TEI_2012 Basics of Income Tax Accounting
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Welcome TEI – Introduction to Financial Reporting for Taxes Agenda ► ► ► ► ► ► ► ► ► ► ► ► ► Welcome and Introduction Financial Accounting Framework Basics of the Liability Method Break Valuation Allowances Uncertain Tax Positions Lunch Preparing a Tax Provision Interim Reporting State and Local Income Tax Break International Tax Disclosures 22Page May, 22008 TEI – Introduction Page 2 to Financial Presentation title Reporting for Taxes 8:30 - 8:45 8:45 - 9:15 9:15 - 10:45 10:45 - 11:00 11:00 - 11:30 11:30 - 12:00 12:00 - 1:00 1:00 - 1:30 1:30 - 2:00 2:00 - 2:30 2:30 - 2:45 2:45 - 4:00 4:00 - 4:30 Your teachers ► John Basseer ► ► ► ► John Gunn ► ► ► ► Partner, Ernst & Young San Francisco 415 894 8614 john.basseer@ey.com Senior Manager, Ernst & Young San Francisco 415 894 8286 john.gunn1@ey.com Helen Wilcenski ► ► ► Senior Manager, Ernst & Young San Francisco 415 894 8029 helen.wilcenski@ey.com 22Page May, 32008 TEI – Introduction Page 3 to Financial Presentation title Reporting for Taxes Your teachers ► Tyler Caldwell ► ► ► ► Senior Manager, Ernst & Young San Francisco 415 894 8065 tyler.caldwell@ey.com Beth Wutzke ► ► ► Senior Manager, Ernst & Young San Francisco 415 894 8480 elizabeth.wutzke@ey.com 22Page May, 42008 TEI – Introduction Page 4 to Financial Presentation title Reporting for Taxes Circular 230 Disclosure - Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. 22Page May, 52008 TEI – Introduction Page 5 to Financial Presentation title Reporting for Taxes Introduction to tax accounting TEI – Introduction to Financial Reporting for Taxes Why are you here? ► ► Tax accounting needs > supply! Industry needs more people with knowledge of: ► ► ► ► 22Page May, 72008 Tax Accounting for income taxes Tax auditing Tax controls and process TEI – Introduction Page 7 to Financial Presentation title Reporting for Taxes Regulatory environment ► ► ► ► ► Sarbanes-Oxley New “SOX-like” regulations globally SEC and PCAOB focus New accounting pronouncements from FASB Enhanced IRS focus 22Page May, 82008 TEI – Introduction Page 8 to Financial Presentation title Reporting for Taxes Changed market environment ► ► ► ► ► Strong, engaged audit committees Focus on risk mitigation Impact on company brand value/reputation Media factor Intense scrutiny by investors, analysts, regulators, Congress, state and local governments 22Page May, 92008 TEI – Introduction Page 9 to Financial Presentation title Reporting for Taxes Why is tax a high risk area? ► ► ► ► ► Complex rules under tax laws and accounting Significant use of estimates and judgment Financial reporting systems often based on management reporting, not legal-entity basis Lack of control over data inputs Lack of communication among tax, financial accounting and budgeting 22Page May, 10 2008 TEI – Introduction Page 10 to Financial Presentation title Reporting for Taxes ► ► ► ► Lack of accountants trained in ASC 740 , particularly in foreign locations True-up in following year Increasing focus as move to risk-based approach Conflicting objectives of regulators And the result ► ► Tax financial reporting under the microscope More pressure than ever on tax departments 22Page May, 11 2008 TEI – Introduction Page 11 to Financial Presentation title Reporting for Taxes What you will learn today ► Accounting for income taxes: ► ► ► ► ► Technical tax accounting topics (ASC 740 , ASC 740-10, etc.) How to calculate a provision, including deferred taxes Financial statement disclosures Working with your auditor SOX 404/Internal controls - tax accounts 22Page May, 12 2008 TEI – Introduction Page 12 to Financial Presentation title Reporting for Taxes Questions? Financial accounting framework TEI – Introduction to Financial Reporting for Taxes Objectives ► ► Identify where tax items are disclosed on financial statements Explain how tax affects other items on the balance sheet and income statement 22Page May, 15 2008 TEI – Introduction Page 15 to Financial Presentation title Reporting for Taxes Discussion activity ► Keep the Caterpillar financial statements handy, your instructors will point out the tax items in the financial statements and footnotes for reference purposes 22Page May, 16 2008 TEI – Introduction Page 16 to Financial Presentation title Reporting for Taxes Financial information sources ► Information about publicly traded companies comes in many forms and may be found in many places: ► ► ► ► 22Page May, 17 2008 Annual reports Securities and Exchange Commission (SEC) filings and databases Company press releases Articles that appear in the financial press TEI – Introduction Page 17 to Financial Presentation title Reporting for Taxes Financial information reporting ► The annual report is important to investors because it is complete and reliable, having been audited by an independent auditor. It includes: ► ► ► ► ► ► ► 22Page May, 18 2008 Financial statements Footnotes to the financial statements A summary of accounting principles used Management’s discussion and analysis of the financial results The auditor’s report Comparative financial data for a series of years Narrative information about the company TEI – Introduction Page 18 to Financial Presentation title Reporting for Taxes Financial information reporting (cont.) ► Publicly traded companies also must prepare reports for government agencies, e.g., the SEC: ► ► 22Page May, 19 2008 Form 10-K – presents financial statement data in greater detail than the financial statements in annual reports Form 10-Q – includes quarterly financial statements that provide more timely but less complete information than annual reports TEI – Introduction Page 19 to Financial Presentation title Reporting for Taxes Financial statement analysis ► ► Financial statement analysis – applying analytical techniques to financial statements and other relevant data to produce information useful for decision-making It is not simply probing for more detail, but rather a process of: ► ► ► 22Page May, 20 2008 Summarization Study of relationships Comparative analyses TEI – Introduction Page 20 to Financial Presentation title Reporting for Taxes Financial statement analysis (cont.) ► Although different investors demand different returns, they all use financial statement analysis for common reasons: ► ► ► To predict their expected returns To assess risk Financial statement analysis focuses on past performance to predict future performance 22Page May, 21 2008 TEI – Introduction Page 21 to Financial Presentation title Reporting for Taxes Basic financial statements ► Income statement: ► ► ► 22Page May, 22 2008 Statement of profit and loss which reports business results over a specified operating period Focus on revenues and expenses (includes EPS) Tax provision = income tax expense (shown “below the line”) TEI – Introduction Page 22 to Financial Presentation title Reporting for Taxes Basic financial statements (cont.) ► General presentation: ► Income from continuing operations before income taxes ► ► Income from continuing operations ► ► 22Page May, 23 2008 Less: extraordinary items (net of tax) = Income before cumulative effect of an accounting change ► ► Less: discontinued operations (net of tax) = Income before extraordinary items ► ► Less: income taxes = Less: cumulative effect of an accounting change (net of tax) = Net income TEI – Introduction Page 23 to Financial Presentation title Reporting for Taxes Basic financial statements (cont.) ► Balance sheet: ► ► ► ► ► ► ► Statement of financial position at a specific point in time Changes in the balance sheet accounts from period-to-period drive the profit and loss activity within the income statement Current taxes payable (including liabilities for tax exposure items) Deferred tax assets and liabilities Basic accounting equation: Assets = liabilities + shareholders’ equity Statement of retained earnings: ► Shows how much of the company’s total earnings have been retained within the business for purposes of future growth vs. how much has been distributed to stakeholders 22Page May, 24 2008 Ending RE Balance (appears on B/S): Prior period RE + current earnings - dividends TEI – Introduction Page 24 to Financial Presentation title Reporting for Taxes Basic financial statements (cont.) ► Statement of cash flows: ► ► Shows cash receipts and disbursements for a period of time Organized by three major business functions: ► ► ► ► ► Operating Investing Financing Income taxes paid and refunds received Ending balance of statement should match cash balance on the balance sheet 22Page May, 25 2008 TEI – Introduction Page 25 to Financial Presentation title Reporting for Taxes Summary ► It is vitally important to “get the numbers right” for tax purposes to provide accurate financial statements and to provide shareholders with accurate information about the financial condition of the company 22Page May, 26 2008 TEI – Introduction Page 26 to Financial Presentation title Reporting for Taxes Questions? Basics of the liability method TEI – Introduction to Financial Reporting for Taxes Objective ► Identify and apply the basic principles of the liability method of accounting for income taxes under ASC 740 22Page May, 29 2008 TEI – Introduction Page 29 to Financial Presentation title Reporting for Taxes Accounting for income taxes APB 11 (Dec. 1967) FAS 96 (Dec. 1987) ASC 740 (Dec. 1992) Superseded 22Page May, 30 2008 TEI – Introduction Page 30 to Financial Presentation title Reporting for Taxes ASC 740 (Dec. 2009) Codification ASC 740 – Introduction ► ASC 740 addresses financial accounting and reporting for the effects of income taxes that result from an enterprise’s activities during the current and preceding years 22Page May, 31 2008 TEI – Introduction Page 31 to Financial Presentation title Reporting for Taxes Application of ASC 740 ► ► ► Domestic federal (national) income taxes and foreign, state, and local (including franchise) taxes based on income An enterprise’s domestic and foreign operations that are consolidated, combined or accounted for by the equity method Foreign enterprises in preparing financial statements in accordance with US generally accepted accounting principles (US GAAP) 22Page May, 32 2008 TEI – Introduction Page 32 to Financial Presentation title Reporting for Taxes