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CPA FAR > F6: Pensions and Income Tax Accounting > Flashcards

F6: Pensions and Income Tax Accounting Flashcards

1
Q

Pension Plan

A

agreement in which the employer provides employees w defined or estimated retired benefits in exchange for current or past services

  • not paid currently
  • form of deferred compensation paid to retired employees, usually periodically
  • accrual accounting, concerned w amts accrued and expensed by the employer company and the funded status of the plan
  • the accting problems, which arise primarily for defined benefit plans, are caused by necessary use of estimates and assumptions, which affect the timing and measurement of pension costs(expense), gains and losses from investment of plan assets, and liabilities
  • use specialist
  • not owned by company, separate entity
  • like a trust account
  • needs to provide it’s own FS
  • we’re concerned w sponsor comp’s acct for pension plans tho
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2
Q

Defined Benefit Plan*

A

benefits the employee receives are determined by formula

  • sponson company’s responsibility to ensure that contributions to the plan are sufficient to pay benefits
  • accting is complex
  • sponsor comp makes multiple JEs
  • defines benefits to be paid to employees at retirement
  • contributions computed using actuarial assumptions of future benefit payments based on factors like:
    a) employee’s compensation levels at or near retirement
    b) # of years of employee service
    c) # of years until employee retires
    d) # of years the plan expects to pay benefits after an employee retires
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3
Q

Defined Contribution Plan

A

contributions the sponsor company makes are determined by formula

  • the employee’s benefits are based on amt of funds in the plan
  • accting is simple
  • sponsor comp makes 1 JE

specifies the periodic amt of contributions to the plan and the way the contributions should be allocated to employees

  • 401(k)
  • considers employee’s length of service and compensation amts
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4
Q

Accounting for Pensino Plans is Concerned Primarily w Determining the Amt of
Pass Key

Pension Plans

A
  1. Pension expense that appears on sponsor’s company’s IS and
  2. any related pension accounts that appear on the sponsor company’s BS
    - asset, liability and/or OCI accts
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5
Q

Characteristics

Pension Plans

A

Written or Implied
- implied from well-defined practice of paying post retirement benefits

Contributory or Noncontributory

  • contributory: employees contribute
  • noncontributory: only employer contributes

Funded or Nonfunded*

  • funding: sponsor company makes contributions
  • funded: when employer makes cash contributions
  • the amt funded doesn’t have to equal the pension plan expense for the period

Overfunded vs Underfunded

  • applies only to defined benefit plans
  • overfunded: has assets > liabilities, vice versa for underfunded
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6
Q

Types of Plans

A

Non-GAAP Methods (cash basis)

  • Pay-as-you-Go: expenses pension plan payments after retirement
  • Terminal Funding: pays entire pension plan liability upon retirement, generally by purchasing an annuity type insurance policy

GAAP Methods

  1. Defined Contribution Plan
  2. *Defined Benefit Plan
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7
Q

Accumulated Benefit Obligation (ABO)

Pension Plans

A

actuarial PV of benefits attributed by a formula based on CURRENT and past compensation levels

  • differs from PBO in that ABO includes no assumption about future compensation levels
  • uses current salaries
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8
Q

Projected Benefit Obligation (PBO)

Pension Plans

A

actuarial PV of all benefits attributed by plan’s benefit formula to employee service rendered prior to that date

  • only uses an assumption as to FUTURE compensation levels
  • use (guess) future salary
  • use for all IS related items

GAAP vs IFRS

  • IFRS uses Defined Benefit Obligation (DBO) is calculated similar to PBO
  • defined benefit pension plan liability
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9
Q

Vested Benefits

Pension Plans

A

vested when employees have earned their benefits by reason of having reached retirement age and/or having otherwise met unique pension plan requirements

  • vested whether or not person has retired
  • not contingent on remaining in service of employer
  • generally, pension plan documents require money be left in plan until retirement
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10
Q

Service Cost

Pension Plans

A

PV of all pension benefits earned by employees in current year

  • provided by actuary
  • increases PBO
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11
Q

