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Accounting for Income Taxes The Basics March Common Questions Before by ramhood17

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									Accounting for Income Taxes –
         The Basics
         March 22, 2006
Common Questions Before We Begin…
  Continuing Professional Education (CPE): CPE certificates will be
  issued automatically to all those who remain on today’s call for 50 minutes.
  Copy of Presentation: A copy of the presentation is available now by
  clicking File>Print>Document or File>Save>Document. Also, a copy will be
  sent to you afterward along with a recording of this event.
  Your Questions: You are invited to submit questions to the presenters at
  any time today. Questions and answers will be anonymous to all but the
  presenters. Use the Q&A box on the lower right hand side of your screen to
  pose questions.




                                     2
The Next FAS 109 Seminar:
  FAS109-International Aspects
  Date\Time:
   • April 12, 8:00 P.M. New York Time
   • April 13, 8:00 A.M. Hong Kong Time
  Subject Matter:
   • Parent - Incremental Tax on Repatriation
   • Common Foreign Subsidiary Reporting Requirements
      • Information for U.S. earnings and profits
      • Taxes paid

  Enrollment: An email will be sent to you shortly




                                    3
Sponsor:
Frans Samyn, CEO, BDO International
                              Welcome to BDO International
           Ranking: 5th largest world wide network of public accounting firms
           Countries Represented: 93 Member firms in 105 countries with
           600 offices

           Staff: More than 27, 800 professionals
           Income: Global fee income of all BDO Member Firms for the year ending
           30 September 2005 totalled € 2,763 million (US$ 3,329 million)
           Headquarters:
                         BDO Global Coordination B.V.
                         Email:bdoglobal@bdoglobal.com
                         Tel: +32 2 778 01 30
                         Fax: +32 2 778 01 43
                         Address: Boulevard de la Woluwe 60
                         B1200 Brussels
                         Belgium.
                                     4
Sponsor:
William Ramirez, CEO, TEI Asia Chapter
                     Welcome to TEI Asia Chapter
           Who We Are: Part of the leading association of tax professionals in the
           world

           Mission: Provide a forum for tax executives to discuss current tax and
           management issues

           Membership: 5,400 members in 53 chapters in the U.S., Canada,
           Europe and Asia
           Why Join: Access to the best, most cost-effective tax training and
           camaraderie of fellow tax professionals
           How to Join:
                     Contact Bill Ramirez at: william.ramirez@ap.altria.com
                                               Or
                     Vincci Lo at: VLo@lexmark.com


                                   5
 Presenters:
 Robert Terpening, CPA
                                                              Professional Profile
                               Present
                               Partner
                               BDO Seidman, LLP, San Jose

                               Experience
                               Rob has more than 16 years of public accounting experience assisting growing
                               companies with their tax needs. His experience includes accounting for income
                               taxes and related Sarbanes-Oxley section 404 tax issues, tax-efficient international
                               expansion, stock-based compensation, research credit and loss limitation issues.
                               He also has substantial experience working with companies in the high technology
                               and life sciences industries. Mr. Terpening will also be the Practice Leader for
                               Income Tax Accounting Services.

                               Education
Areas of Experience:           Bachelor’s, California Polytechnic State University, San Luis Obispo
•Accounting for income taxes   Master’s, taxation, San Jose State University
•International expansion
•Stock-based compensation      Associations
                               California Society of Certified Public Accountants
                               American Institute of Certified Public Accountants




                                                          6
Presenters:
Katherine Morris, CPA
                                                              Professional Profile
                        Experience
                        Katherine is the Southeast Regional Leader of BDO’s National Income Tax Accounting Team and a
                        member of the BDO’s National Corporate Tax Consulting Group, which focuses on recent corporate
                        tax developments and on providing proven tax saving ideas to BDO clients. With over 20 years of
                        experience, Katherine has a breadth of technical skills, is a frequent speaker on income tax
                        accounting matters and the tax impact of the new stock-based compensation rules under FAS
                        123R. She recently published an article in the Tax Advisor on the impact of the Sarbanes Oxley Act
                        on accounting for income taxes and on accounting for tax contingencies.
                        Areas of Specialization
                         FAS 109 consulting projects
                         Tax return preparation and planning
Katherine Morris, CPA    Implementing changes to tax accounting methods
Tax Partner
1100 Peachtree Street    Managing Net Operating Losses
Suite 700                Resolving IRS and state tax audit controversies
Atlanta, GA 30309
Tel: (404) 979-7182     Education
Cell: (404) 317-1883    B.B.A., Accounting, Georgia State University
Fax: (404) 688-1075
kmorris@bdo.com         Professional Affiliations
                        American Institute of Certified Public Accountants
                        Georgia Society of Certified Public Accountants
                        Technology Association of Georgia - TAG
                        Women in Technology – TAG
                                                        7
                        Association for Corporate Growth – Atlanta Chapter
Course Objectives
  Upon successful completion of this course,
  participants will be able to:
  • Describe the basic U.S. GAAP FAS 109 principles
  • Prepare a simple U.S. tax reporting package
  • Review an Effective Rate Reconciliation




