Appendix A — Implementation Guidance and Illustrations
Appendix A — Implementation Guidance and Illustrations
This Roadmap contains the implementation guidance and illustrative
examples from ASC 740-10, ASC
740-20, ASC
740-270, ASC
805-740, ASC
830-740, and ASC
323-740, as included in the FASB Accounting Standards
Codification. This guidance is not all-inclusive; an entity should also consider its
specific facts and circumstances.
ASC 740-10 — Implementation Guidance and Illustrations
General
55-1 This Section is an integral part of the requirements
of this Subtopic. This Section provides additional guidance and
illustrations that address the application of accounting
requirements to specific aspects of accounting for income taxes,
including disclosures. The guidance and illustrations that
follow, unless stated otherwise, assume that the tax law
requires offsetting net deductions in a particular year against
net taxable amounts in the 3 preceding years and then in the 15
succeeding years. These assumptions about the tax law are for
illustrative purposes only. This Subtopic requires that the
enacted tax law for a particular tax jurisdiction be used for
recognition and measurement of deferred tax liabilities and
assets.
Implementation Guidance
55-2 The guidance is organized as follows:
- Application of accounting requirements for income taxes to specific situations
- Subparagraph superseded by Accounting Standards Update No. 2015-17
- Income tax related disclosures.
Application of Accounting Requirements for Income Taxes to
Specific Situations
Recognition and Measurement of Tax Positions — a Two-Step
Process
55-3 The application of the requirements of this Subtopic
related to tax positions requires a two-step process that
separates recognition from measurement. The first step is
determining whether a tax position has met the recognition
threshold; the second step is measuring a tax position that
meets the recognition threshold. The recognition threshold is
met when the taxpayer (the reporting entity) concludes that,
consistent with paragraphs 740-10-25-6 through 25-7 and
740-10-25-13, it is more likely than not that the taxpayer will
sustain the benefit taken or expected to be taken in the tax
return in a dispute with taxing authorities if the taxpayer
takes the dispute to the court of last resort.
55-4 Relatively few disputes are resolved through
litigation, and very few are taken to the court of last resort.
Generally, the taxpayer and the taxing authority negotiate a
settlement to avoid the costs and hazards of litigation. As a
result, the measurement of the tax position is based on
management’s best judgment of the amount the taxpayer would
ultimately accept in a settlement with taxing authorities.
55-5 The recognition and measurement requirements of this
Subtopic related to tax positions require that the entity
recognize the largest amount of benefit that is greater than 50
percent likely of being realized upon settlement.
55-6 See Examples 1 through 12 (paragraphs 740-10-55-81
through 55-123) for illustrations of this guidance.
Recognition of Deferred Tax Assets and Deferred Tax
Liabilities
55-7 Subject to certain specific exceptions identified in
paragraph 740-10-25-3, a deferred tax liability is recognized
for all taxable temporary differences, and a deferred tax asset
is recognized for all deductible temporary differences and
operating loss and tax credit carryforwards. A valuation
allowance is recognized if it is more likely than not that some
portion or all of the deferred tax asset will not be realized.
See Example 12 (paragraph 740-10-55-120) for an illustration of
this guidance.
55-8 To the extent that evidence about one or more sources
of taxable income is sufficient to eliminate any need for a
valuation allowance, other sources need not be considered.
Detailed forecasts, projections, or other types of analyses are
unnecessary if expected future taxable income is more than
sufficient to realize a tax benefit.
55-9 The terms forecast and projection refer
to any process by which available evidence is accumulated and
evaluated for purposes of estimating whether future taxable
income will be sufficient to realize a deferred tax asset.
Judgment is necessary to determine how detailed or formalized
that evaluation process should be. Furthermore, information
about expected future taxable income is necessary only to the
extent positive evidence available from other sources (see
paragraph 740-10-30-18) is not sufficient to support a
conclusion that a valuation allowance is not needed. The
requirements of this Subtopic do not require either a financial
forecast or a financial projection within the meaning of those
terms in the Statements on Standards for Attestation Engagements
and Related Attest Engagements Interpretations [AT], AT section
301, Financial Forecasts and Projections issued by the
American Institute of Certified Public Accountants.
55-10 See Example 12 (paragraph 740-10-55-120) for an
illustration of a situation where detailed analyses are not
necessary.
55-11 See Example 13 (paragraph 740-10-55-124) for an
illustration of determining a valuation allowance for deferred
tax assets.
Offset of Taxable and Deductible Amounts
55-12 The tax law determines whether future reversals of
temporary differences will result in taxable and deductible
amounts that offset each other in future years. The tax law also
determines the extent to which deductible temporary differences
and carryforwards will offset the tax consequences of income
that is expected to be earned in future years. For example, the
tax law may provide that capital losses are deductible only to
the extent of capital gains. In that case, a tax benefit is not
recognized for temporary differences that will result in future
deductions in the form of capital losses unless those deductions
will offset any of the following:
- Other existing temporary differences that will result in future capital gains
- Capital gains that are expected to occur in future years
- Capital gains of the current year or prior years if carryback (of those capital loss deductions from the future reversal years) is expected.
Pattern of Taxable or Deductible Amounts
55-13 The particular years in which temporary differences
result in taxable or deductible amounts generally are determined
by the timing of the recovery of the related asset or settlement
of the related liability. However, there are exceptions to that
general rule. For example, a temporary difference between the
tax basis and the reported amount of inventory for which cost is
determined on a last-in, first-out (LIFO) basis does not reverse
when present inventory is sold in future years if it is replaced
by purchases or production of inventory in those same future
years. A LIFO inventory temporary difference becomes taxable or
deductible in the future year that inventory is liquidated and
not replaced.
55-14 For some assets or liabilities, temporary
differences may accumulate over several years and then reverse
over several years. That pattern is common for depreciable
assets. Future originating differences for existing depreciable
assets and their subsequent reversals are a factor to be
considered when assessing the likelihood of future taxable
income (see paragraph 740-10-30-18(b)) for realization of a tax
benefit for existing deductible temporary differences and
carryforwards.
The Need to Schedule Temporary Difference Reversals
55-15 Reversal patterns of existing temporary differences
may need to be scheduled under the requirements of this Subtopic
as follows:
- Subparagraph superseded by Accounting Standards Update No. 2015-17.
- Deferred tax assets are recognized without reference to offsetting, and then an assessment is made about the need for a valuation allowance. Paragraph 740-10-30-18 lists four possible sources of taxable income that may be available to realize such deferred tax assets. In many cases it may be possible to determine without scheduling that expected future taxable income (see paragraph 740-10-30-18(b)) will be adequate to eliminate the need for a valuation allowance. Disclosure of the amounts and expiration dates (or a reasonable aggregation of expiration dates) of operating loss and tax credit carryforwards is required only on a tax basis and does not require scheduling.
- The adoption of a tax rate convention for measuring deferred taxes when graduated tax rates are a significant factor will, in many cases, eliminate the need for the scheduling. In addition, alternative minimum tax rates and laws are a factor only in considering the need for a valuation allowance for a deferred tax asset for alternative minimum tax credit carryforwards. When there is a phased-in change in tax rates, however, scheduling will often be necessary. See paragraphs 740-10-55-24; 740-10-55-31 through 55-33; and Examples 14 through 16 (paragraphs 740-10-55-129 through 55-138).
55-16 Paragraph 740-10-30-18 lists four possible sources
of taxable income that may be available to realize a future tax
benefit for deductible temporary differences and carryforwards.
One source is future taxable income exclusive of reversing
temporary differences and carryforwards. Future originating
temporary differences and their subsequent reversal are implicit
in estimates of future taxable income. Where it can be easily
demonstrated that future taxable income will more likely than
not be adequate to realize future tax benefits of existing
deferred tax assets, scheduling of reversals of existing taxable
temporary differences would be unnecessary.
55-17 In other cases it may be easier to demonstrate that
no valuation allowance is needed by considering the reversal of
existing taxable temporary differences. Even in that case, the
extent of scheduling will depend on the relative magnitudes
involved. For example, if existing taxable temporary differences
that will reverse over a long number of future years greatly
exceed deductible differences that are expected to reverse over
a short number of future years, it may be appropriate to
conclude, in view of a long (for example, 15 years) carryforward
period for net operating losses, that realization of future tax
benefits for the deductible differences is thereby more likely
than not without the need for scheduling.
55-18 A general understanding of reversal patterns is, in
many cases, relevant in assessing the need for a valuation
allowance. Judgment is crucial in making that assessment. The
amount of scheduling, if any, that will be required will depend
on the facts and circumstances of each situation.
55-19 The following concepts however,
underlie the determination of reversal patterns for existing
temporary differences:
- The particular years in which temporary differences result in taxable or deductible amounts generally are determined by the timing of the recovery of the related asset or settlement of the related liability (see paragraph 740-10-55-13).
- The tax law determines whether future reversals of temporary differences will result in taxable and deductible amounts that offset each other in future years (see paragraph 740-10-55-14).
55-20 State income taxes are deductible for U.S. federal
income tax purposes and therefore a deferred state income tax
liability or asset gives rise to a temporary difference for
purposes of determining a deferred U.S. federal income tax asset
or liability, respectively. The pattern of deductible or taxable
amounts in future years for temporary differences related to
deferred state income tax liabilities or assets should be
determined by estimates of the amount of those state income
taxes that are expected to become payable or recoverable for
particular future years and, therefore, deductible or taxable
for U.S. federal tax purposes in those particular future
years.
55-21 An entity may have claimed certain deductions, such
as repair expenses, on its income tax returns. However, the
entity may have recognized a liability (including interest) for
the unrecognized tax benefit of those tax positions. If
scheduling of future taxable or deductible differences is
necessary, liabilities for unrecognized tax benefits should be
considered. Accrual of a liability for unrecognized tax benefits
of expenses, such as repairs, has the effect of capitalizing
those expenses for tax purposes. Those capitalized expenses are
considered to result in deductible amounts in the later years,
for example, as depreciation expense. If the liability for
unrecognized tax benefits is based on an overall evaluation of
the technical merits of the tax position, scheduling should
reflect the evaluations made in determining the liability for
unrecognized tax benefits that was recognized. The effect of
those evaluations may indicate a source of taxable income (see
paragraph 740-10-30-18(c)) for purposes of assessing the need
for a valuation allowance for deductible temporary differences.
Those evaluations may also indicate lower amounts of taxable
income in other years. A deductible amount for any accrued
interest related to unrecognized tax benefits would be scheduled
for the future year in which that interest is expected to become
deductible.
55-22 Minimizing
complexity is an appropriate consideration in selecting a method
for determining reversal patterns. The methods used for
determining reversal patterns should be systematic and logical.
The same method should be used for all temporary differences
within a particular category of temporary differences for a
particular tax jurisdiction. Different methods may be used for
different categories of temporary differences. If the same
temporary difference exists in two tax jurisdictions (for
example, U.S. federal and a state tax jurisdiction), the same
method should be used for that temporary difference in both tax
jurisdictions. The same method for a particular category in a
particular tax jurisdiction should be used consistently from
year to year. A change in method is a change in accounting
principle under the requirements of Topic 250. Two examples of a
category of temporary differences are those related to
liabilities for deferred compensation and investments in direct
financing and sales-type leases.
Measurement of Deferred Tax Liabilities and Assets
55-23 The tax rate or rates that are used to measure
deferred tax liabilities and deferred tax assets are the enacted
tax rates expected to apply to taxable income in the years that
the liability is expected to be settled or the asset recovered.
Measurements are based on elections (for example, an election
for loss carryforward instead of carryback) that are expected to
be made for tax purposes in future years. Presently enacted
changes in tax laws and rates that become effective for a
particular future year or years must be considered when
determining the tax rate to apply to temporary differences
reversing in that year or years. Tax laws and rates for the
current year are used if no changes have been enacted for future
years. An asset for deductible temporary differences that are
expected to be realized in future years through carryback of a
future loss to the current or a prior year (or a liability for
taxable temporary differences that are expected to reduce the
refund claimed for the carryback of a future loss to the current
or a prior year) is measured using tax laws and rates for the
current or a prior year, that is, the year for which a refund is
expected to be realized based on loss carryback provisions of
the tax law. See Examples 14 through 16 (paragraphs
740-10-55-129 through 55-138) for illustrations of this
guidance.
55-24 Deferred tax liabilities and assets are measured
using enacted tax rates applicable to capital gains, ordinary
income, and so forth, based on the expected type of taxable or
deductible amounts in future years. For example, evidence based
on all facts and circumstances should determine whether an
investor’s liability for the tax consequences of temporary
differences related to its equity in the earnings of an investee
should be measured using enacted tax rates applicable to a
capital gain or a dividend. Computation of a deferred tax
liability for undistributed earnings based on dividends should
also reflect any related dividends received deductions or
foreign tax credits, and taxes that would be withheld from the
dividend.
State and Local Income Taxes
55-25 If deferred tax assets or liabilities for a state or
local tax jurisdiction are significant, this Subtopic requires a
separate deferred tax computation when there are significant
differences between the tax laws of that and other tax
jurisdictions that apply to the entity. In the United States,
however, many state or local income taxes are based on U.S.
federal taxable income, and aggregate computations of deferred
tax assets and liabilities for at least some of those state or
local tax jurisdictions might be acceptable. In assessing
whether an aggregate calculation is appropriate, matters such as
differences in tax rates or the loss carryback and carryforward
periods in those state or local tax jurisdictions should be
considered. Also, the provisions of paragraph 740-10-45-6 about
offset of deferred tax liabilities and assets of different tax
jurisdictions should be considered. In assessing the
significance of deferred tax expense for a state or local tax
jurisdiction, it is appropriate to consider the deferred tax
consequences that those deferred state or local tax assets or
liabilities have on other tax jurisdictions, for example, on
deferred federal income taxes.
55-26 Local (including
franchise) taxes based on income are within the scope of this
Topic. A tax, to the extent it is based on capital, is a
non-income-based tax. As indicated in paragraph 740-10-15-4(a),
if there is an amount of a franchise tax based on income, that
amount is considered an income tax. Any additional amount
incurred is considered a non-income-based tax. An example that
illustrates this guidance is presented in Example 17 (see
paragraph 740-10-55-139).
Special Deductions — Tax Deduction on Qualified Production
Activities Provided by the American Jobs Creation Act of
2004
55-27 The following discussion and Example 18 (see
paragraph 740-10-55-145) refer to and describe a provision
within the American Jobs Creation Act of 2004; however, they
shall not be considered a definitive interpretation of any
provision of the Act for any purpose.
55-28 On October 22, 2004, the Act was signed into law by
the president. This Act includes a tax deduction of up to 9
percent (when fully phased-in) of the lesser of qualified
production activities income, as defined in the Act, or taxable
income (after the deduction for the utilization of any net
operating loss carryforwards). This tax deduction is limited to
50 percent of W-2 wages paid by the taxpayer.
55-29 The qualified production activities deduction’s
characteristics are similar to special deductions discussed in
paragraph 740-10-25-37 because the qualified production
activities deduction is contingent upon the future performance
of specific activities, including the level of wages.
Accordingly, the deduction should be accounted for as a special
deduction in accordance with that paragraph.
55-30 The special deduction should be considered by an
entity in measuring deferred taxes when graduated tax rates are
a significant factor and assessing whether a valuation allowance
is necessary as required by paragraph 740-10-25-37. Example 18
(see paragraph 740-10-55-145) illustrates the application of the
requirements of this Subtopic for the impact of the qualified
production activities deduction upon enactment of the Act in
2004.
Alternative Minimum Tax
55-31 Temporary differences such as depreciation
differences are one reason why tentative minimum tax may exceed
regular tax. Temporary differences, however, ultimately reverse
and, absent a significant amount of preference items, total
taxes paid over the entire life of the entity will be based on
the regular tax system. Preference items are another reason why
tentative minimum tax may exceed regular tax. If preference
items are large enough, an entity could be subject, over its
lifetime, to the alternative minimum tax system; and the
cumulative amount of alternative minimum tax credit
carryforwards would expire unused. No one can know beforehand
which scenario will prevail because that determination can only
be made after the fact. In the meantime, this Subtopic requires
procedures that provide a practical solution to that
problem.
55-32 Under the requirements of this Subtopic, an entity
shall:
- Measure the total deferred tax liability and asset for regular tax temporary differences and carryforwards using the regular tax rate
- Measure the total deferred tax asset for all alternative minimum tax credit carryforward
- Reduce the deferred tax asset for alternative minimum tax credit carryforward by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of that deferred tax asset will not be realized.
55-33 Paragraph 740-10-30-18 identifies four sources of
taxable income that shall be considered in determining the need
for and amount of a valuation allowance. No valuation allowance
is necessary if the deferred tax asset for alternative minimum
tax credit carryforward can be realized in any of the following
ways:
- Under paragraph 740-10-30-18(a), by reducing a deferred tax liability from the amount of regular tax on regular tax temporary differences to not less than the amount of tentative minimum tax on alternative minimum taxable temporary differences
- Under paragraph 740-10-30-18(b), by reducing taxes on future income from the amount of regular tax on regular taxable income to not less than the amount of tentative minimum tax on alternative minimum taxable income
- Under paragraph 740-10-30-18(c), by loss carryback
- Under paragraph 740-10-30-18(d), by a tax-planning strategy such as switching from tax-exempt to taxable interest income.
