EYU
The way we develop
our people
Income Tax Provisions
Morgan Sharp
Sharp, Tax Senior Manager
Chris Prewitt, Tax Senior
Why our focus on income taxes is important
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Not all tax risks and exposures are evident in a top-down
analysis
l i off generall lledger
d
accounts
t ((or a b
balance
l
sheet
h t
focus)
Significant material exposures may not be properly
evaluated, provided for or disclosed
Unique nature of tax risks
Income taxes are a leading cause of restatements
© 2011 EYGM Limited.
Slide 2
Why our focus on income taxes is important
(
(cont.)
t)
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Increasing litigation related
to taxes and tax exposures
Increasing SEC comments
and focus on taxes,
particularly liability for
income tax uncertainty
liabilities
PCAOB review
© 2011 EYGM Limited.
Slide 3
What is so hard about taxes?
►
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Not just another liability/expense account can’t use a
sample
l approach
h tto auditing.
diti
Most of the company’s transactions have income tax
implications, not just a specific subset.
Complex nature of taxes and often times there is a lack of
specific guidance on how to apply tax law.
Short amount of time to do detailed computations required
for tax provisions. High degree of subjectivity in estimates.
Tax laws change frequently; especially state and local
income tax laws.
© 2011 EYGM Limited.
Slide 4
Indicators of potential tax risk
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Personnel issues
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Staffing shortages
Lack of technical expertise
Unclear roles and responsibilities
Inadequate procedures for reviewing and reconciling the
book and tax basis of assets and liabilities
Roll-forwards of balance sheet accounts do not tie to
expense
© 2011 EYGM Limited.
Slide 5
How to Mitigate Audit Risk
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Audit and Tax professionals need to work together
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Audit teams are trained in proper documentation
Tax professionals trained in technical knowledge
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Full Disclosure: Audit adjustments and non-reoccurring
transactions have tax implications.
►
Emphasis on teaming
© 2011 EYGM Limited.
Slide 6
Why is tax accounting important to me?
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As you progress in your career you will become
responsible
ibl ffor review
i
off ttaxes iin public
bli accounting.
ti
Corporate Controller, CAO and CFO ultimately
responsible for all of financial statements, including taxes.
Smaller companies may outsource tax department.
Income tax accounting becomes responsibility of “non-tax”
professionals.
f
Tax accounting can’t be learned quickly. Complex rules
take years to learn and be able to apply to different
situations.
© 2011 EYGM Limited.
Slide 7
FASB Accounting Standards Codification
►
Single source of authoritative nongovernmental US
GAAP
►
►
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Significant change in research of accounting issues
and
d referencing
f
i accounting
ti lit
literature
t
►
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Not intended to change US GAAP
Reorganizes US GAAP pronouncements into approximately 90
accounting topics (certain SEC guidance also will be included)
FAS 109 is codified in ASC topic 740
Effective for interim or annual periods ending after
15 September 2009
© 2011 EYGM Limited.
Slide 8
FASB Accounting Standards Codification
(
(cont.)
t)
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Reorganizes thousands of US GAAP pronouncements into
approximately
i t l 90 accounting
ti ttopics
i
Displays all topics using a consistent structure XXX-YY-ZZ-PP
►
Topics (XXX)
►
►
►
Subtopics (YY)
►
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© 2011 EYGM Limited.
Guidance for the topic
Sections (ZZ)
( )
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Presentation, financial statement account topics (assets, liabilities, equity,
revenue, expenses), broad transactions, industries
Industry topics include incremental guidance specific to an industry or
type of activity
Numbered consistently across subtopics
Paragraphs (PP)
Slide 9
Codification example:
APB 28,
28 para. 19 = S
Subsection
b
ti
740
740-270-30-6
270 30 6
Topic
Subtopic
10 - Overall
Section
05 – Overview
and
background
Subsection
© 2011 EYGM Limited.