                          8
Common Global Provision Reporting
  Tax provisions are calculated for each jurisdiction
  • Common Foreign Subsidiary Reporting Requirements
       •   Provision (Current and Deferred) *
       •   Deferred Tax Assets and Liabilities *
       •   Valuation Allowance *
       •   Tax Contingency Reserves (Final Interpretation Expected)
  Parent - Incremental Tax on Repatriation **
  • Common Foreign Subsidiary Reporting Requirements
       • Information for U.S. earnings and profits
       • Taxes paid

  * Discussed in this session
  ** Discussed in the International Session on April 12 @ 8:00 p.m. New York Time =
                                               April 13 @ 8:00 a.m. Hong Kong Time



                                          9
Polling Question#1
  Does your Company require foreign affiliates to
  prepare provision reporting packages?




                       10
FAS 109: Basic Theory
  Matching Principal
  Current Year’s Book Earnings with
  • Current tax implications
  • Future tax implications




                           11
FAS 109: Objectives
  The objectives of FAS 109 are to recognize
  • The amount of taxes payable/refundable for the current
    year.
  • Deferred tax liabilities/assets for the future tax
    consequences of events that have been recognized in
    an enterprise’s financial statements or tax returns.




                          12
FAS 109: Principles
  Asset and Liability Approach
  • (versus Income Statement)
  Recognize Taxes Currently Payable or
  Refundable
  Recognize Future Taxes Payable (Deferred
  Liabilities) or Future Tax Benefits (Deferred
  Assets)




                        13
Steps in Determining a Tax Provision
1.   Determine permanent and temporary
     differences.
2.   Compute the current tax provision.
3.   Compute the deferred tax provision.
4.   Other Considerations…




                         14
Step 1: Determine Permanent and Temporary
Differences
  What is a Book/Tax Difference?
  • An item treated differently for tax return reporting
    purposes than for financial accounting purposes
  • Compare US GAAP to Foreign Tax
  Two Categories of Book/Tax Differences
  • Permanent Differences – impacts effective tax rate
  • Temporary Differences – typically do not impact
    effective tax rate




                            15
Step 1: Determine Permanent and Temporary
Differences
  Permanent Differences
  • Definition: a book versus tax difference that will never reverse for
    book and tax reporting purposes.
  • Computation:
      • Income or expense amount reported for the financial statements
      • Compared to amount reported in the tax returns
      • Multiplied by the current tax rate
  • Affect Effective Tax Rate (“ETR”)
  • Examples include:
      • Penalties – deductible for books, not tax
      • Meals & Entertainment expenses – deductible for books, not tax
      • Tax-exempt interest income – taxable for books, not tax




                                   16
Step 1: Impact of Permanent Items on ETR
                                   Base   Perm Difference   Pretax Income
                                               Increases        Increases

Pretax Income                       100            100             110

Permanent Difference –               10              15              10
Meals & Entertainment
Taxable Income                      110            115             120

Tax Expense (40%)                    44              46              48

Impacts ETR                        44%            46%           43.6%
(Tax Expense/Pretax Income)



                              17
Step 1: Temporary Differences
  Definition:
   • Difference between the book and tax basis of an asset or liability that
     will result in taxable or deductible amounts in future years when the
     asset or liability is recovered or settled
  Computation:
   •   Use a balance sheet approach.
   •   Book basis of assets / liabilities
   •   Compared to Tax basis of assets / liabilities
   •   Multiplied by the future tax rate expected (i.e., when the item reverses in a
       future period).
  Examples include:
   •   Depreciation
   •   Vacation accruals
   •   Allowance for doubtful accounts
   •   Warranty reserves



