In December 1987, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 96, Accounting for Income Taxes.

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1 Q&A 96 A Guide to Implementation of Statement 96 on Accounting for Income Taxes: Questions and Answers [FASB Statement No. 96, Accounting for Income Taxes, was superseded by FASB Statement No. 109, Accounting for Income Taxes. Therefore, the following implementation guide has been effectively superseded.] [Note: This document is a FASB Special Report issued in December It was written by FASB staff members, E. Raymond Simpson, project manager, Jules M. Cassel, senior technical advisor, Jill Peperone Giles, assistant project manager, and Gregory J. Jonas, practice fellow. The positions and opinions expressed are those of the authors. Official positions of the FASB are determined only after extensive due process and deliberation.] Introduction In December 1987, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 96, Accounting for Income Taxes. The Board cannot anticipate all the implementation questions that may arise for a particular Statement and provide answers to those questions when the Statement is issued. Accordingly, questions of implementation often are raised with the FASB staff by preparers, auditors, and others. Because of the unusually high number of inquiries received and the inherent complexities of accounting for income taxes, the FASB staff determined that this Special Report should be issued as an aid in understanding and implementing Statement 96. The questions and answers in this Special Report are organized by the general topic in Statement 96 to which the questions relate. Illustrations are included as necessary to supplement the answers. Scheduling 1. Q Paragraph 17 of Statement 96 discusses determination of a deferred tax liability or asset as if a tax return were prepared for the net amount of temporary differences that will result in taxable or deductible amounts in each future year. Appendix A presents examples that illustrate temporary differences resulting in taxable or deductible amounts in particular future years, loss carryback of net deductible amounts to earlier years, loss carryforward to later years, and so forth. Paragraph 18, on the other hand, discusses an approach that sometimes may reduce the extent of scheduling, and paragraphs 62 and 63 discuss the use of overall estimates for time spans of several years, calculations on an exception basis, and estimated average tax rates. How much scheduling is required? [17, 18, 62, 63] 1(1) A The need for scheduling is dependent on the facts of each situation and the requirements for: a. Classification of a deferred tax liability or asset as current or noncurrent in a classified statement of financial position (paragraph 24) b. Recognition of tax benefits based on offsetting (paragraph 39), and disclosure of the amounts and expiration dates (or a reasonable aggregation of expiration dates) of operating loss and tax credit carryforwards for financial reporting (paragraph 29) c. Measurements based on enacted tax laws and rates, including (1) alternative tax systems, (2) tax rates that are different for carryforward and carryback periods, and (3) limitations on

2 utilization of tax credits (paragraph 45). Scheduling is required to satisfy those requirements of Statement Q The first of the requirements (refer to question 1) that results in a need for scheduling is the determination of the current portion of a deferred tax liability or asset for purposes of a classified statement of financial position. What procedures are involved in making that determination? [17, 18, 24, 62] A Determination of the current portion of a deferred tax liability or asset initially involves scheduling the taxable or deductible amounts expected for the following year. Many temporary differences (paragraph 10) related to current assets and liabilities will result in taxable or deductible amounts next year. (Also included are temporary differences related to assets or liabilities that are classified as current because of an operating cycle that is longer than one year.) However, some temporary differences related to current assets or liabilities may not be expected to result in taxable or deductible amounts next year, for example, allowances for obsolete inventory and for loan losses (refer to question 8). Other information needed is next year's taxable or deductible amounts that are expected to result from: a. Certain originating and reversing temporary differences, primarily depreciation differences (paragraph 42) b. Temporary differences related to noncurrent assets or liabilities c. Operating loss (and tax credit) carryforwards. The current portion of the deferred tax liability or asset (that is, for next year's estimated net taxable or deductible amount) is determined based on the recognition and measurement requirements of Statement 96, which include, for example, the effects of (a) measuring a deferred tax asset for a net deductible amount next year using enacted tax laws and rates for the carryback year for which a refund could be recovered (paragraph 45), (b) under current U.S. federal tax law, using both the regular tax system and the alternative minimum tax (AMT) system to measure the deferred tax consequences of next year's net taxable or deductible amount (paragraph 47), and (c) the application of qualifying tax-planning strategies, which may affect next year's estimated net taxable or deductible amount. 3. Q The second requirement (refer to question 1) that results in a need for scheduling is the recognition of tax benefits based on offsetting. What procedures are necessary to satisfy that requirement? [17, 18, 39, 62] A The offsetting issue pertains to the requirements for recognition of a tax benefit for temporary differences that will result in deductible amounts in future years and for operating loss (and tax credit) carryforwards. The procedures described in paragraph 17 and the schedules that illustrate offsetting in Appendix A are intended to explain those requirements for recognition of tax benefits and not to create a requirement for scheduling. The existence of a recognizable tax benefit for deductible amounts in future years is determined by the facts of each situation, and application of Statement 96 requires, at a minimum, the following information: a. The type, nature, and amounts of an enterprise's temporary differences b. The future period of years and the general pattern (for example, in approximately equal annual amounts or in decreasing or increasing annual amounts) of taxable or deductible amounts during those years for each significant type of temporary difference c. In the United States, the information in (a) and (b) above for AMT purposes if different than for regular tax purposes d. Identification of provisions of the tax law (including available elections) that might prohibit acceleration or delay of those taxable or deductible amounts

