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Implementation of FAS 96: temporary differences - scheduling and reversals.

Implementation of FAS 96: Temporary Differences--Scheduling and Reversals (*1)

Under Statement of Financial Accounting Standards No. 96, deferred tax assets and liabilities are calculated as if a tax return were prepared for each future year using the net taxable or deductible amounts anticipated to occur in each future year as a result of the reversal of existing temporary differences. Scheduling is the process of estimating the specific years in which existing temporary differences will result in taxable or deductible amounts.

The amount of taxes payable or refundable in each future year must be determined for each tax jurisdiction and for each alternative tax system within each tax jurisdiction (such as the U.S. alternative minimum tax system). Accordingly, it may be necessary to schedule the reversal of temporary differences for each tax jurisdiction and each alternative tax system.

I. Aggregate Calculation

In certain situations, a detailed scheduling exercise may not be necessary for every tax jurisdiction or the scheduling process may be limited to only certain temporary differences. For example, scheduling generally will not be required in a tax jurisdiction if all the following criteria are met:

* The enacted tax rate is the same in all future years.

* The effects of graduated tax rates are not significant.

* All temporary differences result only in taxable amounts in future years (there are no temporary differences that will result in future deductible amounts).

* There are no net operating loss or tax credit carryforwards.

* Alternative tax systems would not have a significant effect on the deferred tax calculation.

* The balance sheet is unclassified or the current portion of deferred taxes can be determined without scheduling.

In certain situations, it may be possible to perform the scheduling process using time spans of several years, exclude certain temporary differences from the scheduling exercise, or limit the scheduling proces to only certain items. For instance, if the tax benefits of future deductible amounts would not qualify for recognition because the future deductible amounts clearly could not offset future taxable amounts or be carried back to recover taxes paid, such future deductible amounts could be excluded from the scheduling process. Similarly, if there are no future deductible amounts and there are sufficient future taxable amounts to use a net operating loss or tax credit carryforward before the carryforward period expires, it may not be necessary to schedule the future taxable amounts that would be offset by the net operating loss carryforward.

Generally, however, it is anticipated that some scheduling will be required in all but the simplest of cases. For instance, some scheduling may be required in any of the following scenarios:

* Scheduling may be necessary for at least the first year after the balance sheet date to determine the current portion of deferred taxes in a classified balance sheet. Because Statement 96 does not permit offsetting deferred tax assets and liabilities relating to different tax jurisdictions, this procedure may be necessary for each tax jurisdiction.

* Scheduling may be necessary to determine whether the tax benefits of temporary differences that will result in future deductible amounts may be recognized.

* If there are net operating loss or tax credit carryforwards, scheduling may be necessary to determine whether the tax benefits of such carryforwards may be recognized.

* Scheduling may be necessary for tax jurisdictions with graduated tax rates or for tax jurisdictions with different tax rates or limitations on various types of income or loss, such as different tax rates on capital gains or limitations on capital losses.

* If the enacted tax rates for all future years are not the same, scheduling may be required to determine the appropriate tax rate to apply to future taxable amounts.

* When alternative tax systems exist, such as the U.S. alternative minimum tax, it may be necessary to schedule the reversal of temporary differences under the regular tax system and the alternative tax system to determine the applicable tax system for each future year.

II. Determining Period of

Reversal

The scheduling of future taxable and deductible amounts is based on the timing of the recovery or settlement of the asset or liability. Determining the periods that a temporary difference will result in taxable or deductible amounts is easy when the recoverability of the asset or the settlement of the related liability is governed by a contract. Scheduling also is easy for depreciation, where financial reporting and tax lives and methods are known. In other cases, determining the period of reversal will require estimates and judgments.

In certain instances, temporary differences will not reverse in the foreseeable future. In those cases, the temporary difference should be scheduled to reverse in the "indefinite column" (the very last column).