                                      18
Exercise 1
  Facts:
   • The Company has $1,000 in pre-tax income and has
     identified the following book / tax differences:
      • Meals & Entertainment expenses – books $10
      • Tax-exempt interest income – books $5
      • Book depreciation of $1,000; tax depreciation of $1,500
      • Warranty reserves – books $10

  Objective:
   • Classify Book/Tax Differences as Permanent or
     Temporary Differences


                               19
Exercise 1
                                                 Current


     Pre-tax Book Income                              $1,000

     Tax Adjustments:

       Meals & Entertainment      Permanent or             10
                                   Temporary?
       Tax-exempt income          Permanent or             (5)
                                   Temporary?
       Accelerated depreciation   Permanent or         (500)
                                   Temporary?
       Warranty reserves          Permanent or             10
                                   Temporary?
     Current Taxable Income for                            515
     Tax Return

      Tax Expense                                          206

                                  20
Exercise 1 Question\Polling Question#2
  Please answer:
   •   The following items are permanent items:
   •   (a) Meals & Entertainment
   •   (b) Tax exempt interest
   •   (c) Accelerated depreciation
   •   (d) Both (a) & (b) above




                            21
Exercise 1 Answer
                                        Permanent or   Current
                                         Temporary?
      Pre-tax Book Income                               $1,000

      Tax Adjustments:

        Meals & Entertainment            Permanent           10

        Tax-exempt income                Permanent          (5)

        Accelerated depreciation         Temporary        (500)

        Warranty reserves                Temporary           10

      Taxable Income                                       515


       Tax Expense                                         206


                                   22
Steps in Determining a Tax Provision
1.   Determine the permanent and temporary
     differences.
2.   Compute the current tax provision.
3.   Compute the deferred tax provision.
4.   Other Considerations…




                         23
Step 2: Current Tax Liability
  The amount of income taxes paid or payable (or
  refundable) for a year as determined by applying
  the provisions of the enacted tax law to the
  taxable income.




                       24
Step 2: Current Tax Liability Computation
Pre-tax Book Income
+/- Tax Adjustments
    = Taxable Income Before NOLs
    - NOL Carryforwards
       =Taxable Income
       x Applicable Tax Rate
              = Current Tax Provision Before Tax Credits
               - Tax Credits
              = Expected Current Tax Liability
                 (Current Provision)


                           25
Steps in Determining a Tax Provision
1.   Determine permanent and temporary
     differences.
2.   Compute the current tax provision.
3.   Compute the deferred tax provision.
     •   Determine if a valuation allowance for DTA’s is
         needed.
     •   Measure based on currently enacted rates
4.   Other Considerations…


                              26
Step 3:
What Would Happen Without Deferred Tax?
                              Year 1    Year 2   Total
Pretax Income                     100     100     200

Temporary Difference –             10     (10)      0
Warranty Reserve
Taxable Income                    110      90     200
Current Tax (40%)                  44      36      80
Effective Tax Rate (“ETR”)        44%    36%     40%
(Without Deferred Tax)




                             27
Step 3: FAS 109 Principles - DTL
  Deferred Tax Liabilities (DTL)
  • Temporary Differences that result in Future Tax
    Payments
  • Typically include:
     • Accelerated depreciation
     • Amortization
     • Current deductions for tax, not books
  • Example:
     • Tax > book depreciation $500,000
     • Book asset basis > tax basis
     • Future tax payments = DTL of $200,000
         •   ($500,000 * ETR 40%)

                                28
Step 3: FAS 109 Principles - DTA
  Deferred Tax Assets (DTA)
  • Future Tax Benefits
  • Typically include:
     • Temporary Differences
         •   Deferred compensation
         •   Accruals and Reserves
         •   Future deductions
     • Net Operating Losses (NOLs)
     • Tax credit carryforwards




                                29
Step 3: FAS 109 Principles - DTA (continued)
  Deferred Tax Assets (DTA)
   • Example 1:
      • $10,000 Accrued Warranty Reserve liability creates book basis
        in excess of tax basis
      • $4,000 in DTA recorded ($10,000 * 40%)
      • Future Tax Deduction occurs upon Payment of the Warranty
        Expenses
   • Example 2:
      • $5,000 NOL for tax cannot be used in current year
         •   (assumes no valuation allowance)
      • $2,000 in DTA recorded ($5,000 * 40%)
      • Future Tax Benefit occurs upon recognizing the NOL to offset
       future taxable income