3 e. If not prohibited by tax law, whether there is a qualifying tax-planning strategy that would permit acceleration or delay of those taxable or deductible amounts f. The amounts, expiration dates, and restrictions (under the tax law) regarding an enterprise's operating loss or tax credit carryforward g. Enacted tax rates and laws (for example, loss carryback rules). Based at least in part on the information listed above, the existence (or absence) of a recognizable tax benefit based on offsetting sometimes can be determined based on (a) estimates pertaining to time spans of several years or (b) the availability of qualifying tax-planning strategies. Time and effort spent in obtaining that information in the year of adopting Statement 96 may facilitate deferred tax calculations in subsequent years. Efforts in subsequent years might be focused more on investigating the effects of changes that have occurred, for example, the addition of new types of temporary differences or changes in the tax law. Deductible Temporary Differences Based on current U.S. federal tax law (with certain exceptions), a deductible temporary difference offsets taxable amounts in the year of the deduction, or in the 3 years preceding the year of the deduction if carried back, or in the 15 succeeding years if carried forward a time span of 19 years. Regardless of the existence of offsetting for regular tax purposes, however, an enterprise still may need to recognize a deferred tax liability for AMT because, for example, (a) the book income adjustment, in effect, cuts in half any net deductible amounts occurring in 1987, 1988, or 1989 (refer to question 5), (b) utilization of operating loss and tax credit carryforwards is limited so that they cannot reduce tentative minimum tax (TMT) to zero, or (c) the pattern of tax depreciation or amortization is different for AMT. A qualifying tax-planning strategy (refer to questions 52-68), however, can change the particular future year in which a temporary difference results in a taxable or deductible amount. Based on such a strategy: a. The reversal of a taxable temporary difference might be accelerated (or delayed) so that it results in a taxable amount either (1) during the carryforward or carryback period associated with a deductible temporary difference for regular tax purposes or (2) during a specific year(s) for AMT purposes. b. The reversal of a deductible temporary difference might be: (1) Accelerated or delayed so that it offsets taxable temporary differences reversing in earlier or later years (2) Accelerated to recover taxes paid in the current or a prior year. Accordingly, consideration of the availability of qualifying tax-planning strategies first might be helpful in determining the amount of scheduling that is required. Operating Loss (and Tax Credit) Carryforwards Based on current U.S. federal tax law and subject to any restrictions set forth in the tax law, an operating loss carryforward generally offsets temporary differences that result in net taxable amounts during the carryforward period a time span of up to 15 years. The issue is whether temporary differences will result in net taxable amounts during the remainder of that 15-year time span. That sometimes may be determined if: a. It is possible to reasonably estimate whether reversal of temporary differences during the remainder of the 15-year time span will result in a net taxable amount that at least equals the tax loss carryforward (or sufficiently exceeds the limitation for an AMT loss or tax credit carryforward).

4 b. There is a qualifying tax-planning strategy to accelerate reversal of taxable temporary differences from after to before the end of the carryforward period. To summarize, approaches that evaluate the existence or absence of offsetting through a process of elimination or on an exception basis may be helpful in determining the amount of scheduling that is required. Under any such approach, an enterprise should consider whether: a. All deductible amounts (deductible temporary differences and tax loss carryforwards) offset taxable amounts (taxable temporary differences or, by loss carryback, taxable income for the current or prior years). If so, a tax benefit is recognized for those deductible amounts. b. All taxable amounts are offset by, but are less than, all deductible amounts. If so, a tax benefit cannot be recognized for any additional deductible amounts. c. Certain deductible amounts (because of their timing and the absence of qualifying tax-planning strategies) do not offset any taxable amounts. If so, a tax benefit cannot be recognized for those deductible amounts. Scheduling is necessary to the extent that the amount of recognizable tax benefit for deductible temporary differences and tax loss carryforwards is not determinable by other means. The foregoing also generally applies to tax credit carryforwards for which the tax law is similar to that applicable to operating loss carryforwards. 4. Q Paragraph 42 of Statement 96 requires consideration of future temporary differences for existing depreciable assets (in use at the end of the current year) in determining the future years in which existing temporary differences result in net taxable or deductible amounts (refer to questions 13-16). Should future originating and reversing depreciation differences always be scheduled for purposes of determining whether there is a recognizable tax benefit based on offsetting? [17, 18, 39, 42, 62] A Not always. Recognition of an otherwise unrecognizable tax benefit as a result of considering future originating and reversing depreciation differences only occurs in certain circumstances. Those circumstances are illustrated in the following example for year 1: Existing Temporary Carryback Differences Years Taxable income $ Taxable (deductible) temporary differences: Installment sale $300. Depreciation 100. Estimated expenses (200.) $200. $ Loss carryforward Loss carryback Net taxable amount There is a $200 temporary difference for estimated expenses that is expected to be deductible in year 7. A tax benefit is recognized for that $200 deductible amount in year 7 based on loss carryback to offset taxable income in year 4. Absent consideration of the $900 originating depreciation difference in year 2, however, (a) there would be no taxable income in year 4 and (b) a tax benefit could not be recognized for the $200 deductible amount in year 7. In that example, there would be no need to consider future originating and reversing depreciation

