The FASB revisits Statement 96, Accounting for Income Taxes.
The long road of Statement 96 isn't nearing its end yet, and roadblocks keep popping up. Is the FASB finally following the same map that Corporate America is? When initially adopted in December 1987, FASB Statement 96, Accounting for Income Taxes, was to have become effective in the first quarter of calendar 1989. After much controversy and two postponing "amendments" (mandatory adoption is now scheduled for 1992), the Board is still actively considering the two aspects of the standard that led two Board members to dissent to its issuance--the recognition of deferred tax assets and the complexity of the tax accounting model.
While it is too early to predict what changes, if any, might result, the Board now is considering whether a "presumptive" approach will increase the acceptance of the liability method of deferred tax accounting and at the same time stay within the confines of the Board's conceptual framework.
Previous alternatives considered
Throughout 1989, the Board deliberated on two alternative approaches to dealing with the Statement 96 controversy. The first alternative would eliminate the existing Statement 96 prohibition against considering the likelihood of future income to justify the recognition of deferred tax assets. This alternative came to be known as a "probability approach." Under it companies would recognize future tax benefits as assets if the ultimate realization met a suitably high threshold of probability, a fundamental change from Statement 96.
The second alternative considered was whether something could be done to reduce the computational complexities of the statement, especially its requirements for scheduling reversals of temporary differences and engaging in hypothetical tax planning strategies. This alternative, referred to as an "aggregate approach," would allow computations based on an overall netting of deferred tax debits and credits, but would not lead to significant change in the underlying theory of the statement.
For a while, it appeared that the probability approach would prevail. However, in October of 1989, when the Board voted on this issue (in conjunction with proposing a one-year delay in the effective date), four Board members opposed the probability approach because anticipating future income is incompatible with the Statement 96 model.
That model restricts the recognition of net deferred tax assets to the amount that would be recovered based upon the presumed carryback of net operating losses that result from scheduling the reversal of existing temporary differences by year. In reality, the net operating losses usually will not occur because, in most cases, companies will generate future taxable income, thereby enabling realization of the deferred tax asset.
At the October meeting, a majority of the Board members also indicated that they did not support the aggregate approach, so it appeared that the Board's reconsideration of Statement 96 was at a standstill.
When it considered the comments on the proposed one-year delay in December, the Board agreed to reconsider whether the probability of future income should be considered in the recognition and measurement of deferred taxes, including deferred tax assets. It also decided to defer the effective date until 1992, on the basis that a one-year period is not sufficient time to consider requests for amendment, allow due process for any changes that might result, and still allow companies time to implement the standard.
A presumptive approach
Currently, the Board is focusing on a variation of the probability approach, under which companies would recognize the future tax consequences of all events that had occurred as of the balance sheet date. The potential future tax benefits of both deductible temporary differences and net operating losses would be recognized as assets unless realization is considered doubtful.
In effect, the approach now being considered would establish a presumption that tax benefits will be realized either by recovering taxes paid in the carryback period or by reducting taxes otherwise payable as a result of future income.
Key to this approach is the meaning of "doubtful" and the level of doubt necessary to overcome the underlying presumption as to the ultimate realization of deferred tax assets. The Board is pursuing establishing "warning lights"--signals that realization of future tax benefits is doubtful enough that they should not be recognized. Suggested "warning lights" include a forecast of future losses, an existing deficit in shareholders' equity, loss of a major customer, and a combined net loss for the current year and preceding two years. No one "warning light" would prohibit deferred tax asset recognition (as was generally the case for net operating losses under APB Opinion No. 11, Accounting for Income Taxes). Instead, one or more would signal the need for management to carefully consider whether realization of the recorded deferred tax asset is doubtful in light of available evidence. A deferred tax asset would not be recognized initially (or would subsequently be written off) if information indicates that ultimate realization is doubtful.
