Presenting a live 110-minute teleconference with interactive Q&A
ASC 740 Income Tax
Accounting Challenges in 2013
Tackling Valuations of Deferred Tax Assets, Tax Expense and UTP Reporting, and Other Issues
TUESDAY, MAY 28, 2013
1pm Eastern
|
12pm Central | 11am Mountain
|
10am Pacific
Today’s faculty features:
Douglas Sayuk, Partner, Clifton Douglas, San Jose, Calif.
Cindy Frank, Senior Director, Tax Process Efficiency and Technology, BDO USA, Phoenix
Jeffrey Zawada, Director, FreedMaxick CPAs, Buffalo, N.Y.
For this program, attendees must listen to the audio over the telephone.
Please refer to the instructions emailed to the registrant for the dial-in information.
Attendees can still view the presentation slides online. If you have any questions, please
contact Customer Service at 1-800-926-7926 ext. 10.
Tips for Optimal Quality
Sound Quality
Call in on the telephone by dialing 1-866-873-1442 and enter your PIN when
prompted.
If you have any difficulties during the call, press *0 for assistance. You may also
send us a chat or e-mail sound@straffordpub.com immediately so we can address
the problem.
Viewing Quality
To maximize your screen, press the F11 key on your keyboard. To exit full screen,
press the F11 key again.
Continuing Education Credits
FOR LIVE EVENT ONLY
Attendees must stay on the line throughout the program, including the Q & A
session, in order to qualify for full continuing education credits. Strafford is
required to monitor attendance.
Record verification codes presented throughout the seminar. If you have not
printed out the “Official Record of Attendance,” please print it now. (see
“Handouts” tab in “Conference Materials” box on left-hand side of your computer
screen). To earn Continuing Education credits, you must write down the
verification codes in the corresponding spaces found on the Official Record of
Attendance form.
Please refer to the instructions emailed to the registrant for additional
information. If you have any questions, please contact Customer Service
at 1-800-926-7926 ext. 10.
Program Materials
If you have not printed the conference materials for this program, please
complete the following steps:
•
Click on the + sign next to “Conference Materials” in the middle of the lefthand column on your screen.
•
Click on the tab labeled “Handouts” that appears, and there you will see a
PDF of the slides and the Official Record of Attendance for today's program.
•
Double-click on the PDF and a separate page will open.
•
Print the slides by clicking on the printer icon.
ASC 740 Income Tax Accounting
Challenges in 2013 Seminar
May 28, 2013
Cindy Frank, BDO USA
cfrank@bdo.com
Jeffrey Zawada, FreedMaxick CPAs
jeff.zawada@freedmaxick.com
Douglas Sayuk, Clifton Douglas
douglas@cliftondouglas.com
Today’s Program
Overview Of ASC 740 And Related Guidance
[Cindy Frank]
Slide 8 – Slide 26
Specific Income Tax Accounting Issues, Best
Practices
[Douglas Sayuk, Cindy Frank and Jeffrey
Zawada]
Slide 27 – Slide 96
Notice
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY
THE SPEAKERS’ FIRMS 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.
Cindy Frank, BDO USA
OVERVIEW OF ASC 740 AND
RELATED GUIDANCE
FAS 109/ASC 740 Objectives
Recognize:
1. The amount of taxes payable or refundable for the current year
2. Deferred tax liabilities and assets for the future tax consequences
9
Basic Principles
10
•
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.
•
These principles apply to domestic federal income taxes, and
foreign and state and local taxes that are based on income.
Components Of Income Tax Expense
Current income tax expense (benefit)
+/- Deferred income tax expense (benefit)
=
11
Total income tax expense (benefit)
Current Income Tax Expense
Item
Pre-tax book income
Permanent differences
Financial taxable income
Temporary differences
Taxable income per return
Amount
$1,000,000
100,000
$1,100,000
200,000
$1,300,000
Tax rate
Tax liability (current portion of tax expense)
40%
$520,000
This example replicates a typical tax return expense calculation and
represents only the current portion of income tax expense.
Without FAS 109/ASC 740 principles, our tax expense would be $520,000.
12
Deferred Tax Expense
13
•
SFAS 109 requires the balance sheet approach to compute
deferred taxes.
•
To compute the deferred expense, you must compare the
beginning balance of temporary differences to their ending
balance.
•
Temporary difference treatment in FAS 109/ASC 740 smoothens
out the rate; there is no impact on book tax expense.
Components Of Total Expense
Permanent differences:
•
Arise from income that is permanently non-taxable and
expense items are permanently non-deductible
•
14
Affect either the financial statements or the tax
return, but not both
•
Will always increase or decrease your effective tax rate
•
Will either cost tax dollars or save tax dollars
Current Income Tax Expense
Item
Pre-tax book income
Permanent differences
Financial taxable income
Temporary differences
Taxable income per return
Tax rate
Tax liability (current portion of tax expense)
15
Amount
$1,000,000
100,000
$1,100,000
200,000
$1,300,000
40%
$520,000
Permanent Differences
Item
Pre-tax book income
Amount
$1,000,000
Permanent differences
• Meals and entertainment
50,000
• Fines and penalties
40,000
• Lobbying expenses
10,000
Total permanent differences
$100,000
Financial taxable income
$1,100,000
16
Permanent Differences (Cont.)
