Income Tax Provisions - Robert Rickettsrricketts.ba.ttu.edu/ASC 740 TTU Presentation Revised.pdf · Permanent differences ... a tdiff t idithtemporary difference as events recognized

EYUThe way we developour people

EYUThe way we developour peopleour peopleour people

Income Tax Provisions

Morgan Sharp Tax Senior ManagerMorgan Sharp, Tax Senior Manager

Chris Prewitt, Tax Senior

Why our focus on income taxes is important

► Not all tax risks and exposures are evident in a top-down l i f l l d t ( b l h tanalysis of general ledger accounts (or a balance sheet

focus)► Significant material exposures may not be properly► Significant material exposures may not be properly

evaluated, provided for or disclosed► Unique nature of tax risks► Income taxes are a leading cause of restatements

© 2011 EYGM Limited. Slide 2

Why our focus on income taxes is important ( t )(cont.)

► Increasing litigation related to taxes and tax exposures

► Increasing SEC comments► Increasing SEC comments and focus on taxes, particularly liability for income tax uncertainty liabilities

► PCAOB review► PCAOB review


What is so hard about taxes?

► Not just another liability/expense account can’t use a l h t ditisample approach to auditing.

► Most of the company’s transactions have income tax implications, not just a specific subset.implications, not just a specific subset.

► Complex nature of taxes and often times there is a lack of specific guidance on how to apply tax law.

► Short amount of time to do detailed computations required for tax provisions. High degree of subjectivity in estimates.

► Tax laws change frequently; especially state and local► Tax laws change frequently; especially state and local income tax laws.


Indicators of potential tax risk

► Personnel issues► Staffing shortages► Lack of technical expertise

► Unclear roles and responsibilities► Unclear roles and responsibilities► Inadequate procedures for reviewing and reconciling the

book and tax basis of assets and liabilities ► Roll-forwards of balance sheet accounts do not tie to

expense


How to Mitigate Audit Risk

► Audit and Tax professionals need to work together► Audit teams are trained in proper documentation► Tax professionals trained in technical knowledge

► Full Disclosure: Audit adjustments and non-reoccurring transactions have tax implications.

► Emphasis on teaming


Why is tax accounting important to me?

► As you progress in your career you will become ibl f i f t i bli tiresponsible for review of taxes in public accounting.

► Corporate Controller, CAO and CFO ultimately responsible for all of financial statements, including taxes.responsible for all of financial statements, including taxes.

► Smaller companies may outsource tax department. Income tax accounting becomes responsibility of “non-tax”

fprofessionals.► Tax accounting can’t be learned quickly. Complex rules

take years to learn and be able to apply to differenttake years to learn and be able to apply to different situations.


FASB Accounting Standards Codification

► Single source of authoritative nongovernmental US GAAP► Not intended to change US GAAP► Reorganizes US GAAP pronouncements into approximately 90► Reorganizes US GAAP pronouncements into approximately 90

accounting topics (certain SEC guidance also will be included)

► Significant change in research of accounting issues d f i ti lit tand referencing accounting literature

► FAS 109 is codified in ASC topic 740

► Effective for interim or annual periods ending after► Effective for interim or annual periods ending after 15 September 2009


FASB Accounting Standards Codification ( t )(cont.)► Reorganizes thousands of US GAAP pronouncements into

i t l 90 ti t iapproximately 90 accounting topics► Displays all topics using a consistent structure XXX-YY-ZZ-PP

► Topics (XXX)► Presentation, financial statement account topics (assets, liabilities, equity,

revenue, expenses), broad transactions, industries► Industry topics include incremental guidance specific to an industry or

type of activitytype of activity► Subtopics (YY)

► Guidance for the topic► Sections (ZZ) ( )

► Numbered consistently across subtopics► Paragraphs (PP)


Codification example: APB 28 19 S b ti 740 270 30 6APB 28, para. 19 = Subsection 740-270-30-6

740 –Income taxes

Topic

10 OverallSubtopic 20 - Intraperiod 30 – Other considerations 270 – Interim 323 – 980

Other10 - OverallSubtopic tax allocation considerations, special areas reporting Other

topics

30 – Initial05 – Overview 15 – Scope 20 – 25 – 35 – 55Section 30 – Initial

measurementandbackground

andexceptions

20 –Glossary

25 –Recognition Other

topics

Subsection 30 – 6 At the end of each interim period the entity shall make its best estimate of the effective tax rate to be applicable for the full fiscal year.