ASC 740 – Scope ► ASC 740 establishes standards of financial accounting and reporting for income taxes that are currently payable and for the tax consequences of: ► ► ► 22Page May, 33 2008 Revenues, expenses, gains or losses that are included in taxable income of an earlier or later year than the year in which they are recognized Other events that create differences between the book and tax bases of assets and liabilities Operating loss or tax credit carrybacks for refunds of income taxes paid in prior years and carryforwards to reduce future taxes payable TEI – Introduction Page 33 to Financial Presentation title Reporting for Taxes Key terms and concepts ► ► Taxable income Total tax expense/(benefit): ► ► ► ► Current tax expense/(benefit) Deferred tax expense/(benefit) Permanent differences Temporary differences: ► ► Deferred tax liabilities (DTLs) Deferred tax assets (DTAs) ► 22Page May, 34 2008 Valuation allowance TEI – Introduction Page 34 to Financial Presentation title Reporting for Taxes ASC 740 – Definitions ► ► Taxable income – The excess of taxable revenues over taxdeductible expenses and exemptions for the year, as defined by the governmental taxing authority Current tax expense/(benefit) – 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 22Page May, 35 2008 TEI – Introduction Page 35 to Financial Presentation title Reporting for Taxes ► ► Deferred tax expense/(benefit) – The change during the year in an enterprise’s deferred tax liabilities and assets Permanent differences – Not specifically defined in ASC 740 ► In general, book-tax differences that increase or decrease current tax liabilities without any future tax implications affecting tax expense ASC 740 – Definitions (cont.) ► ► Temporary differences – A difference between the book and tax base of an asset or liability that will result in taxable or deductible amounts in future years when the reported amount of the asset or liability is recovered or settled DTL (deferred tax liability) – Recognizes the deferred tax consequences attributable to taxable temporary differences 22Page May, 36 2008 TEI – Introduction Page 36 to Financial Presentation title Reporting for Taxes ► ► DTA (deferred tax asset)– Recognizes the deferred tax consequences attributable to deductible temporary differences and carryforwards Valuation allowance – The portion of a DTA for which it is more-likely-than-not that a tax benefit will not be realized ASC 740 – Definitions (cont.) ► ► Carrybacks – Deductions or credits that cannot be used on the tax return during a year that may be carried back to reduce taxable income or taxes payable in a prior year Carryforwards – Deductions or credits that cannot be used on the tax return during a year that may be carried forward to reduce taxable income or taxes payable in a future year 22Page May, 37 2008 TEI – Introduction Page 37 to Financial Presentation title Reporting for Taxes Examples of permanent differences ► Book revenues/gains that will never be taxable due to statutory exclusion, for example: ► ► Book expenses/losses that will never be deductible for income tax purposes, for example: ► ► Municipal bond interest Fines, nondeductible meals and entertainment (M&E), officer’s life insurance expense Items taxable or deductible for tax purposes but not included in financial statements, for example: ► 22Page May, 38 2008 Stock option deduction, transfer pricing adjustments TEI – Introduction Page 38 to Financial Presentation title Reporting for Taxes Liability method basic principles ► ► Focus: balance sheet Objective: measure taxes payable/refundable based on difference between book basis and tax basis of assets and liabilities ► ► ► Deferred tax assets are recognized subject to valuation allowance considerations 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 the estimated future tax effects attributable to temporary differences and carryforwards 22Page May, 39 2008 TEI – Introduction Page 39 to Financial Presentation title Reporting for Taxes How DTAs arise ► ► Expenses currently recognized for book purposes but not for tax purposes Revenues currently recognized for tax purposes but not for book purposes Future (as items reverse) 22Page May, 40 2008 TEI – Introduction Page 40 to Financial Presentation title Reporting for Taxes Book income > Taxable income Examples of DTAs ► Expense items: ► ► ► ► Revenue items: ► ► Allowance for bad debts Compensation accruals (vacation, bonus, commission) Contingency reserve accruals (legal, environmental) Advance receipts for goods (revenue deferred for book but not tax) Tax carryforward items: ► ► 22Page May, 41 2008 Foreign tax credits in worldwide taxation regimes that allow credits for foreign taxes paid Net operating losses TEI – Introduction Page 41 to Financial Presentation title Reporting for Taxes Examples of DTLs ► Expense items: ► ► ► Fixed assets (tax depreciation > book depreciation) Intangible assets (tax goodwill amortization > book goodwill impairment) Revenue items: ► ► 22Page May, 42 2008 Installment sale receivable (revenue deferred for tax but not book) Completed contract tax accounting method TEI – Introduction Page 42 to Financial Presentation title Reporting for Taxes Liability method basic principles: measurement ► ► Measurement of current and deferred tax liabilities and assets is based on provisions of enacted tax law; effects of future changes in tax laws or rates are not anticipated Measurement of DTAs is reduced by the amount of any tax benefits that are not expected to be realized (i.e., a valuation allowance) 22Page May, 43 2008 TEI – Introduction Page 43 to Financial Presentation title Reporting for Taxes Measurement of DTAs and DTLs 1. Identify types and amounts of cumulative temporary differences and carryforwards. 2. Measure total deferred tax liability for taxable temporary differences using applicable enacted tax rate. 3. Measure total deferred tax asset for deductible temporary differences and loss carryforwards using applicable enacted tax rate, plus tax credit carryforwards. 4. Reduce the deferred tax asset by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. 22Page May, 44 2008 TEI – Introduction Page 44 to Financial Presentation title Reporting for Taxes Temporary differences – Book vs. tax basis Interest receivable of $100 Taxed when received Account receivable of $100 Taxed when accrued Cost of asset $100 Depreciation: book $30; tax $40 Accrued expenses of $80 Deductible when paid Goodwill of $100 Book impairment of $20 Nondeductible for tax *assumes 35% tax rate 22Page May, 45 2008 TEI – Introduction Page 45 to Financial Presentation title Reporting for Taxes Book Tax Consequences* $100 0 $35 DTL 100 100 No DT 70 60 3.5 DTL 80 0 28 DTA 80 0 No DT Temporary differences summary Asset Liability Deferred tax benefit/ (DTA) Tax basis > book Tax basis < book basis basis Deferred tax expense/ (DTL) Tax basis < book Tax basis > book basis basis 22Page May, 46 2008 TEI – Introduction Page 46 to Financial Presentation title Reporting for Taxes Tax carryforward Only Computation of tax expense ► Current tax expense = ► ► Deferred tax expense = ► ► Net change in deferred tax liabilities and assets (adjusted for special items) Total tax expense = ► ► Current taxes payable (generally, includes changes in income tax contingency reserves) Current tax expense + deferred tax expense Consider other items: ► ► 22Page May, 47 2008 Prior-year provision-to-return reconciliation items (both permanent and temporary) Previously unrecognized benefits of NOL carryforwards or other DTAs (adjustments to valuation allowance) TEI – Introduction Page 47 to Financial Presentation title Reporting for Taxes Why bother with deferred taxes? ► ► ► Matching of tax expense with economic income earned by the entity When an “event” is recognized in the financial statements, the eventual tax consequences of the event should also be recognized (e.g., “match” the tax to the same financial statement period that includes the gain or loss) Economic results are the focus, not the timing of tax payments 22Page May, 48 2008 TEI – Introduction Page 48 to Financial Presentation title Reporting for Taxes Deferred taxes exercise: “with and without” example ► ► ► Company earns $100 of interest income in both year 1 and year 2 Company sells a product in year 1 and recognizes $100 of book income Due to their tax method of accounting, the $100 gain on the sale will be taxable in year 2 22Page May, 49 2008 TEI – Introduction Page 49 to Financial Presentation title Reporting for Taxes Computation of tax expense without deferred taxes Year 1 Pre-Tax Book Income Year 2 $200 $100 +/- Permanent Differences 0 0 +/- Temporary Differences 100 100 = Taxable Income $100 $200 x Tax Rate 35% 35% = Current Tax Expense $ 35 $ 70 0 0 $ 35 $ 70 17.5% 70.0% + Deferred Tax Expense = Total Tax Expense ETR 22Page May, 50 2008 TEI – Introduction Page 50 to Financial Presentation title Reporting for Taxes Computation of tax expense with deferred taxes Year 1 Pre-Tax Book Income Year 2 $200 $100 +/- Permanent Differences 0 0 +/- Temporary Differences 100 100 = Taxable Income $100 $200 x Tax Rate 35% 35% = Current Tax Expense $ 35 $ 70 35 (35) $ 70 $ 35 35% 35% + Deferred Tax Expense = Total Tax Expense ETR 22Page May, 51 2008 TEI – Introduction Page 51 to Financial Presentation title Reporting for Taxes Exercise – Summary ► Without Deferred Tax: ► ► ► 22Page May, 52 2008 Pre-tax book income in Year 1 of $200, less tax of $35, equals net income of $165; 17.5% tax rate Pre-tax book income in Year 2 of $100, less tax of $70, equals net income of $30; 70% tax rate Total income of $300 and taxes of $105; 35% rate TEI – Introduction Page 52 to Financial Presentation title Reporting for Taxes ► With Deferred Tax: ► ► ► Pre-tax book income in Year 1 of $200, less tax of $70, equals net income of $130; 35% tax rate Pre-tax book income in Year 2 of $100, less tax of $35, equals net income of $65; 35% tax rate Total income of $300 and taxes of $105; 35% rate Exceptions to providing deferred taxes under ASC 740 ► ► ► ► ► ► ASC 740-30, permanent reinvestment exception Temporary differences related to deposits in statutory reserve funds by US Steamship enterprises Leveraged leases Goodwill (or portion) not deductible for tax purposes Intercompany transactions Foreign currency