Item
Amount
Permanent differences
• Meals and entertainment
50,000
• Fines and penalties
40,000
• Lobbying expenses
10,000
Total permanent differences
Tax rate
Tax impact of permanent items
17
$100,000
40%
$40,000
Permanent Differences (Cont.)
Permanent differences will always affect your rate.
Item
Pre-tax book income
Tax rate
Expected tax expense
$1,000,000
40%
$400,000
Tax related to permanent items
40,000
Total expected tax expense
$440,000
Effective tax rate = 440,000/1,000,000 = 44%
(this is a short method of testing the rate)
18
Amount
Components Of Total Expense
Temporary differences:
19
•
Will generally have no impact on your effective tax rate
•
Are book/tax differences that will be deductible or
taxable in one or more future years
•
Will either cost tax dollars or save tax dollars in the
current year, and will have the opposite effect in a future
year
Current Income Tax Expense, Revisited
Item
Pre-tax book income
Permanent differences
Financial taxable income
Amount
$1,000,000
100,000
$1,100,000
Temporary differences
200,000
Taxable income per return
$1,300,000
Tax rate
Tax liability (current portion of tax expense)
20
40%
$520,000
Temporary Differences
Year-End
12/31/2011
Bad debt reserve
Accrued bonus
Total change in temp
differences
Tax rate
Tax impact of
temporary differences
21
Current Year
Activity
Year-End
12/31/2012
$300,000
$250,000
$550,000
200,000
(50,000)
150,000
$500,000
$200,000
$700,000
40%
40%
40%
$200,000
$80,000
$280,000
Temporary Differences (Cont.)
Entry to record impact of temporary differences
Debit
Deferred tax asset
Income tax expense
22
Credit
$80,000
$80,000
Remember Current Expense?
Item
Pre-tax book income
Permanent differences
Amount
$1,000,000
100,000
Financial taxable income
$1,100,000
Temporary differences
200,000
Taxable income per return
Tax rate
Tax liability (current portion of tax expense)
23
$1,300,000
40%
$520,000
Journal Entries
Entries to record tax provision
Debit
Deferred tax asset
$80,000
Income tax expense
Income tax expense
Current tax payable
24
Credit
$80,000
$520,000
$520,000
Income Tax Expense
Income statement looks like:
Item
Deferred tax benefit (reduces tax
expense
Current income tax expense
Total income tax expense
25
Amount
$(80,000)
520,000
$440,000
Remember This Shortcut Method?
Item
Pre-tax book income
Tax rate
Expected tax expense
Tax related to permanent items
Total expected tax expense
Effective tax rate = 440,000/1,000,000 = 44%
(this is a short method of testing the rate)
26
Amount
$1,000,000
40%
$400,000
40,000
$440,000
Douglas Sayuk, Clifton Douglas
Cindy Frank, BDO USA
Jeffrey Zawada, FreedMaxick CPAs
SPECIFIC INCOME TAX
ACCOUNTING ISSUES, BEST
PRACTICES
VALUING AND REPORTING
DEFERRED TAX ASSETS
Calculating The Deferred Tax Asset
Deferred Tax Assets – General Approach
Step 1: Identify temporary differences
Step 2: Identify NOL carryovers
Cumulative timing differences
Step 3: Determine applicable tax rate
Deferred tax asset before credits
Step 4: Identify tax credits
Example
$3,000,000
7,000,000
$10,000,000
40.00%
$4,000,000
500,000
Step 5: Calculate gross deferred tax assets
$4,500,000
Step 6: Value the deferred tax assets
(2,500,000)
Step 7: Calculate net deferred tax assets
$2,000,000
In steps 5-7, current deferred tax assets/liabilities and non-current deferred tax assets/liabilities should
be aggregated, for balance sheet presentation purposes.
29
Deferred Tax Assets: Specific Issues
I.
Applicable tax rate
A.
Use enacted tax rate applicable when differences are expected to affect the
taxes payable
B.
Consider effect of federal deductions for state taxes
C.
1.
Generally, this has the effect of reducing the state rate to 65% of the full
amount (100% – 35% federal rate).
2.
A few states permit a deduction for other state income taxes.
Always use the regular tax rate, even when in an AMT situation
D. Understand implications of tax holidays with limited durations
II.
Foreign branches
30
A.
Foreign DTAs result in a reduction to the future U.S. foreign tax credit.
B.
Thus, a DTL must be established for the future reduction to the FTC.
C.
This has the effect of eliminating a double-counting of branch DTAs.
Valuing The Deferred Tax Assets
I.
II.
Consider other DTA reductions prior to valuation allowance
A.
Worthless DTAs – Sect. 382
B.
ASC 740-10 (FIN 48) DTA reductions (e.g., R&D credit reserves)
Valuation allowance
A.
Remaining gross DTA subject to VA under more-likely-than-not standard
B.
While not a bright-line test, the prior three years of cumulative financial
operations (pre-tax income +/- permanent items) is often considered strong
objective evidence.
C.
Partial VAs based on forecasted future taxable income are not uncommon, but
these can appear to distort the tax rate if sustained for multiple years.
D. VA should be allocated pro rata between current and non-current DTAs
(without netting of DTLs), regardless of the specific asset to which it is related.