Tax benefits attributable to temporary differences that will result in future deductible amounts that are scheduled in the indefinite column generally cannot be recognized. Deferred tax liabilities must be recognized on future taxable amounts scheduled in the indefinite column. Future deductible amounts in the indefinite column may be offset, however, against future taxable amounts in the indefinite column if both the deductible and taxable amounts will be reported in taxable income upon occurrence of the same event, such as the sale of a subsidiary.

In certain cases, qualified tax-planning strategies may be available to accelerate future taxable and deductible amounts in the indefinite column to a particular year.

III. Examples of Scheduling

Temporary Differences

The remainder of this article describes typical temporary differences and provides guidance for determining the periods that those differences will result in taxable or deductible amounts based on the U.S. federal income tax law applicable to the regular tax system.

The guidance in this section does not consider tax-planning strategies. In certain cases, a qualified tax-planning strategy may be used to change the particular years in which a temporary difference results in taxable or deductible amounts.

1. Valuation Allowances for Investments

in Marketable Equity

Securities

In classified balance sheets, the temporary difference attributable to the valuation allowances on current marketable equity securities should be scheduled to result in a deductible amount in the year following the balance sheet date. The temporary difference related to the noncurrent portfolio of marketable equity securities should be scheduled to reverse in the years in which management expects to sell the securities.

2. Investments in Bonds

The financial statement carrying amount of an investment in bonds may differ from the tax basis of the investment because of amortization of discount or premium for financial reporting purposes. The temporary difference as of the balance sheet date should be scheduled as a taxable or deductible amount in either the year of maturity or the estimated year of sale, depending on whether management intends to hold the bond to maturity or sell the bond.

Temporary differences expected to arise in the future as a result of amortization of bond discount or premium for financial reporting purposes should not be considered in the scheduling process.

3. Allowance for Doubtful Accounts

The Tax Reform Act of 1986 eliminated the reserve method of calculating the allowance for doubtful accounts for tax purposes for many taxpayers. For taxable years beginning after December 31, 1986, deductions for bad debts must be based on the specific charge-off method. A temporary difference generally will exist in the amount of the allowance for doubtful accounts for financial reporting purposes. This temporary difference should be scheduled to result in deductible amounts based on management's estimate of the years in which the company will take the related tax deduction under the specific charge-off method. Allowances recognized for specific accounts receivable should be scheduled with reference to the related receivable. The reversal of allowances not attributable to specific accounts receivable shoud be estimated based on historical trends and other information used to calculate that portion of the allowance for doubtful accounts.

For calendar-year taxpayers, the balance of any allowance for doubtful accounts calculated using the reserve method for tax purposes as of December 31, 1986, must be included in taxable income ratably over a four-year period beginning in 1987. The change from reserve method to the specific charge-off method for tax purposes creates another temporary difference for the amount of the tax reserve to be included in taxable income over the four-year period. This amount represents deferred income for tax purposes. In this situation, there are two separate temporary differences relating to the allowance for doubtful accounts that require scheduling. The amount of the allowance for financial reporting purposes represents one temporary difference that will result in deductible amounts in future years as specific accounts are charged off. In addition, the deffered income for tax purposes for the change in tax accounting methods represents another temporary difference that will result in taxable amounts in future years.

4. Inventories

Differences between the financial statement carrying amount and the tax basis of inventories may exist for a number of reasons. For example, differences may be caused by differences in inventoriable costs for financial reporting and tax purposes or by purchase business combinations. Under Statement 96, all differences between the financial statement carrying amount and tax basis of inventories are temporary differences. The scheduling of temporary differences related to inventories should be based on the flow-of-goods assumption rather than the flow-of-cost assumption. Future purchases or production of inventory should not be considered. If inventory is estimated to turn over at least once a year, the related temporary differences should be scheduled to result in taxable or deductible amounts in the first year subsequent to the balance sheet due. In this regard, however, see the discussion of reserves for obsolete inventory in item 6.

