Deferred tax assets for a parent company's excess tax basis in the stock of a segment to be discontinued and impairment recognition for certain mortgage-backed investments.

DEFERRED TAX ASSETS FOR A PARENT COMPANY'S EXCESS TAX BASIS IN THE STOCK OF A SEGMENT TO BE DISCONTINUED AND IMPAIRMENT RECOGNITION FOR CERTAIN MORTGAGE-BACKED INVESTMENTS

Statement on Auditing Standards no. 69, The Meaning of "Present Fairly in Conformity With Generally Accepted Accounting Principles" in the Independent Auditor's Report, identifies Financial Accounting Standards Board emerging issues task force (EITF) concensousness as sources of established generally accepted accounting principles.

This month's column lists new EITF consensuses adopted May 19, 1994 (see the sidebar on page 96). In addition, earlier consensuses on recognition of deferred tax assets for a parent company's excess tax basis in the stock of a subsidiary that is accounted for as a discontinued operation and recognition of impairment for an investment in a collateralized mortgage obligation (CMO) instrument or in a mortgage-backed interest-only (IO) certificate are summarized. The summaries are presented in the order of importance from broad to narrow applicability.

EITF Abstracts, copyrighted by the FASB, is available in soft-cover and loose-leaf versions and may be obtained by contacting the FASB order department at 401 Meritt 7, P.O. Box 5116, Norwalk, Connecticut 06856-5116. Phone: [phone].

ISSUE NO. 93-17

EITF Issue no. 93-17, Recognition of Deferred Tax Assets for a Parent Company's Excess Tax Basis in the Stock of a Subsidiary That Is Accounted for as a Discontinued Operation, addresses the gain recognition limitations of Accounting Principles Board Opinion no. 30, Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, and their effect on the recognition of deferred tax benefits for such excess tax-basis differences.

A temporary difference is created when a parent company's tax basis in a subsidiary's stock exceeds its book basis (for example, when the acquisition of a subsidiary was accounted for as a pooling of interests for book purposes and a taxable exchange for tax purposes). Under FASB Statement no. 109, Accounting for Income Taxes, paragraph 34, the parent company recognizes deferred tax assets for such differences that are essentially permanent in duration only if it is apparent the temporary difference will reverse in the foreseeable future. (A planned disposition of a segment is an example of such an event.

In contrast, under Opinion no. 30, gain recognition is deferred until the disposal date. Paragraph 15 of Opinion no. 30 says, "If a gain is expected (from the proposed sale or abandonment of a segment), it should be recognized when realized, which ordinarily is the disposal date." The disposal date is the closing date of the sale (for a sale) or the date operations cease (for an abandonment).

The issue is whether the tax benefit for the excess of outside tax basis over financial reporting basis of an investment in a subsidiary that meets the Opinion no. 30 requirements to be reported as a discontinued operation should be recognized in accordance with paragraph 34 of Statement no. 109 (when it is apparent a temporary difference will reverse in the foreseeable future) or paragraph 15 of Opinion no. 30 (at the disposal date). That is, do the gain recognition limitations in paragraph 15 of APB Opinion no. 30 preclude recognition of the tax benefit before the disposal date?

The EITF reached a consensus that, following the guidance in Statement no. 109, a deferred tax asset should be recognized when it is apparent the temporary difference will reverse in the foreseeable future. (The decision to sell a subsidiary makes this apparent.) The EITF observed that the criterion of paragraph 34 of Statement no. 109 is met at the measurement date of the disposal, which is "...the date on which the management having authority to approve the action commits itself to a formal plan to dispose of a segment of the business, whether by sale or abandonment."

The EITF noted that the same criterion should apply for recognition of a deferred tax liability that relates to an excess of financial reporting basis over outside tax basis of an investment in a subsidiary.

ISSUE NO. 93-18

EITF Issue no. 93-18, Recognition of Impairment for an Investment in a Collateralized Mortgage Obligation Instrument or in a Mortgage-Backed Interest-Only Certificate, arose from the issuance of FASB Statement no. 115, Accounting for Certain Investments in Debt and Equity Securities, and its impact on EITF Issue no. 89-4, Accounting for Purchased Investment in a Collateralized Mortgage Obligation Instrument or in a Mortgage-Backed Interest-Only Certificate. Statement no. 115, paragraph 16, discusses the measure of impairment losses of securities classified as either available for sale or held to maturity using fair value as the new cost basis. The measure for impairment losses for the securities discussed in Issue no. 89-4 (see JofA, Nov.90, page 123)-high-risk nonequity CMOs and IOs--is based on undiscounted future cash flows.