31
Slide Intentionally Left Blank
Valuation Allowance Allocation
DTA/(DTL)
Current DTA
A
Current DTL
Total current DTA
$2,000,000
A/(A+B) 20.00%
-0-
n/a
$2,000,000
Non-current DTA
B
$8,000,000
Non-current DTL
C
$(1,000,000)
Total non-current DTA
$7,000,000
Total gross DTA
$9,000,000
A+B+C
Valuation allowance
Net DTA
DTA Ratio
VA
VA Allocated
x $9,000,000 = $1,800,000
$(1,800,000)
B/(A+B) 80.00%
Classified
$200,000
x $9,000,000 = $7,200,000
$(7,200,000)
$(200,000)
(9,000,000)
$- 0 -
100.00%
$- 0 -
General rules for classification:
1. Tracks balance sheet classification of underlying asset/liability (e.g., fixed asset DTAs are non-current)
2. Where not tied to an actual balance sheet account, based on when DTA is expected to reverse (i.e.,
less than one year is current, greater than one year is non-current)
33
DTA Movement Reconciliation: NOL Position
Gross Amount
Applicable Rate
DTA
Pre-tax book loss
$(10,000,000)
n/a
Perm differences
2,000,000
n/a
Temp differences
3,000,000
40.00%
1,200,000
$(5,000,000)
-40.00%
2,000,000
500,000
100%
500,000
Taxable loss
Tax credits
Change to DTA
$3,700,000
Gross Amount
Applicable Rate
DTA
Pre-tax book loss
$(10,000,000)
-40.00%
$4,000,000
Perm differences
2,000,000
-40.00%
(800,000)
500,000
100%
500,000
Tax credits
Change to DTA
34
$3,700,000
Return To Provision (RTP) Adjustment
•
During the provision preparation, a comparison is performed to
identify any differences between the numbers used in last year’s tax
provision and the amounts used on the tax return.
•
•
Generally computed during Q3
The differences are “trued up” as part of the tax provision
preparation process for the succeeding year.
35
Return To Provision (RTP) Adjustment
Adjustment resulting from the comparison of individual items
included in the prior year provision to the final income tax returns
•
Adjustments related to permanent items impact the current income
tax expense on the income statement
•
Adjust deferred income tax asset/liability in succeeding year to reflect
impact of discrepancy on amount of tax paid in prior year
Change in Estimate
• Change in estimate when new
information ,not available when
the provision was prepared,
becomes available after the
provision is completed.
36
Error
• Change can be attributed to
facts known or knowable at the
time the provision was prepared.
• Incorrect computation
• Incorrect information used
during provision preparation
Return To Provision (RTP) Adjustment
Return
12/31/2011
Pre-tax book income
Provision
12/31/2011
Difference
*
Tax Effected
$1,000,000
$1,000,000
$0
$0
Meals and
entertainment
50,000
40,000
10,000
4,000
Allowance for bad debts
60,000
80,000
(20,000)
(8,000)
Tax depreciation
(300,000)
(400,000)
100,000
40,000
Taxable income
$810,000
$720,000
$90,000
$36,000
* Assume 40% federal and state statutory rate
37
Return To Provision (RTP) Adjustment
Entries to record tax provision true-up
Debit
Current income tax expense
$ 4,000
Deferred income tax expense
32,000
Income taxes payable
38
Credit
$36,000
ANALYZING AND REPORTING
UNCERTAIN TAX POSITIONS
Uncertain Tax Positions: Brief Overview
I.
Recognition: Determine whether position is sustainable on a more-likelythan-not basis (“on-off” switch)
A. Based on technical merits
B. Administrative practices and precedents
II. Measurement: Calculate the expected benefit of the position, based on
cumulative probability approach
A. Benefit greater than 50% of being realized upon settlement
B. Assume taxing authority has full knowledge of facts
III. Unrecognized tax benefits (UTBs): Tax effect of UTPs
A. FIN 48 liabilities recorded on balance sheets
B. Reduction of DTA (whether or not valuation allowance in recorded)
C. Excludes interest and penalties and well as “indirect benefits”
40
Change In Recognition And Measurement
I.
A change in recognition or measurement may occur when:
A. Management changes its judgment on the position.
B. The statute of limitations tolls.
C. The position is effectively settled.
II.
Change in judgment
A. Critical issue: Was there a change in fact or authority?
B. A simple reassessment of existing facts can result in a restatement issue.
C. Consistency must be maintained; significant consideration should be
given to when establishing a methodology.
III. Statute of limitations
A. Net operating loss and tax credit carrybacks/carryforwards
B. Jurisdictional differences
41
Change In Recognition And Measurement (Cont.)
IV. Effective settlement
A.
B.
42
A tax position is considered “effectively settled” when:
1.
The taxing authority has completed its examination procedures.
2.
The company does not intend to appeal or litigate any aspect of the tax
position.
3.
Possibility is remote that the taxing authority would examine or reexamine
the tax position, assuming it has full knowledge of all relevant information.
Examination closure: Key considerations
1.
A tax position does not need to be legally extinguished, and its resolution
need not be certain, in order to re-measure a tax reserve.
2.
Consider whether the issue was specifically reviewed or examined
3.