[APB 28, para. 19]


Income Tax Provision Basics

Tax vs. book income

► Taxable income often differs from book (financial reporting) income► Taxable income often differs from book (financial reporting) income ► Certain items are treated differently under the applicable

jurisdiction’s tax law than under US GAAP


Permanent differences

► Not defined in ASC 740, other than within the definition of t diff t i d i tha temporary difference as events recognized in the

financial statements that do not have tax consequences and therefore do not give rise to temporary differencesg p y► May include items recognized in the tax returns that will never be

recognized in the financial statements

T

Book

Tax


Permanent differences

Discussion exercise: Temporary vs. permanent differences

-VS-


Temporary differences

► Temporary differences describe the cumulative book-tax b i diff th t ill lt i t bl d d tiblbasis differences that will result in taxable or deductible amounts in future years► Generally, temporary differences exist as a result of timing► Examples include, but are not limited to:

► Revenues or gains taxable before or after they are recognized in financial income

► Expenses or losses that are tax deductible before or after they are recognized in financial income


Liability method basic principles

► A current tax liability or asset is recognized for the ti t d t bl f d bl t t festimated taxes payable or refundable on tax returns for

the current year► A deferred tax liability or asset is recognized for the► A deferred tax liability or asset is recognized for the

estimated future tax effects attributable to temporary differences and carryforwards

f► The focus is on the balance sheet.


Deferred tax assets and liabilities

► A deferred tax liability recognizes the deferred tax tt ib t bl t t bl tconsequences attributable to taxable temporary

differences ► Taxable temporary differences result in taxable amounts in future p y

years

► A deferred tax asset recognizes the deferred tax consequences attributable to deductible temporaryconsequences attributable to deductible temporary differences and carryforwards► Deductible temporary differences result in deductible amounts in

f tfuture years


How deferred tax assets arise

► Expenses currently recognized for book purposes but not f tfor tax purposes

► Revenues currently recognized for tax purposes but not for book purposesfor book purposes

FUTURE(as items reverse)

book income

taxable income>


Examples of deferred tax assets

► Expense items► Allowance for bad debts► Compensation accruals (vacation bonus commission)► Compensation accruals (vacation, bonus, commission)► Contingency accruals (legal, environmental)

► Revenue items► Advance receipts for goods (revenue deferred for book but not tax)► Advance receipts for goods (revenue deferred for book but not tax)

► Tax carryforward items► Foreign tax credits in worldwide taxation regimes that allow credits for

foreign taxes paidforeign taxes paid► Net operating losses► Research credits


Examples of deferred tax liabilities

► Expense items► Depreciation► Pension► Pension ► Prepaid expenses► Goodwill acquired via stock acquisition

► Revenue items► Revenue items► Deferred Capital Gains


Why bother with deferred taxes?

► Recognizing deferred taxes results in the matching of tax ith th i i d b th titexpense with the economic income earned by the entity

► When an “event” is recognized in the financial statements, the eventual tax consequences of the “event” should alsothe eventual tax consequences of the event should also be recognized (i.e., “match” the tax to the same financial statement period that includes the gain or loss)


A with and without example

► Company earns $100 of interest income in both Year 1 d Y 2and Year 2

► Company sells a product in Year 1 and recognizes (for book purposes) 100% of the $300 gainbook purposes) 100% of the $300 gain

► Due to the tax rules for installment sales, 100% of gain on the sale will be taxable in Year 2


Computation of tax expense – without d f d tdeferred taxes

Year 1 Year 2Pre tax book income 400 100Pre-tax book income 400 100

+/- Permanent differences 0 0+/- Temporary differences (300) 300= Taxable income 100 400x Tax rate 35% 35%= Current tax expense 35 140+ Deferred tax expense 0 0= Total tax expense 35 140Total tax expense 35 140

ETR 8.75% 140.0%


Computation of tax expense – with deferred ttaxes

Year 1 Year 2Pre tax book income 400 100Pre-tax book income 400 100

+/- Permanent differences 0 0+/- Temporary differences (300) 300= Taxable income 100 400x Tax rate 35% 35%= Current tax expense 35 140+ Deferred tax expense 105 (105)= Total tax expense 140 35Total tax expense 140 35