Interest Cost

Pension Plans

A

increase in PBO due to passage of time

  • measuring PBO as PV requires accrual of interest cost at rates equal to assumed discount rates
  • always increase PBO bc PV of any liability increases as you get closer to the due date
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12
Q

Prior Service Cost*

Pension Plans

A

cost of benefits based on past service granted for:

  • service prior to initiation of pension plan that employees retroactively receive credit for
  • subsequent plan amendment, reflecting new or increased benefits, that also is applied to service already provided

PSC increases PBO in period of initiation or amendment
- should be amortized to pension expense over future service periods of affected employees

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13
Q

Actuarial Gains and Losses

Pension Plans

A

adjustments to PBO that arise when actuary changes assumptions used to calculate PBO

  • actuarial gains decrease PBO
  • actuarial losses increase PBO
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14
Q

Benefit Payments

Pension Plans

A

paid to pension plan participants after retirement

  • reduces PBO
  • reduces plan assets
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15
Q

Formula to calculate PBO

Pass Key

Pension Plans

A 
BASE
beginning PBO
\+ service cost
\+ interest cost
\+ PSC from current plan amendments
\+ actuarial losses 
- actuarial gains
- benefits paid to retirees
= ending PBO
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16
Q

Plan Assets

Pension Plans

A

assets, generally stocks, bonds, and other investments, set aside to provide for pension benefits

  • reported at FV
  • increase by contributions to the pension plan and by return on plan assets
  • decrease by amts paid to retired employees
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17
Q

Actual Return on Plan Assets

Pension Plans

A

calculated based on FV of plan assets at beginning and ending of the period, adjusted for contributions and benefit payments (a squeeze)

beg. FV of plan assets
\+ contributions
\+ actual return on plan assets (squeeze)
- benefits paid to retirees
= ending FV of plan assets
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18
Q

IS (expense) Formula

IS Accounting
Pension Plans

A 
"SIRAGE"
current Service Cost
Interest cost
< Return on plan assets >
Amortization of PSC
 and Losses
amortization of Existing net obligation or net asset
= net periodic pension cost
  • “AGE”: unamortized amt is in AOCI
  • GAAP vs IFRS: for IFRS, only gains and losses are in AOCI and are not amortized**

GAAP vs IFRS**

  • IFRS, defined benefit cost* includes service cost and net interest on the defined benefit liability (asset)
  • components of defined benefit cost are reported separately on the IS
  • no requirement that these amts be aggregated and presented as one amt
  • defined benefit liability/asset = FV of plan assets - PV of DBO
  • net interest on defined liab/asset = discount * defined benefit liability/asset
  • remeasurements of Net Defined Asset/Liability: actuarial gain/loss + (plan assets * (discount - actual return %))
  • things aren’t amortized out of OCI like GAAP*
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19
Q

Pension Expense

A

increase in PBO during the period, offset by earnings on plan assets, and adjusted for effects of certain smoothing mechanisms
-aka net periodic pension cost

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20
Q

JEs

A

F6-7

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21
Q

Current Service Cost

SIRAGE

A

PV of all benefits earned in current period

  • increase in PBO from employee services in current period
  • provided by actuary
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22
Q

Interest Cost

SIRAGE

A

increase in PBO during current period due to passage of time

beg. period PBO
* discount rate
= interest cost

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23
Q

< Return on Plan Assets >

SIRAGE

A

GAAP allows companies to offset pension expense by either actual return or expected return on plan assets

Actual Return on Plan Assets

  • calculated based on FV of plan assets and beg. and end of period, adjusted for contributions and benefit payments
  • most comps choose not to use actual return bc can vary drastically from period to period, causing earnings volatility
  • beg FV + contributions + Actual Return (squeeze) - benefit payments = end FV

Expected Return on Plan Assets

  • to smooth earnings
  • expected return on plan assets = beg. FV of plan assets * expected rate of return on plan assets
  • when companies use expected, diff b/w actual and expected must be recognized in OCI each period and amortized to pension expense over time w any actuarial gains or losses*

GAAP vs IFRS
- F6-8 (get back to this)

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24
Q

Amortization of Unrecognized PSC

SIRAGE

A

under GAAP, in period pension plan is initiated or amended, PSC increases PBO and recognized in unrecognized PSCI in OCI