If not, is it remote the tax period will be re-examined?
4.
Effective settlement may not affect the tax position in other years, especially
where the issue was not reviewed or “horse-trading” occurred.
Common Unrecognized Tax Benefits
I.
Transfer pricing
A. Benefits and limitations of contemporaneous documentation
B. Potential indirect effects – competent authority and withholding taxes
II.
State nexus/permanent establishment
A. Consider taxing authorities’ administrative policies and practices on SOL
B. Potential indirect effects – throwback and FTCs
III. Foreign withholding taxes
A. Who is liable? Joint vs. separate liability
B. Potential indirect effects – FTC (or deductions)
IV. R&D credits
V. Anti-deferral provisions (Subpart F, Sect. 956, etc.)
43
Example Of Indirect Effects
Facts:
A U.S. company determines that $100 of foreign taxes should have been withheld on
royalty payment made to it by a foreign customer. The company determines that it has
joint liability for payment of the tax in the foreign jurisdiction and that a reserve is
required for this amount. However, the company concludes that it will also receive a $100
foreign tax credit for the taxes withheld, which it can use to offset U.S. taxes.
Conclusion: Ignoring potential interest and penalties, this has no potential future net cash impact to
the company, as the FTC will fully offset the foreign taxes paid. However, this must still be
disclosed as a $100 UTB. The journal entries would be as follows:
Dr. tax expense
Cr. FIN 48 reserve
$100
$100
To record withholding tax reserve
Dr. DTA
Cr. tax expense
To record FTC DTA
44
$100
$100
Uncertain Tax Positions: Required Disclosures
I.
All entities
A.
B.
C.
II.
Interest and penalties
1.
Classification
2.
Current and cumulative amounts
Reasonably possible increases or decreases in UTBs within next 12 months
1.
Nature of uncertainty and potential event causing the change
2.
Estimate of amount (or statement that cannot be reasonably estimated)
Tax years that remain open to examination in major jurisdictions
Public companies
A.
B.
45
Tabular reconciliation of UTBs
1.
Increases: Current year and prior year
2.
Decreases: Settlements, tolling of statutes, changes in judgment
Total amount of UTBs, if recognized, would affect the ETR.
FINANCIAL STATEMENT
DISCLOSURES:
OVERVIEW, ISSUES AND SEC
COMMENTS
Reported, Discussed And Disclosed
Reported amounts
47
•
Balance sheet presentation
•
Income statement presentation
•
Statement of cash flows (SFAS No. 95)
•
Changes in equity, net of taxes
Reported, Discussed And Disclosed
(Cont.)
Discussions
•
MD&A (management discussions and analysis)
•
Commission guidance regarding management’s discussion and analysis of
financial condition and results of operations:
•
48
MD&A should be a discussion and analysis of a company’s business as
seen through the eyes of those who manage that business.
Management has a unique perspective on its business that only it can
present. As such, MD&A should not be a recitation of financial
statements in narrative form or otherwise uninformative series of
technical responses to MD&S requirements, neither of which provides
this important management perspective.
Reported, Discussed And Disclosed
(Cont.)
Discussions (Cont.)
49
•
Effective tax rate
•
Forecasted rate for following year
•
Critical accounting policies
•
Liquidity
•
Contractual obligations
Reported, Discussed And Disclosed
(Cont.)
Disclosed
•
Significant accounting policies
•
Income taxes including, but not limited to:
•
Components of income before taxes
•
Income tax expense (domestic and/or foreign)
•
Rate reconciliation (for public enterprise)
•
50
Individual items in excess of 5%
•
Components of net deferred tax asset/liability, valuation
allowances
•
Certain information related to FIN 48 amounts
Disclosure Requirements
Financial statement presentation
51
•
Classification
•
Entities
•
Jurisdictions
Disclosure Requirements (Cont.)
Financial statement disclosure
52
•
Components of the net deferred tax asset or liability
•
Information for certain deferred tax liabilities not recognized
•
Components of income tax expense (continuing operations)
•
Income tax expense or benefit allocated to continuing
operations and separately allocated to other items
•
Rate reconciliation (public enterprise)
•
Certain carryforwards and certain valuation allowances
•
Certain disclosures for members of a consolidated group
Disclosure Requirements (Cont.)
FIN 48 disclosure
53
•
Policy on interest and penalty classification
•
Tabular reconciliation
•
Unrecognized tax benefit that, if recognized, would affect the effective
tax rate
•
Total interest and penalties
•
Unrecognized tax benefits – reasonable possible of significant change
in the next 12 months
• Nature of uncertainty
• Nature of even that could occur
• Estimate of range of possible change or a statement that an
estimate cannot be made
•
Tax years open to examination
Disclosure Requirements (Cont.)
What to remember:
•
Understand the netting rules when it comes to current and non-current
deferred tax assets and liabilities
•
Understand how amounts are compiled and reported from different
jurisdictions
•
Significant accounting policies related to tax should be disclosed (SFAS 109,
FIN 48, policies on interest and penalties).