translation adjustments 22Page May, 53 2008 TEI – Introduction Page 53 to Financial Presentation title Reporting for Taxes Exercise: classifying permanent and temporary differences ► ► Review the exercise facts and requirements Your classroom instructor will review the case study solution with you 22Page May, 54 2008 TEI – Introduction Page 54 to Financial Presentation title Reporting for Taxes Exercise: computing deferred taxes ► ► Review the exercise facts and requirements Your classroom instructor will review the case study solution with you 22Page May, 55 2008 TEI – Introduction Page 55 to Financial Presentation title Reporting for Taxes Summary ► The total tax expense (benefit) recognized on the financial statement includes current tax expense (benefit) and deferred tax expense (benefit) ► Recognizing deferred taxes matches the tax expense with the economic income earned by the company 22Page May, 56 2008 TEI – Introduction Page 56 to Financial Presentation title Reporting for Taxes Questions? Valuation allowances TEI – Introduction to Financial Reporting for Taxes Objectives ► ► Explain the need for a valuation allowance Describe considerations in determining whether the allowance is adequate 22Page May, 59 2008 TEI – Introduction Page 59 to Financial Presentation title Reporting for Taxes Overview ► Deferred tax assets represent future tax deductions (or tax carryforwards/tax credits) whose realizability is dependent upon future taxable income: ► ► ► 22Page May, 60 2008 Appropriate character (i.e., capital vs. ordinary) Evaluate separately for each “taxpaying component” (i.e., legal entity or group of entities that consolidates for tax purposes in a given tax jurisdiction) Evaluation regarding realizability of deferred tax assets is made on a gross, as opposed to a net, basis TEI – Introduction Page 60 to Financial Presentation title Reporting for Taxes Overview (cont.) ► ► ► A deferred tax asset must be reduced by a valuation allowance if, based upon the weight of available evidence, it is more likely than not (i.e., likelihood of more than 50%) that some portion, or all, of the Deferred Tax Asset (DTA) will not be realized Valuation allowances do not deal with existence of the asset; instead they address the realizability of an asset All available evidence, both positive and negative, should be considered 22Page May, 61 2008 TEI – Introduction Page 61 to Financial Presentation title Reporting for Taxes Overview (cont.) ► ► Companies with DTAs should carefully consider whether a valuation allowance is necessary Assessing the need for, and the amount of, a valuation allowance for DTAs requires significant judgment ► ► 22Page May, 62 2008 Section 404 process Documentation TEI – Introduction Page 62 to Financial Presentation title Reporting for Taxes Illustrative journal entries ► Recording a deferred tax asset Deferred tax asset Income tax expense (benefit) ► xx (Dr.) xx (Cr.) Recording a valuation allowance Income tax expense Valuation allowance 22Page May, 63 2008 TEI – Introduction Page 63 to Financial Presentation title Reporting for Taxes xx (Dr.) xx (Cr.) Negative evidence ► It is more difficult to conclude a valuation allowance is not needed if negative evidence exists: ► ► ► ► ► 22Page May, 64 2008 Cumulative losses in recent years Carryforwards expire unused Expected losses in near term Contingencies with material, adverse long-term effect Brief carryforward/carryback periods TEI – Introduction Page 64 to Financial Presentation title Reporting for Taxes Positive evidence ► Positive evidence can outweigh negative evidence: ► ► ► ► Contracts/backlog Appreciated assets Strong earnings exclusive of specific event Refers to the existence of one or more of the four sources of taxable income 22Page May, 65 2008 TEI – Introduction Page 65 to Financial Presentation title Reporting for Taxes Four sources of taxable income ► ASC 740-10-30-18 identifies four sources of taxable income that may be available to realize a tax benefit for deductible temporary difference and carryforwards (listed in order of the least subjective to the most subjective): ► ► ► ► 22Page May, 66 2008 1. Taxable income in carryback period if carryback permitted under the tax law 2. Future reversals of existing taxable temporary differences 3. Prudent and feasible tax planning strategies 4. Future taxable income exclusive of reversing temporary differences and carryforwards TEI – Introduction Page 66 to Financial Presentation title Reporting for Taxes Source 1: taxable income in carryback period ► Consider appropriate character, or nature, of the taxable income in the carryback period: ► Tax credit carrybacks: ► ► ► Consider requirements for credit utilization Character of income (ordinary income vs. capital gains or losses) Evaluate carryback potential by jurisdiction: ► ► 22Page May, 67 2008 Consider specific carryback rules Take into account changing state apportionment factors TEI – Introduction Page 67 to Financial Presentation title Reporting for Taxes Source 2: future reversals of existing taxable temporary differences ► ► ► ► Offset of gross deferred tax assets against gross deferred tax liabilities Detailed scheduling of the reversals of existing temporary differences is not required Issues resulting from reversal patterns Changes in tax laws or rate 22Page May, 68 2008 TEI – Introduction Page 68 to Financial Presentation title Reporting for Taxes Source 3: tax planning strategies ► ► ► ► ► ► Strategy is prudent and feasible Action management ordinarily might not take, but would take if necessary Would result in the realization of deferred tax assets Not optional — must be considered before a conclusion can be reached about the amount of a valuation allowance Consideration of significant expenses Do not confuse tax planning strategy with income forecasts 22Page May, 69 2008 TEI – Introduction Page 69 to Financial Presentation title Reporting for Taxes Source 3: tax planning strategies (cont.) ► Tax planning strategies are actions that could: ► ► ► 22Page May, 70 2008 Accelerate taxable amounts to use expiring carryforwards Change the character of taxable or deductible amounts from ordinary to capital Change the nature of the income (e.g., from tax exempt to taxable) TEI – Introduction Page 70 to Financial Presentation title Reporting for Taxes Source 4: future taxable income ► ► Future taxable income exclusive of reversal of existing temporary differences and carryforwards Consistency with other projections ► ► ► ► ► ► Impairment MD&A outlook, CEO’s letter, press releases, etc. Analyst consensus Demonstrated ability to achieve forecasts Impact of a going concern opinion Cumulative losses in recent years 22Page May, 71 2008 TEI – Introduction Page 71 to Financial Presentation title Reporting for Taxes Summary ► ► Review the four sources of taxable income to determine whether it is more likely than not that deferred tax assets will be realized If a valuation allowance is needed, it is recorded as a credit against income tax expense 22Page May, 72 2008 TEI – Introduction Page 72 to Financial Presentation title Reporting for Taxes Uncertain Tax Positions TEI – Introduction to Financial Reporting for Taxes US GAAP Accounting for UTPs Overview ► The term “uncertain tax position” is widely used to refer to an item in which the tax treatment is unclear or is a matter of unresolved dispute between the reporting entity and the relevant tax authority ► Uncertain tax positions generally occur where there is an uncertainty as to the meaning of the law, or to the applicability of the law to a particular transaction, or both. ► Estimating the outcome of an uncertain tax position is often one of the most complex and subjective areas in income tax accounting. 22Page May, 74 2008 TEI – Introduction Page 74 to Financial Presentation title Reporting for Taxes 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 ► 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 22Page May, 75 2008 TEI – Introduction Page 75 to Financial Presentation title Reporting for Taxes Two-step process ► Inventory of uncertain tax positions is subject to two-step process that separates recognition analysis from measurement of the benefit I Step 1: Does the tax position meet the “more likely than not” (MLTN) criteria for recognition? 22Page May, 76 2008 TEI – Introduction Page 76 to Financial Presentation title Reporting for Taxes II Step 2: If recognition threshold is met, measure the benefit Initial recognition ► A tax benefit is recognized when it is MLTN to be sustained based on the technical merits of the position ► ► ► ► MLTN represents a likelihood greater than 50% Conclusion regarding financial statement recognition 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 I 22Page May, 77 2008 TEI – Introduction Page 77 to Financial Presentation title Reporting for Taxes Initial recognition (cont.) ► A tax position may be subsequently recognized in the first interim period in which: ► The MLTN threshold is met by the reporting date, ► The statue of limitations has expired, or ► The tax position is effectively settled through examination, negotiation or litigation I 22Page May, 78 2008 TEI – Introduction Page 78 to Financial Presentation title Reporting for Taxes 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 II 22Page May, 79 2008 TEI – Introduction Page 79 to Financial Presentation title Reporting for Taxes 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) ► II 22Page May, 80 2008 TEI – Introduction Page 80 to Financial Presentation title Reporting for Taxes Uncertain Tax Positions U.S. GAAP – Two Step process 1. Recognition How likely is it that the tax benefit will be sustained? MLTN not MLTN 2. Measurement Highly certain or uncertain tax position? 22Page May, 81 2008 highly certain uncertain no UTP accrual total tax benefit <minus> largest tax benefit that is >50% likely of being realized = UTP accrual TEI – Introduction Page 81 to Financial Presentation title Reporting for Taxes UTP accrual for 100% of the tax position 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. 