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Accounting for the nonmonetary exchange of cost-method investments, an employers assumption of insolvent insurance companies' pension obligations and the Texas Franchise Tax.

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 the Financial Accounting Standards Board emerging issues task force (EITF) consensuses as sources of established generally accepted accounting principles.

This month's column lists 1991 and 1992 FASB EITF consensuses adopted from July 11, 1991, through May 21, 1992 (see the side bar on page 104). Summaries are provided for three of these: nonmonetary exchange of cost-method investments, an employer'ss assumption of insolvent insurance companies' pension obligations and accounting for state franchise taxes that include an income-based component.

EITF Abstracts, copyrighted by the FASB, is available in soft-cover and loose-fear versions and may be obtained by contacting the FASB order department at 401 Merritt 7, P.O. Box 5116, Norwalk, Connecticut 06856-5116. Phone: (203) 847-0700.

ISSUE NO. 91-5

EITF issue no. 91-5, Nonmonetary Exchange of Cost-Method Investments, discusses the applicability of APB Opinion no. 29, Accounting for Nonmonetary Transactions, to an investor whose cost-method investee exchanges all its stock for the stock of a public company in a business combination. A typical example: The investee is the target company in a business combination. To effect the combination, target shareholders (including the investor) exchange their shares for acquiring company shares. The combined company's shares will continue to be publicly traded after the merger.

The issue is whether the investor should record the exchange at the fair value of the stock received and recognize a gain or loss to the extent that the fair value of the stock received differs from the investor's cost basis in the shares in the target company.

The consensus did not discuss how to determine the fair value of the combined company. However, based on the guidance in paragraph 5 of FASB Statement no. 107, Disclosures about Fair Value of Financial Instruments, a logical measurement of fair value would be the quoted market price at the date of the combination times the number of shares exchanged.

The EITF reached three consensuses on this issue, which provide different accounting rules depending on the investee's role (acquiree or acquiror) in the business combination. (If the identity of the acquiror is unclear, paragraph 70 of Accounting Principles Board Opinion no. 16, Business Combinations, provides guidance.) The three consensuses are that the investor

* Records the transaction at fair value if its investee is the acquired company in the business combination.

* Continues to carry its investment at historical cost if its investee is the acquiror in the business combination.

* Also follows the guidance in the consensuses above if the investor had cost-method investments in both the acquiree and acquiror before the business combination. That is, after the combination, the investor would use fair value to account for the exchange of the investment in the acquired company and continue to carry its investment in the acquiror at historical cost.

ISSUE NO. 91-7

EITF issue no. 91-7, Accounting for Pension Benefits Paid by Employers after Insurance Companies Fail to Provide Annuity Benefits, arose from companies that assumed, often under pressure from the U.S. Department of Labor, insolvent insurers' annuity contracts payable to retirees. The insolvency of insurance companies such as Executive Life Insurance Co. triggered this issue.

Typically, the employer had settled its pension obligation by purchasing insurance annuity contracts from an insurance company and had recognized a gain or loss in the settlement year. When the insurance company became insolvent and was unable to meet all its obligations under the annuity contract, the employer agreed to assume either some or all of any deficient annuity payments to retirees.

The issue is how the employer should account for those costs of compensating retirees.

The task force reached a consensus that the employer should recognize a loss when the deficiency is assumed if any gain was recognized on the original pension obligation settlement. The loss recognized would be the lesser of (1) any gain recognized on the original settlement or (2) the benefit amount assumed by the employer. Any excess obligation the employer assumed over the loss recognized should be accounted for as a plan amendment or a plan initiation and should be amortized to pension expense over future periods as provided in FASB Statement no. 87, Employers' Accounting for Pensions.

ISSUE NO. 91-8

Issue no. 91-8, Application of FASB Statement 96 to a State Tax Based on the Greater of a Franchise Tax or an Income Tax, arose when Texas changed its franchise tax laws to impose a two-tier tax on corporations-- a capital-based tax and an incomebased tax.

The income-based tax is the excess, if any, of a percentage of a corporation's net taxable income over a percentage of net taxable capital. The tax is payable on May 15 but is based on taxable capital and income of the previous calendar year. The issues are to what extent the new Texas tax is based on income and how to compute deferred taxes under FASB Statement no. 96, Accounting for Income Taxes. This EITF issue was updated recently for FASB Statement no. 109, Accounting for Income Taxes.

The EITF reached a consensus that the total Texas tax is an income tax only to the extent that the total tax exceeds the capital-based tax in a given year. The income portion of the total tax due should be accrued with a charge to income during the period the income was earned. These conclusions were not modified by Statement no. 109.

Under Statement no. 109, deferred taxes are recognized for temporary differences that will reverse in future years for which the tax on annual taxable income is expected to exceed the tax on expected net taxable capital. The change from Statement no. 96 is that the need for scheduling is greatly reduced.

This consensus can be applied to other states with similar franchise tax laws.
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Author:Volkert, Linda A.
Publication:Journal of Accountancy
Date:Sep 1, 1992
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