Operating Loss and Tax Credit Carryforwards and Carrybacks
Recognition of a Tax Benefit for Carrybacks
55-34 An operating loss, certain deductible items that are
subject to limitations, and some tax credits arising but not
utilized in the current year may be carried back for refund of
taxes paid in prior years or carried forward to reduce taxes
payable in future years. A receivable, to the extent it meets
the recognition requirements of this Subtopic for tax positions,
is recognized for the amount of taxes paid in prior years that
is refundable by carryback of an operating loss or unused tax
credits of the current year.
Recognition of a Tax Benefit for Carryforwards
55-35 A deferred tax asset, to the extent it meets the
recognition requirements of this Subtopic for tax positions, is
recognized for an operating loss or tax credit carryforward.
This requirement pertains to all investment tax credit
carryforwards regardless of whether the flow-through or deferral
method is used to account for investment tax credits.
55-36 In assessing the need for a valuation allowance,
provisions in the tax law that limit utilization of an operating
loss or tax credit carryforward are applied in determining
whether it is more likely than not that some portion or all of
the deferred tax asset will not be realized by reduction of
taxes payable on taxable income during the carryforward period.
Example 19 (see paragraph 740-10-55-149) illustrates recognition
of the tax benefit of an operating loss in the loss year and in
subsequent carryforward years when a valuation allowance is
necessary in the loss year.
55-37 An operating loss or tax credit carryforward from a
prior year (for which the deferred tax asset was offset by a
valuation allowance) may sometimes reduce taxable income and
taxes payable that are attributable to certain revenues or gains
that the tax law requires be included in taxable income for the
year that cash is received. For financial reporting, however,
there may have been no revenue or gain and a liability is
recognized for the cash received. Future sacrifices to settle
the liability will result in deductible amounts in future years.
Under those circumstances, the reduction in taxable income and
taxes payable from utilization of the operating loss or tax
credit carryforward gives no cause for recognition of a tax
benefit because, in effect, the operating loss or tax credit
carryforward has been replaced by temporary differences that
will result in deductible amounts when a nontax liability is
settled in future years. The requirements for recognition of a
tax benefit for deductible temporary differences and for
operating loss carryforwards are the same, and the manner of
reporting the eventual tax benefit recognized (that is, in
income or as required by paragraph 740-20-45-3) is not affected
by the intervening transaction reported for tax purposes.
Example 20 (see paragraph 740-10-55-156) illustrates recognition
of the tax benefit of an operating loss in the loss year and in
subsequent carryforward years when a valuation allowance is
necessary in the loss year.
Reporting the Tax Benefit of Operating Loss Carryforwards or
Carrybacks
55-38 Except as noted in paragraph 740-20-45-3, the manner
of reporting the tax benefit of an operating loss carryforward
or carryback is determined by the source of the income or loss
in the current year and not by the source of the operating loss
carryforward or taxes paid in a prior year or the source of
expected future income that will result in realization of a
deferred tax asset for an operating loss carryforward from the
current year. Deferred tax expense (or benefit) that results
because a change in circumstances causes a change in judgment
about the future realization of the tax benefit of an operating
loss carryforward is allocated to continuing operations (see
paragraph 740-10-45-20). Thus, for example:
- The tax benefit of an operating loss carryforward that
resulted from a loss on discontinued operations in a
prior year and that is first recognized in the financial
statements for the current year:
- Is allocated to continuing operations if it offsets the current or deferred tax consequences of income from continuing operations
- Is allocated to a gain on discontinued operations if it offsets the current or deferred tax consequences of that gain
- Is allocated to continuing operations if it results from a change in circumstances that causes a change in judgment about future realization of a tax benefit.
- The current or deferred tax benefit of a loss from
continuing operations in the current year is allocated
to continuing operations regardless of whether that loss
offsets the current or deferred tax consequences of a
gain on discontinued operations that:
- Occurred in the current year
- Occurred in a prior year (that is, if realization of the tax benefit will be by carryback refund)
- Is expected to occur in a future year.
Tax-Planning Strategies
55-39 Expectations about future taxable income incorporate
numerous assumptions about actions, elections, and strategies to
minimize income taxes in future years. For example, an entity
may have a practice of deferring taxable income whenever
possible by structuring sales to qualify as installment sales
for tax purposes. Actions such as that are not tax-planning
strategies, as that term is used in this Topic because they are
actions that management takes in the normal course of business.
For purposes of applying the requirements of this Subtopic, a
tax-planning strategy is an action that management ordinarily
might not take but would take, if necessary, to realize a tax
benefit for a carryforward before it expires. For example, a
strategy to sell property and lease it back for the expressed
purpose of generating taxable income to utilize a carryforward
before it expires is not an action that management takes in the
normal course of business. A qualifying tax-planning strategy is
an action that:
- Is prudent and feasible. Management must have the ability to implement the strategy and expect to do so unless the need is eliminated in future years. For example, management would not have to apply the strategy if income earned in a later year uses the entire amount of carryforward from the current year.
- An entity ordinarily might not take, but would take to prevent an operating loss or tax credit carryforward from expiring unused. All of the various strategies that are expected to be employed for business or tax purposes other than utilization of carryforwards that would otherwise expire unused are, for purposes of this Subtopic, implicit in management’s estimate of future taxable income and, therefore, are not tax-planning strategies as that term is used in this Topic.
- Would result in realization of deferred tax assets. The effect of qualifying tax-planning strategies must be recognized in the determination of the amount of a valuation allowance. Tax-planning strategies need not be considered, however, if positive evidence available from other sources (see paragraph 740-10-30-18) is sufficient to support a conclusion that a valuation allowance is not necessary.
55-40 Paragraph 740-10-30-19 indicates
that tax-planning strategies include elections for tax purposes.
The following are some examples of elections under current U.S.
federal tax law that, if they meet the criteria for tax-planning
strategies, should be considered in determining the amount, if
any, of valuation allowance required for deferred tax assets:
- The election to file a consolidated tax return
- The election to claim either a deduction or a tax credit for foreign taxes paid
- The election to forgo carryback and only carry forward a net operating loss.
55-41 Because the effects of known
qualifying tax-planning strategies must be recognized (see
Example 22 [paragraph 740-10-55-163]), management should make a
reasonable effort to identify those qualifying tax-planning
strategies that are significant. Management’s obligation to
apply qualifying tax-planning strategies in determining the
amount of valuation allowance required is the same as its
obligation to apply the requirements of other Topics for
financial accounting and reporting. However, if there is
sufficient evidence that taxable income from one of the other
sources of taxable income listed in paragraph 740-10-30-18 will
be adequate to eliminate the need for any valuation allowance, a
search for tax-planning strategies is not necessary.
55-42 Tax-planning strategies may shift estimated future
taxable income between future years. For example, assume that an
entity has a $1,500 operating loss carryforward that expires at
the end of next year and that its estimate of taxable income
exclusive of the future reversal of existing temporary
differences and carryforwards is approximately $1,000 per year
for each of the next several years. That estimate is based, in
part, on the entity’s present practice of making sales on the
installment basis and on provisions in the tax law that result
in temporary deferral of gains on installment sales. A
tax-planning strategy to increase taxable income next year and
realize the full tax benefit of that operating loss carryforward
might be to structure next year’s sales in a manner that does
not meet the tax rules to qualify as installment sales. Another
strategy might be to change next year’s depreciation procedures
for tax purposes.
55-43 Tax-planning strategies also may shift the estimated
pattern and timing of future reversals of temporary differences.
For example, if an operating loss carryforward otherwise would
expire unused at the end of next year, a tax-planning strategy
to sell the entity’s installment sale receivables next year
would accelerate the future reversal of taxable temporary
differences for the gains on those installment sales. In other
circumstances, a tax-planning strategy to accelerate the future
reversal of deductible temporary differences in time to offset
taxable income that is expected in an early future year might be
the only means to realize a tax benefit for those deductible
temporary differences if they otherwise would reverse and
provide no tax benefit in some later future year(s). Examples of
actions that would accelerate the future reversal of deductible
temporary differences include the following:
- An annual payment that is larger than an entity’s usual annual payment to reduce a long-term pension obligation (recognized as a liability in the financial statements) might accelerate a tax deduction for pension expense to an earlier year than would otherwise have occurred.
- Disposal of obsolete inventory that is reported at net realizable value in the financial statements would accelerate a tax deduction for the amount by which the tax basis exceeds the net realizable value of the inventory.
- Sale of loans at their reported amount (that is, net of an allowance for bad debts) would accelerate a tax deduction for the allowance for bad debts.
55-44 A significant expense might need to be incurred to
implement a particular tax-planning strategy, or a significant
loss might need to be recognized as a result of implementing a
particular tax-planning strategy. In either case, that expense
or loss (net of any future tax benefit that would result from
that expense or loss) reduces the amount of tax benefit that is
recognized for the expected effect of a qualifying tax-planning
strategy. For that purpose, the future effect of a differential
in interest rates (for example, between the rate that would be
earned on installment sale receivables and the rate that could
be earned on an alternative investment if the tax-planning
strategy is to sell those receivables to accelerate the future
reversal of related taxable temporary differences) is not
considered.
55-45 Example 21 (see paragraph 740-10-55-159) illustrates
recognition of a deferred tax asset based on the expected effect
of a qualifying tax-planning strategy when a significant expense
would be incurred to implement the strategy.
55-46 Under this Subtopic, the requirements for
consideration of tax-planning strategies pertain only to the
determination of a valuation allowance for a deferred tax asset.
A deferred tax liability ordinarily is recognized for all
taxable temporary differences. The only exceptions are
identified in paragraph 740-10-25-3. Certain seemingly taxable
temporary differences, however, may or may not result in taxable
amounts when those differences reverse in future years. One
example is an excess of cash surrender value of life insurance
over premiums paid (see paragraph 740-10-25-30). Another example
is an excess of the book over the tax basis of an investment in
a domestic subsidiary (see paragraph 740-30-25-7). The
determination of whether those differences are taxable temporary
differences does not involve a tax-planning strategy as that
term is used in this Topic.
55-47 Example 22 (see paragraph 740-10-55-163) provides an
example where an entity has identified multiple tax-planning
strategies.
55-48 Under current U.S. federal tax law, approval of an
entity’s change from taxable C corporation status to nontaxable
S corporation status is automatic if the criteria for S
corporation status are met. If an entity meets those criteria
but has not changed to S corporation status, a strategy to
change to nontaxable S corporation status would not permit an
entity to not recognize deferred taxes because a change in tax
status is a discrete event. Paragraph 740-10-25-32 requires that
the effect of a change in tax status be recognized at the date
that the change in tax status occurs, that is, at the date that
the change is approved by the taxing authority (or on the date
of filing the change if approval is not necessary). For example,
as required by paragraph 740-10-25-34, if an election to change
an entity’s tax status is approved by the taxing authority (or
filed, if approval is not necessary) early in Year 2 and before
the financial statements are issued or are available to be
issued (as discussed in Section 855-10-25) for Year 1, the
effect of that change in tax status shall not be recognized in
the financial statements for Year 1.
Examples of Temporary Differences
55-49 The following
guidance presents examples of temporary differences. These
examples are intended to be illustrative and not all-inclusive.
Any references to various tax laws shall not be considered
definitive interpretations of such laws for any purpose.
Premiums and Discounts
55-50 Differences between the recognition for financial
accounting purposes and income tax purposes of discount or
premium resulting from determination of the present value of a
note should be treated as temporary differences in accordance
with this Topic.
Beneficial Conversion Features
55-51 The issuance of convertible debt with a beneficial
conversion feature results in a basis difference for purposes of
applying this Topic. The recognition of a beneficial conversion
feature effectively creates two separate instruments-a debt
instrument and an equity instrument-for financial statement
purposes while it is accounted for as a debt instrument, for
example, under the U.S. Federal Income Tax Code. Consequently,
the reported amount in the financial statements (book basis) of
the debt instrument is different from the tax basis of the debt
instrument. The basis difference that results from the issuance
of convertible debt with a beneficial conversion feature is a
temporary difference for purposes of applying this Topic because
that difference will result in a taxable amount when the
reported amount of the liability is recovered or settled. That
is, the liability is presumed to be settled at its current
carrying amount (reported amount). The recognition of deferred
taxes for the temporary difference of the convertible debt with
a beneficial conversion feature should be recorded as an
adjustment to additional paid-in capital. Because the beneficial
conversion feature (an allocation to additional paid-in capital)
created the basis difference in the debt instrument, the
provisions of paragraph 740-20-45-11(c) apply and therefore the
establishment of the deferred tax liability for the basis
difference should result in an adjustment to the related
components of shareholders’ equity.
Pending Content (Transition Guidance: ASC
815-40-65-1)
Editor's Note: Paragraph 740-10-55-51
will be superseded upon transition, together with
its heading:
Beneficial Conversion Features
55-51 Paragraph superseded by Accounting
Standards Update No. 2020-06.
LIFO Inventory of Subsidiary
55-52 An entity may use the LIFO method to value
inventories for tax purposes which may result in LIFO inventory
temporary differences, that is, for the excess of the amount of
LIFO inventory for financial reporting over its tax basis.
55-53 Even though a deferred tax liability for the LIFO
inventory of a subsidiary will not be settled if that subsidiary
is sold before the LIFO inventory temporary difference reverses,
recognition of a deferred tax liability is required regardless
of whether the LIFO inventory happens to belong to the parent
entity or one of its subsidiaries.
Accrued Postretirement Benefit Cost and the Effect of the
Nontaxable Subsidy Arising From the Medicare Prescription
Drug, Improvement, and Modernization Act of 2003
55-54 The following guidance and Example 23 (see paragraph
740-10-55-165) refer to provisions of the Medicare Prescription
Drug, Improvement, and Modernization Act of 2003; however, they
shall not be considered definitive interpretations of the Act
for any purpose. That Example provides a simple illustration of
this guidance.
55-55 As indicated in paragraph 715-60-05-9, on December
8, 2003, the president signed the Medicare Prescription Drug,
Improvement, and Modernization Act of 2003 into law. The Act
introduces a prescription drug benefit under Medicare (Medicare
Part D) as well as a federal subsidy to sponsors of retiree
health care benefit plans that provide a benefit that is at
least actuarially equivalent to Medicare Part D. An employer’s
eligibility for the 28 percent subsidy depends on whether the
prescription drug benefit available under its plan is at least
actuarially equivalent to the Medicare Part D benefit.
55-56 The Act excludes receipt of the subsidy from the
taxable income of the employer for federal income tax purposes.
That provision affects the accounting for the temporary
difference related to the employer’s accrued postretirement
benefit cost under the requirements of this Topic.
55-57 In the periods in which the subsidy affects the
employer’s accounting for the plan, it shall have no effect on
any plan-related temporary difference accounted for under this
Topic because the subsidy is exempt from federal taxation. That
is, the measure of any temporary difference shall continue to be
determined as if the subsidy did not exist. Example 23 (see
paragraph 740-10-55-165) provides a simple illustration of this
guidance.
Changes in Accounting Methods for Tax Purposes
55-58 The following guidance refers to provisions of the
Tax Reform Act of 1986 and the Omnibus Budget Reconciliation Act
of 1987; however, it shall not be considered a definitive
interpretation of the Acts for any purpose.
55-59 A change in tax law may require a change in
accounting method for tax purposes, for example, the uniform
cost capitalization rules required by the Tax Reform Act of
1986. For calendar-year taxpayers, inventories on hand at the
beginning of 1987 are revalued as though the new rules had been
in effect in prior years. That initial catch-up adjustment is
deferred and taken into taxable income over not more than four
years. This deferral of the initial catch-up adjustment for a
change in accounting method for tax purposes gives rise to two
temporary differences.
55-60 One temporary difference is related to the
additional amounts initially capitalized into inventory for tax
purposes. As a result of those additional amounts, the tax basis
of the inventory exceeds the amount of the inventory for
financial reporting. That temporary difference is considered to
result in a deductible amount when the inventory is expected to
be sold. Therefore, the excess of the tax basis of the inventory
over the amount of the inventory for financial reporting as of
December 31, 1986, is considered to result in a deductible
amount in 1987 when the inventory turns over. As of subsequent
year-ends, the deductible temporary difference to be considered
would be the amount capitalized for tax purposes and not for
financial reporting as of those year-ends. The expected timing
of the deduction for the additional amounts capitalized in this
example assumes that the inventory is not measured on a LIFO
basis; temporary differences related to LIFO inventories reverse
when the inventory is sold and not replaced as provided in
paragraph 740-10-55-13.
55-61 The other temporary difference is related to the
deferred income for tax purposes that results from the initial
catch-up adjustment. As stated above, that deferred income
likely will be included in taxable income over four years.
Ordinarily, the reversal pattern for this temporary difference
should be considered to follow the tax pattern and would also be
four years. This assumes that it is expected that inventory sold
will be replaced. However, under the tax law, if there is a
one-third reduction in the amount of inventory for two years
running, any remaining balance of that deferred income is
included in taxable income for the second year. If such
inventory reductions are expected, then the reversal pattern
will be less than four years.