                                    30
Step 3: Basic Formula
Total Income Tax Expense/Benefit:

  Current Income Tax Payable/Refundable
                   +/-
  Change in Deferred Tax Asset/Liability
  from beginning to the end of the reporting period
                    =
  Total Income Tax Expense/Benefit



                           31
Example – Change in Deferred Taxes

                               Beginning                  Ending                           Deferred
     Timing Difference          Balance     Change        Balance    Pre-tax Book Income

Allowance for Doubtful Accts         125        -             125    Tax Adjustments:
Waranty Reserve                      -           10            10
Profit Sharing Accrual               100        -             100      Meals &
Legal Reserve                        100        -             100    Entertainment
Depreciation                        (100)      (500)         (600)     Tax-exempt income

Totals                              225        (490)         (265)     Accelerated            (500)
Enacted Rate                        40%                       40%    depreciation
                                     90        (196)         (106)     Warranty reserves         10

Income Tax Expense                  196                              Taxable Income           (490)
   Deferred Tax Liability                      196
                                                                      Tax Expense               196
                                                                     Effective Tax Rate    Deferred


                                                     32
Example
                             Permanent or    Book Tax     Deferred    Current
                              Temporary?     Expense
Pre-tax Book Income                             $1,000                 $1,000
Tax Adjustments:

  Meals & Entertainment          Permanent          10                      10
  Tax-exempt income              Permanent          (5)                    (5)
  Accelerated depreciation       Temporary                    (500)      (500)
  Warranty reserves              Temporary                       10         10
Taxable Income                                   1,005        (490)       515


 Tax Expense                                       402          196       206

Effective Tax Rate                               40.2%    Deferred    Payable


                                    33
Journal Entry - Basic
 Tax Expense Exercise:
  •   Pre-tax book income = $1,000
  •   Permanent items = $5
  •   Temporary items = ($490)
  •   ETR 40%
        Journal Entry                                     Debit       Credit
  P&L Income Tax Expense ($1,005 * 40%)                   $402
  B/S Deferred Tax Asset ($10 * 40%)                      $   4
  B/S        Deferred Tax Liability ($500 * 40%)                       $200
  B/S        Income Taxes Payable ($515 * 40%)                         $206

        To record current period book tax expense entry and set up deferred tax asset
          and liability for future taxes



                                        34
Steps in Determining a Tax Provision
1.   Determine permanent and temporary
     differences.
2.   Compute the current tax provision.
3.    Compute the corporation’s deferred tax
      provision.
     • Determine if a valuation allowance for
        DTA’s is needed.
     •   Measure based on currently enacted rates
4.   Other Considerations…

                             35
Step 3: Valuation Allowance (VA)
  Reduce the DTA by a VA if, based on available
  evidence, it is more likely than not (>50%) that
  some portion or all of the DTA will not be realized.
  Reduce the DTA to the amount that is more likely
  than not to be realized.




                        36
Step 3: Valuation Allowance Threshold Tests
  Greater than 50% likelihood – i.e., more likely
  than not criteria
   • Realization Test
      • See ¶96, FAS 109

  Weigh all available evidence
   • Weight of available evidence
      • See ¶17 e., FAS 109
   • Positive and negative evidence
      • See ¶20, FAS 109




                              37
Step 3: Valuation Allowance –
Sources of Taxable Income
  One or more sources of taxable income used
  Sources of taxable income required to be considered:
   • Future reversals of existing taxable temporary differences
   • Future taxable income, irrespective of reversing temporary
     differences
   • Taxable income in open carry back periods
   • Tax planning strategies to prevent an NOL or tax credit from
     expiring unused
       • Must be prudent, feasible
       • Can be an action not normally taken in ordinary course of business
       • Must not be cost prohibitive
       • Not elective
       • See ¶ ¶ 21, 22 & 246 FAS 109




                                     38
Step 3: Valuation Allowance –
Positive and Negative Evidence
  Future Taxable Income - Factors
   • Current financial position
   • Current and preceding years operations
   • Significant recent changes in circumstances when
     reviewing historical information
   • Trends in industry or economy
   • Forecast information