ETR 35% 35%


Interim Reporting

► Focus in on the calculation of estimated annual effective t t d th t t l ttax rate and the total tax expense

► Discrete items are not considered in calculation of estimated annual effective tax rate but are booked in theestimated annual effective tax rate but are booked in the quarter they occur► Change in FIN 48 reserve

Ch i l ti ll► Change in valuation allowance

► Significant return to provision items


Valuation allowances

Objectives

► Identify the criteria for determining the need for a valuation allowance

f► Describe the accounting for uncertain tax positions under ASC 740


Valuation allowances – overview

► DTAs represent future reductions in taxable income h li bilit d d th i t f ffi i twhose realizability depends on the existence of sufficient

taxable income of the appropriate character:► Refers to nature of the taxable income (e.g., tax jurisdiction or ( g , j

capital/ordinary)► In either the carryback or carryforward period (under the tax law)

► A valuation allowance is recognized if based on the► A valuation allowance is recognized if, based on the weight of available evidence, it is more likely than not (MLTN) that some portion, or all, of the deferred tax asset

ill t b li dwill not be realized


Realizability of deferred tax assets

► Evaluation regarding realizability of deferred tax assets is d b i d t t b imade on a gross basis as opposed to a net basis

► All companies with deductible temporary differences and operating loss and tax credit carryforwards are required to evaluate the realizability of their deferred tax assets

► Not only those companies in a net deferred tax asset position

► All available positive and negative evidence should be► All available positive and negative evidence should be considered


Four sources of taxable income

1. Taxable income in carryback period 2. Future reversals of existing taxable temporary

differences► Taxable temporary differences (DTLs) relating to indefinite-lived► Taxable temporary differences (DTLs) relating to indefinite lived

assets generally do not represent a source of future taxable income

3 Prudent and feasible tax planning strategies3. Prudent and feasible tax planning strategies4. Future taxable income exclusive of reversing temporary

differences and carryforwards


Negative evidence

► It is more difficult to conclude that a valuation allowance is t d d if ti id i tnot needed if negative evidence exists

► Examples:► Cumulative losses in recent years► Cumulative losses in recent years► Carryforwards expiring unused► Expected losses in near-term

C ti i ith t i l d l t ff t► Contingencies with material adverse long-term effect► Brief carryback/forward periods


Positive evidence

► Positive evidence can outweigh negative evidence► Positive evidence refers to the existence of one or more of

the four sources of taxable income defined by ASC 740► Examples:► Examples:

► Contracts/firm backlog► Appreciated assets► Strong earnings, exclusive of specific event


Discussion – illustrative journal entries

► Recording a deferred tax assetDeferred tax asset xx (Dr.)

Income tax expense/(benefit) xx (Cr )Income tax expense/(benefit) xx (Cr.)

► Recording a valuation allowanceIncome tax expense xx (Dr )Income tax expense xx (Dr.)

Valuation allowance xx (Cr.)


Accounting for Uncertain Tax Positions

Liabilities for income tax uncertainties

► Tax positions in income tax returns are made based upon i t t ti f th t linterpretations of the tax law

► Taxing authorities may disagree with these interpretations, making such tax positions “uncertain”► Based on local country tax law

► Liabilities for income tax exposures result from various items, including:items, including:► Liabilities related to permanent differences (deductible vs.

nondeductible items)► Uncertainties related to basis differences► Legislative and administrative changes► Income allocation issues, e.g., transfer pricing


Accounting for Uncertainty in Income Taxes

► FIN 48 – Benefit recognition modelT iti t t i i iti th h ld b f b i► Tax position must meet minimum recognition threshold before being recognized in financial statements

► Generally effective for fiscal years beginning after December 15, 2006► Effective date deferred for certain non-public enterprises until annual financial► Effective date deferred for certain non-public enterprises until annual financial

statements for fiscal years beginning after December 15, 2008

► Guidance in FIN 48 has been codified primarily in ASC 740-10► Guidance in FIN 48 has been codified primarily in ASC 740 10


Scope

► Guidance on accounting for uncertainty in income taxes included in ASC 740 (codified from FIN 48) applies to all tax positions accountedASC 740 (codified from FIN 48) applies to all tax positions accounted for in accordance with ASC 740, including positions considered to be “routine”

► A tax position is defined as a position taken in a previously filed tax► A tax position is defined as a position taken in a previously filed tax return or a position expected to be taken in a future income tax return

► Encompasses decisions not to file an income tax return, jurisdictional allocations (i e transfer pricing) characterization of income and taxallocations (i.e., transfer pricing), characterization of income, and tax status


Scope (cont.)

