Download FASB UPDATES TO 10TH EDITION Since the 10th edition of Nikolai

FASB UPDATES TO 10TH EDITION
Since the 10th edition of Nikolai, Bazley, and Jones, Intermediate Accounting, was
published, the FASB has issued five FASB Statements of Standards (155 – 159) and one
FASB Interpretation (48). However, only four have an effect on the discussion in the
textbook, and generally the impact is limited. We briefly summarize the key features
below according to the chapter affected.
Chapter 4: Update for FASB Statement No. 157
On pages 125-126 of Chapter 4, we discuss the proposed standards in the Proposed
Statement dealing with fair value measurements of assets and liabilities. In the
discussion, we explain the FASB’s proposed definition of “fair value” and identify its
proposed hierarchy of five broad categories (levels) for estimating fair value.
In FASB Statement No. 157, “Fair Value Measurements,” the FASB slightly modified
its definition of fair value, and reduced its hierarchy of levels for estimating fair value
from five to three.
Fair value is now defined as the price that a company would receive to sell an asset or
that it would pay to transfer a liability in an orderly transaction between market
participants on the date of measurement. Thus, fair value is based on a measure of exit
value. In determining the price, a company should consider the specific attributes of the
asset or liability.
To increase the consistency and comparability of fair value measurements, the FASB
established a hierarchy which prioritizes the inputs to the valuation techniques companies
are to use to measure fair value. The hierarchy consists of three levels of inputs as
follows:

Level 1 inputs are quoted prices in active markets for identical assets (or
liabilities) that the company can access on the measurement date. A quoted
market price provides the most reliable evidence of fair value and should be used
whenever available.
 Level 2 inputs are exit values (other than the quoted prices included in Level 1)
that are observable for the asset (or liability), either directly or indirectly. These
include, for example, quoted market prices for similar assets (or liabilities) in
active markets or quoted prices for identical or similar assets (or liabilities) in
markets that are not active.
 Level 3 inputs are unobservable values for the asset (or liability). These should be
used to measure fair value only when Level 1 or Level 2 inputs are not available.
Unobservable inputs reflect the company’s assumptions about how market
participants would price the asset (or liability). One example of a Level 3 value is
the use of a present value technique to convert expected future amounts to a single
present amount.
Chapters 4, 15, and 22: Update for FASB Statement No. 159
On page 126 of Chapter 4, we note that the FASB might develop GAAP in which
“financial” assets and liabilities are valued at fair value while “non-financial” assets and
liabilities are valued at historical cost. The FASB moved in this direction when it issued
FASB Statement No. 159, “The Fair Value Option for Financial Assets and Financial
Liabilities, including an Amendment of FASB Statement No. 115.” This Statement
permits companies to measure many financial instruments at fair value even though they
are not required to be measured at fair value. The items that may be measured at fair
value include, for instance, a recognized financial asset (or liability), a firm commitment,
a written loan agreement, the rights and obligations under an insurance contract, and the
rights and obligations under a warranty. If a company elects to measure an item at fair
value, any unrealized gain or loss must be reporting in earnings.
FASB Statement No. 159 also amended FASB Statement No. 115 in two ways. The first
amendment relates to the reporting of investments in available-for-sale securities that we
discuss in Chapter 15. A company is now required to separately report its investments in
available-for-sale securities (and trading securities) separately from similar assets that are
measured using another measurement attribute on the balance sheet. The second
amendment relates to the reporting of the cash flows from purchases, sales, and
maturities of trading securities on the statement of cash flows. As we stated on page
1156 of Chapter 22, these cash flows were reported in the operating activities section of
the statement of cash flows. Now these cash flows are reported based on the nature and
purpose for which the securities were acquired.
Chapter 19: Update for FASB Interpretation No. 48
In Chapter 19, we discuss various transactions involving tax deductions. The tax
treatment of many transactions is not clear-cut. The company and the Internal Revenue
Service (IRS) often disagree on whether a transaction qualifies for a tax deduction, the
period in which the amount can be deducted, and the amount of the deduction, if any.
Because FASB Statement of Financial Accounting Standards No. 109, “Accounting for
Income Taxes,” does not currently provide a confidence threshold that must be met in
order for the benefits from the tax position to be recognized in the financial statements,
considerable diversity has developed in practice for these “uncertain tax provisions.”