55-62 Paragraph 740-10-35-4 requires recognition of the
effect of a change in tax law or rate in the period that
includes the enactment date. For example, the Tax Reform Act of
1986 was enacted in 1986. Therefore, the effects are recognized
in a calendar-year entity’s 1986 financial statements.
55-63 The Omnibus Budget Reconciliation Act of 1987
requires family-owned farming businesses to use the accrual
method of accounting for tax purposes. The initial catch-up
adjustment to change from the cash to the accrual method of
accounting is deferred. It is included in taxable income if the
business ceases to be family-owned (for example, it goes
public). It also is included in taxable income if gross receipts
from farming activities in future years drop below certain 1987
levels as set forth in the tax law. The deferral of the initial
catch-up adjustment for that change in accounting method for tax
purposes gives rise to a temporary difference because an
assumption inherent in an entity’s statement of financial
position is that the reported amounts of assets and liabilities
will be recovered and settled. Under the requirements of this
Topic, deferred tax liabilities may not be eliminated or reduced
because an entity may be able to delay the settlement of those
liabilities by delaying the events that would cause taxable
temporary differences to reverse. Accordingly, the deferred tax
liability is recognized. If the events that trigger the payment
of the tax are not expected in the foreseeable future, the
reversal pattern of the related temporary difference is
indefinite.
Built-in Gains of Nontaxable S Corporations
55-64 An entity may change from taxable C corporation
status to nontaxable S corporation status. An entity that makes
that status change shall continue to recognize a deferred tax
liability to the extent that the entity would be subject to a
corporate-level tax on net unrecognized built-in gains.
55-65 A C corporation that has temporary differences as of
the date of change to S corporation status shall determine its
deferred tax liability in accordance with the tax law. Since the
timing of realization of a built-in gain can determine whether
it is taxable, and therefore significantly affect the deferred
tax liability to be recognized, actions and elections that are
expected to be implemented shall be considered. For purposes of
determining that deferred tax liability, the lesser of an
unrecognized built-in gain (as defined by the tax law) or an
existing temporary difference is used in the computations
described in the tax law to determine the amount of the tax on
built-in gains. Example 24 (see paragraph 740-10-55-168)
illustrates this guidance.
Unrecognized Gains or Losses From Involuntary
Conversions
55-66 Gain or loss
resulting from an involuntary conversion of a nonmonetary asset
to monetary assets that is not recognized for income tax
reporting purposes in the same period in which the gain or loss
is recognized for financial reporting purposes is a temporary
difference for which a deferred tax liability or deferred tax
asset should be recognized as required by this Subtopic.
Treatment of Certain Payments to Taxing Authorities
55-67 An entity may make payments to taxing authorities
for different reasons. The following guidance addresses certain
of these payments.
Payment Made to Taxing Authority to Retain Fiscal Year
55-68 The following guidance refers to provisions of the
Tax Reform Act of 1986 and the Revenue Act of 1987; however, it
shall not be considered a definitive interpretation of the Acts
for any purpose.
55-69 The guidance addresses how a payment should be
recorded in the financial statements of an entity for a payment
to a taxing authority to retain their fiscal year.
55-70 On December 22, 1987, the Revenue Act of 1987 was
enacted, which allowed partnerships and S corporations to elect
to retain their fiscal year rather than adopt a calendar year
for tax purposes as previously required by the Tax Reform Act of
1986. Entities that elected to retain a fiscal year are required
to make an annual payment in a single installment each year that
approximates the income tax that the partners-owners would have
paid on the short-period income had the entity switched to a
calendar year. The payment is made by the entity and is not
identified with individual partners-owners. Additionally the
amount is not adjusted if a partner-owner leaves the entity.
55-71 In this fact pattern, partnerships and S
corporations should account for the payment as an asset since
the payment is viewed as a deposit that is adjusted annually and
will be realized when the entity liquidates, its income declines
to zero, or it converts to a calendar year-end.
Payment Made Based on Dividends Distributed
55-72 The following guidance refers to provisions which
may be present in the French tax structure; however, it shall
not be considered a definitive interpretation of the historical
or current French tax structure for any purpose.
55-73 The French income tax structure is based on the
concept of an integrated tax system. The system utilizes a tax
credit at the shareholder level to eliminate or mitigate the
double taxation that would otherwise apply to a dividend. The
tax credit is automatically available to a French shareholder
receiving a dividend from a French corporation. The precompte
mobilier (or precompte) is a mechanism that provides for the
integration of the tax credit to the shareholder with the taxes
paid by the corporation. The precompte is a tax paid by the
corporation at the time of a dividend distribution that is equal
to the difference between a tax based on the regular corporation
tax rate applied to the amount of the declared dividend and
taxes previously paid by the corporation on the income being
distributed. In addition, if a corporation pays a dividend from
earnings that have been retained for more than five years, the
corporation loses the benefit of any taxes previously paid in
the computation of the precompte.
55-74 Paragraph 740-10-15-4(b) sets forth criteria for
determining whether a tax that is assessed on an entity based on
dividends distributed is, in effect, a withholding tax for the
benefit of recipients of the dividend to be recorded in equity
as part of the dividend distribution in that entity’s separate
financial statements. A tax that is assessed on a corporation
based on dividends distributed that meets the criteria in that
paragraph, such as the French precompte tax, should be
considered to be in effect a withholding of tax for the
recipient of the dividend and recorded in equity as part of the
dividend paid to shareholders.
Excise Tax on Withdrawal of Excess Pension Plan Assets
55-75 An employer that withdraws excess plan assets from
its pension plan may be subject to an excise tax. If the excise
tax is independent of taxable income, that is, it is a tax due
on a specific transaction regardless of whether there is any
taxable income for the period in which the transaction occurs,
it is not an income tax and the employer should recognize it as
an expense (not classified as income taxes) in the period of the
withdrawal.
Other Direct Payments to Taxing Authorities
55-76 Example 26 (see paragraph 740-10-55-202) illustrates
a transaction directly with a governmental taxing authority.
55-77 Paragraph superseded by Accounting Standards Update
No. 2015-17.
55-78 Paragraph superseded by Accounting Standards Update
No. 2015-17.
Income Tax Related Disclosures
55-79 Paragraph 740-10-50-9 requires disclosure of the
significant components of income tax expense attributable to
continuing operations. The sum of the amounts disclosed for the
components of tax expense should equal the amount of tax expense
that is reported in the statement of earnings for continuing
operations. Insignificant components that are not separately
disclosed should be combined and disclosed as a single amount so
that the sum of the amounts disclosed will equal total income
tax expense attributable to continuing operations. Separate
disclosure of the tax benefit of operating loss carryforwards
and tax credits and tax credit carryforwards that have been
recognized as a reduction of current tax expense and deferred
tax expense is required. There are a number of ways to satisfy
that disclosure requirement. Three acceptable approaches,
referred to as the gross method, the net method, and the
statutory tax rate reconciliation method, are illustrated in
Example 29 (see paragraph 740-10-55-212).
55-80 Income tax expense is defined as the sum of current
and deferred tax expense, and the amount to be disclosed under
any of the above approaches is only the amount by which total
income tax expense from continuing operations has been reduced
by tax credits or an operating loss carryforward. For example,
assume that a tax benefit is recognized for an operating loss or
tax credit carryforward by recognizing a deferred tax asset in
Year 1, with no valuation allowance required because of an
existing deferred tax liability. Further, assume that the
carryforward is realized on the tax return in Year 2. For
financial reporting in Year 2:
- Current tax expense will be reduced for the tax benefit of the operating loss or tax credit carryforward realized on the tax return.
- Deferred tax expense will be larger (or a deferred tax benefit will be smaller) by the same amount.
In those circumstances, the operating loss or tax credit
carryforward affects only income tax expense (the sum of current
and deferred tax expense) in Year 1 when a tax asset (with no
valuation allowance) is recognized. There is no effect on income
tax expense in Year 2 because the separate effects on current
and deferred tax expense offset each other. Accordingly, the
requirement for separate disclosure of the effects of tax
credits or an operating loss carryforward is not applicable for
Year 2. However, that disclosure requirement applies to
financial statements for Year 1 that are presented for
comparative purposes.
Illustrations
Example 1: The Unit of Account for a Tax
Position
55-81 This Example illustrates the initial and subsequent
determination by an entity of the unit of account for a tax
position. Paragraph 740-10-25-13 requires an entity to determine
an appropriate unit of account for an individual tax position.
The following Cases illustrate:
- The determination of the unit of account (Case A)
- A change in the unit of account (Case B).
55-82 Cases A and B share all of the following
assumptions.
55-83 An entity anticipates claiming a $1 million research
and experimentation credit on its tax return for the current
fiscal year. The credit comprises equal spending on 4 separate
projects (that is, $250,000 of tax credit per project). The
entity expects to have sufficient taxable income in the current
year to fully utilize the $1 million credit. Upon review of the
supporting documentation, management believes it is more likely
than not that the entity will ultimately sustain a benefit of
approximately $650,000. The anticipated benefit consists of
approximately $200,000 per project for the first 3 projects and
$50,000 for the fourth project.
Case A: Determining the Unit of Account — A Prerequisite to
Recognition Assessment
55-84 This Case illustrates an entity’s initial
determination of the unit of account for a tax position.
55-85 In its evaluation of the appropriate amount to
recognize, management first determines the appropriate unit of
account for the tax position. Because of the magnitude of
expenditures in each project, management concludes that the
appropriate unit of account is each individual research project.
In reaching this conclusion, management considers both the level
at which it accumulates information to support the tax return
and the level at which it anticipates addressing the issue with
taxing authorities. In this Case, upon review of the four
projects including the magnitude of expenditures, management
determines that it accumulates information at the project level.
Management also anticipates the taxing authority will address
the issues during an examination at the level of individual
projects.
55-86 In evaluating the projects for recognition,
management determines that three projects meet the
more-likely-than-not recognition threshold. However, due to the
nature of the activities that constitute the fourth project, it
is uncertain that the tax benefit related to this project will
be allowed. Because the tax benefit related to that fourth
project does not meet the more-likely-than-not recognition
threshold, it should not be recognized in the financial
statements, even though tax positions associated with that
project will be included in the tax return. The entity would
recognize a $600,000 financial statement benefit related to the
first 3 projects but would not recognize a financial statement
benefit related to the fourth project.
Case B: Change in the Unit of Account
55-87 This Case illustrates a change in an entity’s
initial determination of the unit of account for a tax
position.
55-88 In Year 2, the entity increases its spending on
research and experimentation projects and anticipates claiming
significantly larger research credits in its Year 2 tax return.
In light of the significant increase in expenditures, management
reconsiders the appropriateness of the unit of account and
concludes that the project level is no longer the appropriate
unit of account for research credits. This conclusion is based
on the magnitude of spending and anticipated claimed credits and
on previous experience and is consistent with the advice of
external tax advisors. Management anticipates the taxing
authority will focus the examination on functional expenditures
when examining the Year 2 return and thus needs to evaluate
whether it can change the unit of account in subsequent years’
tax returns.
55-89 Determining the unit of account requires evaluation
of the entity’s facts and circumstances. In making that
determination, management evaluates the manner in which it
prepares and supports its income tax return and the manner in
which it anticipates addressing issues with taxing authorities
during an examination. The unit of account should be
consistently applied to similar positions from period to period
unless a change in facts and circumstances indicates that a
different unit of account is more appropriate. Because of the
significant change in the tax position in Year 2, management’s
conclusion that the taxing authority will likely examine tax
credits in the Year 2 tax return at a more detailed level than
the individual project is reasonable and appropriate.
Accordingly, the entity should reevaluate the unit of account
for the Year 2 financial statements based on the new facts and
circumstances.
Example 2: Administrative Practices — Asset
Capitalization
55-90 The guidance in paragraph 740-10-25-7(b) on
evaluating a taxing authority’s widely understood administrative
practices and precedents shall be taken into account when
assessing the more-likely-than-not recognition threshold
established in paragraph 740-10-25-6. This Example illustrates
such consideration.
55-91 An entity has established a capitalization threshold
of $2,000 for its tax return for routine property and equipment
purchases. Assets purchased for less than $2,000 are claimed as
expenses on the tax return in the period they are purchased. The
tax law does not prescribe a capitalization threshold for
individual assets, and there is no materiality provision in the
tax law. The entity has not been previously examined. Management
believes that based on previous experience at a similar entity
and current discussions with its external tax advisors, the
taxing authority will not disallow tax positions based on that
capitalization policy and the taxing authority’s historical
administrative practices and precedents.
55-92 Some might deem the entity’s capitalization policy a
technical violation of the tax law, since that law does not
prescribe capitalization thresholds. However, in this situation
the entity has concluded that the capitalization policy is
consistent with the demonstrated administrative practices and
precedents of the taxing authority and the practices of other
entities that are regularly examined by the taxing authority.
Based on its previous experience with other entities and
consultation with its external tax advisors, management believes
the administrative practice is widely understood. Accordingly,
because management expects the taxing authority to allow this
position when and if examined, the more-likely-than-not
recognition threshold has been met.
Example 3: Administrative Practices — Nexus
55-93 The guidance in paragraph 740-10-25-7(b) on
evaluating a taxing authority’s widely understood administrative
practices and precedents shall be taken into account when
assessing the more-likely-than-not recognition threshold
established in paragraph 740-10-25-6. This Example illustrates
such consideration.
55-94 An entity has been incorporated in Jurisdiction A
for 50 years; it has filed a tax return in Jurisdiction A in
each of those 50 years. The entity has been doing business in
Jurisdiction B for approximately 20 years and has filed a tax
return in Jurisdiction B for each of those 20 years. However,
the entity is not certain of the exact date it began doing
business, or the date it first had nexus, in Jurisdiction B.
55-95 The entity understands that if a tax return is not
filed, the statute of limitations never begins to run;
accordingly, failure to file a tax return effectively means
there is no statute of limitations. The entity has become
familiar with the administrative practices and precedents of
Jurisdiction B and understands that Jurisdiction B will look
back only six years in determining if there is a tax return due
and a deficiency owed. Because of the administrative practices
of the taxing authority and the facts and circumstances, the
entity believes it is more likely than not that a tax return is
not required to be filed in Jurisdiction B at an earlier date
and that a liability for tax exposures for those periods is not
required.
Example 4: Valuation Allowance and Tax-Planning
Strategies
55-96 Paragraph 740-10-30-20 requires that entities
determine the amount of available future taxable income from a
tax-planning strategy based on the application of the
recognition and measurement requirements of this Subtopic for
tax positions. This Example illustrates the recognition aspect
of that requirement.
55-97 An entity has a wholly owned subsidiary with certain
deferred tax assets as a result of several years of losses from
operations. Management has determined that it is more likely
than not that sufficient future taxable income will not be
available to realize those deferred tax assets. Therefore,
management recognizes a full valuation allowance for those
deferred tax assets both in the separate financial statements of
the subsidiary and in the consolidated financial statements of
the entity.
55-98 Management has identified certain tax-planning
strategies that might enable the realization of those deferred
tax assets. Management has determined that the strategies will
meet the minimum statutory threshold to avoid penalties and that
it is not more likely than not that the strategies would be
sustained upon examination based on the technical merits.
Accordingly, those strategies may not be used to reduce the
valuation allowance on the deferred tax assets. Only a
tax-planning strategy that meets the more-likely-than-not
recognition threshold would be considered in evaluating the
sufficiency of future taxable income for realization of deferred
tax assets.
Example 5: Highly Certain Tax Positions
55-99 This Example illustrates the recognition and
measurement criteria of this Subtopic to tax positions where the
tax law is unambiguous. The recognition and measurement criteria
of this Subtopic applicable to tax positions begin in paragraph
740-10-25-5 for recognition and paragraph 740-10-30-7 for
measurement.
55-100 An entity has taken a tax position that it believes
is based on clear and unambiguous tax law for the payment of
salaries and benefits to employees. The class of salaries being
evaluated in this tax position is not subject to any limitations
on deductibility (for example, executive salaries are not
included), and none of the expenditures are required to be
capitalized (for example, the expenditures do not pertain to the
production of inventories); all amounts accrued at year-end were
paid within the statutorily required time frame subsequent to
the reporting date. Management concludes that the salaries are
fully deductible.
55-101 All tax positions are subject to the requirements
of this Subtopic. However, because the deduction is based on
clear and unambiguous tax law, management has a high confidence
level in the technical merits of this position. Accordingly, the
tax position clearly meets the recognition criterion and should
be evaluated for measurement. In determining the amount to
measure, management is highly confident that the full amount of
the deduction will be allowed and it is clear that it is greater
than 50 percent likely that the full amount of the tax position
will be ultimately realized. Accordingly, the entity would
recognize the full amount of the tax position in the financial
statements.
Example 6: Measurement With Information About the Approach
to Settlement
55-102 This Example demonstrates an application of the
measurement requirements of paragraph 740-10-30-7 for a tax
position that meets the paragraph 740-10-25-6 requirements for
recognition. Measurement in this Example is based on identified
information about settlement.