•
Components of income (from different jurisdictions)
•
Components of expense (by jurisdiction, by classification)
•
Rate reconciliation (dollars or percentages)
•
Details for amounts > 5% of total for public companies
•
Robust disclosures for estimates and changes in estimates (valuation
allowances, uncertain tax positions)
54
SEC Comments: Areas Of Focus
Management estimates and judgments
•
•
55
Valuation allowances
•
Basis for having or not having a VA
•
Timing of recording changes
•
Consistency with other forward-looking information
FIN 48-related items
•
Paragraph 21 disclosures
•
Interest and penalty policy disclosures
•
Disclosures and adjustments on adoption
•
Timing of recording changes
SEC Comments: Areas Of Focus (Cont.)
Management estimates and judgments (Cont.)
•
•
Adequacy of disclosure
•
Rate reconciliation items
•
Deferred tax assets and liabilities
•
Uncertain tax positions
•
Timing of reversal
•
Expiration of NOLs in various jurisdictions
Other
•
56
Contingency obligations table
SEC Comments: Areas Of Focus (Cont.)
What to remember – SEC Comments
•
SEC may ask for clarification related to management’s material
estimates and/or judgments.
•
Changes in estimates should be well-documented.
•
Responses to SEC comment letters are easier if the company has
documentation related to:
• Alternative views considered
• Company policies that provide guidance on estimates
• Criteria used in evaluation
•
Consider information that could be important to the user of the
financial statements
57
Slide Intentionally Left Blank
DECIDING ON APPROPRIATE
INTRA-PERIOD ALLOCATIONS
Intraperiod Tax Allocations
I.
Income tax expense or benefit should be allocated among:
A. Continuing operations
B. Other components
1. Discontinued operations
2. Extraordinary items
3. Other comprehensive income
4. Items charged or credited directly to shareholders’ equity
II.
Steps in allocation process
A. Step 1 - Calculate total tax expense
B. Step 2 - Determine tax related to continuing operations
C. Step 3 - Allocate remainder to other components (disc. ops, OCI, etc.)
60
Intraperiod Tax Allocations: Example
NOL Carryover w/
VA
No NOL Carryover
No VA
NOL Carryover
No VA
Pre-tax Income – cont. ops
$3,000,000
$3,000,000
$3,000,000
Pre-tax Income – disc. ops
(1,000,000)
(1,000,000)
(1,000,000)
Pre-tax income
$2,000,000
$2,000,000
$2,000,000
NOL carryover
(2,000,000)
-0-
-0-
$- 0 -
$2,000,000
$2,000,000
40.00%
40.00%
40.00%
$800,000
$800,000
1,200,000
Taxable income
Tax rate
Total tax expense
A
$- 0 -
Related to continuing ops
B
-0-
$3MM x 40%=
1,200,000
A-B
-0-
Current
benefit
(400,000)
Allocated to disc. ops
Deferred
benefit
(400,000)
Note: Net operating losses and other deferred tax assets are utilized before the impact of other
components are considered.
61
Application Of ASC 740-20-45-7
Under this exception to the general rules, all components should be considered in
determining the tax benefit resulting from continuing operations losses.
NOL Carryovers/Full Valuation
Allowance
Pre-tax income – cont. ops
Year X1
$(2,000,000)
$2,000,000
2,000,000
(2,000,000)
$-0-
$-0-
40.00%
40.00%
Pre-tax gain/(loss) – OCI (AFS)
Pre-tax income
Tax rate
Total tax expense
Related to continuing ops
Allocated to disc. ops
Year X2
$-0-
No tax expense due to NOL
C/F and valuation allowance
$(2MM) x 40%=
(800,000)
-0-
$2MM x 40%=
800,000
-0-
Note: Even though the two-year impact of the OCI gain/loss is $nil, the tax effect of the Year X1
application of this rule does not reverse out in Year X2. Rather, the disproportionate tax effects
become lodged in OCI and only reverse under very limited circumstances.
62
$-0-
INTERIM PERIOD TAX
COMPUTATION CALCULATIONS
Interim Period Tax Computation
I.
Guidance
A. ASC 740-270-25-2
1. The tax (or benefit) related to ordinary income (or loss) shall be
computed at an estimated annual effective tax rate, and the
tax (or benefit) related to all other items shall be individually
computed and recognized when the items occur.
2. Ordinary income or loss
a. Includes continuing operations before income taxes or
benefit
b. Excludes significant unusal or infrequently occuring items
(rare)
c. Excludes extraordinary items, cumulative effects of
changes in accounting principles and discontinued
operations
64
Interim Period Tax Computation (Cont.)
I. Calculation
A. Caluclate estimated effective tax rate
1. Forecast annual pre-tax income by entity/tax filing
jurisdiction
2. Calculate current and deferred provisions
3. Consider federal, state and foreign
B. Apply estimated effective tax rate
1. Multiply estimated effective tax rate by actual yearto-date worldwide pre-tax income
C. Layer on items recorded discretely
65
Interim Period Tax Computation (Cont.)
I.
Items recorded discretely in the interim period
A. Prior-year uncertain tax positions
B. Current-year uncertain tax positions related to income excluded
from the effective tax rate calculation
C. Interest and penalties related to uncertain tax positions
D. Change in tax law
E. Change in tax status
F. Changes in realizability of deferred tax assets
G. Changes in judgment regarding APB 23 items (unremitted earnings of
foreign subsidiaries and other outside basis items)
H. Changes in estimates from prior-year provisions (provision to return
adjustments)
66
Interim Period Tax Computation (Cont.)
