- Is allocated to continuing operations if it offsets the current or deferred tax consequences of income from continuing operations
- Is allocated to a gain on discontinued operations if it offsets the current or deferred tax consequences of that gain
- Is allocated to continuing operations if it results from a change in circumstances that causes a change in judgment about future realization of a tax benefit.
- Occurred in the current year
- Occurred in a prior year (that is, if realization of the tax benefit will be by carryback refund)
- Is expected to occur in a future year.
The tax benefit of an operating loss carryforward or carryback (other than for the exceptions related to the carryforwards identified at the end of this paragraph) shall be reported in the same manner as the source of the income or loss in the current year and not in the same manner as the source of the operating loss carryforward or taxes paid in a prior year or the source of expected future income that will result in realization of a deferred tax asset for an operating loss carryforward from the current year. The only exception is the tax effects of deductible temporary differences and carryforwards that are allocated to shareholders’ equity in accordance with the provisions of paragraph 740-20-45-11(c) through (f).
The effect of a change in the beginning-of-the-year balance of a valuation allowance that results from a change in circumstances that causes a change in judgment about the realizability of the related deferred tax asset in future years ordinarily shall be included in income from continuing operations. The only exceptions are changes to valuation allowances of certain tax benefits that are adjusted within the measurement period as required by paragraph 805-740-45-2 related to business combinations and the initial recognition (that is, by elimination of the valuation allowances) of tax benefits related to the items specified in paragraph 740-20-45-11(c) through (f). The effect of other changes in the balance of a valuation allowance are allocated among continuing operations and items other than continuing operations as required by paragraphs 740-20-45-2 and 740-20-45-8.
Under these rules, the intraperiod allocation depends on whether the benefit of the loss or deduction is recognized or realized in the year in which it is generated and whether the income to allow for the realization of the loss relates to the current year or future years. In situations when a reporting entity has recorded a valuation allowance on its beginning-of-year tax attributes, such as net operating losses and capital loss carryforwards, or other DTAs that can be realized in the current year by income from continuing operations, the benefit of this realization is generally allocated to continuing operations rather than to the financial statement component that gave rise to the deferred tax asset in the earlier year.
These rules can be summarized as follows:- When there is an increase or decrease in the valuation allowance applicable to beginning-of-year DTAs that results from changes in circumstances that cause the assessment of the likelihood of realization of these assets by income in future years to change, the effect is reflected in continuing operations. An increase or decrease can include the initial recording of a valuation allowance, a change in measurement of a previously recorded valuation allowance, or a full release of a valuation allowance. This is true except for the initial recognition of source-of-loss items, as discussed in TX 12.3.2.4. See TX 12.3.3.2 for a discussion of valuation allowance changes as a result of NOL carryforward limitations after an initial public offering.
- When income in the current year allows for the release of a valuation allowance, the resulting benefit is allocated to the current-year component of income that allows for its recognition (subject to certain exceptions, such as the initial recognition of source-of-loss items, see TX 12.3.2.4).
- When the tax benefit of a loss in the current year is recognized and would have been realizable absent taxable income in another component, it is allocated to the component that generated the loss regardless of the financial statement source of the taxable income that allows for its recognition. This principle is the same whether the source of income is (a) taxable income in the current year, (b) taxable income in a prior year to which the current-year loss can be carried back, or (c) taxable income that is expected to occur in future years.
Example TX 12-5, Example TX 12-6, and Example TX 12-7 illustrate the general rules for the recording of changes in valuation allowances.
EXAMPLE TX 12-5
Change in valuation allowance on beginning-of-year DTAs resulting from current year income and changes in projections of income in future years
In 20X2, USA Corp has $1,200 of pre-tax income from continuing operations and $600 of pre-tax income from discontinued operations. At the beginning of the year, USA Corp has a $2,000 net operating loss carryforward (which was generated in prior years by what are now discontinued operations) that has been reflected as a DTA of $500 less a valuation allowance of $500 (i.e., no net DTA has been recognized).
At year-end 20X2, based on the weight of available evidence, management concludes that the ending DTA is realizable based on projections of future taxable income. The statutory tax rate for all years is 25%.
How should the tax provision for 20X2 be allocated between continuing operations and discontinued operations?