► A tax position can result in: ► A permanent reduction of taxes payable (permanent differences), ► A deferral of taxes otherwise currently payable to future years

(temporary differences), or ► A change in the expected realizability of deferred tax assets (tax

planning strategies for valuation allowance purposes)

► Tax-planning strategies used in assessing the need for a► Tax planning strategies used in assessing the need for a valuation allowance for deferred tax assets► Subject to the same recognition (MLTN) and measurement criteria

(for those positions that meet recognition threshold largest amount(for those positions that meet recognition threshold, largest amount that is more than 50% likely to be sustained) as all other tax positions


Two-step process

► Inventory of uncertain tax positions is subject to two-step process that separates recognition analysis fromprocess that separates recognition analysis from measurement of the benefit

Step 1: Does the tax position meet Step 2: If recognition thresholdStep 1: Does the tax position meet the “more likely than not” (MLTN) criteria for recognition?

Step 2: If recognition threshold is met, measure the benefit


Initial recognition

► A tax benefit is recognized when it is MLTN to be t i d b d th t h i l it f th itisustained based on the technical merits of the position

► MLTN represents a likelihood greater than 50%► Conclusion regarding financial statement recognition takes into g g g

account tax technical merits, facts and circumstances► Assumes that tax position will be examined by taxing authority► Each position must stand on its own merits► Each position must stand on its own merits


Initial recognition (cont.)

► A tax position may be subsequently recognized in the first i t i i d i hi hinterim period in which:► The MLTN threshold is met by the reporting date,► The statue of limitations has expired or► The statue of limitations has expired, or► The tax position is effectively settled through

examination, negotiation or litigation


Measurement

► A tax position that meets the MLTN recognition threshold shall initially and subsequently be measured as theshall initially and subsequently be measured as the largest amount of tax benefit that is greater than 50% likely of being realized (cumulative probability concept)► Based upon facts and circumstances determined at the reporting

date


Measurement (cont.)( )

► Not all tax positions require detailed consideration of possible outcome amounts and percentage likelihoodpossible outcome amounts and percentage likelihood associated with each amount (cumulative probability approach)

► Differences related to timing (deduction itself is not in question)


Measurement example

Possible estimated outcome ($)

Individual probability of occurring (%)

Cumulative probability of occurring (%)outcome ($) occurring (%) occurring (%)

$ 100 5% 5%$$ 80 25% 30%$ 60 25% 55%$ 50 20% 75%$ 50 20% 75%$ 40 10% 85%$ 20 15% 100%

100%

► $60 is the largest amount of tax benefit that is greater than 50% likely of being realized.


Summary

► Two-step approach► Step 1: Recognition► Step 1: Recognition

► Tax position is MLTN to be sustained based solely on technical merits

► Step 2: For those positions that meet recognition threshold► Step 2: For those positions that meet recognition threshold, measure at largest amount of tax benefit greater than 50% likely to be realized

► Difference between tax benefit as (or to be) reflected in the income ( )tax return and the amount recorded in the financial statements (“unrecognized tax benefit”) should be classified as either:► A current or non-current liability, or ► Reduction of DTA, tax NOL or a tax credit carryforward

► DTAs and DTLs are determined using tax basis reflecting results of recognition and measurement analysis


ASC 740 disclosure requirements

Balance sheet disclosures

► Current taxes payable/receivable► Separate DTAs/DTLs into two classifications

► Current► Noncurrent► Noncurrent

► Netting rules for DTAs/DTLs► Net together only DTAs and DTLs for the same taxing jurisdiction► Net together only current DTAs/DTLs and noncurrent DTAs/DTLs


Coca-Cola’s 2009 balance sheet tax di ldisclosures

p. 68, Coca-Cola’s 2009 Form 10-Kp ,


Income statement disclosures

► Income tax expense, separated into current and deferred tiportions

► Special items (discontinued operations, extraordinary items) presented net of taxitems) presented net of tax