740 –
Income taxes
20 - Intraperiod
tax allocation
15 – Scope
and
exceptions
30 – Other
considerations
considerations,
special areas
20 –
Glossary
270 – Interim
reporting
25 –
Recognition
323 – 980
Other
topics
30 – Initial
measurement
35 – 55
Other
topics
30 – 6 At the end of each interim period the entity shall make its best
estimate of the effective tax rate to be applicable for the full fiscal year.
[APB 28, para. 19]
Slide 10
Income Tax Provision Basics
Tax vs. book income
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Taxable income often differs from book (financial reporting) income
Certain items are treated differently under the applicable
jurisdiction’s tax law than under US GAAP
© 2011 EYGM Limited.
Slide 12
Permanent differences
►
Not defined in ASC 740, other than within the definition of
a temporary
t
difference
diff
as events
t recognized
i d iin th
the
financial statements that do not have tax consequences
and therefore do not g
give rise to temporary
p
y differences
►
May include items recognized in the tax returns that will never be
recognized in the financial statements
Book
T
Tax
© 2011 EYGM Limited.
Slide 13
Permanent differences
Discussion exercise: Temporary vs. permanent differences
-VS-
© 2011 EYGM Limited.
Slide 14
Temporary differences
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Temporary differences describe the cumulative book-tax
b i diff
basis
differences that
th t will
ill result
lt iin ttaxable
bl or deductible
d d tibl
amounts in future years
►
►
Generally, temporary differences exist as a result of timing
Examples include, but are not limited to:
► Revenues or gains taxable before or after they are recognized
in financial income
► Expenses or losses that are tax deductible before or
after they are recognized in financial income
© 2011 EYGM Limited.
Slide 15
Liability method basic principles
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A current tax liability or asset is recognized for the
estimated
ti t d taxes
t
payable
bl or refundable
f d bl on ttax returns
t
ffor
the current year
A deferred tax liability or asset is recognized for the
estimated future tax effects attributable to temporary
differences and carryforwards
The focus
f
is on the balance sheet.
© 2011 EYGM Limited.
Slide 16
Deferred tax assets and liabilities
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A deferred tax liability recognizes the deferred tax
consequences attributable
tt ib t bl tto taxable
t
bl temporary
t
differences
►
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Taxable temporary
p
y differences result in taxable amounts in future
years
A deferred tax asset recognizes the deferred tax
consequences attributable to deductible temporary
differences and carryforwards
►
Deductible temporary differences result in deductible amounts in
f t
future
years
© 2011 EYGM Limited.
Slide 17
How deferred tax assets arise
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Expenses currently recognized for book purposes but not
f tax
for
t purposes
Revenues currently recognized for tax purposes but not
for book purposes
FUTURE
(as items reverse)
© 2011 EYGM Limited.
Slide 18
book
income
>
taxable
income
Examples of deferred tax assets
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Expense items
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Revenue items
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Allowance for bad debts
Compensation accruals (vacation
(vacation, bonus
bonus, commission)
Contingency accruals (legal, environmental)
Advance receipts for goods (revenue deferred for book but not tax)
Tax carryforward items
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Foreign tax credits in worldwide taxation regimes that allow credits for
foreign taxes paid
Net operating losses
Research credits
© 2011 EYGM Limited.
Slide 19
Examples of deferred tax liabilities
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Expense items
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Depreciation
Pension
Prepaid expenses
Goodwill acquired via stock acquisition
Revenue items
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Deferred Capital Gains
© 2011 EYGM Limited.
Slide 20
Why bother with deferred taxes?
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Recognizing deferred taxes results in the matching of tax
expense with
ith the
th economic
i income
i
earned
db
by th
the entity
tit
When an “event” is recognized in the financial statements,
the eventual tax consequences of the “event”
event should also
be recognized (i.e., “match” the tax to the same financial
statement period that includes the gain or loss)
© 2011 EYGM Limited.