5 differences for purposes of offsetting if there is a qualifying tax-planning strategy that would permit offsetting by (a) accelerating the $200 deductible amount from year 7 to an earlier year or (b) delaying $200 of taxable amounts to year 4 or a later year. Alternatively, assume that (a) there are no qualifying tax-planning strategies for those temporary differences and (b) the $200 deductible amount is expected to occur in year 8 or a later year instead of in year 7. Scheduling future originating and reversing depreciation differences does not alleviate the problem that year 8 is beyond the 3-year carryback period to year 4 (the last year of the recovery period for the depreciable assets). In the example above, the critical issue is whether there will be at least $200 of net taxable depreciation differences in year 4. That might be determined by estimates, for example, by comparison of useful lives and the characteristics of depreciation methods for tax purposes and for financial reporting. 5. Q Does AMT preclude the possibility of aggregate calculations of deferred U.S. federal income taxes? [17, 18, 47, 62] A AMT may preclude a single, aggregate calculation of deferred U.S. federal income taxes for many enterprises. However, a qualifying tax-planning strategy to reduce the effect of AMT on the amount of deferred taxes may result in aggregating at least a few years. For example, the illustration that follows paragraph 48 of Statement 96 schedules recovery of depreciable assets in years 2-6 for purposes of regular tax and AMT. The $28 book income adjustment in year 2 results in a $6 increase to the deferred tax liability. If there is a qualifying tax-planning strategy to recover those depreciable assets in year 2, however, there would be no book income adjustment and the deferred tax liability would be reduced from $16 to $10. Based on a qualifying tax-planning strategy to recover the depreciable assets in year 2, an aggregate computation of the deferred tax liability is as follows: Year 2 Regular tax calculation: Net taxable amount $100. Regular tax (35 percent) $ 35. AMT calculation: Regular taxable amount $100. AMT depreciation adjustment (50.) Tentative AMT income (AMTI) 50. Book income adjustment AMTI $ 50. TMT (20 percent) $ 10. Higher of regular tax or AMT $ 35. AMT credit carryforward applied 25. Deferred tax liability $ Q The third requirement (refer to question 1) that results in a need for scheduling is measurement of deferred tax assets or liabilities based on enacted tax laws and rates. How much scheduling is required when enacted changes in the tax law will be phased in over a period of more than one year? [17, 18, 20, 45, 62, 63] A At a minimum, the expected net taxable or deductible amounts for the years of a phased-in

6 change in tax law or rate need to be scheduled. Scheduling additional future years beyond the phase-in period may be necessary in certain circumstances, for example, the circumstances discussed in questions 21 and 22. Paragraph 63 of Statement 96 discusses measurement of deferred taxes for enterprises affected by tax rates that are graduated according to the amount of taxable income. 7. Q Does Statement 96 require separate deferred tax computations for each state or local tax jurisdiction? [17, 18, 62] A If deferred tax expense (or the deferred tax liability) for a state or local tax jurisdiction is significant, Statement 96 requires a separate deferred tax computation for that tax jurisdiction when there are significant differences between the tax laws of that and other tax jurisdictions that apply to the enterprise. In the United States, however, many state or local income taxes are based on U.S. federal taxable income, and an aggregate computation of deferred taxes for at least some of those state or local tax jurisdictions might be acceptable. In assessing whether an aggregate calculation is appropriate, matters such as differences in tax rates or the loss carryback and carryforward periods in those state or local tax jurisdictions should be considered. In assessing the significance of deferred tax expense for a state or local tax jurisdiction, it is appropriate to consider the deferred tax consequences that those deferred state or local tax liabilities or assets have on other taxing jurisdictions, for example, on deferred federal income taxes (refer to question 19). Pattern of Taxable or Deductible Amounts 8. Q The requirements of Statement 96 that result in a need for scheduling are discussed in question 1. For purposes of those requirements, how should an enterprise determine the particular future year(s) in which the following types of temporary differences will result in taxable or deductible amounts: a. An allowance for obsolete inventory that is not deductible until the inventory is disposed of b. An allowance for loan losses that is not deductible until particular loans are deemed wholly or partially worthless or are disposed of c. Unrealized gains or losses on marketable securities (carried at market value) that are not taxable or deductible until the securities are sold? [41] A For each of those temporary differences, there may be qualifying tax-planning strategies that, if implemented, would affect the particular future year(s) that the temporary difference would result in a taxable or deductible amount. However, without regard to qualifying tax-planning strategies: a. An allowance for obsolete inventory is considered to result in deductible amounts in the future year(s) that disposal of that inventory is expected to occur. b. An allowance for loan losses is considered to result in deductible amounts in the future year(s) that the particular loans (or portions thereof) for which there is an allowance for losses at the current financial statement date are expected to be deemed wholly or partially worthless for tax purposes or are planned to be disposed of (if held for sale). c. Unrealized gains or losses on marketable securities (carried at market value) are considered to result in taxable or deductible amounts in the future year(s) in which those securities are expected to be sold. The temporary differences discussed above are examples of temporary differences for which future reversal periods are uncertain. Accordingly, scheduling the taxable or deductible amounts