The principal difference between this "presumptive approach" and the probability approach previously considered is how companies evaluate whether deferred tax assets can be recognized in the balance sheet. Under the probability approach previously considered, companies would have been required to make an affirmative assessment that the future tax benefit would likely be realized in order for the asset to be recorded.
In many cases, this would require forecasting income by year for many years if deductible temporary differences were scheduled to reverse in the distant future. For example, a company accruing postemployment health care costs would expect the related deductible temporary differences to reverse over an extended period, say 20 to 30 years. It would be extremely difficult for that company to demonstrate probability if it had to estimate income for each of those future years. The presumptive approach now being considered is a probability approach in reverse. The deferred tax benefit for deductible temporary differences would be recorded as an asset unless there is evidence that realization is doubtful.
It would seem that the presumptive approach being considered also would eliminate the scheduling effort required by Statement 96, because deferred tax assets would be recognized unless realization is doubtful. Nonetheless, some board members believe the timing of a future deduction is an important factor in assessing whether there is doubt about the realization of future tax benefits. For example, deductible temporary differences that reverse in the near term--such as those related to warranty accruals--might provide a tax benefit either by carryback or as an offset to future taxable income. In contrast, deductible temporary differences that reverse in the distant future--such as those related to long-term deferred compensation plans--might provide a tax benefit only by offsetting future taxable income.
Several potential roadblocks stand in the way of the Board reaching agreement on the presumptive approach. The principal obstacle is the belief of some Board members that it contradicts Statement 96's prohibition of anticipating future income and also contradicts the accounting model's definition of an asset. Those Board members believe that the transaction giving rise to the asset (i.e., future earnings) has not yet occurred, and thus no asset should be recognized.
Some Board members also believe that, if future income were anticipated for purposes of recognizing deferred tax assets, then future losses should be considered for purposes of recognizing deferred tax liabilities. While a deferred tax liability could be considered "impaired"--and written off--if future losses were anticipated, writing down liabilities simply because future losses are expected may be a troublesome issue to deal with.
Another hurdle is the question of whether a presumptive approach should apply to all future tax benefits--net operating loss carryforwards as well as deductible temporary differences. Based on current Board discussions, it would apply equally to both. But some Board members believe that asset recognition for net operating loss carryforwards should be subject to a higher threshold because of the inherently greater uncertainties surrounding a company with a history of losses. APB Opinion No. 11 permitted deferred tax asset recognition for loss carryforwards only in the rare circumstances that realization of the deferred tax assets was assured "beyond a reasonable doubt"--a threshold much higher than mere absence of doubt.
Potential for other changes
Adopting a presumptive approach for recognizing deferred tax assets likely would require that other controversial aspects of Statement 96 be revisited. For example, deferred tax assets might be measured at future tax rates as opposed to the Statement 96 requirement to measure them at carry-back rates. The Board might also revisit a measurement problem that arises in certain business combinations that occur shortly before a change in the tax law. Statement 96 precludes recognition of pending tax law changes, requiring that the effects of such changes be recognized in income when the tax law is enacted. A presumptive approach would seem to permit companies to anticipate the effects of pending tax legislation in allocating the purchase price in a business combination.
A responsible decision
Most companies have put their plans for adopting the statement on hold as the Board continues its reconsideration of fundamental aspects of this controversial standard. Because of the continuing uncertainty, companies will want to keep in touch with developments in this important area.
So far, the FASB has agreed only to explore a presumptive approach. But, because the decision to do so was unanimous, many in the business community are hoping that changes will be forthcoming.
The reconsideration of Statement 96 has been frustrating to many, but, nonetheless, we believe that the Board's reconsideration is a positive sign. The Board has in effect acknowledged an obligation to its constituency to rethink its conclusions, and, to us, that is a responsible decision.
Robert K. Herdman and Robert D. Neary
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|Title Annotation:||Financial Accounting Standards Board|
|Author:||Neary, Robert D.|
|Date:||May 1, 1990|
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