Slide 21
A with and without example
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Company earns $100 of interest income in both Year 1
and
dY
Year 2
Company sells a product in Year 1 and recognizes (for
book purposes) 100% of the $300 gain
Due to the tax rules for installment sales, 100% of gain on
the sale will be taxable in Year 2
© 2011 EYGM Limited.
Slide 22
Computation of tax expense – without
d f
deferred
d taxes
t
Pre tax book income
Pre-tax
Year 1
Year 2
400
100
+/-
Permanent differences
0
0
+/-
Temporary differences
(300)
300
=
Taxable income
100
400
x
Tax rate
35%
35%
=
Current tax expense
35
140
+
Deferred tax expense
0
0
=
Total tax expense
35
140
ETR
© 2011 EYGM Limited.
Slide 23
8.75% 140.0%
Computation of tax expense – with deferred
taxes
Pre tax book income
Pre-tax
Year 1
Year 2
400
100
+/-
Permanent differences
0
0
+/-
Temporary differences
(300)
300
=
Taxable income
100
400
x
Tax rate
35%
35%
=
Current tax expense
35
140
+
Deferred tax expense
105
(105)
=
Total tax expense
140
35
35%
35%
ETR
© 2011 EYGM Limited.
Slide 24
Interim Reporting
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Focus in on the calculation of estimated annual effective
t rate
tax
t and
d the
th total
t t l tax
t expense
Discrete items are not considered in calculation of
estimated annual effective tax rate but are booked in the
quarter they occur
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Change in FIN 48 reserve
Ch
Change
in
i valuation
l ti allowance
ll
Significant return to provision items
© 2011 EYGM Limited.
Slide 25
Valuation allowances
Objectives
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►
Identify the criteria for determining the need for a
valuation allowance
Describe the accounting for
f uncertain tax positions under
ASC 740
© 2011 EYGM Limited.
Slide 27
Valuation allowances – overview
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DTAs represent future reductions in taxable income
whose
h
realizability
li bilit d
depends
d on th
the existence
i t
off sufficient
ffi i t
taxable income of the appropriate character:
►
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Refers to nature of the taxable income ((e.g.,
g , tax jurisdiction
j
or
capital/ordinary)
In either the carryback or carryforward period (under the tax law)
A valuation allowance is recognized ifif, based on the
weight of available evidence, it is more likely than not
(MLTN) that some portion, or all, of the deferred tax asset
will
ill nott be
b realized
li d
© 2011 EYGM Limited.
Slide 28
Realizability of deferred tax assets
►
Evaluation regarding realizability of deferred tax assets is
made
d on a gross basis
b i as opposed
d tto a nett b
basis
i
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All companies with deductible temporary differences and operating
loss and tax credit carryforwards are required to evaluate the
realizability of their deferred tax assets
Not only those companies in a net deferred tax asset position
All available positive and negative evidence should be
considered
© 2011 EYGM Limited.
Slide 29
Four sources of taxable income
1.
2.
Taxable income in carryback period
Future reversals of existing taxable temporary
differences
►
3.
3
4.
Taxable temporary differences (DTLs) relating to indefinite-lived
indefinite lived
assets generally do not represent a source of future taxable
income
Prudent and feasible tax planning strategies
Future taxable income exclusive of reversing temporary
differences and carryforwards
© 2011 EYGM Limited.
Slide 30
Negative evidence
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It is more difficult to conclude that a valuation allowance is
nott needed
d d if negative
ti evidence
id
exists
i t
Examples:
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Cumulative losses in recent years
Carryforwards expiring unused
Expected losses in near-term
C ti
Contingencies
i with
ith material
t i l adverse
d
llong-term
t
effect
ff t
Brief carryback/forward periods
© 2011 EYGM Limited.
Slide 31
Positive evidence
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Positive evidence can outweigh negative evidence
Positive evidence refers to the existence of one or more of
the four sources of taxable income defined by ASC 740
Examples:
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Contracts/firm backlog
Appreciated assets
Strong earnings, exclusive of specific event
© 2011 EYGM Limited.