The Tax Reform Act of 1986 established uniform capitalization rules that specify the types of cost that must be capitalized as part of inventory cost for tax purposes. The new rules generally are effective as of January 1, 1987, for calendar-year taxpayers. If any of the costs required to be capitalized for tax purposes are not capitalizable for financial reporting purposes, a temporary difference will exist for the excess of the tax basis of the inventory over the financial statement carrying amount. this difference will result in a future deductible amount that generally should be scheduled in the first year subsequent to the balance sheet date. Under the tax laws, the effect of applying the uniform capitalization rules as of January 1, 1987 generally must be taken into taxable income over a four-year period. This change in tax accounting methonds creates a separate temporary difference that will result in future taxable amounts. The scheduling of temporary differences resulting from the uniform capitalization rules is illustrated in item 5.

Under APB Opinion 16, the excess of the assigned value over the tax basis of LIFO inventories acquired in a purchase business combination usually was treated as a permanent difference if the company did not inted to liquidate the tax basis LIFO layers. Statement 96 does not permit the consideration of "indefinite reversal" in accounting for temporary differences relating to LIFO inventories. Accordingly, the excess of the assigned value over the tax basis of LIFO inventories acquired in purchase business combinations generally should be scheduled to result in a taxable amount in the first year subsequent to the balance sheet date.

5. Uniform Capitalization

Adjustments

The section 481 adjustment related to the uniform capitalization rules for inventory costing include acceleration provisions that should be considered in the scheduling process. For example, if the inventory levles for two successive years are one-third below the inventory tax basis as calculated upon initial application of the uniform capitalization rules (as of January 1, 1987), the recognition of any remaining section 481 adjustment would be accelarated into the second year. In the scheduling process, the replacement of existing inventory should not be anticipated. Therefore, if inventory turns at least once a year, 25 percent of the section 481 adjustment calculated at December 31, 1986 would be scheduled to reverse in 1987 and 75 percent would be scheduled in 1988. At December 31, 1987 (after 25 percent of the initial section 481 adjustment has been included in 1987 taxable income), 25 percent of the initial section 481 adjustment would be scheduled in 1988 and 50 percent in 1989 if the inventory balance at December 31, 1987, was not one-third below the inventory tax basis calculated upon initial application of the uniform capitalization rules. Example 1 illustrates scheduling temporary differences for uniform capitalization adjustments.

6. Reserves for Obsolete Inventory

For financial reporting purposes, reserves for inventory obsolenscence may be established. For tax purposes, deductions for obsolete inventory are generally not allowed until disposition of the inventory. The temporary difference related to the reserve for inventory obsolenscence should be scheduled to result in deductible amounts in the periods in which the tax deductions are expected to be claimed, irrespective of the overall inventory turnover ratio.

7. Cash Surrender Value of Life

Insurance

Proceeds from a corporate-owned life insurance policy are not taxable upon death of the insured. If the policy is surrendered for its cash value, however, any excess of cash surrender value over the cumulative premiums paid wold be included in taxable income. Generally, an asset is recognized for financial reporting purposes in the amount of the cash surrender value in accordance with the guidance of FASB Technical Bulletin No. 85-4, "Accounting for Purchases of Life Insurance." Paragraph 41 of Statement 96 provides that the excess of the cash surrender value of a corporate-owned life insurance policy over the cumulative premiums paid is a temporary difference.

If the company intends to surrender the policy, the temporary difference should be scheduled to result in taxable income in the year that the company expects to surrender the policy. The company may be able to consider a tax-planning strategy to avoid recognition of deferred taxes on this temporary difference if the company has the intent and ability to hold the policy until death of the insured and no significant future cash payments for premiums or interest are required to keep the policy in force until death of the insured.