The EITF addressed three issues relating to the measurement and recognition of impairment loss for high-risk nonequity CMOs and 10s. The first two issues address whether Statement no. 115 changes the guidance in Issue no. 89-4 regarding when impairment losses are recognized and how they are measured. The third issue addresses whether previously recognized impairment losses should be remeasured at fair value for purposes of determining the cumulative catch-up adjustment on initial adoption of Statement no. 115.

The EITF reached a consensus, which amended Issue no. 89-4, that an impairment loss should be recognized if the present value of estimated future cash flows discounted at a risk-free rate (the rate on monetary assets that are essentially risk-free as to the amount, timing and collection of interest and principal as described in paragraph 4 of FASB Statement no. 76, Extinguishment of Debt) is less than an instrument's amortized cost basis. That comparison should be made at each reporting date. The EITF reiterated the guidance in Issue no. 89-4 that the estimated future cash flows at each reporting date should reflect the most current estimate of future prepayments and use the same assumptions specified by the consensus in Issue no. 89-4.

Issue no. 89-4 recognized an impairment loss when the recorded investment balance exceeded the undiscounted estimated future cash flows. Discounting the estimated future cash flows at a risk-free rate reduces the estimated cash flows below the undiscounted amount. Under Issue no. 93-18, comparing this lower amount with the amortized cost basis triggers earlier recognition of an impairment loss. The difference between the amortized cost basis and the discounted estimated future cash flows is used to determine the timing of recognition but not the amount of the writedown.

The EITF reached a consensus that Statement no. 115 changes the measure of an impairment loss addressed in Issue no. 89-4 from undiscounted cash flows to fair value. The excess of the amortized cost basis over an instrument's fair value should be recognized as a realized loss in the income statement, thereby establishing a new cost basis for the security.

The EITF also reached a consensus that the amortized cost basis of instruments determined to have an other-than-temporary impairment loss at the time of initial adoption of Statement no. 115 should be written down to fair value. The amount of the writedown should be included as part of the cumulative catch-up adjustment. See EITF Abstracts for additional transition guidance relating to early adoption of Statement no. 115.

These consensuses are limited to instruments within the scope of Issue no. 89-4 (high-risk nonequity CMOs and IOs).

EXECUTIVE SUMMARY

* EITF Issue no. 93-17 Accounting problem: If an enterprise decides to sell a segment, should the excess of the parent company's tax basis in the subsidiary's stock over the financial reporting amount of the investment be recognized as a deferred tax asset in accordance with paragraph 34 of FASB Statement no. 109, Accounting for Income Taxes? Consensus: Yes.

* EITF Issue no. 93-18 Accounting problem: (1) Does FASB Statement no. 115, Accounting for Certain Investments in Debt and Equity Securities, change the measure of an impairment loss to fair value for certain mortgage-backed investments? (2) Does Statement no. 115 change a previous consensus on when impairment losses should be recognized for those investments? (3) Should previously recognized impairment losses for such investments be remeasured at fair value for purposes of determining the cumulative catch-up adjustment on initial adoption of Statement no. 115? Consensus: (1) Yes. (2) Yes. (3) Yes.

NEW EITF CONSENSUSES ADOPTED MAY 19, 1994

Listed below are the EITF issues for which consensuses have been reached since the March 24, 1994, meeting (see JofA, May 94, page 102):

Issue no.   Title                   Status
94-1        Accounting for          Consensuses reached 5/19/94
            Restructuring Charges   on when to recognize certain
                                    employee termination
                                    benefit liabilities
                                    and related disclosures

The application of EITF consensuses (category c of the GAAP hierarchy) effective after March 15, 1992, is mandatory under SAS no. 69. EITF consensuses issued before March 16, 1992, become effective in the hierarchy for initial application of an accounting principle after March 15, 1993. See JofA, May92, pages 103-110, for a complete discussion of the new GAAP hierarchy and EITF consensuses.

By LINDA C. DELAHANTY, CPA, technical manager, and LINDA A. VOLKERT, CPA, senior technical manager, of the AICPA technical information division.