Implementation of FAS 96: temporary differences - scheduling and reversals.

• Author: Diebold, Joseph P.

Implementation of FAS 96: Temporary Differences--Scheduling and Reversals (*1)

Under Statement of Financial Accounting Standards No. 96, deferred tax assets and liabilities are calculated as if a tax return were prepared for each future year using the net taxable or deductible amounts anticipated to occur in each future year as a result of the reversal of existing temporary differences. Scheduling is the process of estimating the specific years in which existing temporary differences will result in taxable or deductible amounts.

The amount of taxes payable or refundable in each future year must be determined for each tax jurisdiction and for each alternative tax system within each tax jurisdiction (such as the U.S. alternative minimum tax system). Accordingly, it may be necessary to schedule the reversal of temporary differences for each tax jurisdiction and each alternative tax system.

1. Aggregate Calculation

   In certain situations, a detailed scheduling exercise may not be necessary for every tax jurisdiction or the scheduling process may be limited to only certain temporary differences. For example, scheduling generally will not be required in a tax jurisdiction if all the following criteria are met:

   * The enacted tax rate is the same in all future years.

   * The effects of graduated tax rates are not significant.

   * All temporary differences result only in taxable amounts in future years (there are no temporary differences that will result in future deductible amounts).

   * There are no net operating loss or tax credit carryforwards.

   * Alternative tax systems would not have a significant effect on the deferred tax calculation.

   * The balance sheet is unclassified or the current portion of deferred taxes can be determined without scheduling.

   In certain situations, it may be possible to perform the scheduling process using time spans of several years, exclude certain temporary differences from the scheduling exercise, or limit the scheduling proces to only certain items. For instance, if the tax benefits of future deductible amounts would not qualify for recognition because the future deductible amounts clearly could not offset future taxable amounts or be carried back to recover taxes paid, such future deductible amounts could be excluded from the scheduling process. Similarly, if there are no future deductible amounts and there are sufficient future taxable amounts to use a net operating loss or tax credit carryforward before the carryforward period expires, it may not be necessary to schedule the future taxable amounts that would be offset by the net operating loss carryforward.

   Generally, however, it is anticipated that some scheduling will be required in all but the simplest of cases. For instance, some scheduling may be required in any of the following scenarios:

   * Scheduling may be necessary for at least the first year after the balance sheet date to determine the current portion of deferred taxes in a classified balance sheet. Because Statement 96 does not permit offsetting deferred tax assets and liabilities relating to different tax jurisdictions, this procedure may be necessary for each tax jurisdiction.

   * Scheduling may be necessary to determine whether the tax benefits of temporary differences that will result in future deductible amounts may be recognized.

   * If there are net operating loss or tax credit carryforwards, scheduling may be necessary to determine whether the tax benefits of such carryforwards may be recognized.

   * Scheduling may be necessary for tax jurisdictions with graduated tax rates or for tax jurisdictions with different tax rates or limitations on various types of income or loss, such as different tax rates on capital gains or limitations on capital losses.

   * If the enacted tax rates for all future years are not the same, scheduling may be required to determine the appropriate tax rate to apply to future taxable amounts.

   * When alternative tax systems exist, such as the U.S. alternative minimum tax, it may be necessary to schedule the reversal of temporary differences under the regular tax system and the alternative tax system to determine the applicable tax system for each future year.

2. Determining Period of

   Reversal

   The scheduling of future taxable and deductible amounts is based on the timing of the recovery or settlement of the asset or liability. Determining the periods that a temporary difference will result in taxable or deductible amounts is easy when the recoverability of the asset or the settlement of the related liability is governed by a contract. Scheduling also is easy for depreciation, where financial reporting and tax lives and methods are known. In other cases, determining the period of reversal will require estimates and judgments.

   In certain instances, temporary differences will not reverse in the foreseeable future. In those cases, the temporary difference should be scheduled to reverse in the "indefinite column" (the very last column).

   Tax benefits attributable to temporary differences that will result in future deductible amounts that are scheduled in the indefinite column generally cannot be recognized. Deferred tax liabilities must be recognized on future taxable amounts scheduled in the indefinite column. Future deductible amounts in the indefinite column may be offset, however, against future taxable amounts in the indefinite column if both the deductible and taxable amounts will be reported in taxable income upon occurrence of the same event, such as the sale of a subsidiary.

   In certain cases, qualified tax-planning strategies may be available to accelerate future taxable and deductible amounts in the indefinite column to a particular year.

3. Examples of Scheduling

   Temporary Differences

   The remainder of this article describes typical temporary differences and provides guidance for determining the periods that those differences will result in taxable or deductible amounts based on the U.S. federal income tax law applicable to the regular tax system.

   The guidance in this section does not consider tax-planning strategies. In certain cases, a qualified tax-planning strategy may be used to change the particular years in which a temporary difference results in taxable or deductible amounts.

   1. Valuation Allowances for Investments

      in Marketable Equity

      Securities

      In classified balance sheets, the temporary difference attributable to the valuation allowances on current marketable equity securities should be scheduled to result in a deductible amount in the year following the balance sheet date. The temporary difference related to the noncurrent portfolio of marketable equity securities should be scheduled to reverse in the years in which management expects to sell the securities.

   2. Investments in Bonds

      The financial statement carrying amount of an investment in bonds may differ from the tax basis of the investment because of amortization of discount or premium for financial reporting purposes. The temporary difference as of the balance sheet date should be scheduled as a taxable or deductible amount in either the year of maturity or the estimated year of sale, depending on whether management intends to hold the bond to maturity or sell the bond.

      Temporary differences expected to arise in the future as a result of amortization of bond discount or premium for financial reporting purposes should not be considered in the scheduling process.

   3. Allowance for Doubtful Accounts

      The Tax Reform Act of 1986 eliminated the reserve method of calculating the allowance for doubtful accounts for tax purposes for many taxpayers. For taxable years beginning after December 31, 1986, deductions for bad debts must be based on the specific charge-off method. A temporary difference generally will exist in the amount of the allowance for doubtful accounts for financial reporting purposes. This temporary difference should be scheduled to result in deductible amounts based on management's estimate of the years in which the company will take the related tax deduction under the specific charge-off method. Allowances recognized for specific accounts receivable should be scheduled with reference to the related receivable. The reversal of allowances not attributable to specific accounts receivable shoud be estimated based on historical trends and other information used to calculate that portion of the allowance for doubtful accounts.

      For calendar-year taxpayers, the balance of any allowance for doubtful accounts calculated using the reserve method for tax purposes as of December 31, 1986, must be included in taxable income ratably over a four-year period beginning in 1987. The change from reserve method to the specific charge-off method for tax purposes creates another temporary difference for the amount of the tax reserve to be included in taxable income over the four-year period. This amount represents deferred income for tax purposes. In this situation, there are two separate temporary differences relating to the allowance for doubtful accounts that require scheduling. The amount of the allowance for...