments in the audit
Revenue Agents report
Changes in the law
Notice of Proposed Adjustment
Experience in prior audits
APA
Taxing authority program changes
Public statements by tax authority
77

Balance Sheet Presentation

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

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

79

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

80

Disclosure Requirements
FIN 48 requires additional footnote disclosure
including:

81

An annual reconciliation of unrecognized tax benefits on

an aggregated world-wise basis
Gross amount of increases or decreases relating to
prior period positions
Gross amount of increases or decreases relating to
the current period
Amounts of decreases relating to settlements with
taxing authorities
Reductions due to expiration of
statute of limitations

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

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

Estimate of the range of the change

Changes Caused by FIN 48 (ASC 74010)

Must reexamine:
Non-income based taxes
Planning and controls
Regulations S-K and MD & A disclosures
Implementation of other new accounting
standards
84

Interest and Penalties

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

85

Consider administrative practices and

precedents of the tax authority

Interest and Penalties

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

86

Other Related Topics

Application of ASC 740-10 to Foreign

Subsidiaries
MEASURE TEMPORARY DIFFERENCES SEPARATELY
FOR EACH FOREIGN SUBSIDIARY

U.S. GAAP v. TAX BASIS UNDER FOREIGN LAW

VALUATION ALLOWANCES DETERMINED IN LIGHT OF

FOREIGN LAW

REVIEW UNCERTAIN FOREIGN TAX POSITIONS

Application of ASC 740-10 to Foreign

Branches
BRANCH

INCOME SUBJECT TO BOTH FOREIGN

AND US TAX

ADDITIONAL

SET OF TEMPORARY DIFFERENCES

US GAAP vs. US Tax

US

TAX RECORDED NET OF US FOREIGN TAX

CREDIT

TAX

POSTURE OF US HEAD OFFICE RELEVANT IN

DETERMINING NEED FOR VALUATION ALLOWANCE

Inside Basis Temporary Difference

FAS

109 APPLIES TO DIFFERENCES IN FINANCIAL REPORTING

CARRYING VALUE AND TAX BASIS OF FOREIGN SUBSIDIARIES
ASSETS (i.e., INSIDE BASIS)

MEASURE

TEMPORARY DIFFERENCES SEPARATELY FOR EACH

FOREIGN SUBSIDIARY

US

GAAP vs. TAX BASIS UNDER FOREIGN LAW

VALUATION

LAW

ALLOWANCES DETERMINED IN LIGHT OF FOREIGN

Outside Basis Temporary Difference

THE DIFFERENCE BETWEEN THE

FINANCIAL REPORTING AMOUNT AND THE
TAX BASIS OF THE INVESTMENT ON THE
INVESTORS FINANCIAL STATEMENTS.

Methods Of Accounting For Investments

COST

EQUITY

CONSOLIDATION

Cost Method Of Accounting

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

Cost Method Of Accounting - Continued

A DEFERRED TAX LIABILITY IS RECOGNIZED FOR
AN EXCESS OF THE AMOUNT FOR FINANCIAL
REPORTING OVER THE TAX BASIS OF AN
INVESTMENT IN A LESS-THAN-20-PERCENT-OWNED
FOREIGN INVESTEE.

A DEFERRED TAX ASSET IS RECOGNIZED FOR AN

EXCESS TAX BASIS OVER THE AMOUNT FOR
FINANCIAL REPORTING OF AN INVESTMENT IN A
LESS-THAN-20-PERCENT-OWNED FOREIGN
INVESTEE.

Equity Method Of Accounting

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

Equity Method - Continued

INVESTMENT ORIGINALLY RECORDED AT THE COST
OF SHARES ACQUIRED.
INVESTMENTS CARRYING AMOUNT IS INCREASED OR
DECREASED BY THE INVESTORS PROPORTIONATE
SHARE OF EARNINGS OR LOSSES AND DECREASED
BY ALL DIVIDENDS RECEIVED.
REVENUE CONSISTS OF THE INVESTORS
PROPORTIONATE SHARE OF EARNINGS AND
AMORTIZATION OF ANY PURCHASED
PREMIUM.

Equity Method - Continued

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

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

APB 23 (ASC 740-30) Exception vs.