                          39
Step 3: Valuation Allowance –
Examples of Positive Evidence
  Existing contracts or sales backlog of profitable orders
  Unrealized appreciation on business unit
  Strong earnings history – coupled with support that current
  loss is aberration
   • How many years?
  Strong forecasted earnings
   • Giving weight to forecasts
       • Distance into the future – how many years?
       • Volatility of earnings in the past
       • Ability to meet forecasts in the past




                                     40
Step 3: Valuation Allowance –
Examples of Negative Evidence
  History of losses
  Expiring tax benefits (NOLs or tax credits)
  Expected losses in near future
  Brief carryforward / carryback periods
  • See ¶ 23, FAS 109




                        41
Step 3: Valuation Allowance –
Examples of Tax Planning Strategies
  Sell operating assets
  Change tax accounting methods
   •   Changing inventory methods
   •   Revenue recognition
   •   Electing ADS or straight-line depreciation
   •   Capitalize R&D costs
  Sale / leaseback transaction




                              42
Step 3: Valuation Allowance –
Amount
  Evaluate gross DTA to determine whether that
  asset should be reduced by a valuation allowance
   • Evaluation based on the total gross DTA – not on the
     net DTA (i.e., not net of deferred tax liabilities)
   • Isolate indefinite-lived assets (e.g., goodwill not
     deductible for books)
  Consider each jurisdiction
  Consiser components of DTAs and DTLs



                           43
Example – Recording a Valuation Allowance

Recording Change in Deferred Tax Items                          Effect of Recording a Valuation Allowance against DTA

                            Beginning                Ending                              Beginning            Ending
     Timing Difference       Balance      Change     Balance       Timing Difference      Balance Change      Balance

Allowance for DA                  125         -          125    Allowance for DA             125       -          125
Waranty Reserve                   -            10         10    Waranty Reserve               -         10         10
Profit Sharing Accrual            100         -          100    Profit Sharing Accrual       100       -          100
Legal Reserve                     100         -          100    Legal Reserve                100       -          100
Depreciation                     (100)       (500)      (600)   Depreciation                (100)    (500)       (600)
                                                                Valuation Allowance              0      -10        -10
Totals                           225         (490)      (265)   Totals                       225     (500)       (275)
Enacted Rate                     40%          40%        40%    Enacted Rate                 40%      40%         40%
                                  90         (196)      (106)                                  90    (200)       (110)


Income Tax Expense               196                            Income Tax Expense           200
   Deferred Tax Liability                    196                   Deferred Tax Liability            200




                                         Take-away:
                                         Recording a change to the valuation
                                         allowance has an impact on income tax
                                         expense and on the effective tax rate.
                                                           44
Step 3: Valuation Allowance –
Change in Judgment
  A change in circumstances that causes a change
  in judgment about the ability to realize the related
  DTA in future years should be recognized in
  income from continuing operations in the
  period of change.




                         45
Steps in Determining a Tax Provision
1.   Determine permanent and temporary
     differences.
2.   Compute the current tax provision.
3.   Compute the deferred tax provision.
     •   Determine if a valuation allowance for DTA’s is
         needed.
     • Measure based on currently enacted rates
4.   Other Considerations…


                              46
Step 3: Measurement
  Measurement of deferred taxes is based on the
  applicable tax rate.
  Use the enacted tax rate expected to apply to
  temporary differences in the periods expected to
  be paid (liability) or realized (asset).




                       47
Step 3: Measurement (continued)
  Considerations include:
  • Graduated tax rates
  • Effects of state taxes




                             48
Step 3: Measurement (continued)
  Certain components of the deferred tax
  asset/liability calculations are measured at
  different rates because of the type of
  asset/liability.
  Example:
  • Tax credits are not tax effected since they result in a
    dollar-for-dollar tax reduction.