8. Land

The value assigned to land in a nontaxable business combination accounted for as a purchase may exceed its tax basis. In addition, the carrying amount of land for financial reporting purposes may differ from its tax basis for other reasons, such as differences in capitalized costs or recording contributed land at predecessor cost for financial reporting purposes. Regardless of the origination of the differences, if the company expects to sell the land, the temporary difference should be scheduled to reverse in the expected year of sale; otherwise, the related taxable or deductible amount should be included in the indefinite column in the scheduling exercise.

9. Plant and Equipment

Paragraph 42 of Statement 69 indicates that future originating temporary differences for existing depreciable assets (assets in use at the end of the current year) should be considered in determining the future years in which estimating temporary differences result in taxable or deductible amounts. Accordingly, the differences between the depreciation for financial reporting and tax purposes for each future year should be scheduled as future taxable or deductible amounts. Example 2 illustrates scheduling temporary differences for depreciable assets.

Future originating temporary differences should be considered in the scheduling process only when the temporary difference accumulates over several years and then reverses over several years. Generally, temporary differences caused by depreciation or amortization differences are the only temporary differences that will be scheduled in this manner.

10. Assets Under Construction

The financial statement carrying amount and tax basis of an asset under construction for a company's own use may differ as a result of differences in capitalized costs. For example, interest capitalized for financial reporting may differ from the amount capitalized for tax purposes, or costs required to be capitalized for tax purposes under uniform capitalization rules may not be capitalizable for financial reporting purposes.

Only the existing difference between the financial statement carrying amount and the tax basis of assets under construction for a company's own use should be scheduled. Future originating temporary differences (differences between future depreciation for financial reporting and tax purpose) and future costs to be incurred in constructing the asset should not be considered while the asset is under constrution. The net difference between the financial statement carrying amount and the tax basis should be scheduled to reverse over the expected depreciable life of the asset. When the financial statement carrying amount exceeds the tax basis, the temporary difference would be scheduled to result in taxable amounts, commencing when the asset is expected to be placed in service, using the depreciable life and depreciation methond that will be used for financial reporting purposes.

If the tax basis exceeds the financial statement carrying amount, the tax method of depreciation and depreciable life would be used to schedule the future deductible amounts related to this temporary difference. Example 3 illustrates the scheduling of temporary differences related to assets under construction.

Future differences that will originate owing to different depreciation methods or lives for financial reporting and tax purposes should not be considered until the asset has been placed in service and recognition of depreciation has commenced. Future differences in capitalized costs that will be incurred in future years in constructing the asset should not be considered in the scheduling process until the costs are incurred. If the financial statement carrying amount and tax basis of an asset under construction are the same, no future taxable or deductible amounts should be scheduled.

11. Assets Amortizable (or

Depreciable) for Financial

Reporting Purposes But Not

for Tax

Differences between the financial statement carrying amount and tax basis of certain assets give rise to temporary differences even if the asset has not tax basis or amortization of the asset is not currently deductible for tax purposes. The cost of certain assets, such as franchise agreements with unlimited lives and office buildings in the United Kingdom, is amortized or depreciated for financial reporting purposes, but not for tax purposes. Generally, the value assigned to a franchise agreement with an unlimited life would not be deductible for tax purposes until the related business is sold or until the francise agreement is terminated. The tax basis of an office building in the United Kingdom is indexed for inflation and a capital gain or oss is measured using the inflation-adjusted tax basis when the office building is sold or otherwise disposed of. There are limitations on the recognition of capital losses under the U.K. tax law.

Future originating differences should not be considered in scheduling temporary differences relating to assets that are amortizable or depreciable for financial reporting purposes but not for tax purposes. The temporary difference existing at the balance sheet date should be scheduled to result in a deductible amount in the expected year of disposition. If there is no intention to dispose of the asset, the future deductible amount should be scheduled in the indefinite column.

12. Investments in Common Stock

Accounted for under the Equity

Method.