Coca-Cola’s 2009 income statement tax di ldisclosures

p. 67, Coca-Cola’s 2009 Form 10-Kp ,


Income tax note disclosures: effective tax trate

► Effective tax rate equals income tax expense divided by t b k ipretax book income

► Effective rate reconciliation in monetary units or percentages, reconciling between:percentages, reconciling between:► The reported amount of income tax expense► The amount of income tax expense that would result from applying

domestic federal statutory rate to pre tax incomedomestic federal statutory rate to pre-tax income

► For public companies, separately disclose each reconciling item that is more than 5% of pre-tax income ×statutory rate


Rate reconciliation example

► A tax footnote to financial statements may include the following reconciling items:

Statutory US federal rate 35.0%Permanent book/tax differences (1.8)State tax net of federal benefit 5.2Earnings taxed in foreign jurisdiction (1.5)Tax credit (3.1)( )Effective tax rate 33.8%


Coca-Cola 2009 ETR disclosure

p. 105, Coca-Cola’s 2009 Form 10-K


Other footnote disclosures

► In addition to the rate reconciliation, the tax footnote to the fi i l t t t t di l ( th it )financial statements must disclose (among other items):► Components of the net DTL or DTA:

► Total deferred tax liability► Total deferred tax asset► Total valuation allowance and net change during the year

► Tax effects of each type of temporary difference and carryforward yp p y y(if public company)

► Amount and expiration date of NOL and tax credit carryforwards


Coca-Cola’s 2009 tax note disclosures



Coca-Cola’s 2009 tax note disclosures (cont.)



Tax footnote disclosures (cont.)

► Components of income tax expense attributable to ti i ti i l dicontinuing operations, including:

► Current tax expense or benefit ► Deferred tax expense or benefitp► Investment tax credits► Benefits of operating loss carryforwards► Adjustments to DTA/DTL due to changes in tax law/rate/status► Adjustments to DTA/DTL due to changes in tax law/rate/status► Adjustment to valuation allowance due to changes in judgment

about realizability



► Income tax expense/benefit allocated to:► Continuing operations► Discontinued operations► Extraordinary itemsy► Other comprehensive income► Items charged or credited directly to shareholder’s equity



► Additional disclosures for public companies:► Components of pre-tax income (loss) as either domestic or foreign► Current tax expense or benefit and deferred tax expense or benefit

applicable to:► Federal income taxes► Foreign income taxes► Other income taxes (such as state income taxes)


Coca-Cola’s 2009 tax note disclosures (cont.)



Annual disclosures – income tax t i tiuncertainties

► Interest and penalty classification policyT b l ili ti f t b i i d di► Tabular reconciliation of aggregate beginning and ending unrecognized tax benefits (not required for nonpublic entities)► The following items must be presented separately in the table at the end of

each annual period:each annual period:► The gross amounts of the increases and decreases in unrecognized tax

benefits as a result of tax positions taken during a prior period► The gross amounts of increases and decreases in unrecognized tax benefits as

lt f t iti t k d i th t i da result of tax positions taken during the current period► The amount of decreases in the unrecognized tax benefits relating to

settlements with taxing authorities► Reductions to unrecognized tax benefits as a result of a lapse of the applicable g p pp

statute of limitations► Disclosure as of date of adoption - total amount of UTB


Annual disclosures – income tax t i ti ( t )uncertainties (cont.)

► Effective Tax Rate (not required for nonpublic entities)► The total amount of recognized UTB that would affect effective tax rate g

► Interest and Penalties ► Twelve-Month Look-Forward

If bl ibl th t th t t l t f i d t b fit► If reasonably possible that the total amounts of unrecognized tax benefit will “significantly” change within 12 months of the reporting date:► The nature of the uncertainty► The nature of the event that could occur that would cause the change► The nature of the event that could occur that would cause the change► An estimate of the range of the reasonably possible change or a statement that

an estimate cannot be made

► Description of tax years subject to examination by major p y j y jjurisdictions


Coca-Cola’s 2009 tax note disclosures (cont.)106 C C l ’ 2009 F 10 Kp. 106, Coca-Cola’s 2009 Form 10-K


Questions?


Documents

Income Tax Provisions - Robert Rickettsrricketts.ba.ttu.edu/ASC 740 TTU Presentation Revised.pdf · Permanent differences ... a tdiff t idithtemporary difference as events recognized