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Accounting for income taxes: Statement of Financial Accounting Standards No. 109.

The Financial Accounting Standards Board originally issued FASB 96, Accounting for Income Taxes, in December, 1987. Although the basic concepts of FASB 96 were accepted by the accounting community, it was strongly criticized because of the complexity of application. As issued, FASB 96 was effective for financial statements for fiscal years beginning after December 15, 1988. The effective date was deferred three times, the last date being December 15, 1992.

In June of 1991, the Board issued a new Exposure Draft which retained the approach used in FASB 96, but reduced the complexity. The new Statement of Financial Accounting Standards No. 109 was issued in February of 1992 and is effective for fiscal years beginning after December 15, 1992. FASB 109 is applicable for federal, foreign, state and local taxes that are based on income.

The separate requirements of tax laws and financial accounting can be seen in the differences between "book income" and taxable income and in the different bases of assets and liabilities on the financial statements. FASB 109 addresses these differences and establishes standards for the necessary financial statement reporting. A balance sheet approach is used and the emphasis is on accruing assets and/or liabilities based on future tax consequences.

The statement has two objectives: (1) to recognize the amount of taxes that are currently payable or refundable; and (2) to recognize deferred tax assets and liabilities based on the future tax consequences of events that have been recognized in the current financial statements. In order to accomplish these objectives, certain principles are applied at the date of the financial statements. 1. A current tax liability or asset is

recognized for current year taxes

payable or refundable. 2. A deferred tax liability or asset is

recognized for future tax effects

attributable to temporary differences

and to carryforwards. 3. The measurement of both current

and deferred tax liabilities

and assets is based on the enacted

tax law; future changes in

the tax law are not anticipated. 4. Measurement of deferred tax assets

is reduced, if necessary, by

any tax benefits that are not expected

to be realized.

Events that will have future tax consequences are referred to as temporary differences. Examples of these differences are: 1. Revenues or gains that are taxable

after they are recognized in

the financial statement. The receivable

from an installment sale

will result in future taxable

amounts as the receivable is recovered. 2. Expenses or losses that are deductible

after they are recognized in

the financial statement. Product

warranty liabilities will not

be recognized for tax purposes

until the liability is settled and

will create a future tax deductible

amount. 3. Revenues or gains that are taxable

before they are recognized

in the financial statement. Subscriptions

received in advance are

a good example. 4. Expenses or losses that are deductible

before they are recognized

in the financial statement.

Accelerated depreciation will

cause a taxable event when the

asset is disposed of because of the

difference between the tax basis

of the asset and the book basis. 5. A reduction in basis because of

tax credits. Again the tax basis

and the book basis of the asset

will differ when the asset is disposed


Some events do not have tax consequences and, therefore, a deferred tax asset or liability is not recognized. Interest earned on municipal bonds is an example of an event which has no tax consequences, at least for federal tax purposes.

It is important to make note of the difference between taxable temporary differences and deductible temporary differences. FASB 109 requires these amounts be calculated separately. A taxable temporary difference is one that will result in a taxable amount in the future and creates a liability. A deductible temporary difference results in deductible amounts in future years and creates an asset.

The actual deferred tax expense or benefit is defined as the change during the year in the entity's deferred tax liabilities and assets. The following steps are performed in the calculation: 1. Identify the types (i.e., capital,

ordinary) and amounts of temporary

differences. 2. Identify nature and amount of

operating loss and tax credit

carryforwards and the remaining

length of the related carryforward

period. 3. Measure the total deferred tax

liability using the enacted applicable

tax rate. 4. Measure the total deferred tax

asset for temporary differences

and for operating loss

carryforwards using the applicable

tax rate. 5. Measure deferred tax assets for

each type of tax credit

carryforward. 6. Reduce deferred tax assets by a

valuation allowance if, based on

the weight of available evidence,

it is more likely than not (more

than 50%) that some portion of

all of the asset will not be realized.

The applicable tax rate is defined as the enacted tax rate expected to apply to income in the period in which the deferred tax liability or asset is expected to be settled or realized. Other provisions of the enacted tax law, such as future indexing, are also considered.

Try the following problem which illustrates a very simple deferred tax situation. The answer appears on page 11. Further explanation of the Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes will be given in future issues of the NPA. Please call the Education Department at NSPA with any questions.
 June Problem
 Fix-it Company was formed on January 1, 1991. Book and tax income
for the first year of operation are as follows:
 Income per books $ 12,000
 Excess of tax over book
 depreciation (6,000)
 Potential Litigation 1,500
 Warranty Reserve 1,000
 Taxable Income $ 8 500

The warranty reserve is expected to be applied in 1992 and 1993 in the amounts of $600 and $400 respectively. The firm anticipates settling the litigation in 1995. The accelerated depreciation will reverse equally over the years 1992-1995. Assume a flat tax rate of 40% for all years. Compute the deferred tax expense/benefit and the deferred tax liability/asset and prepare the appropriate journal entry.
 Answer to June Problem
Deferred deductibles Deferred Taxables
 Litigation $ 1,500 Depreciation $ 6,000
 Warranties 1,000
 $ 2,500 $ 6,000
 Tax rate x40% x40%
 Total $ 1,000 $ 2,400
Deferred Tax Expense = $2,400 - $1,000 = $1,400
Deferred Tax Expense $1,400
Deferred Tax Asset $1,000
 Deferred Tax Liability $ 2,400
 To record deferred tax expense and related asset and liability for
year ended 12/31/91.

NOTE: In this case, the amounts can be determined without spreading e information over the appropriate years. If there were changes in the tax rate or any other variables, it would be necessary to schedule the calculation. This technique will be illustrated in a future column.
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Article Details
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Author:Schwartz, Marlyn A.
Publication:The National Public Accountant
Date:Jun 1, 1992
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