Investments in common stock accounted for under the equity method for financial reporting purposes in accordance with Accounting Principles Board Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock," often give rise to temporary differences because such investments generally are accounted for under the cost method for tax purposes. Under the equity method, the investment is adjusted for the investor's share of the undistributed earnings or losses of an investee.

a. Allocation of cost investment. Paragraphs 19(a) and 19(n) of APB Opinion 18 provide that a difference between the cost (or carrying amount) of an investment and the amount of underlying equity in the net assets of an investee should be accounted for as if the investee were a consolidated subsidiary. In concept, the investor is required to allocated the cost of the investment to the net assets of the investee in accordance with the purchase accounting requirements of APB Opinion 16. This allocation may give rise to temporary differences at the investee level that should be considered in determining the investor's share of earnings or losses of an investee as if the investee were a consolidated subsidiary.

For example, if the value assigned by the investor to the investee's depreciable assets exceeds the investee's financial statement carrying amount of the depreciable assets, a temporary difference will be created in the allocation process. Deferred taxes attributable to this temporary difference would also be created in this allocation process. Subsequent changes in the amount of the temporary difference related to the investee's depreciable assets would require an adjustment of the deferred taxes created at the acquisition date and, therefore, would affect the determination of the investor's share of earnings or losses of the investee. The deferred taxes at the investee level in this allocation process are not recognized in the investor's financial statements. The deferred taxes at the investee level that are created in the allocation process are used only in the calculation of the investor's share of the earnings and losses of the investee.

Deferred taxes wold not be created in this allocation process for the amount of the cost of the investment that is allocated to goodwill because Statement 96 prohibits the recognition of deferred taxes related to goodwill. As provided in paragraph 19(n) of APB Opinion 18, if an investor is unable to allocate the difference between the cost of an investment and the amount of underlying equity in the net assets of the investee to specific accounts of the investee, the difference should be treated as goodwill.

B. Temporary difference at investor level. A difference between the investor's financial statement carrying amount and tax basis of an investment in common stock accounted for under the equity method results in a temporary difference. Deferred taxes must be recognized on this temporay difference irrespective of how the cost of the investment was allocated to the investee's net assets. In other words, even if the investor allocated a portion of the cost of the investment to goodwill, the investor would recognize deferred taxes for the tax effect of the entire difference between its financial statement carrying amount and tax basis of the common stock of the investee.

If the financial statement carrying amount of the investment exceeds its tax basis, a temporary difference exists that will result in future taxable amounts. Paragraph 46 of Statement 96 states that deferred taxes are measured based on expected type of net taxable amounts in future years. Future net taxable amounts may result from (a) dividends, (b) liquidation of investee, or (c) sale of the investment. Unless there is evidence that realization will occur in the form of dividends (the investee has paid dividends in excess of current years' earnings in the past and plans to do so in the future), the scheduling process should be based on the assumption that the investor will realize its investment through sale. Generally, this will result in scheduling the future taxable amount relating to this temporary difference in the indefinite column when there are no current plans to dispose of the investment.

If the tax basis exceeds the financial statement carrying amount of the investment in common stock, the temporary difference generaly should be scheduled to result in a future deductible amount in the year in which the investor expects to sell the investment or in the indefinte column when there are no current plans to dispose of this investment. The investor's share of anticipated earnings of the investee in future years should not be considered in scheduling the reversal of this temporary difference because future income for financial reporting purposes should not be anticipated in the deferred tax calculation.

The reversal of a temporary difference relating to the difference between an investor's financial statement carrying amount and tax basis of an investment in common stock accounted for under the equity method may result in a capital gain or loss for tax purposes. It may be necessary in scheduling to segregate temporary differences that will result in capital gains and losses form temporary differences that will in ordinary taxable income and deductions.

13. Warranty Reserves

Tax deductions for warranty reserves generally are not allowed until the liability is settled. A temporary difference will exist in the amount of the reserve for financial reporting purposes. The temporary difference related to warranty reserves should be scheduled to result in deductible amounts in the years in which the tax deductions are expected to be claimed (generally, the period that the financial statement liability will be settled). Historical trends and the terms of the warranty agreements should be considered in estimating the pattern of reversal.