7 related to those temporary differences requires judgment about the timing of their expected occurrence. 9. Q Although an enterprise has a basis under the tax law for certain deductions, such as repair expenses, on its income tax returns, the enterprise may have recognized a liability (including interest) for the probable disallowance of those tax deductions that, if disallowed, would be capitalized for tax purposes and then would be deductible in later years. What scheduling is necessary in those circumstances? [12, 41] A Accrual of a liability for probable disallowance of expenses such as repairs has the effect of implicitly capitalizing those expenses for tax purposes. Those capitalized expenses are considered to result in deductible amounts in the later years in which allowable deductions (such as depreciation expense) are expected for tax purposes. If the liability for probable disallowance is based on an overall evaluation of various exposure areas, scheduling should reflect the evaluations made in determining the liability for probable disallowance that was recognized. Upon disallowance of those expenses, taxable income of the year for which the expenses are disallowed is higher. That additional taxable income is available for offsetting by temporary differences that will result in net deductible amounts during the next three years (that is, in time for carryback). Similarly, taxable income for years after the disallowance will be lower because of annual deductions attributable to those capitalized amounts. A deductible amount for the accrued interest is scheduled for the future year in which that interest is expected to become deductible as a result of settling the underlying issue(s) with the taxing authority. 10. Q To the extent necessary (refer to question 1), how should an enterprise determine the pattern of taxable or deductible amounts in future years for temporary differences related to assets and liabilities that are measured at present values? [41] A For temporary differences related to many assets or liabilities that are measured at present value, there may be qualifying tax-planning strategies that, if implemented, would affect the future years in which the temporary differences would result in taxable or deductible amounts. Absent qualifying tax-planning strategies, taxable or deductible amounts for those temporary differences should be scheduled over the expected recovery or settlement period for the related asset or liability. For a deferred compensation liability, for example, the expected settlement period ordinarily would be determined by the terms of the deferred compensation agreements. For a loan portfolio, however, the recovery period would be shorter than that based solely on the maturity dates of the loans if expected prepayments are used for measurement of amounts related to those loans (for example, for amortization of origination fees and costs). Either of two methods should be used to determine the pattern of taxable or deductible amounts over the expected recovery or settlement period for a temporary difference related to an asset or liability that is measured at present value. One method (the "loan amortization method") is to allocate each future cash receipt or cash payment first to future interest and then any remainder to recovery of the existing asset or settlement of the existing liability. The other method (the "present value method") is to determine the pattern based on the present value of each future cash receipt or cash payment. Under the loan amortization method, the pattern of taxable or deductible amounts in future years is determined by the expected pattern for future recovery or settlement of the asset or liability, that is, the portion of future cash receipts or cash payments that is not allocated to future interest. Under the present value method, the pattern of taxable or deductible amounts in future years is determined by the expected pattern of the present values of future cash receipts or cash payments.

8 The present value method generally will result in larger taxable or deductible amounts in earlier years as compared with the results under the loan amortization method. The same method should be used for all temporary differences within a particular category 2(2) of temporary differences for a particular tax jurisdiction. Different methods may be used for different categories of temporary differences. If the same temporary difference exists in two tax jurisdictions (for example, U.S. federal and a state tax jurisdiction), the same method should be used for that temporary difference in both of those tax jurisdictions. If not, different methods may be used for different tax jurisdictions. The same method for a particular category in a particular tax jurisdiction should be used consistently from year to year. A change in method is a change in accounting principle under APB Opinion No. 20, Accounting Changes. The following examples illustrate application of the two methods to temporary differences related to a liability for deferred compensation and to a note receivable. Also refer to questions 11 and 12. Illustration 1 Temporary Differences Related to Deferred Compensation For financial reporting, an enterprise's liability for deferred compensation earned as of the end of year 1 is $10,000. That liability represents the present value of $20,341 of future cash payments discounted at 10 percent. An analysis of the liability, interest expense, and end-of-year cash payments in future years is shown below. Beginning Ending Year Liability Interest Payments Liability 2 $10,000. $ 1,000. $ $11, ,000. 1, , ,100. 1, , ,310. 1, , ,000. 1,400. 1,400. 1, ,000. 1,400. 2, , ,000. 1,300. 4, , ,000. 1,000. 5,000. 6, , , $10,341. $20,341. The tax basis of the $10,000 deferred compensation liability at the end of year 1 is zero. The loan amortization method determines the future years in which that $10,000 temporary difference will result in deductible amounts by allocating each future payment first to interest expense and then any remainder to settlement of the $10,000 liability for deferred compensation. Future payments would be allocated as follows: Interest Cumulative Beginning on Unpaid Unpaid Year Liability Balance Interest Interest 2 $10,000. $1,000. $1,000. $ 3 11,000. 1,100. 2, ,100. 1,210. 3, ,310. 1,331. 4, ,000. 1,400. 4,000. 1, ,000. 1,400. 3,000. 2,400.