  • the unrecognized PSC in AOCI is amortized to pension expense over plan participant’s remaining years of service
  • amortization calculated using unrecognized PSC balance at beg. of period

beg unrecognized PSC
/ avg remaining service life
= amortization of PSC

GAAP vs IFRS

  • IFRS, PSC is referred to as past service cost
  • past service cost increases DBO and reported as defined benefit service cost in IS
  • not booked to OCI
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25
Q

< Gains > and Losses

SIRAGE

A

gains and losses arise from 2 sources

  1. diff b/w expected and actual return on plan assets when the expected return is used to calc. pension expense and
  2. changes in actuarial assumptions (actuarial gains and losses)

Accounting for Gains and Losses (2 choices)

  1. recognize gains and losses in IS in period incurred or
  2. recognize gains and losses in OCI then amortize the unrecognized gains and losses to pension expense over time using Corridor Approach
    - most companies use this to smooth earnings
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26
Q

Corridor Approach

A

entity’s net unrecognized gain or loss is amortized over employee’s avg remaining service period, if as of beg. of the year, this amt exceeds 10% of greater of beg. of year balances of:

  • market related value of plan assets = assets
  • PBO = liabilities

unrecognized gain or loss
< 10% of PBO or Market Related value (greater) >
= excess
/ avg remaining service life
= amortization of unrecognized gain or loss

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27
Q

pension grrrrreat and leases lessssor (lesser)

A

rule of thumb haha

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28
Q

Amortization of Existing Net Obligation or Net Asset at Implementation

SIRAGE

A

under GAAP, employer was required to determine funded status of the pension plan (FV plan assets - PBO) as of beg. of first year SFAS 87 (ASC 715) was applied

  • effective for most large companies for fiscal years beginning after Dec 15, 1986 (Dec 15 1988 for nonpublic companies that sponsor plans for 100 or fewer ppl)
  • at this time, most companies have fully amortized their SFAS 87 (ASC 715) transition amts and therefore this amt is no longer a common component of net periodic pension cost

*this funded status was required to be amortized over the greater of 15 years or avg remaining job life of company’s employees

PBO
< FV plan assets >
= initial unfunded obligation
/ 15 years or avg employee job life (greater)
= minimum amortization
29
Q

Pension Plan Contributions

BS Accounting
Pension Plans

A

increases pension plan asset (overfunded pension plans) or decreases pension plan liability (underfunded pension plans)
dr: pension benefit asset/liability, cr: cash

  • comp JE when they fund pension
30
Q

Funded Status

BS Accounting
Pension Plans

A

GAAP, comps must report the fnded status on BS as an asset or liability

  • if multiple defined benefit pension plans, funded status of each is calculated separately
  • FV of plan assets and PBO must be disclosed in pension footnote disclosures

FV of plan assets
< PBO >
= funded status (over of under)

Pension Plan Asset

  • overfunded FV of plan assets > PBO
  • all overfunded pension plans are aggregated and reported in total as noncurrent asset

Pension Plan Liability

  • underfunded FV < PBO
  • all underfunded are aggregated and reported as current liabi, noncurrent, or both
  • current to extent the benefit obligation payable w/i next 12 month exceeds FV of plan assets

GAAP vs IFRS

  • IFRS, funded status is reported on BS as net defined benefit liability (asset)
  • DBO - FV of plan assets
  • if net defined benefit asset is reported, the amt of the asset cannot exceed the PV of future economic benefits available to the entity in the form of cash refunds or reductions in future contributions that result from the overfunding
  • doesn’t specify whether an entity should classify as current or noncurrent
31
Q

Ending Funded Status (pension benefit asset/liability)

Pass Key

A 
beginning funded status (pension benefit asset/liability)
\+ Contributions
- Service cost
- Interest cost
\+ expected Return on plan assets
- PSC incurred due to plan amendment
\+ net Gains incurred
- net Losses incurred
= ending funded status (pension benefit asset/liability)

E is usually phased out by now

32
Q

Accumulated Other Comprehensive Income

BS Accounting
Pension Plans

A

GAAP requires that changes in funded status due to PSC and pension gains and losses be reported in OCI