Slide 32
Discussion – illustrative journal entries
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Recording a deferred tax asset
Deferred tax asset
Income tax expense/(benefit)
xx (Dr.)
Recording a valuation allowance
Income tax expense
Valuation allowance
xx (Dr
(Dr.))
© 2011 EYGM Limited.
Slide 33
xx (Cr
(Cr.))
xx (Cr.)
Accounting for Uncertain Tax Positions
Liabilities for income tax uncertainties
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Tax positions in income tax returns are made based upon
i t
interpretations
t ti
off the
th tax
t law
l
Taxing authorities may disagree with these
interpretations, making such tax positions “uncertain”
►
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Based on local country tax law
Liabilities for income tax exposures result from various
items, including:
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Liabilities related to permanent differences (deductible vs.
nondeductible items)
Uncertainties related to basis differences
Legislative and administrative changes
Income allocation issues, e.g., transfer pricing
© 2011 EYGM Limited.
Slide 35
Accounting for Uncertainty in Income Taxes
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FIN 48 – Benefit recognition model
►
►
Tax position
T
iti mustt meett minimum
i i
recognition
iti threshold
th h ld b
before
f
b
being
i
recognized in financial statements
Generally effective for fiscal years beginning after December 15, 2006
►
►
Effective date deferred for certain non-public enterprises until annual financial
statements for fiscal years beginning after December 15, 2008
Guidance in FIN 48 has been codified primarily in ASC 740-10
740 10
© 2011 EYGM Limited.
Slide 36
Scope
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Guidance on accounting for uncertainty in income taxes included in
ASC 740 (codified from FIN 48) applies to all tax positions accounted
for in accordance with ASC 740, including positions considered to be
“routine”
A tax position is defined as a position taken in a previously filed tax
return or a position expected to be taken in a future income tax return
Encompasses decisions not to file an income tax return, jurisdictional
allocations (i
(i.e.,
e transfer pricing)
pricing), characterization of income
income, and tax
status
© 2011 EYGM Limited.
Slide 37
Scope (cont.)
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A tax position can result in:
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A permanent reduction of taxes payable (permanent differences),
A deferral of taxes otherwise currently payable to future years
(temporary differences), or
A change in the expected realizability of deferred tax assets (tax
planning strategies for valuation allowance purposes)
Tax planning strategies used in assessing the need for a
Tax-planning
valuation allowance for deferred tax assets
►
Subject to the same recognition (MLTN) and measurement criteria
(for those positions that meet recognition threshold
threshold, largest amount
that is more than 50% likely to be sustained) as all other tax
positions
© 2011 EYGM Limited.
Slide 38
Two-step process
►
Inventory of uncertain tax positions is subject to two-step
process that separates recognition analysis from
measurement of the benefit
Step 1: Does the tax position meet
the “more likely than not”
(MLTN) criteria for recognition?
© 2011 EYGM Limited.
Slide 39
Step 2: If recognition threshold
is met, measure the benefit
Initial recognition
►
A tax benefit is recognized when it is MLTN to be
sustained
t i db
based
d on th
the ttechnical
h i l merits
it off th
the position
iti
►
►
►
►
MLTN represents a likelihood greater than 50%
Conclusion regarding
g
g financial statement recognition
g
takes into
account tax technical merits, facts and circumstances
Assumes that tax position will be examined by taxing authority
Each position must stand on its own merits
© 2011 EYGM Limited.
Slide 40
Initial recognition (cont.)
►
A tax position may be subsequently recognized in the first
i t i period
interim
i d iin which:
hi h
► The MLTN threshold is met by the reporting date,
► The statue of limitations has expired
expired, or
► The tax position is effectively settled through
examination, negotiation or litigation
© 2011 EYGM Limited.