9 8 13,000. 1,300. 4, ,000. 1,000. 1, , $10,341. Thus, under the loan amortization method, the $10,000 temporary difference at the end of year 1 is considered to result in deductible amounts of $4,000 in year 9 and $6,000 in year 10. Under the present value method, the pattern of deductible amounts in future years for that same $10,000 temporary difference would be considered to be the present value of each future cash payment as determined at the end of year 1. Pattern of Future Present Deductible Year Payments Value Amounts 2 $ $ $ , ,400. 1,355. 1, ,300. 2,207. 2, ,000. 2,333. 2, ,600. 2,798. 2,798. $20,341. $10,000. $10,000. Illustration 2 Temporary Differences Related to Notes Receivable The following example illustrates determination of the pattern of taxable amounts in future years for a temporary difference related to a note receivable that is expected to be held until maturity. The assumptions are as follows: a. The note is acquired at the beginning of year 2 in a nontaxable business combination that is accounted for as a purchase. The note requires annual payments of $2,505 at the end of years 1-5. b. The tax basis of the note at the beginning of year 2 is $8,295 based on the original amortization schedule for the note. That amortization schedule follows: Beginning of Year Receipts Year Balance Interest at 8% Principal Total 1 $10,000. $800. $1,705. $2, , ,841. 2, , ,989. 2, , ,148. 2, , ,317. 2,505. c. At the date of the business combination, interest rates have declined to 7 percent. The note is

10 assigned a value of $8,485 in the purchase price allocation. The amortization schedule based on that value follows: Beginning of Year Receipts Year Balance Interest at 7% Principal Total 2 $8,485. $594. $1,911. $2, , ,045. 2, , ,188. 2, , ,341. 2,505. In summary, the tax basis of the note is $8,295 and its amount for financial reporting is $8,485. Under the loan amortization method, each future receipt is allocated first to interest and then any remainder to recovery of the receivable. Thus, the assumed pattern of recovery of the note is based on the principal column of the amortization schedules. The difference between the amount of principal collected for tax and financial reporting purposes is the pattern in which the taxable temporary difference ($8,485 minus $8,295 equals $190) is expected to reverse. That pattern is determined at the beginning of year 2 as follows: Recovery of Tax Reported Pattern of Year Basis Amount Taxable Amounts 2 $1,841. $1,911. $ ,989. 2, ,148. 2, _2,317. 2, $8,295. $8,485. $190. Under the present value method, the $190 temporary difference would be considered to result in taxable amounts in years 2-5 based on the pattern determined by the present value of each future cash receipt. Those taxable amounts are determined as follows: Present Value of Future Cash Receipts Pattern of Year 8% 7 % Taxable Amounts 2 $2,317. $2,341. $ ,148. 2, ,989. 2, _1,841. 1, $8,295. $8,485. $ Q How should an enterprise determine, if necessary (refer to question 1), the pattern of taxable or deductible amounts in future years for temporary differences related to (a) an investment by a lessor in a lease accounted for as a direct financing lease for financial reporting (the investment equals the present value of future lease payments) if, for tax purposes, the lease qualifies as an operating lease and the leased asset is depreciated for tax purposes or (b) a capital lease of a lessee if that lease is an operating lease for tax purposes? [41]

11 A A lease that is accounted for by the lessor as a direct financing lease for financial reporting gives rise to two temporary differences if that lease qualifies as an operating lease for tax purposes. One temporary difference relates to the investment in the lease (for financial reporting) which has a zero tax basis. The other temporary difference relates to the depreciable asset (for tax purposes), which has a zero basis for financial reporting. The pattern of taxable amounts in future years that will result from the temporary difference related to the investment in the lease (for financial reporting) should be determined by either of the two methods discussed in question 10 (Illustrations 1 and 2) for temporary differences related to assets or liabilities that are measured at present values. The pattern of deductible amounts in future years that will result from the temporary difference related to the depreciable asset (for tax purposes) should be the same as the amount of depreciation that is deductible for tax purposes. Similarly, a lease that is accounted for by the lessee as a capital lease for financial reporting gives rise to two temporary differences if that lease is an operating lease for tax purposes. One temporary difference relates to the leased asset (for financial reporting), which has a zero tax basis. The other temporary difference relates to the capitalized lease obligation (for financial reporting), which also has a zero tax basis. Illustration 3 Temporary Differences Related to a Capitalized Lease Obligation The following example illustrates determination of the pattern of taxable and deductible amounts in future years for temporary differences related to a capital lease for a lessee. The assumptions are as follows: a. A lessee enters into a 5-year capital lease at the beginning of year 1. b. Annual rents are $264. c. The lessee determines the present value of the minimum lease payments using a 10 percent interest rate. d. The leased asset will be depreciated $200 per year over 5 years. e. The lease is an operating lease for tax purposes. For financial reporting, depreciation of the leased asset and amortization of the capital lease liability will be as follows: Leased Asset Capital Lea Year Depreciation Balance Interest Princ At inception $1, $ $100. $ At the end of year 1, there are two temporary differences: a. One is an $800 taxable temporary difference for the leased asset (it has a zero tax basis). b. The other is an $836 deductible temporary difference for the capitalized lease obligation (it has a zero tax basis). At the end of year 1, the pattern of taxable and deductible amounts in future years based on the loan amortization method for the capitalized lease obligation is as follows:

12 Taxable (Deductible) Future Years Amounts Amounts 2 $200. $(180.) (198.) (218.) 5 _200. _(240.) $800. $(836.) The pattern of taxable and deductible amounts in future years based on the present value method for the capitalized lease obligation is as follows: Taxable (Deductible) Future Years Amounts Amounts 2 $200. $(240.) (218.) (198.) 5 _200. _(180.) $800. $(836.) 12. Q How should an enterprise determine the pattern of taxable or deductible amounts in future years for temporary differences related to an employer's accrued (prepaid) pension cost for a defined benefit pension plan? [41] A An employer's accrued (prepaid) pension cost for a defined benefit pension plan results from calculations that use present values. Except as noted in the last paragraph of this answer, either of two approaches should be used. Whichever approach is used, it should be used consistently from year to year for all accrued (prepaid) pension costs for an employer's defined benefit pension plans that exist in a particular tax jurisdiction. A change in approach is a change in accounting principle under Opinion 20. The following answers all assume that the accrued (prepaid) pension cost for financial reporting has a tax basis of zero. Under the first approach: a. The pattern of taxable amounts in future years that will result from the temporary difference related to the prepaid pension cost should be considered to be the same as the pattern of estimated net periodic pension cost (as that term is defined in FASB Statement No. 87, Employers' Accounting for Pensions) for financial reporting for the following year and succeeding years, if necessary, until future net periodic pension cost, on a cumulative basis, equals the amount of the temporary difference. b. The pattern of deductible amounts in future years that will result from the temporary difference related to the liability for accrued pension cost should be considered to be the same as the pattern by which estimated tax deductions are expected to exceed interest attributable to that liability for accrued pension cost for the following year and succeeding years, if necessary, until such excess, on a cumulative basis, equals the amount of the temporary difference. Under the first approach, future recovery of a prepaid pension cost is assumed to be through operations rather than by a reversion of plan assets (the second approach). The approach is similar to the recovery of depreciable assets in that estimated annual net periodic pension cost determines the annual amounts of future revenues that are necessary to recover the amount (for financial

13 reporting) of the prepaid pension cost. Thus, a temporary difference related to a prepaid pension cost is considered to result in taxable amounts in the same pattern as those annual amounts of revenues in future years that recover the prepaid pension cost at the end of the current year. Under this approach, additional employer contributions to the plan, if any, are ignored. It may be estimated, however, that in early years there will be net periodic pension income (because the plan is significantly overfunded). If so, the existing prepaid pension cost will not be recovered until the later years for which it is estimated there will be net periodic pension cost. Under the first approach, settlement of a liability for accrued pension cost is assumed to be by future tax deductible contributions to the plan that exceed the interest related to that liability, that is, similar to the loan amortization method. Each estimated tax deductible contribution to the plan in future years is allocated (a) first to estimated interest expense on the liability for accrued pension cost and (b) then any remainder to settlement of the liability for accrued pension cost at the end of the current year. Thus, a temporary difference related to a liability for accrued pension cost is considered to result in deductible amounts in the same pattern as the portion of those estimated tax deductible contributions to the plan in future years that would settle the recorded amount of the liability at the end of the current year. Under the second approach: a. The temporary difference related to a prepaid pension cost should be considered to result in a taxable amount in the year(s) of an asset reversion from the pension plan. b. The temporary difference related to a liability for accrued pension cost should be considered to result in deductible amounts based on the pattern of present values of estimated tax deductions for the following year and succeeding years, if necessary. The second approach is modeled after the present value method. Reversal patterns are determined without regard to future net periodic pension cost. Absent future net periodic pension cost, recovery of a prepaid pension cost would be by reversion of plan assets. A qualifying tax-planning strategy may be used to determine the particular future year(s). (An excise tax or other penalty charge on withdrawal of plan assets is not accrued prior to withdrawal, and it is not a significant cost for purposes of determining a qualifying tax-planning strategy if the excise tax or penalty rate is the same regardless of the year of withdrawal. Absent anticipation of future net periodic pension cost, an asset reversion is the only feasible means to recover the prepaid pension cost, and there is no incremental cost of withdrawal of plan assets in any particular future year(s).) Similarly, settlement of a liability for accrued pension cost is determined without regard to future net periodic pension cost. Absent future net periodic pension cost, the pattern of deductible amounts is the present value of each future year's estimated tax deductible contribution to the defined benefit pension plan to settle the existing liability for accrued pension cost. If the information necessary to apply either of the above approaches would not be available without the enterprise incurring significant incremental actuarial costs on an ongoing basis, that is, excluding the initial costs of applying the guidance in this answer, the enterprise may use the following approach, which reflects certain aspects of the methodology for recognition and measurement of net periodic pension cost under Statement 87. Temporary differences related to accrued (prepaid) pension cost may be scheduled ratably over the average remaining service period of employees expected to receive benefits under the plan. If all or almost all of a plan's participants are inactive, the inactive participants' average remaining life expectancy should be the appropriate period. 13. Q Paragraph 42 of Statement 96 states that future temporary differences for existing depreciable assets in use at the end of the current year should be considered in determining the future years in which other existing temporary differences result in net taxable or deductible amounts. Does that