55-103 In applying the recognition criterion of this
Subtopic for tax positions, an entity has determined that a tax
position resulting in a benefit of $100 qualifies for
recognition and should be measured. The entity has considered
the amounts and probabilities of the possible estimated outcomes
as follows.
55-104 Because $60 is the largest amount of benefit that
is greater than 50 percent likely of being realized upon
settlement, the entity would recognize a tax benefit of $60 in
the financial statements.
Example 7: Measurement With More Limited Information About
the Approach to Settlement
55-105 As in the preceding Example, this Example also
demonstrates an application of the measurement requirements of
paragraph 740-10-30-7 for a tax position determined to meet
recognition requirements. While measurement in this Example is
also based on identified information about settlement, the
information is more limited than in the preceding Example.
55-106 In applying the recognition criterion of this
Subtopic for tax positions an entity has determined that a tax
position resulting in a benefit of $100 qualifies for
recognition and should be measured. There is limited information
about how a taxing authority will view the position. After
considering all relevant information, management’s confidence in
the technical merits of the tax position exceeds the
more-likely-than-not recognition threshold, but management also
believes it is likely it would settle for less than the full
amount of the entire position when examined. Management has
considered the amounts and the probabilities of the possible
estimated outcomes.
55-107 Because $75 is the largest amount of benefit that
is greater than 50 percent likely of being realized upon
settlement, the entity would recognize a tax benefit of $75 in
the financial statements.
Example 8: Measurement of a Tax Position After Settlement
of a Similar Position
55-108 This Example demonstrates an application of the
measurement requirements of paragraph 740-10-30-7 for a tax
position that meets the paragraph 740-10-25-6 requirements for
recognition. Measurement in this Example is based on settlement
of a similar tax position with the taxing authority.
55-109 In applying the recognition criterion of this
Subtopic for tax positions, an entity has determined that a tax
position resulting in a benefit of $100 qualifies for
recognition and should be measured. In a recent settlement with
the taxing authority, the entity has agreed to the treatment for
that position for current and future years. There are no
recently issued relevant sources of tax law that would affect
the entity’s assessment. The entity has not changed any
assumptions or computations, and the current tax position is
consistent with the position that was recently settled. In this
case, the entity would have a very high confidence level about
the amount that will be ultimately realized and little
information about other possible outcomes. Management will not
need to evaluate other possible outcomes because it can be
confident of the largest amount of benefit that is greater than
50 percent likely of being realized upon settlement without that
evaluation.
Example 9: Differences Relating to Timing of
Deductibility
55-110 This Example demonstrates an application of the
measurement requirements of paragraph 740-10-30-7 for a tax
position that meets the paragraph 740-10-25-6 requirements for
recognition. Measurement in this Example is based on the timing
of the deduction.
55-111 In Year 1, an entity acquired a separately
identifiable intangible asset for $15 million that has an
indefinite life for financial statement purposes and is,
therefore, not subject to amortization. Based on some
uncertainty in the tax code, the entity decides for tax purposes
to deduct the entire cost of the asset in Year 1. While the
entity is certain that the full amount of the intangible is
ultimately deductible for tax purposes, the timing of
deductibility is uncertain under the tax code. In applying the
recognition criterion of this Subtopic for tax positions, the
entity has determined that the tax position qualifies for
recognition and should be measured. The entity believes it is 25
percent likely it would be able to realize immediate deduction
upon settlement, and it is certain it could sustain a 15-year
amortization for tax purposes. Thus, the largest Year 1 benefit
that is greater than 50 percent likely of being realized upon
settlement is the tax effect of $1 million (the Year 1 deduction
from straight-line amortization of the asset over 15 years).
55-112 At the end of Year 1, the entity should reflect a
deferred tax liability for the tax effect of the temporary
difference created by the difference between the financial
statement basis of the asset ($15 million) and the tax basis of
the asset computed in accordance with the guidance in this
Subtopic for tax positions ($14 million, the cost of the asset
reduced by $1 million of amortization). The entity also should
reflect a tax liability for the tax-effected difference between
the as-filed tax position ($15 million deduction) and the amount
of the deduction that is considered more likely than not of
being sustained ($1 million). The entity should evaluate the tax
position for accrual of statutory penalties as well as interest
expense on the difference between the amounts reported in the
financial statements and the tax position taken in the tax
return.
Example 10: Change in Timing of Deductibility
55-113 This Example demonstrates an application of the
measurement requirements of paragraph 740-10-30-7 for a tax
position that meets the paragraph 740-10-25-6 requirements for
recognition. Measurement in this Example is based on a change in
timing of deductibility.
55-114 In 20X1 an entity took a tax position in which it
amortizes the cost of an acquired asset on a straight-line basis
over three years, while the amortization period for financial
reporting purposes is seven years. After one year, the entity
has deducted one-third of the cost of the asset in its income
tax return and one-seventh of the cost in the financial
statements and, consequently, has a deferred tax liability for
the difference between the financial reporting and tax bases of
the asset.
55-115 In accordance with the requirements of this
Subtopic, the entity evaluates the tax position as of the
reporting date of the financial statements. In 20X2, the entity
determines that it is still certain that the entire cost of the
acquired asset is fully deductible, so the more-likely-than-not
recognition threshold has been met according to paragraph
740-10-25-6. However, in 20X2, the entity now believes based on
new information that the largest benefit that is greater than 50
percent likely of being realized upon settlement is
straight-line amortization over 7 years.
55-116 In this Example, the entity would recognize a
liability for unrecognized tax benefits based on the difference
between the three- and seven-year amortization. In 20X2, no
deferred tax liability should be recognized, as there is no
longer a temporary difference between the financial statement
carrying value of the asset and the tax basis of the asset based
on this Subtopic’s measurement requirements for tax positions.
Additionally, the entity should evaluate the need to accrue
interest and penalties, if applicable under the tax law.
Example 11: Information Becomes Available Before Issuance
of Financial Statements
55-117 Paragraphs 740-10-25-6 and 740-10-25-8 require that
tax positions be recognized and measured based on information
available at the reporting date. This Example demonstrates the
effect of information becoming available after the reporting
date but before the financial statements are issued or are
available to be issued (as discussed in Section 855-10-25).
55-118 Entity A has evaluated a tax position at its most
recent reporting date and has concluded that the position meets
the more-likely-than-not recognition threshold. In evaluating
the tax position for recognition, Entity A considered all
relevant sources of tax law, including a court case in which the
taxing authority has fully disallowed a similar tax position
with an unrelated entity (Entity B). The taxing authority and
Entity B are aggressively litigating the matter. Although Entity
A was aware of that court case at the recent reporting date,
management determined that the more-likely-than-not recognition
threshold had been met. After the reporting date, but before the
financial statements are issued or are available to be issued
(as discussed in Section 855-10-25), the taxing authority
prevailed in its litigation with Entity B, and Entity A
concludes that it is no longer more likely than not that it will
sustain the position.
55-119 Paragraph 740-10-40-2 provides the guidance that an
entity shall derecognize a previously recognized tax position in
the first period in which it is no longer more likely than not
that the tax position would be sustained upon examination, and
paragraphs 740-10-25-14; 740-10-35-2; and 740-10-40-2 establish
that subsequent recognition, derecognition, and measurement
shall be based on management’s best judgment given the facts,
circumstances, and information available at the reporting date.
Because the resolution of Entity B’s litigation with the taxing
authority is the information that caused Entity A to change its
judgment about the sustainability of the position and that
information was not available at the reporting date, the change
in judgment would be recognized in the first quarter of the
current fiscal year.
Example 12: Basic Deferred Tax Recognition
55-120 This Example illustrates the
guidance in paragraphs 740-10-55-7 through 55-9 relating to
recognition of deferred tax assets and liabilities, including
when a detailed analysis of sources of taxable income may not be
necessary in considering the need for a valuation allowance for
deferred tax assets. In this Example, an entity has $2,400 of
deductible temporary differences and $1,500 of taxable temporary
differences at the end of Year 3 (the current year).
55-121 A deferred tax liability is recognized at the end
of Year 3 for the $1,500 of taxable temporary differences, and
deferred tax asset is recognized for the $2,400 of deductible
temporary differences. All available evidence, both positive and
negative, is considered to determine whether, based on the
weight of that evidence, a valuation allowance is needed for
some portion or all of the deferred tax asset. If evidence about
one or more sources of taxable income (see paragraph
740-10-30-18) is sufficient to support a conclusion that a
valuation allowance is not needed, other sources of taxable
income need not be considered. For example, if the weight of
available evidence indicates that taxable income will exceed
$2,400 in each future year, a conclusion that no valuation
allowance is needed can be reached without considering the
pattern and timing of the reversal of the temporary differences,
the existence of qualifying tax-planning strategies, and so
forth.
55-122 Similarly, if the deductible temporary differences
will reverse within the next 3 years and taxable income in the
current year exceeds $2,400, nothing needs to be known about
future taxable income exclusive of reversing temporary
differences because the deferred tax asset could be realized by
carryback to the current year. A valuation allowance is needed,
however, if the weight of available evidence indicates that some
portion or all of the $2,400 of tax deductions from future
reversals of the deductible temporary differences will not be
realized by offsetting any of the following:
- The $1,500 of taxable temporary differences and $900 of future taxable income exclusive of reversing temporary differences
- $2,400 of future taxable income exclusive of reversing temporary differences
- $2,400 of taxable income in the current or prior years by loss carryback to those years
- $2,400 of taxable income in one or more of the circumstances described above and as a result of a qualifying tax-planning strategy (see paragraphs 740-10-55-39 through 55-48).
Paragraph 740-10-55-8 provides guidance on when a detailed
analysis of sources of taxable income may not be necessary in
considering the need for a valuation allowance for deferred tax
assets.
55-123 Detailed analyses are not necessary, for example,
if the entity earned $500 of taxable income in each of Years 1–3
and there is no evidence to suggest it will not continue to earn
that level of taxable income in future years. That level of
future taxable income is more than sufficient to realize the tax
benefit of $2,400 of tax deductions over a period of at least 19
years (the year(s) of the deductions, 3 carryback years, and 15
carryforward years) in the U.S. federal tax jurisdiction.
Example 13: Valuation Allowance for Deferred Tax
Assets
55-124 This Example illustrates the guidance in paragraphs
740-10-55-7 through 55-9 relating to recognition of a valuation
allowance for a portion of a deferred tax asset in one year and
a subsequent change in circumstances that requires adjustment of
the valuation allowance at the end of the following year. This
Example has the following assumptions:
- At the end of the current year (Year 3), an entity’s only temporary differences are deductible temporary differences in the amount of $900.
- Pretax financial income, taxable income, and taxes paid for each of Years 1-3 are all positive, but relatively negligible, amounts.
- The enacted tax rate is 40 percent for all years.
55-125 A deferred tax asset in the amount of $360 ($900 at
40 percent) is recognized at the end of Year 3. If management
concludes, based on an assessment of all available evidence (see
guidance in paragraphs 740-10-30-17 through 30-24), that it is
more likely than not that future taxable income will not be
sufficient to realize a tax benefit for $400 of the $900 of
deductible temporary differences at the end of the current year,
a $160 valuation allowance ($400 at 40 percent) is recognized at
the end of Year 3.
55-126 Assume that pretax financial income and taxable
income for Year 4 turn out to be as follows.
55-127 The $50 pretax loss in Year 4 is additional
negative evidence that must be weighed against available
positive evidence to determine the amount of valuation allowance
necessary at the end of Year 4. Deductible temporary differences
and carryforwards at the end of Year 4 are as follows.
55-128 The $360 deferred tax asset recognized at the end
of Year 3 is increased to $380 ($950 at 40 percent) at the end
of Year 4. Based on an assessment of all evidence available at
the end of Year 4, management concludes that it is more likely
than not that $240 of the deferred tax asset will not be
realized and, therefore, that a $240 valuation allowance is
necessary. The $160 valuation allowance recognized at the end of
Year 3 is increased to $240 at the end of Year 4. The $60 net
effect of those 2 adjustments (the $80 increase in the valuation
allowance less the $20 increase in the deferred tax asset)
results in $60 of deferred tax expense that is recognized in
Year 4.
Example 14: Phased-In Change in Tax Rates
55-129 This Example illustrates the guidance in paragraph
740-10-55-23 for determination of the tax rate for measurement
of a deferred tax liability for taxable temporary differences
when there is a phased-in change in tax rates. At the end of
Year 3 (the current year), an entity has $2,400 of taxable
temporary differences, which are expected to result in taxable
amounts of approximately $800 on the future tax returns for each
of Years 4–6. Enacted tax rates are 35 percent for Years 1–3, 40
percent for Years 4–6, and 45 percent for Year 7 and
thereafter.
55-130 The tax rate that is used to measure the deferred
tax liability for the $2,400 of taxable temporary differences
differs depending on whether the tax effect of future reversals
of those temporary differences is on taxes payable for Years
1–3, Years 4–6, or Year 7 and thereafter. The tax rate for
measurement of the deferred tax liability is 40 percent whenever
taxable income is expected in Years 4–6. If tax losses are
expected in Years 4–6, however, the tax rate is:
- 35 percent if realization of a tax benefit for those tax losses in Years 4–6 will be by loss carryback to Years 1–3
- 45 percent if realization of a tax benefit for those tax losses in Years 4–6 will be by loss carryforward to Year 7 and thereafter.
Example 15: Change in Tax Rates
55-131 This Example illustrates the guidance in paragraph
740-10-55-23 for determination of the tax rate for measurement
of a deferred tax asset for deductible temporary differences
when there is a change in tax rates. This Example has the
following assumptions:
- Enacted tax rates are 30 percent for Years 1–3 and 40 percent for Year 4 and thereafter.
- At the end of Year 3 (the current year), an entity has $900 of deductible temporary differences, which are expected to result in tax deductions of approximately $300 on the future tax returns for each of Years 4–6.
55-132 The tax rate is 40 percent if the entity expects to
realize a tax benefit for the deductible temporary differences
by offsetting taxable income earned in future years.
Alternatively, the tax rate is 30 percent if the entity expects
to realize a tax benefit for the deductible temporary
differences by loss carryback refund.
55-133 Further assume for this Example both of the
following:
- The entity recognizes a $360 ($900 at 40 percent) deferred tax asset to be realized by offsetting taxable income in future years.
- Taxable income and taxes payable in each of Years 1–3 were $300 and $90, respectively.
55-134 Realization of a tax benefit of at least $270 ($900
at 30 percent) is assured because carryback refunds totaling
$270 may be realized even if no taxable income is earned in
future years. Recognition of a valuation allowance for the other
$90 ($360 – $270) of the deferred tax asset depends on
management’s assessment of whether, based on the weight of
available evidence, a portion or all of the tax benefit of the
$900 of deductible temporary differences will not be realized at
40 percent tax rates in future years.
55-135 Alternatively, if enacted tax rates are 40 percent
for Years 1–3 and 30 percent for Year 4 and thereafter,
measurement of the deferred tax asset at a 40 percent tax rate
could only occur if tax losses are expected in future Years
4–6.
Example 16: Graduated Tax Rates
55-136 This Example illustrates the guidance in paragraph
740-10-55-23 for determination of the average graduated tax rate
for measurement of deferred tax liabilities and assets by an
entity for which graduated tax rates ordinarily are a
significant factor. At the end of Year 3 (the current year), an
entity has $1,500 of taxable temporary differences and $900 of
deductible temporary differences, which are expected to result
in net taxable amounts of approximately $200 on the future tax
returns for each of Years 4–6. Enacted tax rates are 15 percent
for the first $500 of taxable income, 25 percent for the next
$500, and 40 percent for taxable income over $1,000. This
Example assumes that there is no income (for example, capital
gains) subject to special tax rates.
55-137 The deferred tax liability and asset for those
reversing taxable and deductible temporary differences in Years
4–6 are measured using the average graduated tax rate for the
estimated amount of annual taxable income in future years. Thus,
the average graduated tax rate will differ depending on the
expected level of annual taxable income (including reversing
temporary differences) in Years 4–6. The average tax rate will
be:
- 15 percent if the estimated annual level of taxable income in Years 4–6 is $500 or less
- 20 percent if the estimated annual level of taxable income in Years 4–6 is $1,000
- 30 percent if the estimated annual level of taxable income in Years 4–6 is $2,000.
55-138 Temporary differences usually do not reverse in
equal annual amounts as in the Example above, and a different
average graduated tax rate might apply to reversals in different
future years. However, a detailed analysis to determine the net
reversals of temporary differences in each future year usually
is not warranted. It is not warranted because the other variable
(that is, taxable income or losses exclusive of reversing
temporary differences in each of those future years) for
determination of the average graduated tax rate in each future
year is no more than an estimate. For that reason, an aggregate
calculation using a single estimated average graduated tax rate
based on estimated average annual taxable income in future years
is sufficient. Judgment is permitted, however, to deal with
unusual situations, for example, an abnormally large temporary
difference that will reverse in a single future year, or an
abnormal level of taxable income that is expected for a single
future year. The lowest graduated tax rate should be used
whenever the estimated average graduated tax rate otherwise
would be zero.
Example 17: Determining Whether a Tax Is an Income
Tax
55-139 The guidance in
paragraph 740-10-55-26 addressing when a tax is an income tax is
illustrated using the following example.