Analysis Intraperiod allocation would be performed in the following manner: Step 1: Compute total tax expense or benefit 20X2 pre-tax income/(loss) – Continuing operations 20X2 pre-tax income/(loss) – Discontinued operations Pre-tax income/(loss) Expected tax provision/(benefit) before valuation allowance release Valuation allowance release 20X2 total tax provision/(benefit) Step 2: Compute tax provision/(benefit) attributable to continuing operations 20X2 pre-tax income/(loss) – Continuing operations Expected tax provision/(benefit) before valuation allowance release Change in valuation allowance Resulting from current year income Resulting from projections of future year income 20X2 total tax provision/(benefit) attributable to continuing operationsSince the determination of tax allocated to continuing operations is made first, and because we generally regard all income from projections of taxable income in future years to be attributed to continuing operations, valuation allowance changes usually are recorded in continuing operations. In making this determination, we believe that changes in judgment regarding the projections of future-year income should be attributed to continuing operations, even when the change in estimate about the future is affected by another financial statement component.
Without consideration of the current-year income from discontinued operations of $600, continuing operations would have realized a $300 DTA relating to net operating loss carryforwards that had a valuation allowance recorded against them at 12/31/X1. In addition, the valuation allowance on the $200 DTA relating to the remaining carryforward would have been realized through the projection of future pre-tax income from continuing operations. ASC 740-10-45-20 indicates that the release of the valuation allowance based on income expected in future years should be allocated to continuing operations despite the fact that the losses previously had been generated from what are now discontinued operations.
As discussed in TX 12.3.3, the third step would be to allocate the remaining tax to the other components.
Step 3: Allocated tax to categories other than continuing operations Total tax provision/(benefit) (Step 1) Tax provision/(benefit) allocated to continuing operations (Step 2) Tax provision/(benefit) allocated to discontinued operationsBecause the entire DTA could be supported by the current-year income from continuing operations and by projections of future income, none of the valuation allowance release has been allocated to discontinued operations.
EXAMPLE TX 12-6Example of decreases in valuation allowance resulting from current-year income
At December 31, 20X1, USA Corp has a net DTA of $1,000, including a DTA for net operating loss carryforwards of $1,200 and a DTL for the excess of book basis over tax basis in fixed assets of $200. Because of the existence of significant negative evidence at December 31, 20X1, and the lack of positive evidence of sufficient quality and quantity to overcome the negative evidence, a full valuation allowance was recorded against this $1,000 net DTA.
During 20X2, USA Corp generated pre-tax income from continuing operations of $100 and pre-tax income from discontinued operations of $800. Assume a tax rate of 25%. At December 31, 20X2, based on the weight of available evidence, a full valuation allowance on the existing DTA of $775 ($1,000 of beginning-of-year DTA less $225 (25% of the sum of pre-tax income from both continuing and discontinued operations of $900)) was still required.
What is the intraperiod allocation of the valuation allowance release of $225 that resulted from the current-year realization of net DTAs?
Analysis Intraperiod allocation would be performed in the following manner: Step 1: Compute total tax expense or benefit 20X2 pre-tax income/(loss) – Continuing operations 20X2 pre-tax income/(loss) – Discontinued operations Pre-tax income/(loss) Expected tax provision/(benefit) before valuation allowance release Valuation allowance release 20X2 total tax provision/(benefit) Step 2: Compute tax provision/(benefit) attributable to continuing operations 20X2 pre-tax income/(loss) – continuing operations Expected tax provision/(benefit) before valuation allowance release Valuation allowance release 20X2 total tax provision/(benefit) attributable to continuing operationsAbsent effects of the income from discontinued operations, the provision for continuing operations would be zero, composed of $25 of tax on the $100 of pre-tax income offset by the $25 benefit from the reversal of the valuation allowance on the DTA related to the net operating losses that would have been utilized. The remaining reversal of the valuation allowance of $200 is solely due to an item occurring outside of continuing operations and not a change in judgement related to future realizability.
As discussed in TX 12.3.3, the third step would be to allocate the remaining tax to the other components.
Step 3: Allocate tax to categories other than continuing operations Total tax provision/(benefit) (Step 1) Tax provision/(benefit) related to continuing operations (Step 2) Tax provision/(benefit) allocated to discontinued operationsAs a result of the application of the incremental approach, there is $0 tax expense to allocate to discontinued operations. The $800 of income from discontinued operations and associated tax expense of $200 ($800 multiplied by the 25% tax rate) is fully offset by a release of the valuation allowance, resulting in $0 tax expense from discontinued operations.