14 requirement pertain to other assets or liabilities for which future temporary differences are similar to depreciation temporary differences? [42] A Yes, the requirements of paragraph 42 pertain to other assets or liabilities for which future temporary differences are similar to depreciation temporary differences but few have been identified. One example is intangible assets if the pattern of deductions for tax purposes is different from amortization for financial reporting. 14. Q Do the requirements of paragraph 42 pertain to situations for which the effect of applying those requirements would be to create (a) net deductible amounts for which a tax benefit cannot be recognized in some years and (b) taxable amounts that increase a deferred tax liability for other years? [40, 42, 47] A Paragraph 42 states that "consideration of future originating differences may affect... recognition of a tax benefit for other temporary differences that will result in deductible amounts in future years" (emphasis added). One of the intended results of paragraph 42 is to increase the ability to offset deductible amounts against taxable amounts, and not to increase a deferred tax liability. The example that follows paragraph 42 of Statement 96 illustrates how consideration of future originating depreciation temporary differences can increase offsetting. In that example, there is a $200 temporary difference for estimated expenses that will be deductible in year 7. Absent consideration of the $900 originating depreciation difference in year 2, a tax benefit could not be recognized for that $200 deductible amount in year 7. Consideration of future originating depreciation or amortization differences and their subsequent reversal may sometimes result in (a) net deductible amounts for which a tax benefit cannot be recognized for some years and (b) taxable amounts that increase a deferred tax liability for other years. That result could occur because of limitations on the carryback or carryforward of net deductible amounts to other years, or it could occur if the deductible amounts are capital losses that can only reduce capital gains and there are no capital gain temporary differences that can be offset. For example, assume that (a) carryback and carryforward of net deductible amounts to offset net taxable amounts in other years is not permitted in a certain tax jurisdiction and (b) consideration of future originating depreciation differences (there are no amortizable assets) produces the following results for an enterprise located in that tax jurisdiction: Current Temporary Differences Year Year 2 Year 3 Depreciable assets $200. $(500.) $(500.) All other types of temporary differences 500. _ $700. $ 100. $(400.) Based on the schedule above, the enterprise would recognize a deferred tax liability in the current year for $1,100 of net taxable amounts in years 2, 4, 5, and 6. But the enterprise only has $700 of existing net taxable temporary differences. Consideration of future originating depreciation differences has not increased offsetting. Instead, the originating depreciation difference in year 3 results in a $400 net deductible amount which, based on the tax law in that jurisdiction, cannot be carried back or forward. A tax benefit would not be recognized for that $400 net deductible amount in year 3. A first-in, first-out (FIFO) pattern should be used for all depreciable and amortizable assets in a F

15 particular tax jurisdiction if consideration of future originating differences results in creating net deductible amounts for which a tax benefit cannot be recognized and thereby either increases a deferred tax liability or reduces a deferred tax asset. In other words, there is a limitation on consideration of future originating differences if, as a result, future taxable income is greater than it otherwise would be based on consideration of only the net amount of temporary differences that exist at the date of the financial statements. In the example above, reversal of depreciation differences on a FIFO pattern produces the following results: Current Temporary Differences Year Year 2 Year 3 Depreciable assets $200. $ $ All other types of temporary differences 500. _ $700. $600. $100. That enterprise should recognize a deferred tax liability for $800 of net taxable amounts in years 2, 3, and 4. A tax benefit should not be recognized for the $100 net deductible amount in year 5 unless there is a qualifying tax-planning strategy that would accelerate that net deductible amount to either year 2, 3, or 4. Some assets are deductible for tax purposes only when sold or otherwise disposed of, and that tax deduction can be used only to offset capital gain income. For example, assume that in a particular tax jurisdiction: a. The cost of office buildings is only deductible in the year of sale or other disposition (that is, annual tax deductions for depreciation are not allowed) and that tax deduction can only offset capital gains. b. Net deductible amounts in a particular year may be carried back 3 years and carried forward 10 years to offset net taxable amounts in those years. c. Consideration of future originating depreciation differences (there are no amortizable assets) produces the following results for an enterprise located in that tax jurisdiction: Current Temporary Differences Year Years 2-4 Depreciable assets: Office buildings $(300.) $ 900. All other depreciable assets 100. (300.) Other types of temporary differences _ $ ,300. Loss carryback $1,300. Future originating and reversing differences are separately scheduled for the office building because that asset is the only depreciable asset that results in capital loss deductions. Based on the schedule above, the enterprise would recognize a deferred tax liability for $2,000 of net taxable amounts in years 2-6. It could not recognize a tax benefit for the $1,800 capital loss deduction in year 7 because there are no capital gain temporary differences to offset. In effect, consideration of future originating depreciation differences for the office building creates (a) $1,500 of deductions in year 7 for which a tax benefit cannot be recognized and (b) $1,500 of taxable amounts in years 2-6 for which a deferred tax liability would be recognized. Reversal of depreciation differences on F