Slide 41
Measurement
►
A tax position that meets the MLTN recognition threshold
shall initially and subsequently be measured as the
largest amount of tax benefit that is greater than 50%
likely of being realized (cumulative probability concept)
►
Based upon facts and circumstances determined at the reporting
date
© 2011 EYGM Limited.
Slide 42
Measurement (cont.)
(
)
► Not
all tax positions require detailed consideration of
possible outcome amounts and percentage likelihood
associated with each amount (cumulative probability
approach)
► Differences related to timing (deduction itself is not in
question)
© 2011 EYGM Limited.
Slide 43
Measurement example
Possible estimated
outcome ($)
Individual probability of
occurring (%)
Cumulative probability of
occurring (%)
$ 100
5%
5%
$ 80
25%
30%
$ 60
25%
55%
$ 50
20%
75%
$ 40
10%
85%
$ 20
15%
100%
100%
►
$60 is the largest amount of tax benefit that is greater than 50% likely of being realized.
© 2011 EYGM Limited.
Slide 44
Summary
►
►
►
Two-step approach
► Step 1: Recognition
► Tax position is MLTN to be sustained based solely on technical
merits
► Step 2: For those positions that meet recognition threshold
threshold,
measure at largest amount of tax benefit greater than 50% likely to
be realized
Difference between tax benefit as ((or to be)) reflected in the income
tax return and the amount recorded in the financial statements
(“unrecognized tax benefit”) should be classified as either:
► A current or non-current liability, or
► Reduction of DTA, tax NOL or a tax credit carryforward
DTAs and DTLs are determined using tax basis reflecting results of
recognition and measurement analysis
© 2011 EYGM Limited.
Slide 45
ASC 740 disclosure requirements
Balance sheet disclosures
►
►
Current taxes payable/receivable
Separate DTAs/DTLs into two classifications
►
►
►
Current
Noncurrent
Netting rules for DTAs/DTLs
►
►
Net together only DTAs and DTLs for the same taxing jurisdiction
Net together only current DTAs/DTLs and noncurrent DTAs/DTLs
© 2011 EYGM Limited.
Slide 47
Coca-Cola’s 2009 balance sheet tax
di l
disclosures
p. 68,, Coca-Cola’s 2009 Form 10-K
p
© 2011 EYGM Limited.
Slide 48
Income statement disclosures
►
►
Income tax expense, separated into current and deferred
portions
ti
Special items (discontinued operations, extraordinary
items) presented net of tax
© 2011 EYGM Limited.
Slide 49
Coca-Cola’s 2009 income statement tax
di l
disclosures
p. 67,, Coca-Cola’s 2009 Form 10-K
p
© 2011 EYGM Limited.
Slide 50
Income tax note disclosures: effective tax
rate
t
►
►
Effective tax rate equals income tax expense divided by
pretax
t book
b k income
i
Effective rate reconciliation in monetary units or
percentages, reconciling between:
►
►
►
The reported amount of income tax expense
The amount of income tax expense that would result from applying
domestic federal statutory rate to pre
pre-tax
tax income
For public companies, separately disclose each
reconciling item that is more than 5% of pre-tax income ×
statutory rate
© 2011 EYGM Limited.
Slide 51
Rate reconciliation example
►
A tax footnote to financial statements may include the
following reconciling items:
Statutory US federal rate
Permanent book/tax differences
State tax net of federal benefit
Earnings taxed in foreign jurisdiction
Tax credit
Effective tax rate
© 2011 EYGM Limited.
Slide 52
35.0%
(1.8)
5.2
(1.5)
( )
(3.1)
33.8%
Coca-Cola 2009 ETR disclosure
p. 105, Coca-Cola’s 2009 Form 10-K
© 2011 EYGM Limited.
Slide 53
Other footnote disclosures
►
In addition to the rate reconciliation, the tax footnote to the
fi
financial
i l statements
t t
t mustt disclose
di l
(among
(
other
th items):
it
)
►
Components of the net DTL or DTA:
►
►
►
►
►
Total deferred tax liability
Total deferred tax asset
Total valuation allowance and net change during the year
Tax effects of each type
yp of temporary
p
y difference and carryforward
y
(if public company)
Amount and expiration date of NOL and tax credit carryforwards
© 2011 EYGM Limited.
