FASB 109 implications for foreign financial statements.

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) consensuses as sources of established generally accepted accounting principles.

This month's column lists new EITF consensuses adopted January 20, 1994 (see the sidebar on page 85). In addition, two earlier consensuses on applying FASB Statement no. 109, Accounting for Income Taxes, to foreign financial statements are summarized: (1) general price-level-adjusted financial statements and (2) basis differences within foreign subsidiaries that meet the indefinite reversal criterion. 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 Merritt 7, P.O. Box 5116, Norwalk, Connecticut 06856-5116. Phone: [phone].

ISSUE NO. 93-9

A foreign entity in a country with a highly inflationary economy may prepare its financial statements on the price-level basis of accounting. Paragraph 26 of Accounting Principles Board Statement no. 3, Financial Statements Restated for General Price-Level Changes, says price-level-adjusted financial statements are preferred for foreign currency financial statements of entities operating in highly inflationary economies when they are intended for readers in the United States. (Note: Although American Institute of CPAs Statement of Position no. 93-3, Rescission of Accounting Principles Board Statements, rescinded all APB statements, the SOP retained paragraph 26 of APB Statement no. 3 in the literature and elevated its status to category b in the GAAP hierarchy.) In these financial statements, the tax bases of assets and liabilities often are restated (in indexed amounts) for inflation.

EITF Issue no. 93-9, Application of FASB Statement No. 109 in Foreign Financial Statements Restated for Price-Level-Adjusted Financial Statements, provides guidance on the asset-and-liability approach of Statement no. 109 as it relates to these statements. According to paragraph 39 of APB Statement no. 3, the income tax provision (benefit) in general price-level statements is based on income taxes reflected in historical dollar statements and is not computed based on pretax income of general price-level statements. (The Internal Revenue Code does not recognize general price-level statements for tax purposes.)

The issues are (1) how temporary differences should be computed under Statement no. 109 and (2) how deferred income tax expense or benefit for the year should be determined.

The EITF reached a consensus that for purposes of preparing financial statements restated for general price-level changes using end-of-current-year purchasing power units, temporary differences under Statement no. 109 are determined based on the difference between the indexed tax basis amount of an asset or liability and the related price-level restated amount reported in the financial statements. The EITF's consensus is consistent with paragraph 11(g) of Statement no. 109, which says temporary differences include "an increase in the tax basis of assets because of indexing whenever the local currency is the functional currency."

The EITF also reached a consensus that the deferred tax expense or benefit should be calculated as the difference between (1) deferred tax assets and liabilities reported at the end of the current year, determined in accordance with the above paragraph, and (2) deferred tax assets and liabilities reported at the end of the prior year, recalculated in units of current general purchasing power at the end of the current year. The recalculation of deferred tax assets and liabilities at the end of the prior year is reported with the recalculation of all other assets and liabilities as a restatement of beginning equity.

An exhibit to Issue no. 93-9 in EITF Abstracts illustrates these consensuses' application.

ISSUE NO. 93-16

The second issue regarding Statement no. 109 and foreign subsidiaries is Issue no. 93-16, Application of FASB Statement No. 109 to Basis Differences within Foreign Subsidiaries That Meet the Indefinite Reversal Criterion of APB Opinion No. 23. In general, this issue deals with applying the indefinite reversal criteria in APB Opinion no. 23, Accounting for Income Taxes--Special Areas, to "analogous types of temporary differences," as discussed in paragraph 31 of Statement no. 109. The issue relates to an Italian subsidiary of a U.S. parent.

The Italian subsidiary's financial statements are prepared in the local currency, which is the functional currency. The subsidiary took advantage of a provision in Italy's tax laws to restate its fixed assets for tax purposes to compensate for inflation. The offsetting credit goes to "revaluation surplus" on the tax balance sheet and may be classified as a component of equity for tax purposes. That amount may be taxable if, for example, the Italian subsidiary is liquidated or earnings associated with the revaluation surplus are distributed. For purposes of this issue it is assumed the revaluation surplus eventually will be taxable. The resulting difference represents an "inside basis difference" (a temporary difference within a foreign subsidiary) rather than an "outside basis difference" (a temporary difference between a parent company's tax and book bases in an investment in a foreign subsidiary).

The issue is whether the indefinite reversal criterion of Opinion no. 23, as amended by Statement no. 109, applies only to temporary differences related to outside basis differences or whether it should be applied to the revaluation surplus related to foreign subsidiaries' inside basis differences in the consolidated financial statements of the parent and its foreign subsidiaries.

The EITF reached a consensus that the indefinite reversal criterion of Opinion no. 23, as amended, should not be applied to inside basis differences of foreign subsidiaries and that a deferred tax liability should be provided on the amount of the revaluation surplus. Because the revaluation surplus eventually will be taxable income under the Italian tax law (the concept of deferred taxable income in paragraph 15 of Statement no. 109), it represents a temporary difference (even though it may be classified as an equity component for tax purposes).

The EITF also reached a consensus that entities that did not previously record a deferred tax liability for such inside basis differences must do so for all differences that arise in fiscal years beginning after December 15, 1992. Thus, if inside basis differences exist for revaluations that arose in fiscal years beginning before December 16, 1992, and no deferred tax liability was recognized on adoption of Statement no. 109, no deferred tax liability for those differences is required by this consensus. However, in such situations the EITF said entities should make the disclosures required by paragraph 44 of Statement no. 109.

EXECUTIVE SUMMARY

* EITF Issue no. 93-9

Accounting problem: For foreign financial statements restated for general price-level changes, should temporary differences be determined based on the difference between the indexed tax basis amount of an asset or liability and the related price-level restated amount reported for book purposes?

Consensus: Yes.

* EITF Issue no. 93-16

Accounting problem: Should the indefinite reversal criterion of APB Opinion no. 23, as amended, be applied to inside basis differences of foreign subsidiaries?

Consensus: No. Deferred tax liabilities should be established. NEW EITF CONSENSUSES ADOPTED JANUARY 20, 1994 Listed below are the EITF issues for which consensuses have been reached since the November 18, 1993, meeting (see JofA, Jan.94, page 111):

Issue no.     Title                              Status


93-17    Recognition of Deferred Tax            Consensus
         Assets for a Parent Company's          reached 1/20/94
         Excess Tax Basis in the Stock of a
         Subsidiary That Is Accounted for
         as a Discontinued Operation

93-18    Recognition of Impairment for an       Consensus
         Investment in a Collateralized         reached 1/20/94
         Mortgage Obligation Instrument         on Issue no. 1
         or in a Mortgage-Backed Interest-      only; changes
         Only Certificate                       consensus on
                                                Issue no. 89-4

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 A. VOLKERT, CPA, senior technical manager of the AICPA technical information division.