The FASB's Proposed Rules for Deferred Taxes; Easing the Restrictions of FASB Statement No. 96 on Recognizing Deferred Tax Benefits
In its recently issued exposure draft, Accounting for Income Taxes, the Financial Accounting Standards Board proposed new rules that would establish financial accounting and reporting for the effects of income taxes resulting from an enterprise's activities for current and preceding years. The new requirements would supersede American Institute of CPAs Accounting Principles Board Opinion no. 11 and FASB Statement no. 96, both titled Accounting for Income Taxes, which have been the source of much criticism and controversy. During the relatively short history of Statement no. 96, several prominent groups, including the AICPA accounting standards executive committee, Financial Executives Institute and National Association of Accountants (now the Institute of Management Accountants), as well as many CPA firms have expressed concern that tax asset provisions of FASB Statement no. 96 are too restrictive in allowing recognition of deferred tax benefits only to the extent loss carryback would result in a refund of taxes previously paid. In many situations, the conclusions in the ED should permit recognition of additional tax assets and allow enterprises to avoid the scheduling of temporary differences and consideration of tax planning strategies. According to the ED, enterprises would measure deferred taxes by using the marginal tax rate expected to apply to the last dollars of taxable income in future years when taxable or deductible temporary differences and operating loss and tax credit carryforwards are expected to be paid or realized. Under the new method, enterprises would measure their deferred tax assets assuming all existing tax benefits will be realized. However, a valuation allowance would be established if it is more likely than not some or all of the deferred tax assets would not be realized based on available evidence. When negative evidence is outweighed by positive evidence, an enterprise might conclude the provisions of the new tax standard can be implemented without making detailed computations, forecasts and scheduling. The purpose of this article is to provide CPAs with an understanding of some of the ED's key requirements. Specifically, the article addresses how deferred taxes would be recognized and measured under the new approach. A comprehensive nuts-and-bolts illustration, which should be helpful in assessing whether a valuation allowance should be recorded, also is provided. THE ED's OBJECTIVES AND BASIC PRINCIPLES One objective of accounting for income taxes is to recognize an event's tax effects in the year the event itself is recognized in financial statements. This represents no change from existing rules; the amount of tax currently payable or refundable usually follows an enterprise's current tax return. A second objective is to recognize deferred taxes for the future tax consequences of events already recognized in financial statements or tax returns or that result from enacted changes in the tax laws. The FASB's proposed requirements would change significantly the ways deferred taxes, especially tax assets, are recognized and measured. As with FASB Statement no. 96, the proposed rules are based on a balance sheet approach, which attempts to establish deferred tax assets and liabilities that meet the definitions of assets and liabilities contained in the FASB's conceptual framework. According to FASB Concepts Statement no. 6, Elements of a Financial Statement, assets represent "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events," and liabilities are "probable future sacrifices of economic benefits obtained or controlled by a particular entity as a result of a past transaction or event." The balance sheet approach requires an enterprise to recognize as a deferred tax asset or a deferred tax liability the future income tax effects of the difference between the financial statement carrying amount of an asset or liability and its tax basis. …