EXAMPLE TX 12-7
Example of increase in valuation allowance resulting from current year losses in continuing operations and OCI
- USA Corp disposed of land and incurred a 20X2 pre-tax capital loss in continuing operations of $150,000. In the US, capital losses can be used to offset only capital gain income, and excess capital losses may be carried back three years and forward five years.
- During 20X2, there was an additional $250,000 unrealized pre-tax loss recognized in OCI related to AFS debt securities which results in a deductible temporary difference that is capital in nature.
- At December 31, 20X1, USA Corp had $200,000 of capital gains. Because the $150,000 20X2 capital loss on disposal of land is carried back to 20X1, there is still carryback capacity of $50,000 of capital gains remaining at December 31, 20X2.
- At December 31, 20X1, no valuation allowance was recorded because USA Corp had sufficient capital gains in the carryback period to utilize the DTAs attributable to the AFS debt securities.
- At December 31, 20X2, as only $50,000 of capital gains are available in the carryback period, $56,250 (($275,000 less $50,000) x 25%)) of the deductible temporary differences will need a valuation allowance.
- At December 31, 20X1, USA Corp has a deductible temporary difference of $25,000 related to AFS debt securities. The deferred tax components for 20X1 and 20X2 appear below:
The current-year loss in continuing operations is fully benefited because, in this fact pattern, absent the 20X2 loss reported in OCI, no valuation allowance would have been required due to existing capital gains in the carryback period.
As discussed in TX 12.3.3, the third step would be to allocate the remaining tax to the other components.
Step 3: Allocate tax to categories other than continuing operations Total tax expense/(benefit) (Step 1) Tax provision/(benefit) allocated to continuing operations (Step 2) Tax expense/(benefit) allocated to OCIFollowing the incremental approach, the entire $56,250 valuation allowance recorded during the year was allocated to OCI because, absent the current-year pre-tax loss on the AFS debt securities reported in OCI, no valuation allowance would have been required.
12.3.2.4 Intraperiod application of the source-of-loss rule
Regardless of when it occurs, the initial recognition of the tax benefits of certain deductible differences and carryforwards is classified on the basis of the source of loss that generated them, rather than on the basis of the source of income that utilizes or is expected to utilize them. This aspect of intraperiod allocation sometimes is referred to as "backwards tracing." ASC 740-20-45-3 prohibits backwards tracing except for items specifically included in ASC 740-20-45-11(c) through ASC 740-20-45-11(f). Those specific items should be allocated directly to the related components of shareholder's equity regardless of the source of income that allows for their realization.
The treatment as source-of-loss items only applies to the initial recognition of the tax benefit. If the benefit of a loss carryforward attributable to a tax deduction received in connection with issuing capital stock was previously recognized in equity, but a valuation allowance is recorded subsequently against that item, it would lose its identity as a source-of-loss item. Accordingly, the subsequent re-recognition of the benefit of the carryforward would be recorded based on the “with and without” intraperiod allocation process. That is, the benefit would be allocated based on the general rules for changes in valuation allowances, as noted at TX 12.3.2.3.
Example TX 12-8 illustrates application of the source-of-loss rule. EXAMPLE TX 12-8Application of the source-of-loss rule
In 20X1, USA Corp has $1,000 of income from continuing operations. The applicable tax rate is 25%. USA Corp has a net operating loss carryforward of $1,200 relating to deductible expenditures reported in contributed capital, resulting in a beginning-of-year DTA of $300 ($1,200 × 25%). This $300 DTA has a full valuation allowance recorded against it that was established at the date of a capital-raising transaction and was not subsequently reduced (making the DTA a source-of-loss item).
USA Corp concluded that a full valuation allowance is required at year-end. There are no permanent or temporary differences (either current year or cumulative) other than the net operating loss carryforward noted above.
How should tax expense/benefit be allocated? AnalysisIn Step 1, total tax expense would be zero because the tax effect of the $1,000 pre-tax income at a 25% statutory tax rate would be offset by the reversal of $250 of the $300 valuation allowance that had been recorded on the DTA. Because the tax benefit was initially recognized after the period in which it was generated (by means of utilizing $1,000 of the carryforward to offset the pre-tax income of $1,000), the reversal of the valuation allowance should be backward traced to equity.