  • the tax effects must also be recognized in OCI
  • remain in AOCI until amortized to net periodic pension cost
33
Q

PSC and Pension Losses

AOCI
BS Accounting
Pension Plans

A

Recognition in Period Incurred

  • PSC and pension losses decrease the funded status of the pension plan and are recorded by:
  • dr: OCI, cr: pension benefit asset/liability
  • a deferred tax asset may also be recognized bc PSC and pension losses increase PBO and thus increase total contributions a company must make to fund
  • so when they make the contributions, company will take a tax deduction, decreasing future taxes
  • all elements of AOCI are reported net of tax
  • dr: deferred tax asset, cr: deferred tax benefit- OCI

Amortization to Pension Expense

  • when “AGE” is amortized, they’re reclassified out of AOCI and recognized as component of pension expense
  • dr: net periodic pension cost, cr: OCI
  • related deferred tax benefit must also be removed from AOCI and recorded on IS
  • dr: deferred tax benefit-OCI, cr: deferred tax benefit-IS
34
Q

Pension Gains

AOCI
BS Accounting
Pension Plans

A

Recognition in Period Incurred

  • pension gains increase funded status and recorded with:
  • dr: pension benefit asset/liability, cr: OCI
  • deferred tax liability also recognized bc pension gains decrease PBO thus decrease total contributions company must make to fund
  • results in lower tax deduction, increasing future taxes
  • must be recognized in OCI as offset to unrecognized pension gain
  • dr: deferred tax expense-OCI, cr: deferred tax liability

Amortization to Pension Expense

  • dr: OCI, cr: net periodic pension cost
  • dr: deferred tax expense-IS, cr: deferred tax expense-OCI

GAAP vs IFRS

  • under IFRS, remeasurement of net defined benefit liability (asset) are included in OCI and not reclassified (amortized) to IS in subsequent periods
  • however, an entity can transfer those amts recognized in OCI w/i equity
35
Q

Measurement Date

BS Accounting
Pension Plans

A

GAAP requires measurement date of plan assets and benefit obligations of a defined benefit pension plan must be aligned w the date of the employer’s BS

exceptions

  • when plan is sponsored by a subsidiary that has diff. fiscal year-end, then sub’s plan assets and benefit obligations can be measured as of sub’s BS date
  • when plan sponsored by equity method investee w diff fiscal year end, then investee’s plan can measure as of date of their FSs used to apply equity method
  • when company’s fiscal year end doesn’t coincide w a month end, may elect to measure using month end closes to fiscal year end. contributions made in between should be discloed but will not change FV reported at measurement date
36
Q

Pension Settlement and Curtailment and Termination Benefits

A

Settlements

  • occur when pension plan assets increase in value to the point that sale of it allows company to buy annuity contracts to satisfy pension obligations
  • remaining funds from sale of assets may, w restrictions, be used by the corp

Curtailments
- events that reduce expected remaining years of service for present employees or eliminate accrual of defined benefits for future services of a significant # of employees

Termination Benefits
- arise when employees are paid to terminate their rights to future pension payments
lump sum payments
+ PV termination benefit
= special term benefit
dr: special term benefit expense, cr: special term benefit liability

37
Q

Off-BS Footnote Disclosures

A

F6-19 to F6-22

38
Q

Defined Benefit Pension Plan FS

A

pension plan and sponsoring company are two separate legal entities
- GAAP requires FSs be presented by pension plan itself

Required FSs

  • Statement of Net Assets Available for Benefits: includes info regarding net assets available for benefits at the end of the plan year
  • Statement of Changes in Net Assets Available for Benefits
  • Statement of Accumulated Plan Benefits: info of actuarial PV of accumulated plan benefits as of either the beginning or end of plan year
  • Statement of changes in Accumulated Plan Benefits
  • statement of cash flows not required but may be resented if it provides relevant info about ability of plan to meet future obligations

~F6-23

39
Q

Required Disclosures

Pension Plans

A

more is better
disclose everything

F6-25

40
Q

Postretirement Benefits Other Than Pensions

A

benefits after retirement: health care insurance, life insurance, welfare benefits, tuition assistance, legal services, day care