22Page May, 82 2008 TEI – Introduction Page 82 to Financial Presentation title Reporting for Taxes 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, 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 22Page May, 83 2008 TEI – Introduction Page 83 to Financial Presentation title Reporting for Taxes Questions? Preparing a Tax Provision TEI – Introduction to Financial Reporting for Taxes Objectives ► ► ► Explain how to calculate the current tax expense/benefit Explain how to account for deferred tax assets (DTA) and deferred tax liabilities (DTL) and calculate the deferred income tax expense or benefit Review required financial statement disclosures 22Page May, 86 2008 TEI – Introduction Page 86 to Financial Presentation title Reporting for Taxes Tax provision process 1. Adjust pretax income for all permanent differences 2. Identify all cumulative temporary differences and carryforwards 3. Calculate the current income tax expense or benefit 4. Compute the current taxes payable balance (including reserves) 5. Determine changes to liabilities for tax exposure items 22Page May, 87 2008 TEI – Introduction Page 87 to Financial Presentation title Reporting for Taxes 6. Measure DTAs and DTLs with applicable enacted tax rate 7. Evaluate the need for a valuation allowance 8. Calculate the deferred income tax expense or benefit 9. Book income tax-related journal entries 10. Prepare the financial statements and disclosures Tax provision process: steps 1 – 3 (example) Pre-Tax Income Permanent Differences ► M&E Temporary Differences ► Items A - C Taxable Income Statutory Tax Rate Current Tax Expense (benefit) 22Page May, 88 2008 TEI – Introduction Page 88 to Financial Presentation title Reporting for Taxes $1,000 310 (60) $1,250 x .40 $ 500 Tax provision process: steps 4 – 5 ► Compute the current taxes payable balance by performing the following: ► ► ► ► ► ► 22Page May, 89 2008 Agree the beginning balance to the prior year’s working papers and the ending balance to the company’s GL Reflect accrual-to-return adjustments (if any) Add the current-year tax provision to the beginning balance Adjust balance for tax payments made and refunds received Include tax contingency accruals for uncertain tax positions Include other amounts affecting the taxes payable account (e.g., stock options and purchase accounting) TEI – Introduction Page 89 to Financial Presentation title Reporting for Taxes Tax provision process: steps 4 – 5 (cont.) ► Determine changes to liabilities for tax exposure items including: ► ► ► ► ► ► ► 22Page May, 90 2008 Liabilities related to permanent differences Uncertainties related to basis differences Legislative and administrative changes Negotiated settlement amounts (settled or pending) Penalties and interest on all exposure items whether permanent or temporary differences Income allocation issues (a.k.a. transfer pricing) Tax-advantaged transactions TEI – Introduction Page 90 to Financial Presentation title Reporting for Taxes Tax provision process: steps 6 – 7 Recognize DTAs and DTLs (Assume no valuation allowance necessary) DEDUCTIBLE (TAXABLE) TEMPORARY DIFFERENCES: Cumulative Temporary Differences BOY Current Year Differences Cumulative Temporary Differences EOY Deferred Tax Asset/(Liability) @ 40.00% (A) Litigation Accrual 20,000 30,000 50,000 20,000 (B) Inventory Reserve - 10,000 10,000 4,000 20,000 40,000 60,000 24,000 (C) Accumulated Depreciation (50,000) (100,000) (150,000) (60,000) Subtotal Noncurrent Temporary Differences (50,000) (100,000) (150,000) (60,000) Total Temporary Differences (30,000) (60,000) (90,000) (36,000) Applicable Tax Rate 40.00% 40.00% 40.00% Deferred Tax Asset (Liability) (12,000) (24,000) (36,000) Current Temporary Differences: Subtotal Current Temporary Differences Noncurrent Temporary Differences: 22Page May, 91 2008 TEI – Introduction Page 91 to Financial Presentation title Reporting for Taxes Tax provision process: step 8 Calculate Deferred Income Tax Expense or Benefit DEDUCTIBLE (TAXABLE) TEMPORARY DIFFERENCES: Cumulative Temporary Differences BOY Current Year Differences Cumulative Temporary Differences EOY Deferred Tax Asset/(Liability) @ 40.00% (A) Litigation Accrual 20,000 30,000 50,000 20,000 (B) Inventory Reserve - 10,000 10,000 4,000 20,000 40,000 60,000 24,000 (C) Accumulated Depreciation (50,000) (100,000) (150,000) (60,000) Subtotal Noncurrent Temporary Differences (50,000) (100,000) (150,000) (60,000) Total Temporary Differences (30,000) (60,000) (90,000) (36,000) Applicable Tax Rate 40.00% 40.00% 40.00% Total Deferred Asset (Liability) (12,000) (24,000) (36,000) EOY Deferred Tax Asset (Liability) (36,000) BOY Deferred Tax Asset (Liability) (12,000) Current Temporary Differences: Subtotal Current Temporary Differences Noncurrent Temporary Differences: Deferred Tax Expense / (Benefit) 22Page May, 92 2008 TEI – Introduction Page 92 to Financial Presentation title Reporting for Taxes 24,000 Tax provision process: step 9 ► Illustrative journal entries: ► ASC 740 introduced a balance sheet or liability approach to accrue for income taxes. The following journal entries are intended to illustrate a basic methodology for recording for income taxes: ► 22Page May, 93 2008 In most cases, US GAAP requires a more complex accounting for income taxes than given in these simple illustrations TEI – Introduction Page 93 to Financial Presentation title Reporting for Taxes Tax provision process: step 9 (cont.) ► Recording a current tax liability Income Tax Expense Current Income Tax Payable ► xx (Dr.) xx (Cr.) Recording a deferred tax liability Income Tax Expense Deferred Tax Liability 22Page May, 94 2008 TEI – Introduction Page 94 to Financial Presentation title Reporting for Taxes xx (Dr.) xx (Cr.) Tax provision process: step 9 (cont.) ► Recording a deferred tax asset Deferred Tax Asset Income Tax Expense/(Benefit) ► xx (Dr.) xx (Cr.) Recording a liability for an uncertain tax position Income Tax Expense Current/Noncurrent liability 22Page May, 95 2008 TEI – Introduction Page 95 to Financial Presentation title Reporting for Taxes xx (Dr.) xx (Cr.) Tax provision process: step 10 ► Required disclosures ► ► ► ► Current taxes Deferred taxes ► ► ► Valuation allowance ASC 740-30 Foreign Subsidiary Exception ► ► ASC 740 SEC Investment in a foreign subsidiary that is essentially permanent Uncertain tax positions Tax rate reconciliation 22Page May, 96 2008 TEI – Introduction Page 96 to Financial Presentation title Reporting for Taxes Summary ► ► ► Calculate the current tax expense/benefit Account for deferred tax assets and liabilities and calculate the deferred income tax expense or benefit Understand financial statement tax disclosures 22Page May, 97 2008 TEI – Introduction Page 97 to Financial Presentation title Reporting for Taxes Questions? Interim reporting TEI – Introduction to Financial Reporting for Taxes Objectives ► ► ► ► Discuss interim financial statement requirements under ASC 740-270 Estimate annual effective tax rate Review impact of discrete items on quarterly tax provisions Identify audit/review considerations 22Page May, 100 2008 TEI – Introduction Page 100 to Financial Presentation title Reporting for Taxes Relevant guidance: interim periods ► ASC 270, Interim Financial Reporting ► ► ► ► ► ► 22Page May, 101 2008 Recognition – ASC 740-270-25 Initial Measurement – ASC 740-270-30 Subsequent Measurement – ASC 740-270-35 Disclosure – ASC 740-270-50 Use the best estimate of the annual effective tax rate for the year to record taxes in the current period (ASC 740-270-30-6) Do not include the tax related to “significant unusual or extraordinary items” in estimated annual effective tax rate (EAETR) (ASC 740-270-30-12) TEI – Introduction Page 101 to Financial Presentation title Reporting for Taxes Estimating annual effective tax rate ► Estimate the annual effective tax rate by modifying the federal statutory tax rate by the following types of items: ► ► ► ► ► State and local statutory tax rate Foreign tax rates Permanent tax items (M&E, tax-exempt interest, etc.) Tax credits Projected deferred tax effects of year-end temporary differences ► 22Page May, 102 2008 Include the tax effect of a valuation allowance expected to be necessary at end of year for deferred tax assets related to deductible temporary differences or carryforwards originating during the year TEI – Introduction Page 102 to Financial Presentation title Reporting for Taxes Computing income tax provisions in interim periods ► Compute year-to-date income tax expense (benefit) ► ► ► ► Estimate annual effective tax rate Multiply EAETR by year-to-date ordinary income (loss) at end of the period Add tax expense (benefit) of discrete items and other exceptions to the general rules Compute interim income tax expense (benefit) ► 22Page May, 103 2008 Difference between year-to-date income tax expense (benefit) and amounts reported for prior interim periods TEI – Introduction Page 103 to Financial Presentation title Reporting for Taxes Example: computing income tax provisions in interim periods Q1 Projected income at quarter $ Q2 Q3 Q4 4,000 $ 4,000 $ 4,000 $ 4,000 - (200) (200) (200) 1,600 1,520 1,520 1,520 40% 38% 38% 38% 1,000 1,000 1,000 1,000 Year-to-date tax 400 760 1,140 1,520 Tax 400 360 380 380 Current quarter 40% 36% 38% 38% Year-to-date 40% 38% 38% 38% Projected permanent items Tax at 40% statutory rate EAETR Pre-tax income at quarter 22Page May, 104 2008 TEI – Introduction Page 104 to Financial Presentation title Reporting for Taxes Companies subject to tax in multiple jurisdictions ► One overall EAETR should be used, unless: ► ► ► 22Page May, 105 2008 In a separate jurisdiction, a loss is anticipated for which a tax benefit cannot be realized Enterprise is unable to estimate annual effective rate in dollars in a foreign jurisdiction Otherwise enterprise is unable to make a reliable estimate of ordinary income (or loss) or of the related tax (or benefit) in a foreign jurisdiction TEI – Introduction Page 105 to Financial Presentation title Reporting for Taxes Companies subject to tax in multiple jurisdictions (cont.) ► If exception applies, separately compute interim tax (benefit) for jurisdiction as it reports ordinary income (loss)* for the period: ► ► Exclude both income (loss) and related tax expense (benefit) from calculation of EAETR Tax (benefit) related to income (loss) in a jurisdiction may include tax (benefit) in another jurisdiction that results from providing taxes on unremitted foreign earnings, foreign tax credits, etc. * 22Page May, 106 2008 Note that this