Election
Not an election
Exception applies if the specific facts and
circumstances warrant
Based on a companys ability and intent to
control the reversal of a taxable temporary
difference (i.e. the outside basis difference in
the stock of CFC due to unrepatriated earnings)

APB 23 (ASC 740-30) Issues

FAS 109 INCORPORATES UNREMITTED
EARNINGS IN THE OUTSIDE BASIS
DIFFERENCE

The outside basis" also includes

SAB 51 gains
Currency translation adjustments

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

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

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

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

How the compensation is recorded depends on

the vesting schedule
Cliff Vesting
Graded Vesting

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

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

Fair Value

If an observable market price exists for an

option with the same or similar terms,
companies should use that price

Otherwise, a valuation technique based on

established financial economic theory should
be used

Valuation Models

Must be consistent with the fair value

measurement objective and

Capable of incorporating all the substantive

characteristics unique to employee stock
options

Factors Considered in Fair Value

Exercise Price
The expected term of the award
Current Price
Expected Volatility
Expected Dividends
Risk Free Interest Rate

Application of ASC 740-10 to Stock

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

Effect on DTA Tax Deduction

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

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

Effect of ASC 740-10 for ISOs

Companies should not record a deferred tax
asset for ISOs because they cannot assume
that these awards will result in a tax deduction

A current tax benefit will result if there is a

disqualifying dispostion

Accounting for Income Taxes - Interim

FIN 18 Accounting for Income Taxes in Interim Periods
amended APB 28

Tackles how to measure the tax provision for interim

reports when the actual tax expense is based on annual
income.

Allows estimates and judgments to determine the interim

tax provision

Accounting for Income Taxes

Income taxes for interim reporting is divided into:

1. Those applicable to income from continuing
operations
2. Those applicable to significant, unusual or
infrequently occurring items, discontinued items
and extraordinary items

Tax effect of the second set of items are calculated

separately and added to tax expense for the quarter

Annual Effective Rate Method

To calculate the provision under the annual effective

rate method you must:
1. Determine the projected income, all permanent
and temporary differences, credits and
carryforwards for the entire year
2. Calculate the tax liability for the year
3. Calculate the ETR for the year; and
4. Apply the ETR to quarterly earnings

Annual Effective Rate Method

Estimated ETR is applied to year-to-date
income

Prior quarter income taxes are deducted to

compute the current quarterly income tax
expense

Post Sarbanes-Oxley
Prior to Sarbanes-Oxley many companies did
not separate the income tax provision into
current and deferred
APB 11 approach

Currently, a complete tax provision that shows

a breakdown of current and deferred taxes are
required for public companies

Updating the Annual Estimate

A company must update its ETR each quarter

An accurate projection of ETR is very important

Because it is an estimate the amount may change during the

year

If ETR is miscalculated early in the year it is better to overstate

taxes in the earlier quarter

Operating Losses in an Interim Period

SFAS 109 addresses the case where a
company has an operating loss for a quarter

Under SFAS 109 realization of a tax benefit

must be assured beyond a reasonable doubt
before the benefit may be recognized in the
financial statements

Operating Losses in an Interim Period

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

Accounting Changes in Interim Periods

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

Intraperiod Tax Allocations

Income tax expense or benefit must be
allocated among
Continuing operations
Discontinued operations
Extraordinary items
Items charged or credited directly to
shareholders equity

Intraperiod Tax Allocations

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

Intraperiod Tax Allocations

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

Allocation Between Types of Income

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

Allocation Between Types of Income

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

Balance Sheet Presentation

Classified Balance Sheet
Break out current and noncurrent portions

Netting of Deferred Tax Assets and Liabilities of the Same

Jurisdiction

No Netting of Deferred Tax Assets and Liabilities from

Different Jurisdictions
127

Financial Statement Disclosures

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

Financial Statement Disclosure

Tax effect of each type of temporary difference and
carryforward that gives rise to significant portions of the
deferred tax liabilities or assets

Significant matters affecting comparability of information

for all periods presented

Amounts and expiration dates of tax loss and credit

carryforwards
129

Financial Statement Disclosure

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

130

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

Cases Rate Reconciliation

The reasons for the difference between income taxes
computed by applying the statutory federal income tax rate
and income tax expense in the financial statements are:
Statutory Rate

832,000

26.00%

State taxes, net of federal tax benefit

91,760

2.87%

Key-man life insurance

(390,000)

(12.19)%

Tax-exempt interest

( 39,000)

(1.22)%

Dividends Received Deduction

( 10,400)

( .32)%

Change in of tax rate

( 5,409)

( .17)%

Effective tax rate

478,951

14.97%

132