Accrual Requirement if:

  • obligation is attributable to emloyees’ services already rendered
  • employees’ rights accumulate or vest
  • payment is probable and
  • amt of benefits can be reasonably estimated

GAAP vs IFRS

  • under both, acct for postretirement benefits mirrors pension accting
  • pension accct differences b/w IFRS and GAAP are the same b/w postretirement benefit accting
41
Q

Accumulated Postretirement Benefit Obligation (APBO)

A

PV of all future benefits that have vested as of the measurement date

  • APBO is discounted using an assumed discount rate
  • rate should reflect return on high quality, fixed income investments
  • discount rate used to determine APBO, EPBO, and the service and interest cost components of net periodic post retirement benefit cost
42
Q

Expected Postretirement Benefit Obligation (EPBO)

A

PV of all future benefits expected to be paid as of the measurement date

  • amt that has vested (APBO) plus
  • PV of expected future benefits that have not yet vested
43
Q

Income Statement Approach

Postretirement Benefits Other Than Pensions

A
  • Benefit-years-of-service approach is used over attribution period
  • postretirement benefit obligation is accrued during the period the employee works (the attribution period); GR: beginning at employee’s date of hire and ending at full eligibility date
44
Q

Income Statement Formula

Postretirement Benefits Other Than Pensions

A

same SIR AGE as pension plans

current Service Cost
Interest cost (on APBO): beg. APBO * disc. rate
< Return on plan assets >
1. expected = beg. FV of plan assets * expected LT rate of return
2. actual = diff b/w FV of plan assets at beg and end of period, adj. for contributions and benefit payments
Amortization of PSC
< Gains > and Losses
amortization / Expense transition amount (net obligation)*
= net Postretirement Benefits Expense/Cost

45
Q

Amortization or Expense of Transition Obligation

SIRAGE
Postretirement Benefits Other Than Pensions

A

transition to accrual accting done in one of 2 ways:

  1. immediate expense recognition by recording the entire obligation in one year as the effect of a change in acct principal or
  2. delayed recognition using straight-line amortization over GREATER of: avg remaining service period of active plan participants or 20 years
  3. Accum. postretirement benefit obligation
    < FV of plan assets >
    = initial unfunded
    / 20 years or avg remaining service period (greater)
    = minimum amortization
    OR
  4. expense full amt

2 differences to E for pension plans

  • option to expense full
  • 20 years min vs 15 min
46
Q

BS Presentation

Postretirement Benefits Other Than Pensions

A

same BS presentation as pension plans
- if multiple postretirement benefit plans, funded status of each plan calculated separately

Funded Status

  • FV of plan assets - APBO = funded status
    1. Postretirement Benefit Plan Asset
  • all overfunded are aggregated and reported in total as noncurrent asset
    2. Postretirement Benefit Plan Liability
  • all underfunded are aggregated and reported as a current liability, noncurrent liability, or both
  • current to extent that benefit obligation payable w/i next 12 months > FV of plans’ assets

Accumulated OCI

  • under GAAP, postretirement benefit gains or losses, PSCs, and transition net assets or obligations in OCI when incurred
  • unless recognized on IS in period incurred
  • tax effects also recognized in OCI
  • AGE in AOCI until amortized to IS
47
Q

Required Disclosures

Postretirement Benefits Other Than Pensions

A

more is better, disclose as much as reasonably possible

  • effect on APBO, service cost, and interest cost of a 1% increase and a 1% decrease in the health care cost trend rate

~F6-29

48
Q

Postemployment Benefits

Other Deferred Compensation and Benefits

A

benefits paid by companies to former or inactive employees during period after their employment, but before their retirement
- salary continuation, severance benefits, continuation of other fringe benefits (insurance), job training, disability related- including workers’ comp

49
Q

Liability Recognition

Postemployment Benefits

A

liabilities accrued if all following are met:

  • employer’s obligation is attributable to services already rendered
  • obligation relates to rights that vest or accumulated
  • payment of compensation is probably
  • amt can be reasonably estimated

if not met, disclosure is required

dr: severance expense, cr: severance liability

50
Q

Deferred Compensation Arrangements

A

these contracts must be accounted for individually and on an accrual basis

Liability Recognition

  • accounted for at PV of benefits expected to be provided in exchange for employee’s service to date
  • if terms of deferred compensation arrangement attribute all or portion of expected future benefits to an individual year of employee’s service, the cost of the benefits should be recognized in that year
  • if terms attribute all or portion of expected future benefits to > 1 year, cost of benefits *should be recognized in a systematic and rational manner over that period
51
Q

Compensation for Future Absences

A

Liability Recognition accrued if all are met:
- employer’s obligation is attributable to services already rendered
- obligation related to rights that vest or accumulate
- payment of the compensation is probable
- amt can be reasonably estimated
if only first 3 met, disclosure in a note to FS is adequate

Sick Pay Benefits

    • accrue for vesting, don’t accrue for nonvesting accumulating rights to receive sick pay benefits
  • bc lower degree of reliability of estimates of future sick pay and cost of making and evaluating estimates don’t justify making an accrual

GAAP vs IFRS
- IFRS requires accrual of sick pay benefits as services are rendered by employees

52
Q

Accounting for Income Taxes

A

involves both intraperiod and interperiod tax allocation

  • intraperiod allocation matches portion of provision for income tax to applicable components of net income and RE
  • income for tax and financial acct differ
  • tax uses IRS tax code and financial acct uses GAAP
  • thus, income tax expense and income tax payable may differ
  • incongruity caused by temporary differences in taxable and/or deductible amts and requires interperiod tax allocation
53
Q

Intraperiod Tax Allocation

Accounting for Income Taxes

A

involves apportioning total tax provision for financial accting purposes in a period b/w income or loss from “IDA PUFER”

  • Income from cont. ops is shown gross, then net of tax
  • DA PUFER is all shown net of tax
54
Q

Interperiod Tax Allocation

A

objective is to recognize through the matching principle the amt of current and future tax related to events that have been recognized in financial accting income

55
Q

Differences

Interperiod Tax Allocation

A

2 types of diffs b/w pretax GAAP financial income and taxable income

  1. Permanent Differences
    - affect current, do not affect deferred
    - affect only period in which they occur, not future financial or taxable income
    - enter GAAP, but not tax
    - enter tax, but not GAAP
    - no deferred taxes
  2. Temporary Differences
    - affect current and deferred
    - enter GAAP in period before tax
    - enter GAAP in period after tax
    - deferred taxes required
56
Q

Comprehensive Allocation

Interperiod Tax Allocation

A

asset and liability method (aka BS Approach) is required by GAAP for comprehensive allocation

  • interperiod tax allocation is applied to all temp diffs
  • either income taxes payable or deferred tax liability (asset) be recorded for all tax consequences of the current period

temporary differences require
- liability (for future taxable amts) or
- an asset (for future deductible amts)
recognized in FS until diff turns around

57
Q

Accounting for Interperiod Tax Allocation

A

total income tax expense (GAAP income tax expense) or benefit for the year = current income tax expense/benefit + deferred income tax expense/benefit

  • current income tax = income taxes payable or refundable as determined on corporate tax return (Form 1120) (owe now)
  • deferred income tax = change in deferred tax on BS from beg. to end of year (BS Approach) (owe later)

current income tax (BS) + deferred income tax (BS) = total income tax expense or benefit (IS)

58
Q

F6-36

A

good chart!
NEVER: F/S * tax rate = tax expense bc
- FS income has permanent differences, which you ignore
- use of current tax rate ignores future changes to enacted rate

59
Q

Permanent Differences

A

only affects income per books or taxable income, but not both
- create a discrepancy b/w taxable income and financial accting income that will never reverse

No Deferred Taxes*

  • only impacts current taxes/year
  • bc they don’t reverse themselves, no interperiod tax allocation necessary for permanent differences
  • income tax provision for financial accting is computed on basis of pretax book income adj. for all perm differences

examples: nontaxable, nondeductible, or special tax allowances
- tax exempt interest (municipal, state)
- life insurance proceeds on officer’s key man policy
- life insurance premiums when corp is beneficiary
- penalties, fines, bribes, kickbacks, etc
- nondeductible portion of meals and entertainment
- dividends received deductions
- excess percent depletion over cost depletion

pass key: investment interest expense is limited to net taxable investment income