As a result, the entry to allocate tax for the year would be as follows: Dr. Deferred tax provision – continuing operations Dr. Valuation allowance12.3.2.5 Determining the source of a realized tax benefit
The general rules for allocating the effects of changes in valuation allowances discussed at TX 12.3.2.3 apply to most changes in valuation allowances. However, because of the source-of-loss exceptions for the initial recognition of certain tax benefits and because a deductible temporary difference may reverse and be utilized on a tax return but be replaced with another deductible temporary difference within the same year (thus not realizing a tax benefit), the determination of which carryforward or deductible temporary difference produced a realized tax benefit during the year may become important when applying the intraperiod allocation rules.
When there are both DTAs at the beginning of the year and DTAs arising in the current year from sources other than continuing operations, a change in the valuation allowance must be “sourced” to the assets that gave rise to the change.
In determining whether the reversal of a particular deductible temporary difference or carryforward provided a benefit, one must consider the interaction of originating temporary differences with loss and other carryforwards. Just because a net operating loss carryforward was utilized (used on the tax return), it does not mean that a benefit was realized. ASC 740-10-55-37 indicates that the reversal of a deductible temporary difference as a deduction or through the use of a carryforward does not constitute realization when reversal or utilization resulted because of the origination of a new deductible temporary difference. This is because the DTA that has been utilized has simply been replaced by the originating DTA without providing for realization. Accordingly, ASC 740-10-55-37 indicates that the "source" of the benefit of the originating deductible temporary difference would not be the component of income in which the originating deductible temporary difference arose; rather, it would take on the source of the deduction or carryforward that it replaced.
The specific example in ASC 740-10-55-37 is in regard to deferred revenue, but the reference to ASC 740-20-45-3 makes it clear that the same rationale applies when an origination or increase of a deductible temporary difference during the year allows for the utilization of a deduction or carryforward that originated in equity (e.g., the tax benefit and related valuation allowance are recorded in equity, consistent with ASC 740-20-45-11(c) and (f)).
Example TX 12-9 illustrates a reduction in an NOL from an equity transaction that is replaced by a subsequent originating DTA.
EXAMPLE TX 12-9
Example of a reduction in an NOL from an equity transaction that is replaced by a subsequent originating DTA
On December 31, 20X1, USA Corp raised new capital from its investors. USA Corp recorded a DTA related to a $2,000 loss carryforward arising from a large expenditure related to the capital-raising transaction, for which a full valuation allowance was also recognized and recorded in equity.
In 20X2, USA Corp generated a pre-tax loss from continuing operations of $1,000. Included in this $1,000 loss was $3,000 of warranty reserve expense that is not deductible until paid for income tax purposes. Taxable income for the year of $2,000 was offset by the utilization of a net operating loss carryforward, resulting in net taxable income of $0 as shown below.
Pre-tax loss from continuing operations Originating deductible temporary differences Usage of loss carryforward, which was originally recorded in equity Taxable incomeWas the utilized loss carryforward realized (such that the source of loss exception would allocate the tax benefit to equity) or was it merely transformed into a deductible temporary difference?
AnalysisEven though the $2,000 net operating loss carryforward was utilized during the year, no realization of DTAs occurred because the loss from pre-tax continuing operations only served to increase the net DTA (and related valuation allowance). As a result, while the $2,000 net operating loss carryforward was “consumed” on the tax return, it was not realized; rather, it was transformed into the deductible temporary difference for the warranty reserve. The carryforward did not result in incremental cash tax savings.
Deductible temporary differences that reverse and manifest themselves into an originating temporary difference (or an NOL carryforward) have not been realized. Instead, that portion of the originating temporary difference (i.e., the warranty reserve) takes on the character of the reversing DTA related to the NOL, and a $2,000 tax benefit would be allocated to equity, in accordance with ASC 740-20-45-3, once the tax benefit of the loss carryforward is recognized in a future period.
Example TX 12-10 demonstrates how ASC 740-10-55-37 can affect the ordering in intraperiod allocation.