Slide 54
Coca-Cola’s 2009 tax note disclosures
p. 107, Coca-Cola’s 2009 Form 10-K
© 2011 EYGM Limited.
Slide 55
Coca-Cola’s 2009 tax note disclosures (cont.)
p. 108, Coca-Cola’s 2009 Form 10-K
© 2011 EYGM Limited.
Slide 56
Tax footnote disclosures (cont.)
►
Components of income tax expense attributable to
continuing
ti i operations,
ti
iincluding:
l di
►
►
►
►
►
►
Current tax expense or benefit
Deferred tax expense
p
or benefit
Investment tax credits
Benefits of operating loss carryforwards
Adjustments to DTA/DTL due to changes in tax law/rate/status
Adjustment to valuation allowance due to changes in judgment
about realizability
© 2011 EYGM Limited.
Slide 57
Tax footnote disclosures (cont.)
►
Income tax expense/benefit allocated to:
►
►
►
►
►
Continuing operations
Discontinued operations
Extraordinary
y items
Other comprehensive income
Items charged or credited directly to shareholder’s equity
© 2011 EYGM Limited.
Slide 58
Tax footnote disclosures (cont.)
►
Additional disclosures for public companies:
►
►
Components of pre-tax income (loss) as either domestic or foreign
Current tax expense or benefit and deferred tax expense or benefit
applicable to:
►
►
►
© 2011 EYGM Limited.
Federal income taxes
Foreign income taxes
Other income taxes (such as state income taxes)
Slide 59
Coca-Cola’s 2009 tax note disclosures (cont.)
p. 104, Coca-Cola’s 2009 Form 10-K
© 2011 EYGM Limited.
Slide 60
Annual disclosures – income tax
uncertainties
t i ti
►
Interest and penalty classification policy
►
Tabular
T
b l reconciliation
ili ti off aggregate
t b
beginning
i i and
d ending
di
unrecognized tax benefits (not required for nonpublic entities)
►
The following items must be presented separately in the table at the end of
each annual period:
►
►
►
►
►
The gross amounts of the increases and decreases in unrecognized tax
benefits as a result of tax positions taken during a prior period
The gross amounts of increases and decreases in unrecognized tax benefits as
a resultlt off tax
t positions
iti
ttaken
k during
d i th
the currentt period
i d
The amount of decreases in the unrecognized tax benefits relating to
settlements with taxing authorities
Reductions to unrecognized
g
tax benefits as a result of a lapse
p of the applicable
pp
statute of limitations
Disclosure as of date of adoption - total amount of UTB
© 2011 EYGM Limited.
Slide 61
Annual disclosures – income tax
uncertainties
t i ti (cont.)
(
t)
►
Effective Tax Rate (not required for nonpublic entities)
►
►
►
The total amount of recognized
g
UTB that would affect effective tax rate
Interest and Penalties
Twelve-Month Look-Forward
►
If reasonably
bl possible
ibl th
thatt th
the ttotal
t l amounts
t off unrecognized
i d ttax b
benefit
fit
will “significantly” change within 12 months of the reporting date:
►
►
►
►
The nature of the uncertainty
The nature of the event that could occur that would cause the change
An estimate of the range of the reasonably possible change or a statement that
an estimate cannot be made
Description
p
of tax yyears subject
j
to examination by
y major
j
jurisdictions
© 2011 EYGM Limited.
Slide 62
Coca-Cola’s 2009 tax note disclosures (cont.)
p. 106,
106 C
Coca-Cola’s
C l ’ 2009 F
Form 10
10-K
K
© 2011 EYGM Limited.
Slide 63
Questions?
© 2011 EYGM Limited.
Slide 64