I.
Modification to estimated effective tax rate approach (ASC 740-27030-30 through ASC 740-270-30-34)
A. Loss limitation (year-to-date loss exceeds the full-year expected
loss, and full realization of tax benefit is assured, i.e. no need
for a valuation allowance)
A. Recalculate tax based on year-to-date results
B. Good example: ASC 740-270-55-16
B. Loss limitation (year-to-date loss exceeds the full year expected
loss, and partial realization of tax benefit is assured)
A. Calculate estimated effective tax rate based on amount of
tax benefit assured
B. Recalculate tax based on year-to-date results
C. Good example: ASC 740-270-55-20
67
Interim Period Tax Computation (Cont.)
I.
Example – ASC 740-270-55-16
Ordinary Income
Tax
Overall
Estimated
Reporting
Period
First Qtr
Annual
Year-to-
Year-to-
Less
Reporting
Year-to-
Effective
Date -
Date -
Previously
Reporting
Period
Date
Tax Rate
Computed
Limited
Reported
Period
20,000
20,000
60%
12,000
-
12,000
Second Qtr
(80,000)
(60,000)
60%
(36,000)
12,000
(48,000)
Third Qtr
(80,000)
(140,000)
60%
(84,000)
(36,000)
(44,000)
Fourth Qtr
40,000
(100,000)
60%
(60,000)
(80,000)
20,000
Fiscal Year
(100,000)
(60,000)
Year to date ordinary loss ($140,000 X 50%)
(70,000)
Estimated Tax Credits
(10,000)
(80,000)
68
(80,000)
Interim Period Tax Computation (Cont.)
I.
Example – ASC 740-270-55-20 (overall ETR limited to partial unrealizable
losses)
Ordinary Income
Tax
Overall
Estimated
Reporting
Period
First Qtr
Annual
Year-to-
Year-to-
Less
Reporting
Year-to-
Effective
Date -
Date -
Previously
Reporting
Period
Date
Tax Rate
Computed
Limited
Reported
Period
20,000
20,000
20%
4,000
-
4,000
Second Qtr
(80,000)
(60,000)
20%
(12,000)
4,000
(16,000)
Third Qtr
(80,000)
(140,000)
20%
(28,000)
(12,000)
(8,000)
Fourth Qtr
40,000
(100,000)
20%
(20,000)
(20,000)
-
Fiscal Year
(100,000)
69
(20,000)
(20,000)
Interim Period Tax Computation (Cont.)
C. ASC 740-270-30-36(a) – If a separate jurisdiction has yearto-date ordinary loss or anticipates ordinary loss for the
year, and no tax benefit can be recognized, then that
entity should be excluded from the estimated effective
tax rate calculation.
70
Interim Period Tax Computation (Cont.)
I.
Example – ASC 740-270-55-39
Anticipated ordinary income for the fiscal year:
In the United States
In Country A
Total
Anticipated tax for the fiscal year:
In the United States ($60,000 at 50% statutory rate)
In Country A ($40,000 at 20% statutory rate)
Total
Overall estimated annual effective tax rate ($38,000 / $100,000)
71
$
60,000
40,000
$ 100,000
$
$
30,000
8,000
38,000
38%
Interim Period Tax Computation (Cont.)
I.
Example – ASC 740-270-55-40 – quarterly tax computation
Ordinary Income
Tax
Overall
Estimated
Annual
Reporting
United
Period
States
First Qtr
Country A
Total
Less
Year-to-
Effective
Year-to-
Previously
Reporting
Date
Tax Rate
Date
Reported
Period
5,000
15,000
20,000
20,000
38%
7,600
-
7,600
Second Qtr
10,000
10,000
20,000
40,000
38%
15,200
7,600
7,600
Third Qtr
10,000
10,000
20,000
60,000
38%
22,800
15,200
7,600
Fourth Qtr
35,000
5,000
40,000
100,000
38%
38,000
22,800
15,200
Fiscal Year
60,000
40,000
100,000
72
38,000
Interim Period Tax Computation (Cont.)
I.
Example – ASC 740-270-55-41 – ordinary loss; realization not MLTN
I.
Country B history of losses, 40% rate, expected tax benefit will not be
realized on these losses
Ordinary Income
Tax
Overall
Reporting
United
Period
States
Year-to-
Annual
Date -
Less
Year-to-
Effective
Excluding
Previously
Reporting
Date
Tax Rate
Country B
Reported
Period
Country A
Country B
5,000
15,000
(5,000)
15,000
15,000
38%
7,600
-
7,600
Second Qtr
10,000
10,000
(25,000)
(5,000)
10,000
38%
15,200
7,600
7,600
Third Qtr
10,000
10,000
(5,000)
15,000
25,000
38%
22,800
15,200
7,600
Fourth Qtr
35,000
5,000
(5,000)
35,000
60,000
38%
38,000
22,800
15,200
Fiscal Year
60,000
40,000
(40,000)
60,000
First Qtr
Total
Estimated
Note: Format above different than actual ASC 740-270-55-41 example
73
38,000
Interim Period Tax Computation (Cont.)
I.