EXAMPLE TX 12-10
Determining the impact of originating temporary differences on the application of source of loss rules
- Coming into the year, there are no available carryforwards or income available in carryback years.
- The deductible temporary difference that is reversing was originally established in equity with a full valuation allowance of $1,000 against it. This valuation allowance has not been reduced subsequently.
- The DTA at the end of the current year requires a full valuation allowance, despite income in the current year, because the company is projecting losses.
- The statutory tax rate is 25%.
The total tax expense for the year is zero because there was no pre-tax income for the year ($1,000 income from continuing operations less $1,000 loss from discontinued operations), and the reversing equity-related deductible temporary differences created a taxable loss of $1,000 for which the related DTA requires a full valuation allowance.
ASC 740's intraperiod allocation rules would allocate a tax expense of $250 to continuing operations and a tax benefit of $250 to discontinued operations. No tax benefit is allocated to the reversing equity-related deductible temporary differences because the DTA that arose in equity has merely been transformed into a DTA relating to an NOL carryforward. Said another way, while the equity-related deductible temporary differences reversed, they did not provide for incremental cash tax savings and thus were not realized. A tax benefit will be allocated to equity, in accordance with ASC 740-20-45-3, once the NOL DTA is realized in a future period.
Had the loss from discontinued operations in this example instead been $300, then $700 of the reversing equity-related deductible temporary differences would have been realized (resulting in incremental cash tax savings). As a result, the total tax expense of zero would be allocated as follows:
Tax expense/(benefit) allocated to continuing operations $250 [1,000 × 25%] Tax expense/(benefit) allocated to discontinued operations $(75) [(300) × 25%] Tax expense/(benefit) allocated to equity in accordance with ASC 740-20-45-3 $(175) [(700) × 25%]12.3.3 Intraperiod allocation of remaining tax to other components
The portion of total tax that remains after allocation of tax to continuing operations (i.e., the difference between the total tax expense computed in Step 1 and the amount allocated to continuing operations computed in Step 2) is then allocated among the other financial statement components in accordance with the guidance in ASC 740-20-45-11, ASC 740-20-45-12, and ASC 740-20-45-14.
The tax effects of the following items occurring during the year shall be charged or credited directly to other comprehensive income or to related components of shareholders' equity:
- Adjustments of the opening balance of retained earnings for certain changes in accounting principles or a correction of an error. Paragraph 250-10-45-8 addresses the effects of a change in accounting principle, including any related income tax effects.
- Gains and losses included in comprehensive income but excluded from net income (for example, translation adjustments accounted for under the requirements of Topic 830 and changes in the unrealized holding gains and losses of securities classified as available-for-sale as required by Topic 320).
- An increase or decrease in contributed capital (for example, deductible expenditures reported as a reduction of the proceeds from issuing capital stock).
- Subparagraph superseded by Accounting Standards Update No. 2016-09.
- Subparagraph superseded by Accounting Standards Update No. 2016-09.
- Deductible temporary differences and carryforwards that existed at the date of a quasi reorganization.
- All changes in the tax bases of assets and liabilities caused by transactions among or with shareholders shall be included in equity including the effect of valuation allowances initially required upon recognition of any related deferred tax assets. Changes in valuation allowances occurring in subsequent periods shall be included in the income statement.
If there is only one item other than continuing operations, the portion of income tax expense or benefit for the year that remains after the allocation to continuing operations is allocated to that item.
If there are two or more items other than continuing operations, the amount that remains after the allocation to continuing operations shall be allocated among those other items in proportion to their individual effects on income tax expense or benefit for the year. When there are two or more items other than continuing operations, the sum of the separately calculated, individual effects of each item sometimes may not equal the amount of income tax expense or benefit for the year that remains after the allocation to continuing operations. In those circumstances, the procedures to allocate the remaining amount to items other than continuing operations are as follows:
- Determine the effect on income tax expense or benefit for the year of the total net loss for all net loss items.
- Apportion the tax benefit determined in (a) ratably to each net loss item.
- Determine the amount that remains, that is, the difference between the amount to be allocated to all items other than continuing operations and the amount allocated to all net loss items.
- Apportion the tax expense determined in (c) ratably to each net gain item.