14. Interest Accrued for Aggresive

Tax Positions

Interest expense recognized for financial reporting purposes for the tax effect of expected adjustments by taxing authorities should not be reported as income tax expense under Statement 96. (See footnote 11 to paragraph 27 of the Statement.) Generally, the interest accrual for financial reporting purposes is not deductible for taxpurposes until a settlement is reached with the taxing authority. Accordingly, the deductible amount attributable to this temporary difference should be scheduled to occur in the year in which settlement is expected.

15. Deferred Profit on Installment

Sales

Although the deferral of profit on certain types of installment sales has been eliminated or restricted under the provisions of the Tax Reform Act of 1986, certain types of installment sales may result in a gain that is recognized immediately for financial reporting purposes but deferred for tax purposes. Generally, taxable income will be recognized as the receivable is collected. The taxable amounts attributable to this temporary difference should be scheduled based on the payment terms of the installment contract.

The taxable income recognized on installment sales may include both ordinary income and capital gains. It may be necessary to schedule future capital gains separately from future ordinary income.

16. Deferred Intercompany Profits

Intercompany gains on the sale of assets (such as inventory or fixed assets) between members of a consolidated group that operate in different tax jurisdictions are recognized at the time of the intercompany sale for tax purposes, but deferred for financial statement purposes. The buyer's financial statement carrying amount and tax basis in the asset are the same. The elimination of the intercompany profit in consolidation, however, results in a temporary difference in the buyer's tax jurisdiction equal to the excess of the buyer's tax basis over the consolidated financial statement carrying amount because it is assumed that the inventory will be recovered in the buyer's tax jurisdiction at the consolidated financial statement carrying amount.

In consolidation, the calculation of the buyer's deferred taxes should include the effect of the future deductible amount related to this temporary difference. Recognition of the tax benefit associated with this temporary difference will depend upon the buyer's deferred tax situation and carry-back ability. This temporary difference would be scheduled to result in deductible amounts in the periods in which the deferred intercompany profit is expected to be recognized for financial reporting purposes. For example, inventory differences would be scheduled to reverse in the year of expected sale of the inventory to a third party. For deferred intercompany profit on the sale of fixed assets, the related temporary difference would be scheduled to reverse over the depreciable life of the asset based on the differences in depreciation for financial reporting and tax purposes.

REcognition of a deferred tax asset or reduction of a deferred tax liability attributable to this future deductible amount may create net income or loss in the consolidated financial statements if the buyer's and seller's tax rates differ. Example 4 illustrates temporary differences resulting from intercompany sales of inventory.

17. Self-Insurance Reserves

The temporary difference attributable to self-insurance reserves recognized for financial reporting purposes but not for tax purposes, would be scheduled to result in deductible amounts in the years in which the company experts to claim the tax deduction. Historical trends and other information used to compute the liability should be used in estimating the periods of reversal.

18. Accrual of Loss Contingencies

Generally, accruals of loss contingencies, such as pending litigation, recognized in accordance with Statement of Financial Accounting Standards No. 5, "Accounting for Contingencies," are not deductible for tax purposes until paid. Accordingly, the related temporary difference should be scheduled to result in a deductible amount in the year in which the deduction for the liability is expected to be taken.

19. Discontinued Operations

If losses are expected from the discontinuance of a business segment, the estimated loss is recognized for financial reporting purposes at the measurement date in accordance with 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." For tax purposes, the losses are deductible when incurred. This temporary difference should be scheduled to reverse in the periods in which the losses are expected to be deductible for tax purposes.

