Financial accounting: EITF update.

Accounting for Tax Effects of Transactions among or with Shareholders and Revenue Recognition on Equipment Sold and Subsequently Repurchased Subject to an Operating Lease 

This month's column lists new EITF consensuses adopted January 18, 1996 (see the sidebar below). In addition, earlier consensuses on accounting for tax effects of transactions among or with shareholders and revenue recognition on equipment sold and subsequently repurchased subject to an operating lease are summarized. The summaries are presented in the order of importance from broad to narrow applicability.

ISSUE NO. 94-10

Issue no. 94-10, Accounting by a Company for the Income Tax Effects of Transactions among or with Its Shareholders under FASB Statement no. 109, addresses whether such tax effects should be included in the income statement or in the equity section of the balance sheet in the separate financial statements of the company affected.

Some transactions among shareholders affect the tax attributes of the company itself. For example, in general, if more than 50% of the stock of a company changes hands within a specified period, future utilization of any existing net operating loss carryforwards of the company may be limited or prohibited. A valuation allowance not otherwise needed now may be required for that deferred tax asset or the deferred tax asset may need to be written off. Certain transactions with shareholders (that is, transactions between a company and its shareholders) have the same effect.

Other transactions among shareholders may change the tax bases of the assets and liabilities of the company. For example, an investor purchases 100% of a company's outstanding stock in a transaction that is treated as a purchase of assets for tax purposes but does not "push down" the purchase price for financial reporting purposes to the acquired company. The acquired company's financial reporting bases of its assets and liabilities do not change but the tax bases of its assets and liabilities are adjusted and, consequently, the deferred tax liabilities and assets also are adjusted accordingly. This issue does not address transactions among or with minority shareholders of a subsidiary or shareholder transactions that involve a change in the tax status of a company (such as a change from nontaxable S corporation status to taxable C corporation status).

The Task Force reached a consensus that changes in valuation allowances due to changed expectations about the realization of deferred tax assets caused by transactions among or with shareholders should be included in the income statement. The Task Force also reached a consensus that a writeoff of a preexisting deferred tax asset that an entity can no longer realize as a result of a transaction among or with its shareholders similarly should be charged to the income statement. The Task Force observed that the same net effect results from eliminating a deferred tax asset and increasing a valuation allowance to 100% of the amount of the related deferred tax asset.

The Task Force also reached a consensus that the tax effects of all changes in the tax bases of assets and liabilities caused by transactions among or with shareholders should be included in equity. If transactions among or with shareholders result in recognition of deferred tax assets from changes in the tax bases of assets and liabilities, the effect of valuation allowances initially required on recognition of those deferred tax assets also should be included in equity. Changes in valuation allowances occurring in subsequent periods should be included in the income statement.

ISSUE NO. 95-4

Issue no. 95-4, Revenue Recognition on Equipment Sold and Subsequently Repurchased Subject to an Operating Lease, addresses whether a manufacturer is precluded from recognizing a sale of a product to a dealer if the customer subsequently enters into an operating lease with the manufacturer or its finance affiliate, which acquires that product subject to the lease.

To fully understand this issue, some background information is necessary: A manufacturer sells finished products to dealers that, in turn, sell or lease the products to end users (customers). The customers may be individuals or independent enterprises, may pay cash for their purchases, finance them using their own financing sources or use sources available through the dealer. The finance sources may include lease arrangements provided by commercial banks and other finance companies, including the manufacturer or an affiliate of the manufacturer (finance affiliate).

The EITF reached a consensus that a manufacturer would not be precluded from recognizing a sale at the time the product is transferred to the dealer if all of the following conditions exist:

1. The dealer is a substantive and independent enterprise that transacts business separately with the manufacturer and customers.

2. The manufacturer has delivered the product to the dealer, and the risks and rewards of ownership have passed to the dealer, including responsibility for the ultimate sale of the product and for insurability, theft or damage. A customer's failure to enter into a lease with the finance affiliate (or manufacturer) would not allow the dealer to return the product to the manufacturer.

3. The finance affiliate (or manufacturer) has no legal obligation to provide a lease arrangement to a dealer's potential customer at the time the dealer takes delivery.

4. The customer has other financing alternatives available from parties unaffiliated with the manufacturer and is in control of, the selection of financing alternatives.

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.

Statement on Auditing Standards no. 69, The Meaning of "Present Fairly in Conformity With Generally Accepted Accounting Principles" in the Independent Auditor5 Report, identifies Financial Accounting Standards Board emerging issues task force (EITF) consensuses as sources of established generally accepted accounting principles.

EXECUTIVE SUMMARY

* EITF Issue no. 94-10

Accounting problem: (1) Should changes in the deferred tax asset valuation allowance and a writeoff of preexisting deferred tax assets caused by transactions among or with shareholders be included in the income statement? (2) should the tax effects of all changes in the tax bases of assets and liabilities caused by transactions among or with shareholders be included in equity? Consensus: (1) Yes. (2) Yes.

* EITF Issue no. 95-4 Accounting problem: May a manufacturer recognize the sale of a product to a dealer if the customer subsequently enters into an operating lease with the manufacturer or its finance affiliate which acquires that product subject to the lease? Consensus: Yes, if certain conditions are met.

By LINDA A. VOLKERT, CPA, senior technical manager of the AICPA technical hotline team.