                            49
Step 3: Measurement (continued)
  If tax rates change, the deferred tax asset or
  liability must be adjusted.
  3 common reasons for change:
     • Changes in Tax Laws or Rates
     • Change in the Valuation Allowance
     • Change in tax status of an entity




                               50
Steps in Determining a Tax Provision
1.   Determine permanent and temporary
     differences.
2.   Compute the current tax provision.
3.   Compute the deferred tax provision.
4.   Other Considerations…
     •   Deferred Tax Asset/Liability Classification
     •   Changes in Tax Laws
     •   Deferred Taxes
     •   Effective Tax Rate Reconciliation


                               51
Step 4: Other Considerations
Deferred Tax Asset / Liability Classification
  Is classified as short-term or long-term deferred
  based on the balance sheet classification of the
  asset or liability that gives rise to the temporary
  difference
  If there is no underlying asset or liability,
  classification is determined based on when the
  amount will be realized




                         52
Example – DTA / DTL Classification
                               Beginning           Ending Enacted       Deferred Tax Asset/(Liability)
    Timing Difference           Balance Change     Balance Rate          Current        Non-Current

Allowance for Doubtful Accts       125      -          125    40.00%          50
Waranty Reserve                    -         10         10    40.00%           4
Profit Sharing Accrual             100      -          100    40.00%          40
Legal Reserve                      100      -          100    40.00%          40
Depreciation                      (100)    (500)      (600)   40.00%                             (240)

Totals                             225     (490)      (265)                 134                  (240)
Enacted Rate                       40%      40%        40%
                                    90     (196)      (106)

Income Tax Expense                 196                                 Tax Exp      196
   Deferred Tax Liability                  196                         DTA          134
                                                                                   DTL            240


                                  Take-away:
                                  Proper classification of DTAs and DTLs is
                                  made in the tax journal entry and will also
                                  be disclosed in the notes to the financial
                                  statements. 53
Step 4: Other Considerations
Changes in Tax Laws
  Recognized in the period of change (enactment)
  Amount of adjustment is measured by the
  • change in laws/rates applied to the remaining
    cumulative temporary differences.
  The adjustment is to income tax expense for that
  period as a component of income from continuing
  operations.




                          54
Step 4: Other Considerations
Deferred Taxes
  Certain events, such as Business Combinations,
  can also create differences between the financial
  statement basis and the tax basis of assets and
  liabilities
  • e.g., assets may be restated at current value for
    financial statement purposes but recorded at a
    carryover basis for tax purposes
  When there is a Book/Tax Basis Difference,
  consider deferred tax requirements


                           55
Step 4: Other Considerations
Effective Tax Rate Reconciliation

Rate Reconciliation
                                            Pretax      Tax
                                           Amounts    Effected    Percentages
Expected Federal Provision                    1,000        350          35.00%

Meals & Entertainment                           10           4           0.35%
Tax Exempt Income                               (5)      (1.75)         -0.18%
State Provision net of Fed. Benefit             77          50           5.02%

Effective Tax Rate                                        402          40.20%




Threshold for disclosure (5% of pretax x 35%)            17.5



                                      56
Open Discussion




                  57
Contact Information:
58




William Ramirez,                Robert Terpening, Partner   Katherine Morris, Partner
President                       BDO Seidman, LLP125 South   BDO Seidman, LLP
TEI Asia Chapter                Market Street, # 800        1100 Peachtree Street
Email:                          San Jose, CA 95113          Atlanta, GA 30309
william.ramirez@ap.altria.com   Tel: (408)352-1952          Tel: (404)979-7182
                                rterpening@bdo.com          Fax: (404)688-1075
                                                            kmorris@bdo.com




                                                 58
Appendix
  Helpful Websites for U.S. Purposes
  Valuation Allowance – Examples 1 & 2
  Disclaimers
  About BDO Seidman, LLP
  Our principles ensure success…




                       59
Helpful Websites for U.S. Guidelines
  Financial Accounting Standards Board (FASB)
   • FASB - http://www.fasb.org/
       • The Financial Accounting Standards Board Home Page
       • FASB on Income Tax Accounting – FAS 109

  Other helpful websites:
   • Internal Revenue Service - http://www.irs.gov/
       • Internal Revenue Service Home Page
   • AICPA - http://www.aicpa.org
       • The American Institute of Certified Public Accountants Home Page
   • Federal Reserve Board - http://www.federalreserve.gov/releases/
       • Statistics: Releases and Historical Data, such as interest and foreign exchange
         rates
   • International Accounting Standards Board - http://www.iasb.org
       • International Accounting Standards Board Home Page
   • SEC - http://www.sec.gov
       • The U.S. Securities and Exchange Commission Home Page




                                       60
Example 1 - Valuation Allowance:
Is Enough Positive Evidence Present?
  Negative evidence
   • Estimated Net Operating Loss (NOL) current year $50
     Million
   • NOL prior three years total an additional $150 Million
   • Next year’s forecast shows a $15 Million NOL
   • The Company had a change in ownership last year; the
     maximum amount of the NOL that can be used in any
     year is $3 Million
  Potential positive evidence
   • The NOL will not begin to expire for 16 years.

