Welcome back. In this lesson,

we're going to talk about Intraperiod Tax Allocation.

Intraperiod Tax Allocations are just a matter of geography

where we're going to display tax expense and therefore,

defer tax items on the income statement,

whether it will be within operating income or somewhere else.

So, we're going to allocate taxes between different items on the income statement,

statement of comprehensive income based

upon the source of the income or loss in the current year.

And well, it's not in the manner as a source of

the operating loss carry forward or taxes paid in the prior year,

so we're not going to look back to a prior year.

And we're not going to look forward to a future year and try

to see how that realization would be done in a future year.

We're going to do it based upon the current year.

So we're going to allocate between a number of

different sub totals and the statement of

comprehensive income with net income being one of the subtotals.

The subtotals are going to be continuing operations,

discontinued operations both net income,

other comprehensive income which is outside of net income but incomprehensive income,

and items charge are credited directly to shareholders equity,

and we'll give some examples of each of those.

Let's start with Disc Op, or discontinued operations.

Those are reported net of taxes including the deferred taxes.

So, what is a Disc Op?

A disposal of a component of an entity or group of components as reported in Disc Op,

if the disposal represents

a strategic shift that will have a major effect on operations or financial results,

and it either meets the criteria to be classified as held for sale,

has been disposed of by sale,

or is disposed of by abandonment or distribution to owners in a spinoff.

Now this is a change in fairly recent years that we've gone back and forth in GAAP,

as to whether a discontinued operations should be defined so that

there's a lot of them or defined so that there's very few.

Currently, we've decided that a Disc Op must be a strategic shift,

which means it's a fairly high bar and you wouldn't expect to

see a lot of them under the way we're currently describing those,

but if you do have one you're going to account for it separately net of tax effect.

Other comprehensive income, so these are items that we've talked about previously,

as gains and losses on AFS securities,

available for sale securities, our pension,

and Other Post Employment Benefits,

foreign currency translation adjustments are included in OCI.

All of these are net of tax and they are included,

including the deferred taxes,

there's really sort of two categories of deferred taxes initially that's

deferred taxes for operating income and deferred taxes

for these other items especially other comprehensive income.

And that certain transactions go direct to equity.

It's kind of rare but you do get it within

error correction might be charged but that goes back several years.

The cumulative effect up to the beginning,

the first financial statement presented maybe recognized directly in retain income.

Sometimes changes in accounting standards are done that way.

This year a lot of companies will be required reporting

the net impact of adopting the new revenue recognition standard.

For example, direct to income,

direct to equity, adjustment to beginning retained earnings.

And then there's a various changes to

stock options too that are recorded that way as equity transactions.

So those too get reported net of any tax impact.

Income from operations, well income from operations is just about everything else.

Even some stuff that you normally may not expect to be in operations.

What do we mean by that?

There is something called backwards tracing that you may come across this term,

it may become quite prominent if we have

a change in tax rates in this in the coming period.

Why? Because it means that when I have a change in something,

a change in judgment about the realization of deferred tax assets or

a change in tax laws or tax rates,

a change in tax status.

Am I going to be a taxable entity or not?

Tax deductible dividends paid to shareholders.

All of these things generally,

you don't go back and look to see

where the item was originally recognized in other comprehensive income,

for example, or as a part of a Disc Op.

You're going to just take it all through operations.

This I can said could be a significant item

in the coming period if we have a change in the tax.

So let's look at an example,

AutoCar invest in debt securities

including $1,000 that are classified as held to maturity.

$1,000 classified as trading and $1,000

classified as available for sale. Why are we doing this?

We're going to show you the difference in intraperiod tax allocation based on an item,

first not having a taxable difference,

second having a taxable difference that's recognized in net income, and third,

a taxable difference that's recognized in OCI,

and this is a convenient way to have the same relatively same set of facts and show

you the difference based upon how the gain or loss is recognized or not recognized.

So let's had say they have received $10 in interest to in each of December 31, X7.

The fair value of each security is also $1,100.

They're all the same and we're assuming a tax rate of 25%.

Now what's a deferred tax impact?

Well let's look at the held to maturity item first.

So there is no deferred tax impact because

the book basis and the tax basis are both $1,000.

I haven't had an unrealized change.

Now, for all three scenarios you're going to recognize

a $10 interest income in taxable revenue.

But again, there'll be

no deferred tax difference so it will be recognized pretty much for

the same period for taxable and for GAAP purposes.

Now, let's look at the one that's really

recorded at fair value through net income, a trading security.

So now there'll be an unrealized gain on

the investment and that will be included in earnings.

But it's not included in taxable income until you sell the security.

So the temporary difference is included in

the overall determination of deferred taxes on earnings.

So I have $100 gain on the investment and I have tax expense of $25 recognized on that,

but my deferred tax,

since I'm not recognizing it for income tax purposes,

I'll have a deferred tax liability of $25.

Again, the tax rate times the unrealized gain.

Now let's look forward at the one that's available for sale which is

recognize at fair value but through other comprehensive income.

So the unrealized gain or loss is included in OCI net

of tax and it's not included in taxable income.

So now, I will have AFS investments will be have a $100 gain but I'm

going to record that gain in OCI at $75 net of the deferred tax through OCI.

So the amount of OCI that will be reported on it will only be $75 net of the tax.

Notice in the fair value net income,

we recorded it gross,

we recorded the entire $100 gain because the tax effect will be taken care of in the over

all tax entry that reduces

taxable income by the tax income taxes expense.

In OCI we'll attributed to each individual item and

each individual item will be reported net of taxes.

You can, for display purposes,

display it as an overall impact but the recording,

the reporting requirement is that items in OCI are reported net of tax,

items in operating income are not.

Finally, let's do an example for a Disc Op, a discontinued operation.

We have AutoCar decides to discontinue

its driver operated autos in favor of driverless cars.

A strategic shift that qualifies as a discontinued operation.

So now, they expect a loss of a million dollars on sale of the related assets.

So assuming a tax rate of 25%,

what is the deferred tax impact?

So because AutoCar expects that loss on the assets that are now held for sale,

they're going to reclassify the assets as held for sale for 9 million dollars.

And they'll recognized in loss,

but the loss is going to be net of tax because it's Disc Op.

So we have a loss and Disc Op of 750,000 and deferred

tax asset for 250,000 reflecting the 25% tax rate.

So they are expecting to get a deferred,

a loss, a recognized loss for tax purposes in the future when the sale is completed.

Now there also need to assess

whether they need a valuation allowance for the deferred tax asset.

So, we've talked now about temporary items,

we've talked about net operating loss carry forwards and carry backs,

we talked about intraperiod tax allocation.

That's the guts, that's the heart of deferred tax accounting.

We'll continue in our next session the discussion on tax rates. Thank you.

Intraperiod Tax Allocation

Accounting Analysis II: Measurement and Disclosure of Liabilities

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