55-140 A state’s
franchise tax on each corporation is set at the greater of 0.25
percent of the corporation’s net taxable capital and 4.5 percent
of the corporation’s net taxable earned surplus. Net taxable
earned surplus is a term defined by the tax statute for federal
taxable income.
55-141 In this Example,
the amount of franchise tax equal to the tax on the
corporation’s net taxable earned surplus is an income tax.
55-142 Deferred tax
assets and liabilities are required to be recognized under this
Subtopic for the temporary differences that exist as of the date
of the statement of financial position using the tax rate to be
applied to the corporation’s net taxable earned surplus (4.5
percent).
55-143 The portion of
the total computed franchise tax that exceeds the amount equal
to the tax on the corporation’s net taxable earned surplus
should not be presented as a component of income tax expense
during any period in which the total computed franchise tax
exceeds the amount equal to the tax on the corporation’s net
taxable earned surplus.
55-144 While the tax
statutes of states or other jurisdictions differ, the accounting
described in paragraphs 740-10-55-140 through 55-143 would be
appropriate if the tax structure of another state or
jurisdiction was essentially the same as in this Example.
Example 18: Special Deductions
55-145 Paragraph 740-10-55-27 introduces guidance relating
to a special deduction for qualified production activities that
may be available to an entity under the American Jobs Creation
Act of 2004.
55-146 This Example illustrates how an entity with a
calendar year-end would apply paragraphs 740-10-25-37 and
740-10-35-4 to the qualified production activities deduction at
December 31, 2004. In particular, this Example illustrates the
methodology used to evaluate the qualified production activities
deduction’s effect on determining the need for a valuation
allowance on an entity’s existing net deferred tax assets. This
Example intentionally is not comprehensive (for example, it
excludes state and local taxes).
55-147 This Example has the following assumptions:
- Expected taxable income (excluding the qualified production activities deduction and net operating loss carryforwards) for 2005: $21,000
- Expected qualified production activities income for 2005: $50,000
- Net operating loss carryforwards at December 31, 2004, which expire in 2005: $20,000
- Expected W-2 wages for 2005: $10,000
- Assumed statutory income tax rate: 35%
- Qualified production activities deduction: 3% of the lesser of qualified production activities income or taxable income (after deducting the net operating loss carryforwards); limited to 50% of W-2 wages: $30.
55-148 Based on these assumptions, the entity would not
recognize a valuation allowance for the net operating loss
carryforwards at December 31, 2004, because expected taxable
income in 2005 (after deducting the qualified production
activities deduction) exceeds the net operating loss
carryforwards, as follows.
Example 19: Recognizing Tax Benefits of Operating
Loss
55-149 This Example illustrates the guidance in paragraphs
740-10-55-35 through 55-36 for recognition of the tax benefit of
an operating loss in the loss year and in subsequent
carryforward years when a valuation allowance is necessary in
the loss year. This Example has the following assumptions:
- The enacted tax rate is 40 percent for all years.
- An operating loss occurs in Year 5.
- The only difference between financial and taxable income results from use of accelerated depreciation for tax purposes. Differences that arise between the reported amount and the tax basis of depreciable assets in Years 1–7 will result in taxable amounts before the end of the loss carryforward period from Year 5.
-
Financial income, taxable income, and taxes currently payable or refundable are as follows.
- At the end of Year 5, profits are not expected in Years 6 and 7 and later years, and it is concluded that a valuation allowance is necessary to the extent realization of the deferred tax asset for the operating loss carryforward depends on taxable income (exclusive of reversing temporary differences) in future years.
55-150 The deferred tax liability for the taxable
temporary differences is calculated at the end of each year as
follows.
55-151 The deferred tax asset and related valuation
allowance for the loss carryforward are calculated at the end of
each year as follows.
55-152 Total tax expense for each period is as
follows.
55-153 In Year 5, $2,800 of the loss is carried back to
reduce taxable income in Years 2–4, and $1,120 of taxes paid for
those years is refunded. In addition, a $1,520 deferred tax
liability is recognized for $3,800 of taxable temporary
differences, and a $2,400 deferred tax asset is recognized for
the $6,000 loss carryforward. However, based on the conclusion
described in paragraph 740-10-55-149(e), a valuation allowance
is recognized for the amount by which that deferred tax asset
exceeds the deferred tax liability.
55-154 In Year 6, a portion of the deferred tax asset for
the loss carryforward is realized because taxable income is
earned in that year. The remaining balance of the deferred tax
asset for the loss carryforward at the end of Year 6 equals the
deferred tax liability for the taxable temporary differences. A
valuation allowance is not needed.
55-155 In Year 7, the remaining balance of the loss
carryforward is realized, and $760 of taxes are payable on net
taxable income of $1,900. A $2,040 deferred tax liability is
recognized for the $5,100 of taxable temporary differences.
Example 20: Interaction of Loss Carryforwards and Temporary
Differences
55-156 This Example
illustrates the guidance in paragraph 740-10-55-37 for the
interaction of loss carryforwards and temporary differences that
will result in net deductible amounts in future years. This
Example has the following assumptions:
- The financial loss and the loss reported on the tax return for an entity’s first year of operations are the same.
- In Year 2, a gain of $2,500 from a transaction that is a sale for tax purposes but does not meet the sale recognition criteria for financial reporting purposes is the only difference between pretax financial income and taxable income.
55-157 Financial and taxable income in this Example are as
follows.
55-158 The $4,000
operating loss carryforward at the end of Year 1 is reduced to
$1,500 at the end of Year 2 because $2,500 of it is used to
reduce taxable income. The $2,500 reduction in the loss
carryforward becomes $2,500 of deductible temporary differences
that will reverse and result in future tax deductions when the
sale occurs (that is, control of the asset transfers to the
buyer-lessor). The entity has no deferred tax liability to be
offset by those future tax deductions, the future tax deductions
cannot be realized by loss carryback because no taxes have been
paid, and the entity has had pretax losses for financial
reporting since inception. Unless positive evidence exists that
is sufficient to overcome the negative evidence associated with
those losses, a valuation allowance is recognized at the end of
Year 2 for the full amount of the deferred tax asset related to
the $2,500 of deductible temporary differences and the remaining
$1,500 of operating loss carryforward.
Example 21: Tax-Planning Strategy With Significant
Implementation Cost
55-159 This Example illustrates the guidance in paragraph
740-10-55-44 for recognition of a deferred tax asset based on
the expected effect of a qualifying tax-planning strategy when a
significant expense would be incurred to implement the strategy.
This Example has the following assumptions:
- A $900 operating loss carryforward expires at the end of next year.
- Based on historical results and the weight of other available evidence, the estimated level of taxable income exclusive of the future reversal of existing temporary differences and the operating loss carryforward next year is $100.
- Taxable temporary differences in the amount of $1,200 ordinarily would result in taxable amounts of approximately $400 in each of the next 3 years.
- There is a qualifying tax-planning strategy to accelerate the future reversal of all $1,200 of taxable temporary differences to next year.
- Estimated legal and other expenses to implement that tax-planning strategy are $150.
- The enacted tax rate is 40 percent for all years.
55-160 Without the tax-planning strategy, only $500 of the
$900 operating loss carryforward could be realized next year by
offsetting $100 of taxable income exclusive of reversing
temporary differences and $400 of reversing taxable temporary
differences. The other $400 of operating loss carryforward would
expire unused at the end of next year. Therefore, the $360
deferred tax asset ($900 at 40 percent) would be offset by a
$160 valuation allowance ($400 at 40 percent), and a $200 net
deferred tax asset would be recognized for the operating loss
carryforward.
55-161 With the tax-planning strategy, the $900 operating
loss carryforward could be applied against $1,300 of taxable
income next year ($100 of taxable income exclusive of reversing
temporary differences and $1,200 of reversing taxable temporary
differences). The $360 deferred tax asset is reduced by a $90
valuation allowance recognized for the net-of-tax expenses
necessary to implement the tax-planning strategy. The amount of
that valuation allowance is determined as follows.
55-162 In summary, a $480 deferred tax liability is
recognized for the $1,200 of taxable temporary differences, a
$360 deferred tax asset is recognized for the $900 operating
loss carryforward, and a $90 valuation allowance is recognized
for the net-of-tax expenses of implementing the tax-planning
strategy.
Example 22: Multiple Tax-Planning Strategies
Available
55-163 This Example illustrates the guidance in paragraphs
740-10-55-39 through 55-48 relating to tax-planning strategies.
An entity might identify several qualifying tax-planning
strategies that would either reduce or eliminate the need for a
valuation allowance for a deferred tax asset. For example,
assume that an entity’s required valuation allowance would be
reduced $5,000 based on Strategy A, $7,000 based on Strategy B,
and $12,000 based on both strategies. The entity may not
recognize the effect of one of those strategies in the current
year and postpone recognition of the effect of the other
strategy to a later year.
55-164 The entity should recognize the effect of both
tax-planning strategies and reduce the valuation allowance by
$12,000 at the end of the current year. Paragraph 740-10-30-19
provides guidance on tax-planning strategies and establishes the
requirement that strategies meeting the criteria set forth in
that paragraph shall be considered in determining the required
valuation allowance.
Example 23: Effects of Subsidy on Temporary
Difference
55-165 Paragraph 740-10-55-54 introduces guidance relating
to a nontaxable subsidy that may be available to an entity under
the Medicare Prescription Drug, Improvement, and Modernization
Act of 2003. This Example illustrates that guidance.
55-166 Before the accounting for the effects of the Act,
an employer’s carrying amount of accrued postretirement benefit
cost (the amount recognized in the statement of financial
position) is $100 for a noncontributory, unfunded prescription
drug benefit plan with only inactive participants who are not
yet eligible to collect benefits. Assuming a tax rate of 35
percent and no corresponding tax basis for the accrued
postretirement benefit cost, the employer would report a $35
deferred tax asset related to that $100 deductible temporary
difference. Because the employer has a policy of amortizing
gains and losses under paragraph 715-60-35-29, upon recognition
of a $28 actuarial gain resulting from the estimate of the
expected subsidy, neither the carrying amount of accrued
postretirement benefit cost nor the deferred tax asset would
change. Subsequently, ignoring interest on the accumulated
postretirement benefit obligation (which includes interest on
the subsidy), as the actuarial gain related to the subsidy is
amortized as a component of net periodic postretirement benefit
cost, the carrying amount of accrued postretirement cost would
be reduced. However, the associated temporary difference and
deferred tax asset would remain unchanged. That is, after the
gain related to the subsidy is amortized in its entirety, the
carrying amount of accrued postretirement benefit cost would be
$72, and the deferred tax asset would remain at $35.
55-167 For purposes of simplicity, this
Example ignores complexities regarding the amount and timing of
the subsidies reflected in the carrying amount of accrued
postretirement benefit cost arising from any of the
following:
- Netting gains and losses and application of the corridor amortization approach described in paragraph 715-60-35-29
- Recognition of additional subsidies through amortization of prior service costs that include effects of the subsidy
- Reduction in future service and interest costs.
Those complexities must be considered in determining the
temporary difference on which the deferred tax effects under
this Topic will be based.
Example 24: Built-In Gains of S Corporation
55-168 This Example
illustrates an entity’s change from taxable C corporation status
to nontaxable S corporation status, in accordance with the
guidance provided in paragraph 740-10-55-65. This Example has
the following assumptions:
-
An entity’s S corporation election is effective for calendar-year 1990 and that at the conversion date its assets comprise marketable securities, finished goods inventory, and depreciable assets as follows.
- The entity has no tax loss or credit carryforwards available to offset the built-in gains.
- The depreciable assets will be recovered by use in operations (and, therefore, will not result in a taxable amount pursuant to the tax law applied to built-in gains).
- The marketable securities will be sold in the same year that the inventory is sold, the $50 built-in gain on the inventory is reduced by the $10 built-in loss on the marketable securities, and $40 would be taxed in the year that the inventory turns over and the securities are sold. Accordingly, the entity should continue to display in its statement of financial position a deferred tax liability for that $40 net taxable amount.
55-169 At subsequent financial statement dates until the
end of the 10 years following the conversion date, the entity
should remeasure the deferred tax liability for net built-in
gains based on the provisions of the tax law. Deferred tax
expense (or benefit) should be recognized for any change in that
deferred tax liability.
Example 25: Purchase Transactions That Are Not Accounted
for as Business Combinations
55-170 Paragraph 740-10-25-51 addresses the accounting
when an asset is acquired outside of a business combination and
the tax basis of the asset differs from the amount paid. The
following Cases illustrate the required accounting for purchase
transactions that are not accounted for as business combinations
in the following circumstances:
- The amount paid is less than the tax basis of the asset (Case A).
- The amount paid is more than the tax basis of the asset (Case B).
- The transaction results in a deferred credit (Case C).
- A deferred credit is created by a financial asset (Case D).
- Subparagraph not used.
- The result is a purchase of future tax benefits (Case F).
Case A: Amount Paid Is Less Than Tax Basis of Asset
55-171 This Case illustrates an asset purchase that is not
a business combination in which the amount paid differs from the
tax basis of the asset (tax basis is greater).
55-172 As an incentive for acquiring specific types of
equipment in certain sectors, a foreign jurisdiction permits a
deduction, for tax purposes, of an amount in excess of the cost
of the acquired asset. To illustrate, assume that Entity A
purchases a machine for $100 and its tax basis is automatically
increased to $150. Upon sale of the asset, there is no recapture
of the extra tax deduction. The tax rate is 35 percent.
55-173 In accordance with paragraph 740-10-25-51, the
amounts assigned to the equipment and the related deferred tax
asset should be determined using the simultaneous equations
method as follows (where FBB is Final Book Basis; CPP is Cash
Purchase Price; and DTA is Deferred Tax Asset):
Equation A (determine the final book basis
of the equipment):
FBB – [Tax Rate × (FBB – Tax Basis)] = CPP
Equation B (determine the amount assigned to
the deferred tax asset):
(Tax Basis – FBB) × Tax Rate = DTA.
55-174 In this Case, the following variables are known:
- Tax Basis = $150
- Tax Rate = 35 percent
- CPP = $100.
55-175 The unknown variables (FBB and DTA) are solved as follows:
Equation A: FBB = $73
Equation B: DTA = $27.
55-176 Accordingly, the entity would record the following
journal entry.
Case B: Amount Paid Is More Than Tax Basis of Asset
55-177 This Case illustrates an asset purchase that is not
a business combination in which the amount paid differs from the
tax basis of the asset (tax basis is less).
55-178 Assume that an entity pays $1,000,000 for the stock
of an entity in a nontaxable acquisition (that is, carryover
basis for tax purposes). The acquired entity’s sole asset is a
Federal Communications Commission (FCC) license that has a tax
basis of zero. Since the acquisition of the entity is in
substance the acquisition of an FCC license, no goodwill is
recognized. A deferred tax liability would need to be recorded
for the temporary difference (in this Case, the entire
$1,000,000 plus the tax-on-tax effect from increasing the
carrying amount of the FCC license acquired) related to the FCC
license. The tax rate is 35 percent.
55-179 In accordance with paragraph 740-10-25-51, the
amounts assigned to the FCC license and the related deferred tax
liability should be determined using the simultaneous equations
method as follows (where FBB is Final Book Basis; CPP is Cash
Purchase Price; and DTL is Deferred Tax Liability):
Equation A (determine the FBB of the FCC license):
FBB – [Tax Rate × (FBB – Tax Basis)] = CPP
Equation B (determine the amount assigned to
the DTL):
(FBB – Tax Basis) × Tax Rate = DTL.
55-180 In this Case, the following variables are known:
- Tax Basis = $0
- Tax Rate = 35 percent
- CPP = $1,000,000.
55-181 The unknown variables (FBB and DTL) are solved as follows:
Equation A: FBB = $1,538,462
Equation B: DTL = $538,462.
55-182 Accordingly, the entity would record the following
journal entry.
Case C: Transaction Results In Deferred Credit
55-183 This Case provides an illustration of a transaction
that results in a deferred credit.
55-184 Entity A buys a machine for $50 with a tax basis of
$200. The tax rate is 35 percent.
55-185 In accordance with paragraph 740-10-25-51, the
amounts assigned to the machine and the deferred tax asset
should be determined using the simultaneous equations method as
follows (where FBB is Final Book Basis; CPP is Cash Purchase
Price; and DTA is Deferred Tax Asset):
Equation A (determine the FBB of the machine):
FBB – [Tax Rate × (FBB – Tax Basis)] = CPP
Equation B (determine the amount assigned to
the DTA):
(Tax Basis – FBB) × Tax Rate = DTA.
55-186 In this Case, the following variables are known:
- Tax Basis = $200
- Tax Rate = 35 percent
- CPP = $50.
55-187 The unknown variables (FBB and DTA) are solved as follows:
Equation A: FBB = $(31). However, because the FBB
cannot be less than zero, the FBB is recorded at
zero.
Equation B: DTA = $70.
55-188 The excess of the amount assigned to the deferred
tax asset over the cash purchase price paid for the machine is
recorded as a deferred credit. Accordingly, the entity would
record the following journal entry.