applies even if separate jurisdiction has interim-period income but projects loss for the year TEI – Introduction Page 106 to Financial Presentation title Reporting for Taxes Example: companies subject to tax in multiple jurisdictions Without applying exception Est. Ord. Income EAETR Est. Tax Jurisdiction 1 $ 2,500 30% $ 750 Jurisdiction 2 2,000 40% 800 Jurisdiction 3 (1,000) 0% 0 $ 3,500 44.3% $ 1,550 Group Q1 Actual Q1 – Group 22Page May, 107 2008 TEI – Introduction Page 107 to Financial Presentation title Reporting for Taxes $ 1,200 EAETR 44.3% Tax Q1 $ 532 Example: companies subject to tax in multiple jurisdictions Exception applied Est. Ord. Income EAETR Est. Tax Jurisdiction 1 $ 2,500 30% Jurisdiction 2 2,000 40% 800 $ 4,500 34.4% $ 1,550 Jurisdiction 3 Group Q1 – Jurisdiction 3 Q1 – Group Q1 – ETR 22Page May, 108 2008 TEI – Introduction Page 108 to Financial Presentation title Reporting for Taxes 750 (1,000) 0 $ 3,500 $ 1,500 Q1 Actual Q1 – Jurisdictions 1&2 $ $ 1,600 EAETR 34.4% Tax Q1 $ 550 (400) 0 $ 1,200 $ 550 45.8% Losses in current periods ► Benefits of losses arising in the current year should be included in the EAETR computation if either one of the following applies: ► ► ► Benefit is expected to be realized during the current year Benefit is expected to be recognizable as deferred tax asset at end of the year If YTD ordinary loss exceeds anticipated ordinary loss for the year, the benefit recognized for the YTD loss shall not exceed the amount of benefit that would be recognized if the YTD loss were the anticipated ordinary loss for the fiscal year. 22Page May, 109 2008 TEI – Introduction Page 109 to Financial Presentation title Reporting for Taxes Losses in current periods (cont.) ► If tax effects of losses that arise early in the year are not recognized in that interim period: ► ► 22Page May, 110 2008 Recognize in later interim period if realization becomes more likely than not No tax provision shall be made for income that arises in later periods until tax effects of previous interim losses are utilized TEI – Introduction Page 110 to Financial Presentation title Reporting for Taxes Discrete items ► Tax (benefit) related to “ordinary” income shall be computed at the EAETR, and the tax (benefit) related to all other items shall be individually computed and recognized when the items occur. (ASC 740-270-30-8) ► 22Page May, 111 2008 Extraordinary items, gains or losses from disposal of a component of an entity, and unusual or infrequently occurring items shall not be prorated over the balance of the fiscal year. TEI – Introduction Page 111 to Financial Presentation title Reporting for Taxes Tax uncertainties ► ► ► The projected tax effect of tax positions arising in the current year are reflected as a component of the annual effective tax rate. Any adjustment or reversal of a prior-year tax contingency reserve should be recognized in full in the interim period in which the event causing the change in judgment occurs. Interest and penalties 22Page May, 112 2008 TEI – Introduction Page 112 to Financial Presentation title Reporting for Taxes Changes in tax laws or rates ► Effect on deferred tax balances ► ► Effect on current-year taxes payable or receivable ► ► Included in income in the interim period that includes the enactment date Reflected in the computation of the annual effective tax rate beginning as of the first interim period that includes the enactment date of new legislation Retroactive legislation ► ► ► Enactment date is the date the bill becomes law Prior interim periods should not be restated Recognize in interim period law is enacted, even if change is retroactive ► ► Applies to all tax jurisdictions Disclosure Requirement 22Page May, 113 2008 TEI – Introduction Page 113 to Financial Presentation title Reporting for Taxes Changes in valuation allowance ► ► Benefit expected to be realized because of: ► Current year’s “ordinary” income ► Effect of the change included in the EAETR ► Current year’s income other than “ordinary” income ► Effect of the change included in the interim period that includes the other income ► Future year’s income ► Effect of the change recognized as a discrete event as of the date of change in circumstances ► Both current and future years’ income ► Effect of the change allocated between the interim period that includes the date of the change and inclusion in the EAETR Increase in a valuation allowance for assets recorded in a prior annual period is a discrete event 22Page May, 114 2008 TEI – Introduction Page 114 to Financial Presentation title Reporting for Taxes Provision to return true-up ► ► Include as a discrete event in the interim period in which the adjustment is identified Area of increased focus ► 22Page May, 115 2008 Error vs. change in estimate TEI – Introduction Page 115 to Financial Presentation title Reporting for Taxes Error vs. change in estimate ► ASC 250 definition of error: ► ► ► ► Mathematical mistakes Mistakes in the application of GAAP Oversight or misuse of facts that existed at the time the financial statements were prepared ASC 250 definition of change in estimate: ► ► 22Page May, 116 2008 Consequence of assessment of present status and expected future benefits and obligations associated with assets and liabilities Results from new information TEI – Introduction Page 116 to Financial Presentation title Reporting for Taxes Questions? State and local tax issues TEI – Introduction to Financial Reporting for Taxes Objectives ► ► Identify how ASC 740 applies to state and local taxes (SALT) Explain how to calculate the state effective tax rate 22Page May, 119 2008 TEI – Introduction Page 119 to Financial Presentation title Reporting for Taxes ASC 740 applied to SALT ► ► ► ► ASC 740 applies at the entity level State taxes are deductible for federal income tax purposes Decrease federal income tax expense but increase total income tax expense (increase the overall effective tax rate) In statutory rate reconciliation, state income tax represents total state income tax provision (current and deferred) net of effect on federal taxes 22Page May, 120 2008 TEI – Introduction Page 120 to Financial Presentation title Reporting for Taxes Determining the rate ► Determining the separate company rate in a multistate environment: ► ► Function of apportionment percentages and marginal rates in each state Apportionment formulae vary by state: ► ► 22Page May, 121 2008 Apportionment methodology determined by client may be the result of aggressive planning Implicit need to reconcile each company’s aggregate apportionment percentage to 100% TEI – Introduction Page 121 to Financial Presentation title Reporting for Taxes Determining the rate (cont.) ► Unitary filing: ► ► Computation of taxable income on combined basis for members of controlled corporate group constituting a unitary business Consolidated return filing: ► May involve reporting taxable incomes of more than one corporation determined under the separate return method and reported on a single tax return or ► 22Page May, 122 2008 May embody a distinct method of computing taxable income only in those states that adopt a version of the federal consolidated return method for determining a group's apportionable business income TEI – Introduction Page 122 to Financial Presentation title Reporting for Taxes Determining the rate (cont.) ► How to account for the unitary benefit/detriment: ► Mandatory combined returns based upon unitary principle create issues about which entity or entities should absorb the differential: ► ► ► ► ► ► 22Page May, 123 2008 Absorbed by common parent? Allocated to legal entity subject to tax? Allocated to income companies? Allocated based on apportionment percentages? Other methods? Regardless of method used to allocate or absorb difference, temporary differences at each entity should be tax-effected using a rate that considers the unitary element TEI – Introduction Page 123 to Financial Presentation title Reporting for Taxes SALT ETR – Example SALT Jurisdictions Apportioned income Tax rate Tax A (separate company 1) $7,000 7% $490 A (separate company 2) $6,000 7% $420 B (unitary) $12,000 9% $1,080 C (combined) $10,000 8% $800 Total SALT Total pre-tax income 22Page May, 124 2008 $2,790 $35,000 TEI – Introduction Page 124 to Financial Presentation title Reporting for Taxes SALT ETR (before federal benefit) 7.97% ASC 740 – SALT deferred taxes ► ► If Deferred Tax Assets or Deferred Tax Liabilities for a particular SALT jurisdiction are significant, separate deferred tax computation may be required If state/local taxes are based on US federal taxable income, aggregate computations of DTAs and DTLs for at least some of those SALT jurisdictions might be acceptable: ► In assessing whether an aggregate calculation is appropriate, consider matters such as differences in tax law between jurisdictions: ► ► 22Page May, 125 2008 Tax rates Loss carryback and carryforward periods TEI – Introduction Page 125 to Financial Presentation title Reporting for Taxes SALT ETR on deferred taxes ► ► ASC 740 does not specifically address the apportionment of income for future years when temporary differences will reverse One approach would be to estimate future allocations to the state based on historical relationships: ► ► 22Page May, 126 2008 Adjusted for known changes Absent evidence to the contrary TEI – Introduction Page 126 to Financial Presentation title Reporting for Taxes Income tax or other tax? ► Franchise tax may be measured by income or by capital ► ► ► Texas margin tax ► ► Difficulties created by states when the tax contains an income element and a capital element States with multiple taxes on a single return Tax based substantially on income, thus subject to ASC 740 Michigan business tax ► 22Page May, 127 2008 Both components, Business Income Tax (BIT) and the Modified Gross Receipts Tax (MGRT) are considered income taxes under ASC 740 TEI – Introduction Page 127 to Financial Presentation title Reporting for Taxes Questions? International Considerations TEI – Introduction to Financial Reporting for Taxes Overview ► Foreign Subsidiary Exception in ASC 740-30 and the treatment of outside basis differences in foreign subsidiaries ► Tax effect of intercompany transactions for financial statement reporting purposes ► Currency translation adjustments