12.3.3.1 Determining the intraperiod tax effects of other components
We believe that the individual effects on income tax expense or benefit of a specific financial statement component represent that component’s incremental tax effect (on a jurisdiction-by-jurisdiction basis) on consolidated tax expense or benefit. Accordingly, we believe that this amount should be quantified by means of comparing the difference between the total tax expense or benefit computed for the year that includes all sources of income and loss and the total tax expense or benefit for the year computed with all sources of income and loss except for the financial statement component being quantified.
While that amount may not be the amount that ultimately is allocated to the respective financial statement component, it represents the individual incremental effect of the item for purposes of applying the allocation procedure outlined in ASC 740-20-45-14. All items (other than continuing operations) should be given equal priority for purposes of intraperiod tax allocation, unless there is specific guidance that provides otherwise.
12.3.3.2 Intraperiod allocation for equity items other than OCI
ASC 740 specifically allocates to shareholders’ equity the tax effects of changes during the year of the following items:
- Cumulative effect adjustments to beginning retained earnings for changes in accounting principle or error correction (ASC 740-20-45-11(a)); see TX 12.4.4 for additional discussion);
- Increases or decreases in contributed capital (ASC 740-20-45-11(c)), including the tax effect of items that are classified in equity for financial statement purposes such as:
- Issuance costs that are recorded as a reduction of proceeds received on equity issuances for book purposes but which are deductible for tax purposes; and
- The tax effects of the exercise of a financial instrument classified as equity (other than stock-based compensation under ASC 718) by the issuer;
Question TX 12-1 discusses intraperiod tax allocation considerations for changes in a deferred tax asset balance, or a valuation allowance, that are a result of limitations in future utilization of a NOL carryforward due to an initial public offering.
Question TX 12-1
PwC response
Should the tax consequences of reducing a deferred tax asset (or increasing a valuation allowance) related to NOL carryforwards for which future utilization is limited as a result of the tax change in ownership rules after completing an initial public offering be charged to contributed capital or recognized in the income statement?The effects of writing off a deferred tax asset (or recording a valuation allowance) in these circumstances should be recognized in the income statement. ASC 740-10-45-21 states that changes in valuation allowances due to changed expectations about the realization of deferred tax assets caused by transactions among or with shareholders should be included in the income statement. The guidance further concludes that the write-off of a pre-existing deferred tax asset in these circumstances should be charged to income because the same net effect results from eliminating a deferred tax asset or increasing a valuation allowance to 100% of the amount of the related deferred tax asset.
This guidance differs from the guidance for changes in tax bases of assets and liabilities that are caused by transactions with or among shareholders for which ASC 740-20-45-11(g) concludes the related tax effects should be included in equity.
12.3.3.3 Intraperiod allocation for OCI items
Certain gains and losses are included in comprehensive income but excluded from net income. Such items, when recognized, are reflected directly in OCI, a component of shareholders’ equity. Generally, the tax effect of gains and losses recorded in OCI should also be recorded in OCI (ASC 740-20-45-11(b)). These gains and losses include:
- Foreign currency translation gains and losses reflected in the CTA account within OCI for foreign operations using a foreign functional currency or the foreign currency transaction gain or loss on a nonderivative instrument (ASC 830);
- Unrealized gains and losses on AFS debt securities (ASC 320);
- Net unrecognized gains and losses and unrecognized prior service cost related to pension and other postretirement benefit arrangements (ASC 715); and
- The effective portion of the gain or loss on a derivative instrument designated and qualifying as a cash flow hedge instrument (ASC 815).
When a jurisdiction (and in some cases a separate filing when entities within a jurisdiction do not file a consolidated return) includes more than one item of OCI (e.g., derivatives under ASC 815 and AFS debt securities under ASC 320), each item should be treated as a separate component of the financial statements, at a level no higher than the separate components presented in the statement of comprehensive income as discussed in ASC 220-10-45-13 for purposes of the application of intraperiod allocation. As a result, the incremental tax effect of each separate component of OCI income should be considered. We also believe that both favorable and unfavorable adjustments (for changes in uncertain tax positions assessments) to deferred taxes recorded in OCI should, depending on the accounting policy election, either be (1) backwards traced to OCI or (2) recognized in income tax from continuing operations (refer to TX 15.7 for additional discussion on uncertain tax positions and intraperiod allocation).