                            61
Question 1 – Evaluating Positive Evidence
  Please select one of the following choices:
   (a) The Company will never be able to use all of the NOL
     because of the change in ownership so a valuation
     allowance for the full amount should be recorded.
   (b) The Company does not need to record a valuation
     allowance because the NOLs can be used in the next
     16 years.
   (c) The Company has one item of positive evidence so no
     valuation allowance needs to be recorded at this time.
   (d) The Company must evaluate all of the available
     evidence and calculate the amount of the valuation
     allowance that should be recorded.


                           62
Answer 1 – Evaluating Positive Evidence
  The answer is (d).
   • The Company must evaluate all of the available
     evidence and calculate the amount of the valuation
     allowance that should be recorded.
  It is possible to record a valuation allowance
  against a part of the NOL.
  All available evidence – positive and negative –
  must be evaluated to determine the amount of
  valuation allowance to be recorded against any
  deferred tax asset.


                           63
Example 2 - Valuation Allowance:
Is Enough Positive Evidence Present?
  Continue from Question 1…
  Potential positive evidence
   • The Company plans to sell an appreciated division; the potential gain is
     estimated to be approximately $250 Million. This gain existed at the time
     of the ownership change.
   • The Company has prepared projections that support that it will utilize the
     NOL in less than a 16 year period
   • NOL does not begin to expire for 16 years
   • The Company has reduced the debt burden and has only $1.5 Million in
     interest expense annually.
   • The Company has another division that has appreciated by $50 Million
  Tax planning strategies
   • S/L depreciation for tax return to decrease current year NOL
   • Elect to capitalize R&D and amortize over 10 years, creates taxable
     income


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Question 2 – Evaluating Positive Evidence
  Please select one of the following choices:
   (a) The Company will never be able to use all of the NOL because of
      the change in ownership so a valuation allowance for the full
      amount should be recorded.
   (b) The Company does not need to record a valuation allowance
      because the weight of the positive evidence indicates that the
      NOLs can be used before they begin to expire in 16 years.
   (c) The Company has had losses for the last three years and it is
      required to record a full valuation allowance against the NOL.
   (d) The Company cannot rely on the possibility of future events in
      considering whether a valuation allowance should be recorded.




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Answer 2 – Evaluating Positive Evidence
  The answer is (b).
   • The Company does not need to record a valuation
     allowance because the weight of the positive evidence
     indicates that the NOLs can be used before they begin
     to expire in 16 years.
  The Company must evaluate all of the available
  evidence and calculate the amount of the
  valuation allowance that should be recorded.
  It is required for a company to evaluate all positive
  and negative evidence to determine if it is more
  likely than not that the NOL will be utilized.

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Disclaimers
  Material discussed in this presentation is meant to provide general
  information and should not be acted on without obtaining professional
  advice tailored to your firm’s or company’s individual needs.
  It is not intended that the material be considered advice on the
  application of accounting principles as described in Statement on
  Auditing Standards (SAS) No. 50 (as amended by SAS No. 97)
  To ensure compliance with Treasury Department regulations, we wish
  to inform you that any tax advice that may be contained in this
  communication is not intended or written to be used, and cannot be
  used, for the purpose of (i) avoiding tax-related penalties under the
  Internal Revenue Code or applicable state or local tax law provisions
  or (ii) promoting, marketing or recommending to another party any tax-
  related matters addressed herein.




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About BDO Seidman, LLP
  As the U.S. member firm of BDO International, BDO Seidman, LLP is
  the fifth largest accounting services firm and belongs to a worldwide
  network of independent professional firms that combined offer over
  23,000 partners and staff operating in 105 countries and over 600
  offices.
  BDO Seidman, LLP is a national professional services firm providing
  assurance, tax, financial advisory and consulting services to private
  and publicly traded businesses. For more than 95 years, we have
  provided quality service and leadership through the active involvement
  of our most experienced and committed professionals.
  BDO Seidman, LLP serves public and private clients through more
  than 30 U.S. offices and over 250 independent alliance firm locations
  nationwide.
  Visit us at: www.bdo.com


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BDO Seidman, LLP
Our principles ensure success…


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