60
Q

Transactions that cause Temporary Differences

Temporary Differences

A

4 basic categories, which reverse in future periods:

  1. FS income first, tax income later: future tax liab
    - installment sales, contractors accting (% vs completed), equity method (undistributed dividends)
  2. tax income first, FS income later: prepaid tax benefit (asset)
    - prepaid rent, prepaid interest, prepaid royalties
    - IRC uses “prepaid”, GAAP uses “unearned”
  3. FS expense first, tax expense later: future tax benefit (asset)
    - bad debt expense (allowance vs direct w/o), est. liability/warranty expense, start-up expenses
  4. tax expense first, FS expense later: future tax liability
    - depreciation expense, amortization of franchise, prepaid expenses (cash basis for tax)

additional causes of temp differences:

  • diff b/w financial reporting and tax basis of assets and liabilities arising in a business combination accounted for as a purchase
  • diff in tax basis of assets due to indexing, whenever the local currency is the functional currency
61
Q

Deferred Tax Liabilities and Assets Recognition

Temporary Differences

A

DTL: future tax acct income > future financial acct income
DTA: future tax acct income < future financial acct income

Deferred Tax Liabilities

  • tax deductible first/financial expense later
  • financial income first/tax income later

Deferred Tax Assets

  • when amt of taxes paid in current period > amt of income tax expense in current period
  • anticipated future benefits derived from situations where future taxable income will be less than future financial accting income due to temp diffs
  • gift certificate

Valuation Allowance

  • if more likely than not (>50%) that part or all of the deferred tax asset will not be realized, a valuation allowance is recognized
  • the net deferred tax asset should equal the amt that based on available evidence, is more likely than not to be realized
  • only for DTA
  • change in valuation recognized in income from cont ops* in period of change

GAAP vs IFRS

  • IFRS, valuation accts are not permitted
  • deferred tax asset is recognized when it is probable that sufficient taxable profit will be available against which the temp diff can be utilized
62
Q

Uncertain Tax Positions

Temporary Differences

A

some level of uncertainty of the sustainability of a particular tax position taken by a company

  • aggressive tax positions
  • GAAP requires more-likely-than-not level of confidence before reflecting a tax benefit in an entity’s FSs

Scope

  • income taxes, not sales or payroll taxes
  • tax deduction (most common), decision not to file tax return, allocation or shift of income b/w jurisdictions, characterization of income in a tax return or a decision to exclude reporting taxable income, decision to classify a transaction, entity, or other position in a tax return as tax exempt

Two-Step Approach
1. Recognition of the Tax Benefit
Test “more likely than not” if a dispute w taxing authority were taken to the court of last resort
- each tax position should be evaluated separately
Test Failed: tax benefit not recognized in FS and FS tax expense is increased
2. Measurement of the Tax Benefit
Recorded Amount
- recognize the largest amt of tax benefit that has >50% likelihood of being realized upon ultimate settlement w taxing authority
- tax position based on clear and unambiguous tax law- recognize full benefit in FS

Pass Key
step 1: evaluation based on expected outcome in court of last resort
step 2: evaluation based on expected outcome in a settlement w taxing authority

GAAP vs IFRS

  • uncertain tax positions are not specifically addressed by IFRS
  • under IFRS, tax consequences of events should be accounted for in a manner consistent w the expected resolution of the tax position w tax authorities as of the BS date
63
Q

Enacted Tax Rate

Temporary Differences

A

used for deferred taxes (temporary differences)

they’ll try to trick you with

  • anticipated tax, proposed tax, unsigned tax: don’t use!
  • use tax rate in effect when temporary difference reverses itself