and ASC 830 22Page May, 130 2008 TEI – Introduction Page 130 to Financial Presentation title Reporting for Taxes Foreign subsidiary exception 22Page May, 131 2008 TEI – Introduction Page 131 to Financial Presentation title Reporting for Taxes Reducing effective tax rate ► Company A has 100 million shares outstanding and $10 million of earnings before income taxes US Earnings Earnings before Taxes Income Tax Rate Income Taxes Earnings after Taxes ► $ 5 million 35% $1.75 million $ 3.25 million Foreign Earnings $5 million 10% $ 500,000 $4.5 million Company A has an effective tax rate of 22.5%, because of earnings generated in lower tax foreign jurisdiction (10% versus 35% in US) 22Page May, 132 2008 TEI – Introduction Page 132 to Financial Presentation title Reporting for Taxes Reducing effective tax rate (cont.) ► Impact on Earnings Per Share (EPS) and potentially share price ► ► Due to lower effective tax rate, Company A saved $ 1.25 million in taxes; thereby increasing earnings by $ 1.25 million Increased earnings generates additional $ 0.0125 of earnings per share 22Page May, 133 2008 TEI – Introduction Page 133 to Financial Presentation title Reporting for Taxes Reducing effective tax rate (cont.) ► Does such tax planning reduce the Company’s effective tax rate? U.S. Earnings Earnings before Taxes $ 5 million Income Tax Rate 35% Income Taxes $1.75 million Effective Tax Rate No Foreign Subsidiary Exception Overall Company ETR ► Foreign Earnings $5 million 10% $ 500,000 $1.25 million Total $10M $2.25M 22.5% $3.5M 35% Company A has an effective tax rate of 22.5% with the Foreign Subsidiary Exception in ASC 740-30, but 35% without such exception. 22Page May, 134 2008 TEI – Introduction Page 134 to Financial Presentation title Reporting for Taxes Foreign subsidiary exception – Where does it fit in? ► ► ► US Parent (USP) computes deferred taxes on book-tax basis differences (inside-basis differences) Controlled foreign corporation (CFC) computes deferred taxes in much the same manner as USP (US GAAP book vs. relevant tax basis) USP also must compute deferred taxes on outside basis in CFC shares: ► 22Page May, 135 2008 Where the Foreign Subsidiary Exception in ASC 740-30 applies TEI – Introduction Page 135 to Financial Presentation title Reporting for Taxes Inside vs. outside basis USP Outside basis Inside basis 22Page May, 136 2008 TEI – Introduction Page 136 to Financial Presentation title Reporting for Taxes Foreign subsidiary Foreign subsidiary exception ► ► FAS 109 (as codified in ASC 740) retained exception contained in APB 23 A deferred tax liability is not recognized for the following types of temporary differences unless it becomes apparent that those differences will reverse in the foreseeable future: ► 22Page May, 137 2008 An 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 TEI – Introduction Page 137 to Financial Presentation title Reporting for Taxes Deferred tax asset ► Query: What about excess of tax basis over book value? When can a deferred tax asset be recorded on the outside-basis difference? ► ► 22Page May, 138 2008 ASC 740 restricts recognition of a deferred tax asset for the excess of the tax basis over the book basis of an investment in a subsidiary or corporate joint venture, either foreign or domestic A deferred tax asset is recognized “only if it is apparent that the difference will reverse in the foreseeable future” TEI – Introduction Page 138 to Financial Presentation title Reporting for Taxes Outside basis difference ► USP make an initial cash contribution to CFC A of $8,000. CFC A earns $2,000 in Year 1 Book basis Tax basis Original investment $8,000 $8,000 Undistributed earnings $2,000 -0- $2,000 Outside basis $10,000 $8,000 $2,000 22Page May, 139 2008 TEI – Introduction Page 139 to Financial Presentation title Reporting for Taxes Difference -0- Outside basis difference (cont.) ► Does the outside basis difference change if the $2,000 earned by CFC A is subpart F? Book basis Tax basis $8,000 $8,000 -0- Year 1 earnings / Previously taxed $2,000 income $2,000 -0- Outside basis $10,000 -0- Original investment 22Page May, 140 2008 $10,000 TEI – Introduction Page 140 to Financial Presentation title Reporting for Taxes Difference Consolidation of all majority-owned subsidiaries ► General rule – The usual condition for a controlling financial interest is ownership of a majority voting interest ► ► 22Page May, 141 2008 Ownership by one company, directly or indirectly, of over 50% of the outstanding voting shares of another company is a condition pointing toward consolidation There is an exception to the general rule if control does not rest with the majority owner TEI – Introduction Page 141 to Financial Presentation title Reporting for Taxes Undistributed earnings temporary differences ► Temporary difference results from undistributed earnings of a subsidiary included in the pretax accounting income of the parent, either through consolidation or equity method of accounting ► General presumption for a domestic subsidiary is that deferred tax liability should be recorded unless tax law provides a means by which investment can be recovered tax-free 22Page May, 142 2008 TEI – Introduction Page 142 to Financial Presentation title Reporting for Taxes Undistributed earnings temporary differences (cont.) ► A deferred tax liability is not recognized for the following types of temporary differences unless it becomes apparent that those temporary differences will reverse in the foreseeable future: ► 22Page May, 143 2008 Undistributed earnings of a domestic subsidiary or a domestic corporate joint venture that is essentially permanent in duration that arose in fiscal years beginning on or before December 15, 1992 TEI – Introduction Page 143 to Financial Presentation title Reporting for Taxes Undistributed earnings temporary differences (cont.) ► Must assess whether an excess of the amount for financial reporting over the tax basis of an investment in a more-than-50%-owned domestic subsidiary is a taxable temporary difference 22Page May, 144 2008 TEI – Introduction Page 144 to Financial Presentation title Reporting for Taxes Example ► ► ► ► ► Parent (XYZ Corp) owns less than 80% of a domestic subsidiary (ABC Company) Investment is not expected to be recovered in a tax-free transaction XYZ Corp acquired 60% of the stock of ABC Company in 2004 for $8,000 Tax rate is 34% Dividends received deduction is not considered for purpose of the example 22Page May, 145 2008 TEI – Introduction Page 145 to Financial Presentation title Reporting for Taxes Example (cont.) ► As of December 31, 2007, the inside book and tax bases of XYZ’s 60% investment in ABC Company were as follows: Book basis Tax basis Difference Assets $11,000 $10,000 $1,000 Liabilities $(1,000) $(1,000) Net $10,000 $9,000 22Page May, 146 2008 TEI – Introduction Page 146 to Financial Presentation title Reporting for Taxes -0$1,000 Example (cont.) ► As of December 31, 2007, XYZ’s investment in ABC Company’s stock was as follows: Book basis Tax basis Original Investment $8,000 $8,000 Undistributed Earnings $2,000 -0- $2,000 Purchase Cost $10,000 $8,000 $2,000 22Page May, 147 2008 TEI – Introduction Page 147 to Financial Presentation title Reporting for Taxes Difference -0- Example (cont.) ► In this example, deferred tax liabilities would be recognized for both temporary differences ► ► ► 22Page May, 148 2008 Inside basis difference of $1,000 x 34% tax rate = DTL $340 Outside basis difference of $2,000 x 34% tax rate = DTL of $680 Total DTL on a consolidated basis of $1,020 TEI – Introduction Page 148 to Financial Presentation title Reporting for Taxes Deferred tax liability on outside basis difference ► USP 100% owns Controlled Foreign Corporation (CFC). USP needs to repatriate CFC’s earnings. CFC’s earnings are not subpart F income US Parent Earnings before Taxes Income Tax Rate Income Taxes Outside basis difference Deferred tax liability ► ► $ 5 million 35% $1.75 million N/A Controlled Foreign Corp $5 million 10% $ 500,000 $4.5 million $1.25 million DTL is computed as follows: (($4.5M+$500,000)*35%) - $500,000 USP has an effective tax rate of 35% 22Page May, 149 2008 TEI – Introduction Page 149 to Financial Presentation title Reporting for Taxes Domestic vs. foreign ► ► Note that domestic subsidiaries and foreign subsidiaries are treated differently ASC 740-30 retained the foreign subsidiary exception contained in APB 23 ► ► ► Reinvestment exception available for all foreign subsidiaries and foreign corporate joint ventures Reinvestment exception only available for domestic subsidiaries and domestic corporate joint ventures for undistributed earnings prior to December 15, 1992 (and permanently reinvested) A determination of whether an entity is a domestic or foreign subsidiary is made under a bottom-up approach based on the entity’s immediate parent company 22Page May, 150 2008 TEI – Introduction Page 150 to Financial Presentation title Reporting for Taxes Domestic vs. foreign example ► ► ► ► ► ► US Parent (USP) is a U.S. corporation Foreign Holdco (FHC) is incorporated in Country A, and is 100% owned by USP Foreign Sub (FSA) is also incorporated in Country A, and is 100% owned by FHC Foreign Sub (FSB) is incorporated in Country B, and is also 100% owned by FHC Both FSA and FSB plan to reinvest their earnings for the indefinite future Dividends paid by FSA and FSB are fully taxable in Country A 22Page May, 151 2008 TEI – Introduction Page 151 to Financial Presentation title Reporting for Taxes USP FHC FSA FSB Domestic vs. foreign example (cont.) ► Is FHC required to recognize a deferred tax liability for the undistributed earnings of its subsidiaries? 