ACCT 5306

FALL 2015

FAS 109 Accounting for Income Taxes

  1. Scope of FAS 109
  1. FAS 109, par. 4—principles and requirements apply to the following:
  2. Domestic federal income taxes
  3. Foreign income taxes
  4. State income taxes
  5. Standard applies to an enterprise’s domestic and foreign operations that are consolidated, combined, or accounted for using the equity method
  6. Also applies to foreign enterprise’s financial statements that are being prepared in accordance with GAAP
  7. Conversion—IAS 12 applies similar principles, although specific requirements differ with respect to treatment of purchased goodwill and other specialized issues
  1. General Principles
  1. Current tax liability or asset is recognized for the estimated taxes payable or refundable on tax returns for the current or prior years;
  2. Deferred tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and carryforwards;
  3. Permanent differences must be subtracted from GAAP taxable income for purposes of accounting for income taxes.
  4. Amounts recognized are measured based on provisions of current tax law. The effects of future changes in tax laws or rates are not anticipated;
  5. Valuation allowance is required to adjust deferred tax assets by the amount of tax benefits that, based on available evidence, are not expected to be realized.
  6. No discounting is allowed to account for the time value of money.
  1. Temporary Differences
  1. Temporary differences arise due to timing differences in the recognition of income or deduction for book and tax purposes.
  2. Such differences generally result in different bases for assets or liabilities for book and tax purposes.
  3. Examples:
  4. Depreciation of fixed assets
  5. Amortization of goodwill (allowed for tax, not for book)*
  6. Warranty expenses (cash method used for tax; accrual method for book)
  7. Bad debt expense (cash method used for tax; accrual method for book)
  8. Charitable contributions (limited to 10% of taxable income for tax)
  9. Capital losses (limited to capital gains for tax)
  10. NOL carryforwards/carrybacks
  11. Foreign tax credit carryforwards/carrybacks
  12. Etc.
  13. Income of CFCs:
  14. Excess U.S. tax on CFC’s non-subpart F earnings is recorded currently as a deferred tax liability
  15. When earnings are distributed to U.S. parent, deferred tax liability is reversed (into current tax liability)
  16. Exception—where U.S. parent classifies CFC’s earnings as “permanently reinvested” (i.e., it plans to reinvest such earnings in foreign market rather than repatriating them to U.S.), no deferred tax liability is recorded.
  17. Stock Options:
  18. Non-qualified options generate tax deduction for company at date of exercise equal to difference between strike price and market price.
  19. For book, compensation expense is recorded at date of issue in amount equal to estimated value of options (at such date).
  20. Book expense is treated as timing difference which reverses upon exercise (or lapse) of options.
  21. Tax benefits attributable to excess tax deduction at date of exercise are capitalized into equity.
  22. Accounting for stock options and related tax consequences to be discussed more fully next class period
  1. Permanent Differences
  1. Permanent differences are those differences between book and tax income or deduction that will not reverse.
  2. Examples:
  3. Dividends received deduction
  4. Section 199 deduction
  5. Nondeductible fines/penalties
  6. Nondeductible meals & entertainment expense
  7. Executive compensation disallowed under Section 162(m)
  8. Book compensation expense recorded on qualified stock options
  9. Permanently reinvested earnings
  10. Etc.
  1. Accounting for Deferred Taxes
  1. Identify temporary and permanent differences between book and taxable income
  2. Identification is generally based on reconciliation of book to tax income on Schedule M-3 of the corporate income tax return
  3. Classify differences as temporary vs. permanent
  4. Add/subtract permanent differences to/from book income to calculate the tax base on which book tax expense is recorded;
  5. Apply applicable tax rate to book tax base to calculate book tax expense;
  6. Different jurisdictions are accounted for separately
  7. Multiply applicable tax rate to aggregated temporary differences to calculate deferred tax expense/asset;
  8. Difference between book tax expense and deferred tax expense/asset is equal to current tax liability;
  9. Evaluate need for valuation allowance on deferred tax assets and make adjustments as necessary to recorded tax expense and deferred tax asset.
  10. Entry generally will conform to following format:

Income tax expense

Deferred tax asset

Current taxes payable (or cash)

Deferred tax liability

  1. As deferred liabilities/assets reverse, entry will look as follows:

Income tax expense

Deferred tax liability

Current taxes payable (or cash)

Deferred tax asset

1