Case D: Deferred Credit Created by Financial Asset
55-189 This Case provides an illustration of a deferred
credit created by the acquisition of a financial asset.
55-190 Entity A acquires the stock of another corporation
for $250. The principal asset of the corporation is a marketable
equity security with a readily determinable fair value of $200
and a tax basis of $500. The tax rate is 35 percent. The
acquired entity has no operations and so the acquisition is
accounted for as an asset purchase and not as a business
combination.
55-191 In accordance with paragraph 740-10-25-51, the
acquired financial asset should be recognized at fair value, and
a deferred tax asset should be recorded at the amount required
by this Subtopic. The excess of the fair value of the financial
asset and the deferred tax asset recorded over the cash purchase
price should be recorded as a deferred credit. Accordingly, the
entity would record the following journal entry.
Case E: Simultaneous Equations Method and Reduction in
Preexisting Valuation Allowance
55-192 Paragraph not used.
55-193 Paragraph not used.
55-194 Paragraph not used.
55-195 Paragraph not used.
55-196 Paragraph not used.
55-197 Paragraph not used.
55-198 Paragraph not used.
Case F: Purchase of Future Tax Benefits
55-199 This Case provides an illustration of the purchase
of future tax benefits.
55-200 A foreign entity that has nominal assets other than
its net operating loss carryforwards is acquired by a foreign
subsidiary of a U.S. entity for the specific purpose of
utilizing the net operating loss carryforwards (this type of
transaction is often referred to as a tax loss acquisition). It
is presumed that this transaction does not constitute a business
combination, since the acquired entity has no operations and is
merely a shell entity. As a result of the time value of money
and because the target entity is in financial difficulty and has
ceased operations, the foreign subsidiary is able to acquire the
shell entity at a discount from the amount corresponding to the
gross deferred tax asset for the net operating loss
carryforwards. Assume, for example, that $2,000,000 is paid for
net operating loss carryforwards having a deferred tax benefit
of $5,000,000 for which it is more likely than not that the full
benefit will be realized. The tax rate is 35 percent.
55-201 In accordance with paragraph 740-10-25-51, the
amount assigned to the deferred tax asset should be recorded at
its gross amount (in accordance with this Subtopic) and the
excess of the amount assigned to the deferred tax asset over the
purchase price should be recorded as a deferred credit as
follows.
Example 26: Direct Transaction With
Governmental Taxing Authority
55-202 Guidance is provided on various types of payments
made to taxing authorities in paragraphs 740-10-55-67 through
55-75. This Example illustrates one possible payment
situation.
55-203 In this Example,
tax laws in a foreign country enable corporate taxpayers to
elect to step up the tax basis for certain fixed assets
($1,000,000) to fair value ($2,000,000) in exchange for a
current payment to the government of 3 percent of the step-up
($30,000). An entity would be expected to avail itself of this
election (and make the upfront payment) as long as it believed
that it was likely that it would be able to utilize the
additional deductions (at a tax rate of 35 percent) that were
created as a result of the step-up to reduce future taxable
income and that the timing and amount of the resulting future
tax savings justified the current payment. (For purposes of this
Example, it is assumed that the transaction that accomplishes
this step-up for tax purposes does not create a taxable
temporary difference. A taxable temporary difference would
exist, for example, if the tax benefit associated with the
transaction with the governmental taxing authority becomes
taxable in certain situations, such as those described in
paragraph 830-740-25-7.)
55-204 In this Example, the tax effects of transactions
directly with a taxing authority are recorded directly in income
as follows.
55-205 Paragraph superseded by Accounting Standards Update
No. 2015-17.
55-206 Paragraph superseded by Accounting Standards Update
No. 2015-17.
55-207 Paragraph superseded by Accounting Standards Update
No. 2015-17.
55-208 Paragraph superseded by Accounting Standards Update
No. 2015-17.
55-209 Paragraph superseded by Accounting Standards Update
No. 2015-17.
55-210 Paragraph superseded by Accounting Standards Update
No. 2015-17.
55-211 Paragraph superseded by Accounting Standards Update
No. 2015-17.
Example 29: Disclosure Related to Components of Income
Taxes Attributable to Continuing Operations
55-212 Paragraph 740-10-55-79 provides guidance on
satisfying the required disclosure of the significant components
of income taxes and identifies three acceptable approaches
illustrated in this Example:
- The gross method (Case A)
- The net method (Case B)
- The statutory tax rate reconciliation method (Case C).
55-213 Cases A, B, and C share the following
assumptions:
- An entity has $1,588 of taxable income and $100 of investment tax credits for the current year. The $100 deferred tax asset for $295 of operating loss carryforwards was fully reserved at the beginning of the current year.
- Pretax financial income from continuing operations is $5,000.
- Income tax expense from continuing operations is $1,500.
- Effective tax rate is 30%.
- Statutory tax rate is 34%.
Case A: Gross Method
55-214 The first acceptable approach, illustrated as
follows, to disclosure of components of income tax expense from
continuing operations is referred to as the gross method.
Case B: Net Method
55-215 The second acceptable approach, illustrated as
follows, to disclosure of components of income tax expense from
continuing operations is referred to as the net method.
Case C: Statutory Tax Rate Reconciliation Method
55-216 The third acceptable approach, illustrated as
follows, to disclosure of components of income tax expense from
continuing operations is referred to as the statutory tax rate
reconciliation method.
Example 30: Disclosure Relating to Uncertainty in Income
Taxes
55-217 This Example illustrates the guidance in paragraph
740-10-50-15 for disclosures about uncertainty in income taxes.
The Company or one of its subsidiaries files income tax
returns in the U.S. federal jurisdiction, and various
states and foreign jurisdictions. With few exceptions,
the Company is no longer subject to U.S. federal, state
and local, or non-U.S. income tax examinations by tax
authorities for years before 20X1. The Internal Revenue
Service (IRS) commenced an examination of the Company’s
U.S. income tax returns for 20X2 through 20X4 in the
first quarter of 20X7 that is anticipated to be
completed by the end of 20X8. As of December 31, 20X7,
the IRS has proposed certain significant adjustments to
the Company’s transfer pricing and research credits tax
positions. Management is currently evaluating those
proposed adjustments to determine if it agrees, but if
accepted, the Company does not anticipate the
adjustments would result in a material change to its
financial position. However, the Company anticipates
that it is reasonably possible that an additional
payment in the range of $80 to $100 million will be made
by the end of 20X8. A reconciliation of the beginning
and ending amount of unrecognized tax benefits is as
follows.
At December 31, 20X7, 20X6, and 20X5, there are $60,
$55, and $40 million of unrecognized tax benefits that
if recognized would affect the annual effective tax
rate.
The Company recognizes interest accrued related to
unrecognized tax benefits in interest expense and
penalties in operating expenses. During the years ended
December 31, 20X7, 20X6, and 20X5, the Company
recognized approximately $10, $11, and $12 million in
interest and penalties. The Company had approximately
$60 and $50 million for the payment of interest and
penalties accrued at December 31, 20X7, and 20X6,
respectively.
Example 31: Disclosure Relating to Realizability Estimates
of Deferred Tax Asset
55-218 This Example illustrates the guidance in paragraph
275-10-50-8 for disclosure relating to the realizability
estimates of a deferred tax asset.
55-219 In this Example, Entity A develops, manufactures,
and markets limited-use vaccines. The entity has a dominant
share of the narrow market it serves. As of December 31, 19X4,
the entity has no temporary differences and has aggregate loss
carryforwards of $12 million that originated in prior years and
that expire in varying amounts between 19X5 and 19X7. As of
December 31, 19X4, the entity has a deferred tax asset of $4.8
million that represents the benefit of the remaining $12 million
in loss carryforwards, and it has concluded at that date that a
valuation allowance is unnecessary. The loss carryforwards arose
during the entity’s development stage when it incurred high
levels of research and development expenses prior to commencing
sales. While the entity has earned, on average, $6 million
income before tax (taxable income before carryforwards) in each
of the last 5 years, future profitability in this competitive
industry depends on continually developing new products. The
entity has a number of promising new vaccines under development,
but it is aware that other entities recently began testing
vaccines that would compete with the vaccines being developed by
the entity as well as products that will compete with the
vaccines that are currently generating the entity’s profits.
Rapid introduction of competing products or failure of the
entity’s development efforts could reduce estimates of future
profitability in the near term, which could affect the entity’s
ability to fully utilize its loss carryforward.
55-220 Illustrative disclosure for the entity follows.
The entity has recorded a deferred tax asset
of $4.8 million reflecting the benefit of $12 million in loss
carryforwards, which expire in varying amounts between 19X5 and
19X7. Realization is dependent on generating sufficient taxable
income prior to expiration of the loss carryforwards. Although
realization is not assured, management believes it is more
likely than not that all of the deferred tax asset will be
realized. The amount of the deferred tax asset considered
realizable, however, could be reduced in the near term if
estimates of future taxable income during the carryforward
period are reduced.
55-221 In addition to other disclosures, information as to
the amount of loss carryforwards and their expiration dates and
the amount of any valuation allowance with respect to the
recorded deferred tax asset is required under This Subtopic.
55-222 The disclosure in this Example informs users
that:
- Realization of the deferred tax asset depends on achieving a certain minimum level of future taxable income within the next three years
- Although management currently believes that achievement of the required future taxable income is more likely than not, it is at least reasonably possible that this belief could change in the near term, resulting in establishment of a valuation allowance.
Example 32: Definition of a Tax Position
55-223 Entity A has sales in Jurisdiction S but no
physical presence. Management has reviewed the nexus rules for
filing a return in Jurisdiction S and must determine whether
filing a tax return in Jurisdiction S is required. In evaluating
the tax position to file a tax return, management should
consider all relevant sources of tax law. The evaluation of
nexus has to be made for all jurisdictions where Entity A might
be subject to income taxes. Each of these evaluations is a
separate tax position that is subject to the recognition,
measurement, and disclosure requirements of this Subtopic.
Example 33: Definition of a Tax Position
55-224 Entity S converted to an S Corporation from a C
Corporation effective January 1, 20X0. In 20X7, Entity S
disposed of assets subject to built-in gains and reported a tax
liability on its 20X7 tax returns. Tax positions to consider
related to the built-in gains tax include, but are not limited
to:
- Whether other assets were sold subject to the built-in gains tax
- Whether the income associated with the calculation of the taxable amount of the built-in gains is correct
- Whether the basis associated with the built-in gains calculation is correct.
It should be noted that whether or not Entity S is subject to the
built-in gains tax also is a tax position subject to the
provisions of this Subtopic.
Example 34: Definition of a Tax Position
55-225 Entity N, a tax-exempt not-for-profit entity,
enters into transactions that may be subject to income tax on
unrelated business income. Tax positions to consider include but
are not limited to:
- Entity N’s characterization of its activities as related or unrelated to its exempt purpose
- Entity N’s allocation of revenue between activities that relate to its exempt purpose and those that are allocated to unrelated business income
- The allocation of Entity N’s expenses between activities that relate to its exempt purpose and those that are allocated to unrelated business activities.
Even if Entity N were not subject to income taxes on unrelated
business income, it still has a tax position of whether it
qualifies as a tax-exempt not-for-profit entity.
Example 35: Attribution of Income Taxes to the Entity or
Its Owners
55-226 Entity A, a partnership with two partners—Partner 1
and Partner 2—has nexus in Jurisdiction J. Jurisdiction J
assesses an income tax on Entity A and allows Partners 1 and 2
to file a tax return and use their pro rata share of Entity A’s
income tax payment as a credit (that is, payment against the tax
liability of the owners). Because the owners may file a tax
return and utilize Entity A’s payment as a payment against their
personal income tax, the income tax would be attributed to the
owners by Jurisdiction J’s laws whether or not the owners file
an income tax return. Because the income tax has been attributed
to the owners, payments to Jurisdiction J for income taxes
should be treated as a transaction with the owners. The result
would not change even if there were an agreement between Entity
A and its two partners requiring Entity A to reimburse Partners
1 and 2 for any taxes the partners may owe to Jurisdiction J.
This is because attribution is based on the laws and regulations
of the taxing authority rather than on obligations imposed by
agreements between an entity and its owners.
Example 36: Attribution of Income Taxes to the Entity or
Its Owners
55-227 If the fact pattern in paragraph 740-10-55-226
changed such that Jurisdiction J has no provision for the owners
to file tax returns and the laws and regulations of Jurisdiction
J do not indicate that the payments are made on behalf of
Partners 1 and 2, income taxes are attributed to Entity A on the
basis of Jurisdiction J’s laws and are accounted for based on
the guidance in this Subtopic.
Example 37: Attribution of Income Taxes to the Entity or
Its Owners
55-228 Entity S, an S Corporation, files a tax return in
Jurisdiction J. An analysis of the laws and regulations of
Jurisdiction J indicates that Jurisdiction J can hold Entity S
and its owners jointly and severally liable for payment of
income taxes. The laws and regulations also indicate that if
payment is made by Entity S, the payments are made on behalf of
the owners. Because the laws and regulations attribute the
income tax to the owners regardless of who pays the tax, any
payments to Jurisdiction J for income taxes should be treated as
a transaction with its owners.
Example 38: Financial Statements of a Group of Related
Entities
55-229 Entity A, a partnership with 2 partners, owns a 100
percent interest in Entity B and is required to issue
consolidated financial statements. Entity B is a taxable entity
that has unrecognized tax positions and a related liability for
unrecognized tax benefits. Because entities within a
consolidated or combined group should consider the tax positions
of all entities within the group regardless of the tax status of
the reporting entity, Entity A should include in its financial
statements the assets, liabilities, income, and expenses of both
Entity A and Entity B, including those relating to the
implementation of this Subtopic to Entity B. This is required
even though Entity A is a pass-through entity.
ASC 740-20 — Implementation Guidance and Illustrations
Illustrations
Example 1: Allocation to Continuing Operations
55-1 Paragraph 740-20-45-8 states that the amount of
income tax expense or benefit allocated to continuing operations
is the tax effect of pretax income or loss from continuing
operations that occurred during the year plus or minus certain
adjustments.
55-2 The adjustments include the tax effects of:
- Changes in circumstances that cause a change in judgment about the realization of deferred tax assets in future years
- Changes in tax laws or rates
- Changes in tax status
- Tax-deductible dividends paid to shareholders.
55-3 The allocation of income tax expense between pretax
income from continuing operations and other items shall include
deferred taxes.
55-4 This Example illustrates allocation of current and
deferred tax expense. The assumptions are as follows:
- Tax rates are 40 percent for Years 1, 2, and 3 and 30 percent for Year 4 and subsequent years. No valuation allowances are required for deferred tax assets.
-
At the end of Year 1, there is a $500 taxable temporary difference relating to the entity’s contracting operations and a $200 deductible temporary difference related to its other operations. Determination of the entity’s deferred tax assets and liabilities at the end of Year 1 is as follows.
- During Year 2, the entity decides that it will sell its contracting operations in Year 3. As a result, all temporary differences related to the contracting operations (the $500 taxable temporary difference that existed at the end of Year 1, plus an additional $200 taxable temporary difference that arose during Year 2) are now considered to result in taxable amounts in Year 3 because the contracting operations will be sold in Year 3.
- At the end of Year 2, the entity also has $300 of deductible temporary differences ($100 of the temporary difference that existed at the end of Year 1, plus an additional $200 that arose during Year 2) from continuing operations.
- For Year 2, the entity has $50 of pretax reported income from continuing operations and $200 of pretax reported income from discontinued operations.
-
Determination of the entity’s deferred tax asset and liability at the end of Year 2 is as follows.
55-5 Total deferred tax expense for Year 2 is $100 ($170 –
$70). The deferred tax benefit of the deductible temporary
differences related to the entity’s continuing operations during
Year 2 is determined as follows.
55-6 The deferred tax expense for taxable temporary
differences related to the entity’s discontinued operations
during Year 2 is determined as follows.
55-7 Total tax expense and tax expense allocated to
continuing and discontinued operations for Year 2 are determined
as follows.
Example 2: Allocations of Income Taxes to Continuing
Operations and One Other Item
55-8 If there is only one item other than continuing
operations, the portion of income tax expense or benefit for the
year that remains after the allocation to continuing operations
is allocated to that item. If there are two or more items other
than continuing operations, the amount that remains after the
allocation to continuing operations is allocated among those
other items in proportion to their individual effects on income
tax expense or benefit for the year.
55-9 The following Cases both present allocations of
income tax to continuing operations when there is only one item
other than income from continuing operations:
- Loss from continuing operations with an extraordinary gain (Case A)
- Income from continuing operations with a loss from discontinued operations (Case B).
Case A: Loss From Continuing Operations With a
Gain on Discontinued Operations (Tax Benefit Realizable)
55-10 This Case
illustrates allocation of income tax expense if there is only
one item other than income from continuing operations. The
assumptions are as follows:
- The entity’s pretax financial income and taxable income are the same.
- The entity’s ordinary loss from continuing operations is $500.
- The entity also has a gain on discontinued operations of $900 that is a capital gain for tax purposes.
- The tax rate is 40 percent on ordinary income and 30 percent on capital gains. Income taxes currently payable are $120 ($400 at 30 percent).