22Page May, 152 2008 TEI – Introduction Page 152 to Financial Presentation title Reporting for Taxes Domestic vs. foreign example (cont.) ► ► FHC’s investment in FSB is “foreign” and will not trigger a deferred tax liability as long as FHC’s investment in FSB is, essentially, permanent in duration FHC’s investment in FSA is “domestic,” not foreign; FHC might be required to provide a deferred tax liability on undistributed earnings after 12/15/1992, unless the investment will be realized in a tax-free manner 22Page May, 153 2008 TEI – Introduction Page 153 to Financial Presentation title Reporting for Taxes Domestic vs. foreign ► ► Foreign subsidiary – eligible for 1 ASC 740-30 exception Domestic Subsidiary – the exception is not available 2 USP 1 Swiss 2 1 Swiss UK 2 UK 22Page May, 154 2008 TEI – Introduction Page 154 to Financial Presentation title Reporting for Taxes Impact of domestic vs. foreign determination to effective tax rate ► ► ► ► ► ► ► US Parent (USP) is a U.S. corporation. Pre-tax USP earnings are $5,000 All entities are 100% owned CFC 1 is incorporated in Country A CFC 2 is incorporated in Country A and cannot be liquidated into CFC 1 in a taxfree manner CFC 3 is incorporated in Country B Both CFC 2 and CFC 3 plan to reinvest their earnings for the indefinite future All entities’ respective E&P amounts are equivalent to respective outside basis amounts 22Page May, 155 2008 TEI – Introduction Page 155 to Financial Presentation title Reporting for Taxes USP CFC 1 CFC 2 E&P $1,000 Taxes $100 ETR 9% E&P $1,000 Taxes $1,000 ETR 50% CFC 3 E&P $1,000 Taxes $200 ETR 17% Impact of domestic vs. foreign determination to effective tax rate (cont.) ► USP thought it had an effective tax rate of 27.22% as follows: USP CFC 1 CFC 2 CFC 3 ► Pre-tax earnings $5,000 $2,000 $1,000 $1,000 Taxes DTL/(DTA) $1,750 $1,000 (300) Indefinitely Reinvested Indefinitely Reinvested Tax expense (current plus deferred) $2,450 (i.e.,( $7,000 x 35%) Effective tax rate 27.22% (i.e., $2,450 divided by $9,000) However, CFC 2 is considered a domestic subsidiary of CFC 1. Therefore, CFC 2 does not meet the ASC 740-30 exception (unless CFC 1’s investment in CFC 2 can be realized in a tax-free manner). Assumes CFC 2 and CFC 3 taxes are not current year taxes. 22Page May, 156 2008 TEI – Introduction Page 156 to Financial Presentation title Reporting for Taxes Impact of domestic vs. foreign determination to effective tax rate (cont.) ► If CFC 1’s investment in CFC 2 cannot be realized in a tax-free manner, USP is considered to have an effective tax rate of 31.11% as follows: USP CFC 1 CFC 2 CFC 3 Pre-tax earnings $5,000 $2,000 $1,000 $1,000 Taxes DTL/(DTA) $1,750 $1,000 (300) $100 250 Indefinitely Reinvested Tax expense $2,800 (i.e.,( $8,000 x 35%) (current plus deferred) Effective tax rate ► 31.11% (i.e., $2,800 divided by $9,000) Assumes CFC 3 taxes are not current year taxes 22Page May, 157 2008 TEI – Introduction Page 157 to Financial Presentation title Reporting for Taxes ASC 740-30 exception for foreign subsidiaries ► ► ► As circumstances change, an increase and decrease in required deferred tax liabilities for repatriation taxes are recorded directly to the income statement Sufficient evidence required in order to qualify for exception Disclosure requirements 22Page May, 158 2008 TEI – Introduction Page 158 to Financial Presentation title Reporting for Taxes Intercompany Transactions 22Page May, 159 2008 TEI – Introduction Page 159 to Financial Presentation title Reporting for Taxes Treatment of intercompany transactions ► ASC 740 codified the treatment under ARB 51 for income taxes paid on intercompany profits on assets remaining within the group ► ► Under ARB 51, all intercompany balances and transactions shall be eliminated It prohibits recognition of a deferred tax asset for the difference between the tax basis and the book basis of the assets in the buyer’s jurisdiction and the cost as reported in the consolidated financial statements 22Page May, 160 2008 TEI – Introduction Page 160 to Financial Presentation title Reporting for Taxes Intercompany transactions: example ► US parent sells inventory to foreign sub: ► ► ► $20,000 profit is eliminated in consolidation: ► ► ► ► ► Selling price = $100,000 US book/tax basis = $80,000 US tax rate of 35% US has current tax of $7,000 Foreign sub now has tax basis in inventory of $100,000 Book basis remains at $80,000 (intercompany profit was eliminated) Foreign tax rate is 50% 22Page May, 161 2008 TEI – Introduction Page 161 to Financial Presentation title Reporting for Taxes Intercompany transactions: example (cont.) ► ► ► ► Intercompany profit US tax on intercompany profit Foreign tax basis > book Tax-effected foreign basis difference 22Page May, 162 2008 TEI – Introduction Page 162 to Financial Presentation title Reporting for Taxes $20,000 $ 7,000 $20,000 $10,000 Intercompany transactions – example (cont.) ► ► ► ► Does the foreign basis difference create a deferred tax asset of $10,000? Can net effect of intercompany transaction be a negative $3,000 of income tax expense ($10,000 less $7,000 paid to US)? No – Intercompany sale should have no impact on ETR In practical terms, the $7,000 US tax paid in the year of the intercompany sale should be recorded as a prepaid tax 22Page May, 163 2008 TEI – Introduction Page 163 to Financial Presentation title Reporting for Taxes Currency Translation Adjustments 22Page May, 164 2008 TEI – Introduction Page 164 to Financial Presentation title Reporting for Taxes Key Concepts ► ► ► ► ► ASC 830 (which codified FAS 52) Functional currency Re-measurement Translation process Cumulative translation adjustments 22Page May, 165 2008 TEI – Introduction Page 165 to Financial Presentation title Reporting for Taxes Application of ASC 830 ► The Statement applies to the translation of financial statements for purposes of: ► ► ► ► Consolidation Combination Equity method of accounting ASC 830 applies to the financial statements of all enterprises prepared in conformity with US GAAP, whether the US dollar or a foreign currency is the reporting currency ► 22Page May, 166 2008 For example, a foreign enterprise may report in its local currency in conformity with US GAAP. If so, it should follow the requirements of ASC 830 TEI – Introduction Page 166 to Financial Presentation title Reporting for Taxes ASC 830: Approach ► 1. 2. 3. ASC 830 utilizes the functional currency approach to translation. Each entity’s financial statements are measured in its functional currency before being translated into the reporting currency Identify the functional currency for each entity included in the financial statements of the reporting enterprise Convert the accounts of each entity to US GAAP Remeasure accounts from local currency to functional currency 22Page May, 167 2008 TEI – Introduction Page 167 to Financial Presentation title Reporting for Taxes ASC 830: Approach (cont.) 4. 5. 6. Adjustments required to balance financials after remeasurement are made to income Translate functional currency financials into the reporting currency of the reporting enterprise (usually the US dollar) Adjustments required to balance financials after translation are made to a separate component of shareholder’s equity – usually called the Cumulative Translation Account (CTA) 22Page May, 168 2008 TEI – Introduction Page 168 to Financial Presentation title Reporting for Taxes Functional currency ► ► Functional currency: The currency of the primary environment in which the entity operates Reporting currency: The currency in which the financial results of the ultimate parent are reported 22Page May, 169 2008 TEI – Introduction Page 169 to Financial Presentation title Reporting for Taxes Determining functional currency ► An entity's functional currency is the currency of the primary economic environment in which the entity operates ► ► Normally, functional currency is the currency of the jurisdiction in which an entity primarily generates and expends cash The functional currency of an entity is based upon facts and circumstances 22Page May, 170 2008 TEI – Introduction Page 170 to Financial Presentation title Reporting for Taxes The remeasurement process ► Remeasurement is the process of calculating, in the functional currency, those financial statements that are maintained in another currency ► Objective is to produce the same result as if the entity’s books of record had been initially recorded in the functional currency 22Page May, 171 2008 TEI – Introduction Page 171 to Financial Presentation title Reporting for Taxes When is remeasurement required? ► Required if an entity’s books of record are not maintained in its functional currency, ASC 830 requires remeasurement into the functional currency prior to translation into the reporting currency 22Page May, 172 2008 TEI – Introduction Page 172 to Financial Presentation title Reporting for Taxes Why is remeasurement included in income? ► The economic effects of an exchange rate change on a foreign operation that is an extension of the parent’s domestic operations (i.e., a foreign entity whose functional currency is the reporting currency) relate to individual assets and liabilities and impact the parent’s cash flows directly. Accordingly, the exchange gains and losses in such an operation are included in net income 22Page May, 173 2008 TEI – Introduction Page 173 to Financial Presentation title Reporting for Taxes The translation process ► The process of expressing functional currency measurements in the reporting currency ► If an entity’s functional currency is not the same as the reporting currency, ASC 830 requires translation into the reporting currency ► If an entity’s functional currency is the same as the reporting currency, the process is complete after remeasurement 22Page May, 174 2008 TEI – Introduction Page 174 to Financial Presentation title Reporting for Taxes What is the objective of translation? ► The translation of the financial statements of each component entity of an enterprise should: ► Provide information that is generally compatible with the expected economic effects of a rate change on an enterprise’s cash flows and equity ► Reflect in consolidated statements the financial results and relationships of the individual consolidated entities as measured in their functional currencies in conformity with US GAAP 22Page May, 175 2008 TEI – Introduction Page 175 to Financial Presentation title Reporting for Taxes Why is translation not included in income? ► The economic effects of an exchange rate change on a foreign operation that operates in its local currency impact the entity’s net assets and, hence, the reporting enterprise’s net investment in the foreign entity. As a result, the effect of changes in exchange rates is reported in equity. 