16 a FIFO pattern produces the following results: Current Temporary Differences Year Years 2-4 Depreciable assets: Office buildings $(300.) $ All other depreciable assets 100. Other types of temporary differences _400. _700. $ Loss carryback $700. That enterprise should recognize a deferred tax liability for $700 of net taxable amounts in years 2-4. A tax benefit should not be recognized for the $200 net deductible (ordinary loss) amount in year 8 unless there is a qualifying tax-planning strategy that would accelerate that net deductible amount to years 2-4. A tax benefit cannot be recognized for the $300 capital loss deduction in year 7 because there are no capital gain temporary differences to offset. Whether to schedule future originating and reversing depreciation and amortization differences or to use the FIFO pattern for all depreciable and amortizable assets in a particular tax jurisdiction is an annual decision, and a change in method due to different facts and circumstances for different years is not a change in accounting principle. However, whenever the FIFO pattern is used: a. That pattern also should be used for classification of that deferred tax liability or asset as current or noncurrent in a classified statement of financial position. b. In the United States, that pattern should be used for AMT purposes as well as for regular tax purposes. 15. Q Do the requirements of paragraph 42 pertain to construction in progress? [42] A The requirement of paragraph 42 to consider future temporary differences for existing depreciable assets in use at the end of the current year does not pertain to construction in progress. Construction in progress is not in use at the end of the year, and significant future events will be required before construction in progress can be depreciated. However, a temporary difference between the reported amount and the tax basis of construction in progress may already exist at the date of the financial statements. (For example, the amount of interest capitalized for financial reporting may differ from the amount capitalized for tax purposes.) Taxable or deductible amounts attributable to that temporary difference will commence when the asset is placed in service. If the reported amount exceeds the tax basis of construction in progress, the pattern of taxable amounts in future years is considered to be the same as the future pattern of depreciation for financial reporting (for example, straight-line over five years if that is how the asset will be depreciated for financial reporting). Conversely, if the tax basis exceeds the reported amount of construction in progress, the pattern of deductible amounts in future years is considered to be the same as the future pattern of depreciation for tax purposes. 16. Q Do the requirements of paragraph 42 pertain to depreciable or amortizable assets acquired in a business combination? [42, 66, 67] A The requirement of paragraph 42 to consider future originating and reversing temporary differences pertains to purchase accounting for a business combination regardless of whether there is a temporary difference related to the acquired depreciable or amortizable assets at the date of

17 the business combination. Paragraphs 66 and 67 require recognition of a deferred tax liability or asset in accordance with the recognition and measurement requirements of Statement 96. Those recognition and measurement requirements include the requirements of paragraph 42. Unlike construction in progress, for example, depreciable assets acquired in a business combination are deemed to be in use and no significant future events will be required before depreciation can commence. 17. Q A change in tax law may require a change in accounting method for tax purposes, for example, the uniform cost capitalization rules required by the Tax Reform Act of For calendar-year taxpayers, inventories on hand at the beginning of 1987 are revalued as though the new rules had been in effect in prior years. That initial catch-up adjustment is deferred and taken into taxable income over not more than four years. Does the deferral of the initial catch-up adjustment for a change in accounting method for tax purposes give rise to a temporary difference? [12] A Yes. The uniform cost capitalization rules required by the Tax Reform Act of 1986 initially give rise to two temporary differences. One temporary difference is related to the additional amounts initially capitalized into inventory for tax purposes. As a result of those additional amounts, the tax basis of the inventory exceeds the amount of the inventory for financial reporting. That temporary difference is considered to result in a deductible amount when the inventory is expected to be sold. The other temporary difference is related to the deferred income for tax purposes that results from the same initial catch-up adjustment. As stated above, that deferred income likely will be included in taxable income over four years. However, under the tax law, if there is a one-third reduction in the amount of inventory for two years running, any remaining balance of that deferred income is included in taxable income for the second year. Future purchases of inventory are future events that are not anticipated under Statement 96 (paragraph 41), and absent anticipation of those purchases, there would be a one-third reduction of inventory for two consecutive years if the inventory turnover period is less than two years. Therefore, as of December 31, (3) and as of the three successive year-ends, the pattern of taxable amounts in future years that will result from that temporary difference for a calendar-year taxpayer with inventory that turns over once a year should be considered to be as follows: a. For the balance of the temporary difference as of December 31, 1986, 25 percent in 1987 and 75 percent in 1988 b. For the balance of the temporary difference as of December 31, 1987, 33 percent in 1988 and 67 percent in 1989 c. For the balance of the temporary difference as of December 31, 1988, 50 percent in 1989 and 50 percent in 1990 d. For the balance of the temporary difference as of December 31, 1989, 100 percent in If the amount of the initial catch-up adjustment that is deferred for tax purposes equals $100 in the example above, the pattern of taxable amounts in future years as of December 31, 1986 and as of successive year-ends should be considered to be as follows: a. As of December 31, 1986, $25 in 1987 and $75 in 1988 b. As of December 31, 1987, $25 in 1988 and $50 in 1989 c. As of December 31, 1988, $25 in 1989 and $25 in 1990 d. As of December 31, 1989, $25 in As of December 31, 1986, there also is an initial $100 deductible temporary difference (the additional amount capitalized into inventory for tax purposes), that is, the excess of the tax basis