- The entity has determined that the deferred tax asset that would have resulted from the loss from continuing operations if the gain on discontinued operations had not occurred would be expected to be realized (that is, a valuation allowance would not have been needed).
55-11 Income tax expense
is allocated between the pretax loss from operations and the
gain on discontinued operations as follows.
55-12 The effect of the
$500 loss from continuing operations was to offset an equal
amount of capital gains that otherwise would be taxed at a 30
percent tax rate. However, the guidance in paragraph 740-20-45-7
requires that an entity determine the tax effects of pretax
income from continuing operations by a computation that does not
consider the tax effects of items that are not included in
continuing operations. The entity has determined that, absent
the capital gain from discontinued operations, a valuation
allowance would not have been needed on the deferred tax asset
resulting from the $500 loss from continuing operations. Thus,
$200 ($500 at 40 percent) of tax benefit is allocated to
continuing operations. The $320 incremental effect of the gain
on discontinued operations is the difference between $120 of
total tax expense and the $200 tax benefit allocated to
continuing operations.
Case A1: Loss From Continuing Operations With a Gain on
Discontinued Operations (Tax Benefit Not Realizable)
55-12A This Case
illustrates allocation of income tax expense if there is only
one item other than income from continuing operations. The
assumptions are the same as in Case A except that the entity has
determined that the deferred tax asset that would have resulted
from the loss from continuing operations if the gain on
discontinued operations had not occurred would not be expected
to be realized (that is, a valuation allowance would have been
needed).
55-12B Income tax
expense is allocated between the pretax loss from operations and
the gain on discontinued operations as follows.
55-12C The effect of the
$500 loss from continuing operations was to offset an equal
amount of capital gains that otherwise would be taxed at a 30
percent tax rate. However, the guidance in paragraph 740-20-45-7
requires that an entity determine the tax effects of pretax
income from continuing operations by a computation that does not
consider the tax effects of items that are not included in
continuing operations. The entity has determined that, absent
the capital gain from discontinued operations, a valuation
allowance would have been needed on the deferred tax asset
resulting from the $500 loss from continuing operations. Thus,
zero tax benefit is allocated to continuing operations. The $120
incremental income tax expense related to the gain on
discontinued operations is the difference between $120 of total
tax expense and the zero tax benefit allocated to continuing
operations.
Case B: Income From Continuing Operations With a Loss From
Discontinued Operations
55-13 This Case further illustrates the general
requirement to determine the tax effects of pretax income from
continuing operations by a computation that does not consider
the tax effects of items that are not included in continuing
operations.
55-14 To illustrate,
assume that in the current year an entity has $1,000 of income
from continuing operations and a $1,000 loss from discontinued
operations. At the beginning of the year, the entity has a
$2,000 net operating loss carryforward for which the deferred
tax asset, net of its valuation allowance, is zero, and the
entity did not reduce that valuation allowance during the year.
No tax expense should be allocated to income from continuing
operations because the $2,000 loss carryforward is sufficient to
offset that income. Thus, no tax benefit is allocated to the
loss from discontinued operations.
Example 3: Allocation of the Benefit of a Tax Credit
Carryforward
55-15 This Example illustrates the guidance in paragraphs
740-20-45-7 through 45-8 for allocation of the tax benefit of a
tax credit carryforward that is recognized as a deferred tax
asset in the current year. The assumptions are as follows:
- The entity’s pretax financial income and taxable income are the same.
- Pretax financial income for the year comprises $300 from continuing operations and $400 from a gain on discontinued operations.
- The tax rate is 40 percent. Taxes payable for the year are zero because $330 of tax credits that arose in the current year more than offset the $280 of tax otherwise payable on $700 of taxable income.
- A $50 deferred tax asset is recognized for the $50 ($330 – $280) tax credit carryforward. Based on the weight of available evidence, management concludes that no valuation allowance is necessary.
55-16 Income tax expense or benefit is allocated between
pretax income from continuing operations and the gain on
discontinued operations as follows.
55-17 Absent the gain on discontinued operations and
assuming it was not the deciding factor in reaching a conclusion
that a valuation allowance is not needed, the entire tax benefit
of the $330 of tax credits would be allocated to continuing
operations. The presence of the gain on discontinued operations
does not change that allocation.
Example 4: Allocation to Other Comprehensive
Income
55-18 Income taxes are sometimes allocated directly to
shareholders’ equity or to other comprehensive income. This
Example illustrates the allocation of income taxes for
translation adjustments under the requirements of Subtopic
830-30 to other comprehensive income. In this Example, FC
represents units of foreign currency.
55-19 A foreign subsidiary has earnings of FC 600 for Year
2. Its net assets (and unremitted earnings) are FC 1,000 and FC
1,600 at the end of Years 1 and 2, respectively.
55-20 The foreign currency is the functional currency. For
Year 2, translated amounts are as follows.
55-21 A $260 translation adjustment ($1,200 + $660 -
$1,600) is reported in other comprehensive income and
accumulated in shareholders’ equity for Year 2.
55-22 The U.S. parent expects that all of the foreign
subsidiary’s unremitted earnings will be remitted in the
foreseeable future, and under the requirements of Subtopic
740-30, a deferred U.S. tax liability is recognized for those
unremitted earnings.
55-23 The U.S. parent accrues the deferred tax liability
at a 20 percent tax rate (that is, net of foreign tax credits,
foreign tax credit carryforwards, and so forth). An analysis of
the net investment in the foreign subsidiary and the related
deferred tax liability for Year 2 is as follows.
55-24 For Year 2, $132 of deferred taxes are charged
against earnings, and $52 of deferred taxes are reported in
other comprehensive income and accumulated in shareholders’
equity.
ASC 740-270 — Implementation Guidance and Illustrations
General
55-1 This Section, which is an integral part of the
requirements of this Subtopic, provides Examples of applying the
required accounting for interim period income taxes to some
specific situations. In general, the Examples illustrate matters
unique to accounting for income taxes at interim dates. The
Examples do not include consideration of the nature of tax
credits and events that do not have tax consequences or
illustrate all possible combinations of circumstances.
Illustrations
Example 1: Accounting for Income Taxes Applicable to
Ordinary Income (or Loss) at an Interim Date if Ordinary
Income Is Anticipated for the Fiscal Year
55-2 The following Cases illustrate the guidance in
Sections 740-270-30 and 740-270-35 for accounting for income
taxes applicable to ordinary income (or loss) at an interim date
if ordinary income is anticipated for the fiscal year:
- Ordinary income in all interim periods (Case A)
- Ordinary income and losses in interim periods (Case B)
- Changes in estimates (Case C).
55-3 Cases A and B share all of the following
assumptions:
- For the full fiscal year, an entity anticipates ordinary income of $100,000. All income is taxable in one jurisdiction at a 50 percent rate. Anticipated tax credits for the fiscal year total $10,000. No events that do not have tax consequences are anticipated. No changes in estimated ordinary income, tax rates, or tax credits occur during the year.
-
Computation of the estimated annual effective tax rate applicable to ordinary income is as follows.
- Tax credits are generally subject to limitations, usually based on the amount of tax payable before the credits. In computing the estimated annual effective tax rate, anticipated tax credits are limited to the amounts that are expected to be realized or are expected to be recognizable at the end of the current year in accordance with the provisions of Subtopic 740-10. If an entity is unable to estimate the amount of its tax credits for the year, see paragraphs 740-270-30-17 through 30-18.
Case A: Ordinary Income in All Interim Periods
55-4 The entity has ordinary income in all interim
periods. Quarterly tax computations are as follows.
Case B: Ordinary Income and Losses in Interim Periods
55-5 The following Cases illustrate ordinary income and
losses in interim periods:
- Year-to-date ordinary income (Case B1)
- Year-to-date ordinary losses, realization more likely than not (Case B2)
- Year-to-date ordinary losses, realization not more likely than not (Case B3).
Case B1: Year-to-Date Ordinary Income
55-6 The entity has ordinary income and losses in interim
periods; there is not an ordinary loss for the fiscal year to
date at the end of any interim period. Quarterly tax
computations are as follows.
Case B2: Year-to-Date Ordinary Losses, Realization More Likely
Than Not
55-7 The entity has ordinary income and losses in interim
periods, and there is an ordinary loss for the year to date at
the end of an interim period. Established seasonal patterns
provide evidence that realization in the current year of the tax
benefit of the year-to-date loss and of anticipated tax credits
is more likely than not. Quarterly tax computations are as
follows.
Case B3: Year-to-Date Ordinary Losses, Realization Not More
Likely Than Not
55-8 The entity has ordinary income and losses in interim
periods, and there is a year-to-date ordinary loss during the
year. There is no established seasonal pattern and it is more
likely than not that the tax benefit of the year-to-date loss
and the anticipated tax credits will not be realized in the
current or future years. Quarterly tax computations are as
follows.
Case C: Changes in Estimates
55-9 During the fiscal year, all of an entity’s operations
are taxable in one jurisdiction at a 50 percent rate. No events
that do not have tax consequences are anticipated. Estimates of
ordinary income for the year and of anticipated credits at the
end of each interim period are as shown below. Changes in the
estimated annual effective tax rate result from changes in the
ratio of anticipated tax credits to tax computed at the
statutory rate. Changes consist of an unanticipated strike that
reduced income in the second quarter, an increase in the capital
budget resulting in an increase in anticipated investment tax
credit in the third quarter, and better than anticipated sales
and income in the fourth quarter. The entity has ordinary income
in all interim periods. Computations of the estimated annual
effective tax rate based on the estimate made at the end of each
quarter are as follows.
55-10 Quarterly tax computations are as follows.
Example 2: Accounting for Income Taxes Applicable to
Ordinary Income (or Loss) at an Interim Date if an
Ordinary Loss Is Anticipated for the Fiscal
Year
55-11 The following Cases illustrate the guidance in
Section 740-270-30 for accounting for income taxes applicable to
ordinary income (or loss) at an interim date if an ordinary loss
is anticipated for the fiscal year:
- Realization of the tax benefit of the loss is more likely than not (Case A)
- Realization of the tax benefit of the loss is not more likely than not (Case B)
- Partial realization of the tax benefit of the loss is more likely than not (Case C)
- Reversal of net deferred tax credits (Case D).
55-12 Cases A, B, and C share the following
assumptions.
- For the full fiscal year, an entity anticipates an ordinary loss of $100,000. The entity operates entirely in one jurisdiction where the tax rate is 50 percent. Anticipated tax credits for the fiscal year total $10,000. No events that do not have tax consequences are anticipated.
-
If there is a recognizable tax benefit for the loss and the tax credits pursuant to the requirements of Subtopic 740-10, computation of the estimated annual effective tax rate applicable to the ordinary loss would be as follows.
55-13 Cases A, B, and C state varying assumptions with
respect to assurance of realization of the components of the net
tax benefit. When the realization of a component of the benefit
is not expected to be realized during the current year or
recognizable as a deferred tax asset at the end of the current
year in accordance with the provisions of Subtopic 740-10, that
component is not included in the computation of the estimated
annual effective tax rate.
Case A: Realization of the Tax Benefit of the Loss Is More Likely
Than Not
55-14 The following Cases illustrate when realization of
the tax benefit of the loss is more likely than not:
- Ordinary losses in all interim periods (Case A1)
- Ordinary income and losses in interim periods (Case A2).
Case A1: Ordinary Losses in All Interim Periods
55-15 The entity has ordinary losses in all interim
periods. The full tax benefit of the anticipated ordinary loss
and the anticipated tax credits will be realized by carryback.
Quarterly tax computations are as follows.
Case A2: Ordinary Income and Losses in Interim Periods
55-16 The entity has
ordinary income and losses in interim periods and for the year
to date. The full tax benefit of the anticipated ordinary loss
and the anticipated tax credits will be realized by carryback.
The full tax benefit of the maximum year-to-date ordinary loss
can also be realized by carryback. Quarterly tax computations
are as follows.
Case B: Realization of the Tax Benefit of the Loss Is Not More
Likely Than Not
55-17 In Cases A1 and A2, if neither the tax benefit of
the anticipated loss for the fiscal year nor anticipated tax
credits were recognizable pursuant to Subtopic 740-10, the
estimated annual effective tax rate for the year would be zero
and no tax (or benefit) would be recognized in any quarter. That
conclusion is not affected by changes in the mix of income and
loss in interim periods during a fiscal year. However, see
paragraph 740-270-30-18.
Case C: Partial Realization of the Tax Benefit of the Loss Is
More Likely Than Not
55-18 The following Cases illustrate when partial
realization of the tax benefit of the loss is more likely than
not:
- Ordinary losses in all interim periods (Case C1)
- Ordinary income and losses in interim periods (Case C2).
Case C1: Ordinary Losses in All Interim Periods
55-19 The entity has an ordinary loss in all interim
periods. It is more likely than not that the tax benefit of the
loss in excess of $40,000 of prior income available to be offset
by carryback ($20,000 of tax at the 50 percent statutory rate)
will not be realized. Therefore the estimated annual effective
tax rate is 20 percent ($20,000 benefit more likely than not to
be realized divided by $100,000 estimated fiscal year ordinary
loss). Quarterly tax computations are as follows.
Case C2: Ordinary Income and Losses in Interim Periods
55-20 The entity has ordinary income and losses in interim
periods and for the year to date. It is more likely than not
that the tax benefit of the anticipated ordinary loss in excess
of $40,000 of prior income available to be offset by carryback
($20,000 of tax at the 50 percent statutory rate) will not be
realized. Therefore the estimated annual effective tax rate is
20 percent ($20,000 benefit more likely than not to be realized
divided by $100,000 estimated fiscal year ordinary loss), and
the benefit that can be recognized for the year to date is
limited to $20,000 (the benefit that is more likely than not to
be realized). Quarterly tax computations are as follows.
Case D: Reversal of Net Deferred Tax Credits
55-21 The entity anticipates a fiscal year ordinary loss.
The loss cannot be carried back, and future profits exclusive of
reversing temporary differences are unlikely. Net deferred tax
liabilities arising from existing net taxable temporary
differences are present. A portion of the existing net taxable
temporary differences relating to those liabilities will reverse
within the loss carryforward period. Computation of the
estimated annual effective tax rate to be used (see paragraphs
740-270-30-32 through 30-33) is as follows.
55-22 Quarterly tax computations are as follows.
55-23 Note that changes in the timing of the loss by
quarter would not change this computation.
Example 3: Accounting for Income Taxes Applicable to
Unusual or Infrequently Occurring Items
55-24 The following Cases illustrate accounting for income
taxes applicable to unusual or infrequently occurring items when
ordinary income is expected for the fiscal year:
- Realization of the tax benefit is more likely than not at date of occurrence (Case A)
- Realization of the tax benefit not more likely than not at date of occurrence (Case B).
55-25 Cases A and B illustrate the computation of the tax
(or benefit) applicable to unusual or infrequently occurring
items when ordinary income is anticipated for the fiscal year.
These Cases are based on the assumptions and computations
presented in paragraph 740-270-55-3 and Example 1, Cases A and B
(see paragraphs 740-270-55-4 through 55-8), plus additional
information supplied in Cases A and B of this Example. The
computation of the tax (or benefit) applicable to the ordinary
income is not affected by the occurrence of an unusual or
infrequently occurring item; therefore, each Case refers to one
or more of the illustrations of that computation in Example 1,
Cases A and B (see paragraphs 740-270-55-4 through 55-8), and
does not reproduce the computation and the assumptions. The
income statement display for tax (or benefit) applicable to
unusual or infrequently occurring items is illustrated in
Example 7 (see paragraph 740-270-55-52).
Case A: Realization of the Tax Benefit Is More Likely Than Not at
Date of Occurrence
55-26 As explained in paragraph 740-270-55-25, this Case
is based on the computations of tax applicable to ordinary
income that are illustrated in Example 1, Case A (see paragraph
740-270-55-4). In addition, the entity experiences a
tax-deductible unusual or infrequently occurring loss of $50,000
(tax benefit $25,000) in the second quarter. Because the loss
can be carried back, it is more likely than not that the tax
benefit will be realized at the time of occurrence. Quarterly
tax provisions are as follows.
55-27 Note that changes in assumptions would not change
the timing of the recognition of the tax benefit applicable to
the unusual or infrequently occurring item as long as
realization is more likely than not.
Case B: Realization of the Tax Benefit Not More Likely Than Not
at Date of Occurrence
55-28 As explained in paragraph 740-270-55-25, this Case
is based on the computations of tax applicable to ordinary
income that are illustrated in Example 1, Cases A and B1 (see
paragraphs 740-270-55-4 through 55-6). In addition, the entity
experiences a tax-deductible unusual or infrequently occurring
loss of $50,000 (potential benefit $25,000) in the second
quarter. The loss cannot be carried back, and available evidence
indicates that a valuation allowance is needed for all of the
deferred tax asset. As a result, the tax benefit of the unusual
or infrequently occurring loss is recognized only to the extent
of offsetting ordinary income for the year to date. Quarterly
tax provisions under two different assumptions for the
occurrence of ordinary income are as follows.