20. Gains Arising from Issuance of

Stock by a Subsidiary

Gains recognized for financial reporting purposes by a parent company on the issuance of stock by a subsidiary will result in temporary differences, whether the gain is recognized in income or equity for financial reporting purposes. The gain is not included in taxable income in the year the subsidiary issues the stock. The gain would be reported in taxable income of the parent, however, if the parent sells the stock of the subsidiary. This temporary difference should be scheduled to result in a taxable amount in the indefinite column, unless the parent currently has plans to sell the subsidiary. Qualified tax-planning strategies may be available to avoid recognition of deferred taxes on such temporary differences.

21. Assets and Liabilities Measured

at Present Value

Certain assets and liabilities are measured at present value for financial reporting purposes. For example, certain assets, such as notes receivable, mortgage loans, and commercial loans, acquired in purchase business combinations are assigned values based on the present value of amounts to be received. In nontaxable business combinations, the acquired company's tax basis in these assets would carry over to the acquiring company. A temporary difference will result for the difference between the assigned value and the tax basis of the asset.

Other types of assets measured at present values include sales-type or direct financing leases. The lease receivables are recognized for financial reporting purposes at the present value of the amounts to be received. For tax purposes, the lease is accounted for as an operating lease and, therefore, there is no lease receivable. In addition, certain liabilities are recognized for financial reporting purposes at amounts equal to the present value of expected payments. Examples of liabilities measured at present values include deferred compensation and capital lease obligations. For tax purposes, no liability exists for such obligations because the deductions are not allowed until payments are made.

The following alternatives are available for scheduling the reversal of temporary differences relating to assets and liabilities measured at present value:

1. Approach A. The temporary difference may be scheduled to reverse based on the future reductions in the principal balance of the asset or liability.

2. Approach B. The temporary difference may be scheduled to reverse based on the present value of future cash flows.

Earlier this year, the FASB tentatively concluded that either approach would be acceptable. The FASB staff, however, continues to consider approaches to scheduling assets that are measured at present value. Under a third approach, for example, when the tax basis exceeds the financial statement carrying amount of an asset or liability measured at present value, the related temporary difference would be scheduled to result in future taxable or deductible amounts either (i) on the first day of the year subsequent to the balance-sheet date or (ii) based on the present value or future cash flows (Approach B). The FASB staff may well provide further guidance on this issue.

Examples 5 and 6 illustrate the application of Approach A and Approach B.

As illustrated by Examples 5 and 6 the two approaches produce dramatically different effects on the scheduling process. The pattern of the future deductible or taxable amounts reverses under the two approaches. Whichever approach is selected, it should be applied consistently from year to year. Although it would be desirable to use the same approach for all assets and liabilities measured at present value, different approaches may be used for different classes of assets and liabilities. The same approach, however, should be used for all assets and liabilities within a class.

22. Leasing

a. Lessee. Certain lease agreements that are treated as operating leases for tax purposes are classified by lessee as capital leases for financial reporting purposes. For financial reporting purposes, the lessee records an asset and a capital lease obligation at the inception of the lease at an amount equal to the present value of minimum lease payments during the lease term. No related asset or liability exists for tax purposes are classified by a lestx purposes. Example 7 illustrates scheduling temporary differences for capital leases of a lessee.

b. Lessor. Certain lease agreements that are treated as operating leases for tax purposes are classified by a lessor as direct-financing or sales-types leases for financial reporting purposes. Generally, the present value of the lease payments during the lease term and the residual value of the leased asset at the end of the lease term are recognized for financial reporting purposes as the net investment in the lease.