GAAP vs IFRS
- IFRS permits use of enacted or substantively enacted tax rates

64
Q

Treatment of and Adjustment for Changes

Temporary Differences

A

*Changes in Tax Laws or Rates (prospective)
- liability method requires deferred tax account balance be adjusted when the tax rates change
- when future tax rates are enacted, not just proposed or estimated, deferred tax will be recalculated
- changes in tax laws or rates are recognized *in the period of change (enactment)
- the adj. enters into income tax expense for that period as a component of income from continuing ops
GAAP vs IFRS
- IFRS, when deferred tax balance arises from something in OCI, adjustments should be recorded in OCI not IS

  • Net Temporary Adjustment (from beg balance)
  • deferred tax acct is adj. for change in deferred taxes, due to the current year’s events
  • income tax expense/benefit-deferred is the diff b/w beg balance in deferred tax acct and ending bal

Change in the Valuation Allowance
- recognized in income from cont ops in period of change

Change in Tax Status of an Enterprise

  • entity’s tax status may change from taxable to nontaxable or vice versa
  • at date nontaxable becomes taxable, deferred tax liability or asset recognized for any temp diff
  • at date taxable becomes nontaxable, any existing deferred tax liab/asset should be written off
  • eliminating or recognizing a deferred tax asset/liab should be included in income from cont ops in period of change
65
Q

Balance Sheet Presentation

Temporary Differences

A

under GAAP, deferred tax liabilities and assets should be classified and reported as a current amt and noncurrent amt on the BS

  1. Deferred tax items should be classified based on classification of related asset/liability for financial reporting
  2. Deferred tax items not related to an asset or liability should be classified based on expected reversal date of the temporary difference (~F6-46)
  3. all deferred tax assets/liabs classified as current are netted and presented as one amt
  4. all deferred tax assets/liabs classified as noncurrent are netted and presented as one amt
  5. any valuation allowance for a deferred tax asset should be allocated pro rata to current and noncurrent deferred assets

GAAP vs IFRS

  • IFRS, all deferred tax assets/liabs are reported as noncurrent on BS*
  • DTAs and DTLs may be netted if entity has legally enforceable right to offset current assets against current liabilities and DTAs and DTLs related to income taxes levied by same tax authorities
66
Q

Operating Losses

Temporary Differences

A

under US tax law, operating loss carried back 2 carry forward 20 and applied as reduction of taxable income
- taxable income and financial acct income will differ for periods to which the loss is carried back or forward

Operating Loss Carrybacks

  • 100% collectible, no valuation allowance
  • tax carrybacks are a tax benefit (asset) and should be recognized in the period loss occurs (?)
  • a claim for refund of past taxes is shown on BS at a separate item from deferred taxes
  • this income tax refund receivable is usually classified as current
    dr: tax refund receivable, cr: tax benefit

Operating Loss Carryforwards

  • valuation allowance may be necessary
  • tax effects recognized to extent that tax benefit is more likely than not to be realized
  • recognized as deferred tax asset (bc they represent future tax savings) in the period they occur
  • NOL carryforwards valued using enacted tax rate for the periods they are expected to be used
    dr: deferred tax asset, cr: tax benefit
67
Q

Investee’s Undistributed Earnings~

A

Income Tax Return

  • dividends received deduction: includes dividends received - DRD
  • DRD is permanent diff

GAAP Financial Statement
- use equity method for 20% to 50% investment in sub, recognize % of investee’s income

Temporary Discount

  • taxable dividend income - financial’s % of dividend income
  • multiply diff ^ by excess % not excluded from DRD (e.g. if 80% DRD, multiply by 20%)
  • use product as permanent diff and multiply by enacted rate
68
Q

Income Tax Disclosures

A

more is better
- don’t repeat or be too positive

BS Disclosures

  • components f net deferred tax liability or asset
  • valuation allowance for deferred tax assets

IS Disclosures

  • amt of income tax expense or benefit allocated to continuing operations and the amts separately allocated to other items must be disclosed
  • benefits of NOL carryforwards

~ F6-50

69
Q

effective tax rate

A

income tax expense / pretax financial income

HW
Fern Co has net income, before taxes, of $200,000, including 20,000 interest revenue from municipal bonds and 10,000 paid for officers’ life insurance premiums where the comp is the beneficiary. the tax rate for the current year is 30%. what is Fern’s effective tax rate?
- 28.5%

CPA FAR (10 decks)

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