Example 4: Accounting for Income Taxes Applicable to Income
(or Loss) From Discontinued Operations at an Interim
Date
55-29 This Example illustrates the guidance in paragraph
740-270-45-7. An entity anticipates ordinary income for the year
of $100,000 and tax credits of $10,000. The entity has ordinary
income in all interim periods. The estimated annual effective
tax rate is 40 percent, computed as follows.
55-30 Quarterly tax computations for the first two
quarters are as follows.
55-31 In the third quarter a decision is made to
discontinue the operations of Division X, a segment of the
business that has recently operated at a loss (before income
taxes). The pretax income (and losses) of the continuing
operations of the entity and of Division X through the third
quarter and the estimated fourth quarter results are as
follows.
55-32 No changes have occurred in continuing operations
that would affect the estimated annual effective tax rate.
Anticipated annual tax credits of $10,000 included $2,000 of
credits related to the operations of Division X. The revised
estimated annual effective tax rate applicable to ordinary
income from continuing operations is 45 percent, computed as
follows.
55-33 Quarterly computations of tax applicable to ordinary
income from continuing operations are as follows.
55-34 Tax benefit applicable to Division X for the first
two quarters is computed as follows.
55-35 The third quarter tax benefits applicable to both
the loss from operations and the provision for loss on disposal
of Division X are computed based on estimated annual income with
and without the effects of the Division X losses. Current year
tax credits related to the operations of Division X have not
been recognized. It is assumed that the tax benefit of those
credits will not be realized because of the discontinuance of
Division X operations. Any reduction in tax benefits resulting
from recapture of previously recognized tax credits resulting
from discontinuance or current year tax credits applicable to
the discontinued operations would be reflected in the tax
benefit recognized for the loss on disposal or loss from
operations as appropriate. If, because of capital gains and
losses, and so forth, the individually computed tax effects of
the items do not equal the aggregate tax effects of the items,
the aggregate tax effects are allocated to the individual items
in the same manner that they will be allocated in the annual
financial statements. The computations are as follows.
55-36 The resulting revised quarterly tax provisions are
summarized as follows.
Example 5: Accounting for Income Taxes Applicable to
Ordinary Income if an Entity Is Subject to Tax in
Multiple Jurisdictions
55-37 The following Cases illustrate the guidance in
paragraph 740-270-30-36 for accounting for income taxes
applicable to ordinary income if an entity is subject to tax in
multiple jurisdictions:
- Ordinary income in all jurisdictions (Case A)
- Ordinary loss in a jurisdiction; realization of the tax benefit not more likely than not (Case B)
- Ordinary income or tax cannot be estimated in one jurisdiction (Case C).
55-38 Cases A, B, and C assume that an entity operates
through separate corporate entities in two countries. Applicable
tax rates are 50 percent in the United States and 20 percent in
Country A. The entity has no unusual or infrequently occurring
items during the fiscal year and anticipates no tax credits or
events that do not have tax consequences. (The effect of foreign
tax credits and the necessity of providing tax on undistributed
earnings are ignored because of the wide range of tax planning
alternatives available.) For the full fiscal year the entity
anticipates ordinary income of $60,000 in the United States and
$40,000 in Country A. The entity is able to make a reliable
estimate of its Country A ordinary income and tax for the fiscal
year in dollars. Computation of the overall estimated annual
effective tax rate in Cases B and C is based on additional
assumptions stated in those Cases.
Case A: Ordinary Income in All Jurisdictions
55-39 Computation of the overall estimated annual
effective tax rate is as follows.
55-40 Quarterly tax computations are as follows.
Case B: Ordinary Loss in a Jurisdiction; Realization of the Tax
Benefit Not More Likely Than Not
55-41 In this Case, the entity operates through a separate
corporate entity in Country B. Applicable tax rates in Country B
are 40 percent. Operations in Country B have resulted in losses
in recent years and an ordinary loss is anticipated for the
current fiscal year in Country B. It is expected that the tax
benefit of those losses will not be recognizable as a deferred
tax asset at the end of the current year pursuant to Subtopic
740-10; accordingly, no tax benefit is recognized for losses in
Country B, and interim period tax (or benefit) is separately
computed for the ordinary loss in Country B and for the overall
ordinary income in the United States and Country A. The tax
applicable to the overall ordinary income in the United States
and Country A is computed as in Case A of this Example.
Quarterly tax provisions are as follows.
Case C: Ordinary Income or Tax Cannot Be Estimated in One
Jurisdiction
55-42 In this Case, the entity operates through a separate
corporate entity in Country C. Applicable tax rates in Country C
are 40 percent in foreign currency. Depreciation in that country
is large and exchange rates have changed in prior years. The
entity is unable to make a reasonable estimate of its ordinary
income for the year in Country C and thus is unable to
reasonably estimate its annual effective tax rate in Country C
in dollars. Accordingly, tax (or benefit) in Country C is
separately computed as ordinary income (or loss) occurs in
Country C. The tax applicable to the overall ordinary income in
the United States and Country A is computed as in Case A of this
Example. Quarterly computations of tax applicable to Country C
are as follows.
55-43 Quarterly tax provisions are as follows.
Example 6: Effect of New Tax Legislation
55-44 The following
Example illustrates the guidance in paragraphs 740-270-25-5
through 25-6 for accounting in interim periods for the effect of
new tax legislation on income taxes when legislation is
effective in a future interim period.
- Subparagraph superseded by Accounting Standards Update No. 2019-12.
- Subparagraph superseded by Accounting Standards Update No. 2019-12.
Legislation Effective in a Future Interim
Period
55-45 The assumed facts
applicable to this Example follow.
55-46 For the full fiscal year, an entity anticipates
ordinary income of $100,000. All income is taxable in one
jurisdiction at a 50 percent rate. Anticipated tax credits for
the fiscal year total $10,000. No events that do not have tax
consequences are anticipated.
55-47 Computation of the estimated annual effective tax
rate applicable to ordinary income is as follows.
55-48 Further, assume that new legislation creating
additional tax credits is enacted during the second quarter of
the entity’s fiscal year. The new legislation is effective on
the first day of the third quarter. As a result of the estimated
effect of the new legislation, the entity revises its estimate
of its annual effective tax rate to the following.
55-49 The effect of the
new legislation shall be reflected in the computation of the
annual effective tax rate beginning in the first interim period
that includes the enactment date of the new legislation.
Accordingly, quarterly tax computations are as follows.
55-50 Paragraph
superseded by Accounting Standards Update No. 2019-12.
55-51 Paragraph
superseded by Accounting Standards Update No. 2019-12.
Example 7: Illustration of Income Taxes in Income Statement
Display
55-52 The following illustrates the location in an income
statement display of the various tax amounts computed under this
Subtopic.
ASC 805-740 — Implementation Guidance and Illustrations
General
55-1 This Section is an integral part of the requirements
of this Subtopic. This Section provides illustrations that
address the application of accounting requirements to specific
aspects of accounting for income taxes in connection with
business combinations. The illustrations that follow make
various assumptions about the tax law. These assumptions about
the tax law are for illustrative purposes only.
Illustrations
Example 1: Nontaxable Business Combination
55-2 This Example illustrates the guidance in paragraphs
805-740-25-2 through 25-3 and 805-740-30-1 relating to the
recognition and measurement of a deferred tax liability and
deferred tax asset in a nontaxable business combination. The
assumptions are as follows:
- The enacted tax rate is 40 percent for all future years, and amortization of goodwill is not deductible for tax purposes.
- A wholly owned entity is acquired for $20,000, and the entity has no leveraged leases.
- The tax basis of the net assets acquired (other than goodwill) is $5,000, and the recognized value is $12,000. Future recovery of the assets and settlement of the liabilities at their assigned values will result in $20,000 of taxable amounts and $13,000 of deductible amounts that can be offset against each other. Therefore, no valuation allowance is necessary.
55-3 The amounts recorded to account for the business
combination transaction are as follows.
Example 2: Valuation Allowance at Acquisition Date
Subsequently Reduced
55-4 This Example illustrates the guidance in paragraphs
805-740-25-3 and 805-740-45-2 relating to the recognition of a
deferred tax asset and the related valuation allowance for
acquired deductible temporary differences at the date of a
nontaxable business combination and in subsequent periods when
the tax law limits the use of an acquired entity’s deductible
temporary differences and carryforwards to subsequent taxable
income of the acquired entity in a consolidated tax return. The
assumptions are as follows:
- The enacted tax rate is 40 percent for all future years.
- The purchase price is $20,000, and the assigned value of the net assets acquired is also $20,000.
- The tax basis of the net assets acquired is $60,000. The $40,000 ($60,000 – $20,000) of deductible temporary differences at the combination date is primarily attributable to an allowance for loan losses. Provisions in the tax law limit the use of those future tax deductions to subsequent taxable income of the acquired entity.
-
The acquired entity’s actual pretax results for the two preceding years and the expected results for the year of the business combination are as follows.
55-5 The acquired entity’s pretax financial income and
taxable income for Year 3 (after the business combination) and
Year 4 are as follows.
55-6 At the end of Year 4, the remaining balance of
acquired deductible temporary differences is $15,000 ($40,000 –
$25,000). The deferred tax asset is $6,000 ($15,000 at 40
percent). Based on an assessment of all available evidence at
the end of Year 4, management concludes that no valuation
allowance is needed for that $6,000 deferred tax asset.
Elimination of the $6,000 valuation allowance results in a
$6,000 deferred tax benefit that is reported as a reduction of
deferred income tax expense because the reversal of the
valuation allowance occurred after the measurement period (see
paragraph 805-740-45-2). Tax benefits realized in Years 3 and 4
attributable to reversals of acquired deductible temporary
differences are reported as a zero current income tax expense.
The consolidated statement of earnings would include the
following amounts attributable to the acquired entity for Year 3
(after the business combination) and Year 4.
Example 3: Acquirer’s Taxable Temporary Differences
Eliminate Need for Acquiree Valuation
Allowance
55-7 This Example illustrates the guidance in paragraph
805-740-25-3 if there is an elimination of the need for a
valuation allowance for the deferred tax asset for an acquired
loss carryforward based on offset against taxable temporary
differences of the acquiring entity in a nontaxable business
combination. This Example assumes that the tax law permits use
of an acquired entity’s deductible temporary differences and
carryforwards to reduce taxable income or taxes payable
attributable to the acquiring entity in a consolidated tax
return. The other assumptions are as follows:
- The enacted tax rate is 40 percent for all future years.
- The purchase price is $20,000. The tax basis of the identified net assets acquired is $5,000, and the assigned value is $12,000, that is, there are $7,000 of taxable temporary differences. The acquired entity also has a $16,000 operating loss carryforward, which, under the tax law, may be used by the acquiring entity in the consolidated tax return.
- The acquiring entity has temporary differences that will result in $30,000 of net taxable amounts in future years.
- All temporary differences of the acquired and acquiring entities will result in taxable amounts before the end of the acquired entity’s loss carryforward period.
55-8 In assessing the
need for a valuation allowance, future taxable income exclusive
of reversing temporary differences and carryforwards (see
paragraph 740-10-30-18(b)) need not be considered because the
$16,000 operating loss carryforward will offset the acquired
entity’s $7,000 of taxable temporary differences and another
$9,000 of the acquiring entity’s taxable temporary differences.
The amounts recorded to account for the purchase transaction are
as follows.
Example 4: Tax Deductible Goodwill Exceeds Financial
Reporting Goodwill
55-9 This Example illustrates the guidance in paragraphs
805-740-25-8 through 25-9 on accounting for the tax consequences
of goodwill when tax-deductible goodwill exceeds the goodwill
recorded for financial reporting at the acquisition date. The
assumptions are as follows:
- At the acquisition date, the reported amount of goodwill for financial reporting purposes is $600 before taking into consideration the tax benefit associated with goodwill and the tax basis of goodwill is $900.
- The tax rate is 40 percent for all years.
55-10 As of the acquisition date, the
goodwill for financial reporting purposes is adjusted for the
tax benefit associated with goodwill by using the following
simultaneous equations method. In the following equation, the
Preliminary Temporary Difference variable is the excess of tax
goodwill over book goodwill, before taking into consideration
the tax benefit associated with goodwill, and the Deferred Tax
Asset variable is the resulting deferred tax asset.
(Tax Rate ÷ [1-Tax Rate]) × Preliminary
Temporary Difference = Deferred Tax Asset
55-11 In this Example, the following variables are known:
Tax rate = 40 percent
Preliminary Temporary Difference = $300 ($900 −
$600)
55-12 The unknown variable (Deferred Tax Asset) equals
$200, and the goodwill for financial reporting purposes would be
adjusted with the following entry.
55-13 Goodwill for financial reporting would be
established at the acquisition date at $400 ($600 less the $200
credit adjustment).
ASC 830-740 — Implementation Guidance and Illustrations
Example 1: Illustration of Foreign Financial Statements
Restated for General Price-Level Changes
55-1 This Example illustrates the guidance in paragraphs
830-740-25-5 and 830-740-30-1 through 30-2. An entity has one
asset, a nonmonetary asset that is not depreciated for financial
reporting or tax purposes. The local currency is FC. Units of
current purchasing power are referred to as CFC. The enacted tax
rate is 40 percent. The asset had a price-level-adjusted
financial reporting amount of CFC 350 and an indexed basis for
tax purposes of CFC 100 at December 31, 19X2, both measured
using CFC at December 31, 19X2. The entity has a taxable
temporary difference of CFC 250 (CFC 350 – CFC 100) and a
related deferred tax liability of CFC 100 (CFC 250 × 40 percent)
using CFC at December 31, 19X2.
55-2 General price levels increase by 50 percent in 19X3,
and indexing allowed for 19X3 for tax purposes is 25 percent. At
December 31, 19X3, the asset has a price-level-adjusted
financial reporting amount of CFC 525 (CFC 350 × 150 percent)
and an indexed basis for tax purposes of CFC 125 (CFC 100 × 125
percent), using CFC at December 31, 19X3. The entity has a
taxable temporary difference of CFC 400 (CFC 525 – CFC 125) and
a related deferred tax liability of CFC 160 (CFC 400 × 40
percent) at December 31, 19X3, using CFC at December 31, 19X3.
The deferred tax liability at December 31, 19X2 is restated to
units of current general purchasing power as of December 31,
19X3. The restated December 31, 19X2 deferred tax liability is
CFC 150 (CFC 100 × 150 percent). For 19X3, the difference
between CFC 160 and CFC 150 is reported as deferred tax expense
in income from continuing operations. The difference between the
deferred tax liability of CFC 100 at December 31, 19X2 and the
restated December 31, 19X2 deferred tax liability of CFC 150 is
reported in 19X3 as a restatement of beginning equity.
55-3 The following is a tabular presentation of this
Example.
ASC 323-740 — Implementation Guidance and Illustrations
55-1 This Section is an integral part of the requirements
of this Subtopic.
Illustrations
Example 1: Application of Accounting Guidance to a Limited
Partnership Investment in a Qualified Affordable Housing
Project
55-2 This Example illustrates the application of the cost,
equity, and proportional amortization methods of accounting for
a limited liability investment in a qualified affordable housing
project.
55-3 The following are
the terms for this Example.
55-4 This Example has the following assumptions:
- All cash flows (except initial investment) occur at the end of each year.
- Depreciation expense is computed, for book and tax purposes, using the straight-line method with a 27.5 year life (the same method is used for simplicity).
- The investor made a $100,000 investment for a 5 percent limited partnership interest in the project at the beginning of the first year of eligibility for the tax credit.
- The partnership finances the project cost of $4,000,000 with 50 percent equity and 50 percent debt.
- The annual tax credit allocation (equal to 4 percent of the project’s original cost) will be received for a period of 10 years.
- The investor’s tax rate is 40 percent.
- The project will operate with break-even pretax cash flows including debt service during the first 15 years of operations.
- The project’s taxable loss will be equal to depreciation expense. The cumulative book loss (and thus the cumulative depreciation expense) recognized by the investor is limited to the $100,000 investment.
- Subparagraph superseded by Accounting Standards Update No. 2014-01.
- It is assumed that all requirements are met to retain allocable tax credits so there will be no recapture of tax credits.
- The investor expects that the estimated residual value of the investment will be zero.
- All of the conditions described in paragraph 323-740-25-1 are met to qualify the investment for the use of the proportional amortization method.
55-5 An analysis of the proportional amortization method
follows.
55-6 Paragraph superseded by Accounting Standards Update
No. 2014-01.
55-7 A detailed analysis of the cost method with
amortization follows.
Pending Content (Transition Guidance: ASC
323-740-65-2)
55-7 Paragraph superseded by Accounting
Standards Update No. 2023-02.
55-8 A detailed analysis
of the equity method follows.
Pending Content (Transition Guidance: ASC
323-740-65-2)
55-8 Paragraph superseded by Accounting
Standards Update No. 2023-02.
55-9 This Example is but one method for recognition and
measurement of impairment of an investment accounted for by the
equity method. Inclusion of this method in this Example does not
indicate that it is a preferred method.
Pending Content (Transition Guidance: ASC
323-740-65-2)
55-9 Paragraph superseded by Accounting
Standards Update No. 2023-02.
55-10 Paragraph superseded by Accounting Standards Update
No. 2014-01.