22Page May, 176 2008 TEI – Introduction Page 176 to Financial Presentation title Reporting for Taxes Summary LC = Local Currency RC = Reporting Currency If the Functional Currency is the: LC Remeasurement LC Remeasurement: • Adjustment through current P&L • Monetary Assets/Liabilities – Current fx Rate • Non-Monetary Assets/Liabilities – Historical fx Rate • Revenue/Expense – Weighted Avg. fx Rate 22Page May, 177 2008 TEI – Introduction Page 177 to Financial Presentation title Reporting for Taxes Other Functional Currency RC Translation RC Translation: • Adjustment through CTA – Component of Equity • Monetary Assets/Liabilities – Current fx Rate • Non-Monetary Assets/Liabilities – Historical fx Rate • Revenue/Expense – Weighted Avg. fx Rate Key Points ► ► ► Income tax effects of gains and losses from remeasurement are included in P&L Income tax effects of gains and losses from translation adjustments under ASC 830 are included in equity Deferred taxes recorded on translation adjustments if a foreign subsidiary’s earnings are not indefinitely reinvested 22Page May, 178 2008 TEI – Introduction Page 178 to Financial Presentation title Reporting for Taxes Questions? 22Page May, 179 2008 TEI – Introduction Page 179 to Financial Presentation title Reporting for Taxes Financial statement disclosures TEI – Introduction to Financial Reporting for Taxes Objectives ► ► Describe ASC 740 requirements for balance sheet, income statement and footnote disclosures for public and nonpublic companies Identify inaccuracies and inadequacies in example disclosures 22Page May, 181 2008 TEI – Introduction Page 181 to Financial Presentation title Reporting for Taxes Why is disclosure important? ► ► The tax provision expense generally is the largest item for a company The financial statements are the means by which important stakeholders, such as shareholders and financial institutions, interpret the current and future value of a company ► ► Improper disclosure could affect a company’s stock price or borrowing capacity Disclosures are the end result of the complicated income tax provision calculations ► 22Page May, 182 2008 Without proper disclosure, these calculations become meaningless TEI – Introduction Page 182 to Financial Presentation title Reporting for Taxes Tax-related disclosures ► ► ► Balance sheet – deferred assets, deferred liabilities and, if material, current taxes payable/receivable Income statement – tax expense and special items net of taxes Footnotes: ► ► ► ► Tax expense (current vs. deferred, federal vs. state and local vs. foreign) Deferred assets and liabilities (valuation allowances) Rate reconciliation Other disclosures ► ► 22Page May, 183 2008 Net operating losses (NOLs): amounts and expiration Credits: amounts and expiration TEI – Introduction Page 183 to Financial Presentation title Reporting for Taxes Balance sheet disclosure ► Separate deferred tax assets/deferred tax liabilities into two classifications (ASC 740-10-45-4): ► ► ► For a particular component and within a particular tax jurisdiction (ASC 740-10-45-6): ► ► ► Net current (short-term) DTA/DTL Net noncurrent (long-term) DTA/DTL Current taxes payable/(receivable): ► ► Current Noncurrent Generally represents current taxes payable or contingencies expected to be paid within the next 12 months Non current taxes payable: ► 22Page May, 184 2008 Generally includes tax contingency reserves not expected to be paid within the next 12 months TEI – Introduction Page 184 to Financial Presentation title Reporting for Taxes Income statement disclosure ► Income tax expense (disclosed below “net income before taxes”): ► ► ► Sometimes segregated into current and deferred Combines federal, state and local and foreign tax provisions Special items (net of tax): ► 22Page May, 185 2008 Intraperiod allocation TEI – Introduction Page 185 to Financial Presentation title Reporting for Taxes Tax footnote disclosure ► ► Tax footnote disclosures provide an informed reader with sufficient detail to understand the impact of the various components of the income tax provision and related balance sheet accounts Components of the net DTL or DTA (ASC 740-10-50-2): ► ► ► ► Total Deferred Tax Liability (DTL) Total Deferred Tax Asset (DTA) Total valuation allowance and net change during the year Tax effects of each type of temporary difference and carryforward (if a public company) (ASC 740-10-50-6) 22Page May, 186 2008 TEI – Introduction Page 186 to Financial Presentation title Reporting for Taxes Tax footnote disclosure (cont.) ► The following information is disclosed whenever a DTL is not recognized due to the Foreign Subsidiary Exception in ASC 740-30 (ASC 740-10-50-2): ► ► ► 22Page May, 187 2008 A description of the types of temporary differences for which a DTL has not been recognized and the types of events that would cause those differences to become taxable The cumulative amount of each type of temporary difference The amount of the unrecognized DTL for temporary differences related to investments in foreign subsidiaries, or a statement that determination is not practicable TEI – Introduction Page 187 to Financial Presentation title Reporting for Taxes Tax footnote disclosure (cont.) ► Components of income tax expense attributable to continuing operations (ASC 740-10-50-9): ► ► ► ► ► ► ► ► 22Page May, 188 2008 Current tax expense or benefit Deferred tax expense or benefit Investment tax credits Government grants Benefits of operating loss carryforwards Tax expense recorded directly to equity/goodwill Adjustments to DTA/DTL due to changes in tax law/rate/status Adjustment to valuation allowance due to changes in judgment about realizability TEI – Introduction Page 188 to Financial Presentation title Reporting for Taxes Tax footnote disclosure (cont.) ► Income tax expense allocated to (ASC 740-10-50-10): ► ► ► ► ► ► 22Page May, 189 2008 Continuing operations Discontinued operations Extraordinary items Cumulative effect of accounting changes Prior-period adjustments Other items charged directly to equity TEI – Introduction Page 189 to Financial Presentation title Reporting for Taxes Tax footnote disclosure (cont.) ► Public companies ► Must provide effective tax rate reconciliation in dollars or percentages between (ASC 740-10-50-12): ► ► ► ► The reported amount of income tax expense The amount of income tax expense that would result from applying federal statutory rates to pretax financial income Separately disclose a reconciling item if it is more than 5% of the amount computed by multiplying pretax income by the statutory tax rate (Regulation S-X, Rule 4-08(h)(2)) Nonpublic companies ► 22Page May, 190 2008 Explain major reconciling items and may omit numerical reconciliation TEI – Introduction Page 190 to Financial Presentation title Reporting for Taxes Tax footnote disclosure (cont.) ► Public companies must also disclose the following (Regulation S-X, Rule 4-08(h)): ► ► The components of pretax income (loss) as either domestic or foreign The amounts of current tax expense and deferred tax expense applicable to: ► ► ► 22Page May, 191 2008 Federal income taxes Foreign income taxes Other income taxes, such as state income taxes TEI – Introduction Page 191 to Financial Presentation title Reporting for Taxes Tax footnote disclosure (cont.) ► All companies must disclose the following: ► ► ► ► 22Page May, 192 2008 Nature and effect of any significant matters affecting comparability of information (ASC 740-10-50-14) Amount and expiration date of NOL and tax credit carryforwards (ASC 740-10-50-3) Any portion of the VA for DTAs for which subsequent recognition of a tax benefit for that item will be directly credited to equity (ASC 740-10-50-3) Intercompany allocation method (if an entity is a member of a group that files a consolidated return but issues separate financial statements) (ASC 740-10-50-17) TEI – Introduction Page 192 to Financial Presentation title Reporting for Taxes Disclosure of uncertain tax positions ► Public Companies ► Tabular reconciliation of the aggregate beginning and ending unrecognized tax benefits that separately presents the following (ASC 740-10-15A(a)): ► ► ► ► ► 22Page May, 193 2008 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 the increases and decreases in unrecognized tax benefits as a result of tax positions taken during the current period The amount of decreases in unrecognized tax benefits relating to settlements with taxing authorities Reductions to unrecognized tax benefits as a result of lapse of applicable statute of limitations The amount of unrecognized tax benefits that, if recognized, would change the effective tax rate (ASC 740-10-15A(b)) TEI – Introduction Page 193 to Financial Presentation title Reporting for Taxes Disclosure of uncertain tax positions (cont.) ► All Companies ► ► ► The classification of interest and penalties (ASC 740-10-50-19) The amount of interest and penalties recognized in the income statement and the amount of interest and penalties accrued in the statement of financial position (ASC 740-10-50-15(c)) If it is reasonably possible that the total amounts of unrecognized tax benefits will change significantly within 12 months, then disclose (ASC 740-10-50-15(d)): ► ► ► ► 22Page May, 194 2008 The nature of uncertainty The nature of the event that would cause the change An estimate of the range of the reasonably possible change, or state that an estimate cannot be made A description of tax years that remain subject to examination by major tax jurisdictions (ASC 740-10-50-15(e)) TEI – Introduction Page 194 to Financial Presentation title Reporting for Taxes Tax disclosure of internal controls ► ► ► ► Footnote disclosures, by definition, are always significant Thus, tax disclosure processes always will be in scope in an integrated audit Controls should ensure the completeness, appropriateness, accuracy and fairness of tax disclosures Disclosures involving judgment contain higher control risk 22Page May, 195 2008 TEI – Introduction Page 195 to Financial Presentation title Reporting for Taxes Summary ► ► ► Current and deferred taxes are disclosed on the balance sheet Tax expense appears on the income statement The footnote disclosures are important to explain the impact of the numbers disclosed on the balance sheet and income statement 22Page May, 196 2008 TEI – Introduction Page 196 to Financial Presentation title Reporting for Taxes Questions? Thank you for your participation and feedback! Page 198 TEI – Introduction to Financial Reporting for Taxes