Example – ASC 740-270-55-41 – what if country B was included
Anticipated ordinary income for the fiscal year:
In the United States
In Country A
In Country B
Total
Anticipated tax for the fiscal year:
In the United States ($60,000 at 50% statutory rate)
In Country A ($40,000 at 20% statutory rate)
Total
Overall estimated annual effective tax rate ($38,000 / $60,000)
74
$
60,000
40,000
(40,000)
$ 60,000
$
$
30,000
8,000
38,000
63.33%
Interim Period Tax Computation (Cont.)
I.
Example – ASC 740-270-55-41 – what if country B was included (Cont.)
I.
Country B history of losses, 40% rate, expected tax benefit will not be
realized on these losses
Ordinary Income
Tax
Overall
Reporting
United
Period
States
Year-to-
Annual
Date -
Less
Year-to-
Effective
Including
Previously
Reporting
Date
Tax Rate
Country B
Reported
Period
Country A
Country B
5,000
15,000
(5,000)
15,000
15,000
63.33%
9,500
-
9,500
Second Qtr
10,000
10,000
(25,000)
(5,000)
10,000
63.33%
6,333
9,500
(3,167)
Third Qtr
10,000
10,000
(5,000)
15,000
25,000
63.33%
15,833
6,333
9,500
Fourth Qtr
35,000
5,000
(5,000)
35,000
60,000
63.33%
37,998
15,833
22,166
Fiscal Year
60,000
40,000
(40,000)
60,000
First Qtr
Total
Estimated
Note: Format above different than actual ASC 740-270-55-41 example
75
37,998
Slide Intentionally Left Blank
MERGER AND ACQUISITION
TOPICS
Business Combinations: Key Steps
Step 1: Determine transaction structure (stock vs. asset acquisition)
•
Stock – historical tax basis carryover; can lead to significant DTA/DTLs
•
Asset – tax basis stepped up to FMV; DTA/DTL may be minimal
Step 2: Identify existing deferred tax assets and liabilities
•
Typically, a short period cut-off provision is calculated.
•
Consider the impact of stock awards and other non-recurring charges.
•
When combined returns will be filed with the acquirer, the applicable tax rate
in valuing DTA/DTLs should be reassessed.
Step 3: Calculate DTA/DTL from purchase accounting fair value adjustments
78
•
In a stock transaction, every FV adjustment will result in a DTA/DTL. Nongoodwill intangibles often result in a significant DTL.
•
Consider the impact of an acquired DTL on the acquirer’s VA, as the benefit of
any release will be recorded to P&L.
Business Combinations: Key Steps (Cont.)
Step 4: Evaluate deferred tax asset valuation
•
Consider whether the combined operation’s financial position changes
the assessment of deferred tax asset utilization
•
Changes to the acquired company’s VA are recorded in purchase
accounting, while the acquirer’s VA is recorded outside of purchase
accounting.
•
Also consider the need to write-off DTAs due to Sect. 382, SRLY or other
acquisition related limitations
Step 5: Consider tax reserve needs
79
•
Leverage off of conclusions reached in due diligence
•
Consider the impact of indemnifications
•
Continue to evaluate information available at the acquisition date during
the one-year measurment period
STOCK AWARD ISSUES
Stock Awards
I.
Guidance
A. When the settlement of an award creates or increases a net
operating loss
A. This provides that the excess tax benefit and the credit to
APIC (and our APIC pool) for the windfall should not be
recorded until the deduction reduces income taxes payable.
B. ASC 718-740-25-10
A. A share option exercise may result in a tax deduction before
the actual realization of the related tax benefit because the
entity, for example, has a net operating loss carryforward.
In that situation, a tax benefit and a credit to additional
paid-in capital for the excess deduction would not be
recognized until that deduction reduces taxes payable.
81
Stock Awards (Cont.)
I.
Result
A. Net operating losses
A. The deferred tax asset on the company’s net operating
losses will differ from the net operating losses actually
on its tax return.
B. The net operating losses relating to this windfall tax
benefit will have to be tracked separately.
C. The net operating losses disclosed in the footnote should
be the actual net operating losses per the tax return.
D. The footnote should also disclose the amount of benefit
still to be recorded in additional paid-in capital once the
net operating loss carryforward is realized.
82
Stock Awards (Cont.)
I. Accounting policy
A. Generally two approaches allowed:
A. With and without – results in windfall tax benefits
being realized last
B. Tax law ordering – results in windfall tax benefit being
realized first (should be less complex)
B. Election of method is an accounting policy that must be
applied consistently.
83
Stock Awards (Cont.)
I.
Examples
I.
84
Facts:
NOL carryforward from prior years – actual per
tax return
$500,000
Deferred tax asset on NOL at 40%
$200,000
Current-year taxable income (before excess tax
deduction for stock-based comp)
$600,000
Current-year excess tax deduction for stock
based compensation
$250,000
Stock Awards (Cont.)