The deductible amount scheduled in each future year should be based on the depreciation to be recognized for tax purposes in those future years. The taxable amount scheduled in each future year should be based on the present value of amounts to be received in each future year or on the future principal reductions in the lease receivable.

c. Deferred Gains on Sale and Leaseback Transactions. Generally, gains on sale and leaseback transactions are taxable in the year of sale, but are deferred for financial reporting purposes under the provisions of Statements of Financial Accounting Standards No. 28, "Acounting for Sales with Leaseback," and No. 98, "Accounting for Leases: Sale-Leaseback Transactions Involving Real Estate, Sales-Type Leases of Real Estate, Definition of Lease Term, Initial Direct Costs of Direct Financing Leases." The leaseback may be classified as a capital lease or an operating lease. The deferred gain would be amortized in proportion to the amortization of the leased asset, if a capital lease, or in proportion to the gross rental charged to expense over the lease term, if an operating lease.

The temporary difference attributable to the deferred gain on a sale and leaseback transaction should be scheduled to result in deductible amounts based on the amount of the deferred gain expected to be recognized in income in each future year.

23. Pensions

Temporary differences frequently will arise as a result of differences between the tax basis of pension assets and liabilities and the amounts recognized under Statement of Financial Accounting Standards No. 87, "Employers' Accounting for Pensions." For example, assuming that a company funds pension cost to the extent deductible for tax purposes, a pension asset will be recognized when the amount funded is in excess of pension cost determined under Statement 87. A pension liability will be recognized when the amount funded is less than pension cost determined under Statement 87. In addition, settlement gains and losses recognized under Statement of Financial Accounting Standards No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits," will create temporary differences because the transactions generally are not taxable or deductible at the date recognized for financial reporting purposes. Because of the complexities of accounting for pensions, there will be numerous other situations that will result in temporary differences.

Under one approach to scheduling temporary differences related to pensions, the future taxable amount related to a pension asset should be scheduled in the indefinite column unless the company plans to terminate the plan. The temporary difference attributable to a pension liability recognized for financial reporting purposes may be scheduled to result in deductible amounts based on the present value of the estimated deductible contributions (based on current plan participants and assumptions) to the pension plan in future years, limited to the amount of the pension liability.

Example 8 illustrates the application of the percent value approach to scheduling temporary differences related to pension liabilities.

An alternative approach is (i) to schedule temporary differences related to pension assets to result in future taxable amounts based on the estimated pension expense for financial reporting purposes in future years, limited to the amount of the pension asset, and (ii) to schedule the temporary differences related to a pension liability to result in future deductible amounts based on estimated future tax deductible contributions to the pension plan in excess of estimated future pension expense for financial reporting purposes, limited to the amount of the pension liability. Whichever approach is used, it should be applied consistently from year to year and for all of the company's pension plans.

24. Deferred Investment Tax Credits

The temporary difference related to investment tax credits that are deferred for financial reporting purposes should be scheduled to result in future deductible amounts in the periods in which the deferred credits will be recognized for financial reporting purposes.

Conclusion

Identification and scheduling of temporary differences under Statement 96 will be a complex and time-consuming process. In many cases, precise determination of the scheduling pattern may be impossible and substantial judgments and estimates will be required. This article has addressed the scheduling pattern for a number of common temporary differences. Further guidance on scheduling issues and other issues arising from the implementation of Statement 96 will be addressed in a Question-and-Answer book expected to be issued by the FASB's staff before the end of this year.

Editor's Note: At the September 28, 1988, meeting of the FASB, the Board tentatively concluded to issue an exposure draft of a Statement that would defer the effective date of Statement 96 for one year. The Board will likely issue such a Final Statement by the end of the year. For a corporation with a December 31 year-end, the effective date deferral will mean that Statement 96 must be adopted no later than the year ended December 31, 1990, with the effects of the new standard being reflected as of the beginning of the fiscal year.

(*) This article is adapted from the author's presentation to Tax Executives Institute's seminar on "Implementation of FAS 96: Techniques and Planning Strategies," which was held in Chicago, Illinois on September 26-27 1988. The material that the author used was derived from his firm's publication on the subject matter, entitled "Accounting for Income Taxes: An Analysis of FASB Statement 96."
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Author:Diebold, Joseph P.
Publication:Tax Executive
Date:Sep 22, 1988
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