Many companies have recorded the tax benefits on an “as-filed” basis. That is, they
recognized any current or deferred tax assets or liabilities when they took the related tax
position. They frequently recorded a valuation allowance to reduce any current or
deferred tax benefit if it was “more likely than not” that an adjustment to the tax benefit
would be required. Such amounts often are significant and their resolution will often take
years. For example, in its 2005 annual report, Microsoft reported an adjustment
(reduction) of $776 million to its 2005 tax provision due to resolution of tax matters
related to the 1997-1999 tax years. 1 Because of the variety of approaches that companies
1
Other companies will employ other methods to recognize such benefits such as gain contingency
accounting or the accrual of amounts based on a predetermined threshold of whether the position will be
sustained on audit.
use to recognize the tax benefits associated with their uncertain tax positions, the FASB
issued FASB Interpretation No. 48 (FIN 48), “Uncertain Tax Positions,” which contains
guidance on (1) the recognition and (2) the measurement of all tax positions accounted
for in accordance with FASB Statement No. 109.
First, the initial recognition of an uncertain tax position is determined by whether the tax
position is “more likely than not” (greater than 50% probability) of being sustained on
audit, based on the technical merits of the position. In making this determination, a
company must assume that the uncertain tax position will be audited, which effectively
removes detection risk from consideration. Assuming that a tax position meets the
recognition criteria, the second step is for a company to measure the tax benefit as the
largest dollar amount that is above the “more likely than not” threshold.
If a company’s best estimate of the tax benefit changes due to new information, the
subsequent recognition and measurement is based on management’s best estimate as of
the reporting date. If a previously recognized tax benefit no longer meets the “more
likely than not” recognition threshold, a company must “derecognize” this benefit by
recording an income tax liability or decreasing a deferred tax asset; the use of a valuation
allowance is not appropriate for derecognition. In addition, a company is required to
accrue any interest and/or penalties related to an underpayment of taxes based on
management’s best estimate of the amount that will ultimately be paid in the same period
that (1) the interest would begin accruing and/or (2) the penalties would first be assessed.
The difference between the tax benefit recognized in the financial statements and the tax
benefit reflected in the tax return would result in either an increase in the income tax
liability, an increase in a deferred tax liability (if the difference relates to a taxable
temporary difference), or a decrease in a deferred tax asset (if the difference is due to a
deductible temporary difference). Among the required disclosures are (1) a table that
reconciles the beginning and ending balances of the unrecognized tax benefits, (2) the
total amount of the unrecognized tax benefits that, if recognized, would affect the
effective tax rate, (3) the total amount of interest and penalties recognized in the financial
statements, and (4) a discussion of the tax positions that management believes are
reasonably possible to change significantly in the next 12 months.
Example: To illustrate the accounting for uncertain tax positions, assume that a
company claims a research and experimentation tax credit of $1,000,000 on its tax return.
Historically, the IRS has challenged whether some of the expenditures meet the definition
of “qualified research expenses” under IRC Section 41. Before the company can
recognize the tax benefit, it must first determine if the tax position is “more likely than
not” to be sustained on audit. Based on the technical merits of the position, the company
believes that all the expenditures are valid and supportable, and the majority of them will
be sustained on audit. The company has met the recognition threshold and must now
determine the amount of the benefit to recognize.
The company estimates that the following probability distribution of possible outcomes.
Dollar Amount of Tax Benefit
that Management Anticipates
will be Sustained
$1,000,000
$910,000
$850,000
Probability that the
Tax Position will be
Sustained
30%
30%
40%
Cumulative Probability
that the Tax Position
will be Sustained
30%
60%
100%
Because $910,000 is the largest dollar amount above the 50% threshold, the company
will recognize a current tax benefit of $910,000 in its financial statements. The $90,000
difference between the tax credit claimed on the tax return ($1,000,000) and the amount
estimated to be ultimately sustained ($910,000) is the “unrecognized tax benefit” and is
recorded as a non-current liability since the company does not expect settlement within
the next year. Additionally, the company should accrue taxes and penalties, if applicable,
on the $90,000 using the applicable statutory rate. The ultimate settlement, at an amount
greater or less than $90,000, would be accounted for in the period of settlement.
Chapter 20: Update for FASB Statement No. 158
In Chapter 20, we discussed the accounting for postemployment benefits. At the time of
publication of the 10th edition, companies were not required to report the over- or
underfunded status of their defined benefit postretirement plans. FASB Statement No.
158, “Employers’ Accounting for Defined Benefit Pension Plans and Other
Postretirement Plans, an Amendment of FASB Statements No. 87, 88, 106, and 132(R),”
changed the reporting requirements for postemployment benefits. Now, companies are
required to recognize the overfunded or underfunded status of their defined benefit
postretirement plans as an asset or liability on their balance sheets. They are also
required to recognize any change in the funded status of these plans in comprehensive
income for the year in which the change occurs. The intent of the Statement is to
improve financial reporting.
Reporting the overfunded or underfunded status of a postretirement plan significantly
changed the accounting for defined benefit pension plans and other postretirement benefit
plans. Therefore, last fall the authors completely updated Chapter 20. The updated
Chapter 20 (77 pages) may be downloaded from our section of the
www.thomsonedu.com/accounting/nikolai web site, or may be purchased (its ISBN
number is 0-324-65168-6).