Example 1: No valuation allowance
With and
Without
Without
Tax Law
Ordering
With
Taxable income before NOL and excess tax deduction
$
600,000 $
600,000 $
600,000
$
600,000
Current year excess tax deduction for stock based compensation
NOL Carryforward from prior years
$
$
(250,000) $
(500,000) $
$
(500,000) $
(100,000)
(500,000)
$
$
(250,000)
(350,000)
Taxable Income or NOL carryforward to next year
$
(150,000) $
100,000 $
Journal Entry
Income Taxes Payable
Current Tax Expense
Deferred Tax Expense
Deferred Tax Asset
Additional Paid-in Capital
$
$
$
$
$
-
40,000
200,000
(200,000)
(40,000)
$
$
$
$
$
$
-
100,000
140,000
(140,000)
(100,000)
Memo Entry - Debit / (Credit)
Deferred Tax Asset
$
60,000
$
Additional Paid-in Capital
$
(60,000)
$
- With and Without - memo entry to reflect the $150,000 excess tax deduction for which there has been no cash benefit yet received
Actual Remaining Net Operating Losses
Deferred Tax Asset
85
$
$
(150,000)
0%
$
$
-
(150,000)
60,000
40%
Stock Awards (Cont.)
Example 2: Full valuation allowance
With and
Without
Without
Tax Law
Ordering
With
Taxable income before NOL and excess tax deduction
$
600,000 $
600,000 $
600,000
$
600,000
Current year excess tax deduction for stock based compensation
NOL Carryforward from prior years
$
$
(250,000) $
(500,000) $
$
(500,000) $
(100,000)
(500,000)
$
$
(250,000)
(350,000)
Taxable Income or NOL carryforward to next year
$
(150,000) $
100,000 $
Journal Entry
Income Taxes Payable
Current Tax Expense
Valuation Allowance
Deferred Tax Asset
Additional Paid-in Capital
$
$
$
$
$
-
40,000
200,000
(200,000)
(40,000)
$
$
$
$
$
$
-
100,000
140,000
(140,000)
(100,000)
Memo Entry - Debit / (Credit)
Deferred Tax Asset
$
60,000
$
Additional Paid-in Capital
$
(60,000)
$
- With and Without - Memo entry to reflect the $150,000 excess tax deduction for which there has been no cash benefit yet received
Actual Remaining Net Operating Losses
Deferred Tax Asset
Valuation Allowance
86
$
$
$
(150,000)
-
$
$
$
-
(150,000)
60,000
(60,000)
CURRENT AUDITOR RED
FLAGS
Current Auditor Hot Topics
I.
PCAOB materiality guidelines
II.
Deferred tax asset disclosure
A.
Classification – current vs. non-current
B.
Stock-based compensation
C.
1.
Terminations and cancellations
2.
Sect. 83(b) elections
Cost basis – fixed/intangible assets
D. “True-up” impact – estimate vs. error
III. Permanent reinvestment of foreign earnings rep under APB 23
88
A.
Ability – sufficient cash to fund domestic operations
B.
Intent – established company policy; earnings need to fund operations
C.
Reasonable estimate of deferred taxes
Current Auditor Hot Topics (Cont.)
IV. Valuation allowance
A. Allocation between current and non-current assets
B. Jurisdictional issues (e.g., cost plus entities)
V. ASC 740-10 (FIN 48)
A. Statute of limitation periods
B. Disclosure regarding changes in next 12 months
VI. Intraperiod tax allocations to OCI
89
Current Auditor Red Flags
I. Effective tax rate reconciliation
A. Foreign effective tax rate varies significantly from
statutory rate.
II. Business combinations
A. Contingent liabilities and consideration
III. Deferred tax roll
IV. Uncertain tax positions
A. Inter-company transactions/transfer pricing
B. Foreign audits
90
Slide Intentionally Left Blank
RISK MITIGATION
Risk Mitigation
I. Valuation allowance documentation
II. ASC 740-30-25-17 (APB 23) documentation
III. Tax provision software
IV. Department capability and internal controls
93
Risk Mitigation (Cont.)
I.
Valuation allowance documentation
I.
Four sources of taxable income
A. Taxable income in carryback years
1. Consider character of income
B. Future reversal of existing temporary differences
1. Consider timing of future reversals
C. Tax planning strategies
1. Must be prudent and feasible
2. Must be something management wouldn’t ordinarily
take
3. Must prevent deferred tax asset from expiring unused
4. Must result in the realization of a deferred tax asset
94
Risk Mitigation (Cont.)
I. Valuation allowance documentation (Cont.)
D. Future taxable income exclusive of reversing
temporary differences and carryforwards
1. Three-year cumulative pretax book earnings
2. Forecast accuracy!!!
3. How many years of forecasted pre-tax income
would be needed to realize all of the deferred tax
assets?
4. Document and consider company liquidity,
backlog, market trends, losses of significant
customers, forecast divestitures, and expected
restructuring or changes in operations.
95
Risk Mitigation (Cont.)
I.
ASC 740-30-25-17 (APB 23) documentation
A.
Document policy of permanent reinvestment
B.
Consider all aspects of outside basis differences (unremitted earnings,
cumulative translation adjustments, transactions with non-controlling
shareholders and other comprehensive income)
C.
Document uses of excess cash at foreign subsidiary (working capital needs,
capital expenditures, acquisitions, repay inter-company obligations, loan to
other foreign entities, etc.
D.
Document or forecast need or lack thereof of cash at the parent company
1.
E.
Consider history of earnings remittances
1.
F.
96
Operations, debt service, acquisitions, capital expenditures, intercompany obligations
Consider policy of not remitting past earnings
Consider dispositions/available for sale entities