CTASome pre-tax transaction gains and losses (ASC 830-20-35-2) and all translation adjustments (ASC 830-30-45-21) are recorded directly in the CTA account. ASC 830-20-45-5 requires the tax effects of these items to be attributed to the CTA account.
Allocation to the CTA account is required for both current and deferred taxes on transaction gains and losses recorded in the CTA account and for deferred taxes on translation adjustments. With respect to deferred taxes provided by a parent or investor for an “outside basis” temporary difference, the method of allocating the tax effect on the current year change in this outside basis temporary difference between continuing operations and other items (such as CTA) must be considered. Refer to TX 13.9 for additional information on intraperiod tax allocation for CTA.
If withholding taxes are accrued as part of the outside basis temporary difference, the treatment of foreign currency movements will likely differ from the treatment of amounts reported as part of CTA. Refer to TX 13.3.
Unrealized gains and losses on AFS debt securities (ASC 320)ASC 320 requires that debt investments classified as AFS be carried at fair value. This would generally result in temporary differences because the laws in most tax jurisdictions defer the recognition of gains and losses from investments until the investments are sold.
ASC 320 reflects pre-tax changes in market value as OCI. ASC 740-20-45-11(b) requires that the tax effects of pre-tax changes to OCI occurring during the year be recorded net against the pre-tax changes in OCI.
Example TX 12-11 illustrates considerations related to appreciation in AFS debt securities when there is a valuation allowance.
EXAMPLE TX 12-11
Appreciation in AFS debt securities when there is a valuation allowance Assume the following facts for USA Corp:- Tax rate of 25%
- At year-end 20X1, there is a full valuation allowance on USA Corp’s net DTA as shown:
- During 20X2, financial results for pre-tax continuing operations were breakeven and $4,000 of pre-tax gains from unrealized appreciation on AFS debt securities was included in OCI.
- At December 31, 20X2, management concluded that a full valuation allowance continued to be required.
When there is a valuation allowance applicable to beginning-of-year DTAs and there is a change in circumstances during the year that causes the assessment of the likelihood of realization in future years to change, the effect would be reflected in continuing operations. However, if the reversal of the valuation allowance is directly related to the appreciation of a reporting entity’s AFS debt security during the current year (current-period income) and not to expectations of taxable income in future periods, the reversal of the valuation allowance would be recorded in OCI.
In this example, USA Corp would have a total tax expense of zero and a net DTA of $2,000 with a full valuation allowance. As pre-tax income related to continuing operations is zero, no tax provision or benefit would be allocated to it. Due solely to the income from AFS debt securities of $4,000, $1,000 of the prior-year valuation allowance would be released. As a result, the entire valuation allowance release of $1,000 would offset the tax attributable to the $4,000 pre-tax gain from OCI of $1,000 ($4,000 times 25%), resulting in no tax allocated to the AFS component of OCI.
ASC 740-20-45-15 through ASC 740-20-45-18 contains guidance specific to the presentation of DTAs relating to losses on available-for-sale debt securities. However, as indicated in Question TX 12-2, that specific guidance is consistent with normal intraperiod guidance, including when an entity has a change in valuation allowance related to a DTA for unrealized losses on available-for-sale debt securities.
Question TX 12-2
PwC response
At the end of 20X1, an entity had a DTA for unrealized losses on available-for-sale debt securities and concluded a valuation allowance against that DTA was not necessary due to the presence of a DTL which could serve as a source of income.
At the end of 20X2, that DTL is no longer available as a source of income and there are no other sources of income available to support realization. In addition, the company experienced additional current year unrealized losses on available-for-sale debt securities in OCI resulting in an increase to the DTA for unrealized losses on available-for-sale debt securities. The company records a full valuation allowance at the end of 20X2. Would the full valuation allowance be charged to OCI?No. In this circumstance, a portion of the effect of recording a valuation allowance should be recognized in OCI while a portion should be recognized in continuing operations. The valuation allowance related to the 20X2 current year unrealized loss on available-for-sale debt securities from OCI would be recorded in OCI per ASC 740-20-45-4 and ASC 740-20-45-16. The valuation allowance related to the portion of the DTA for unrealized losses that existed as of the end of 20X1 would be recorded in continuing operations in accordance with ASC 740-10-45-20 since it is a change in the beginning-of-the-year balance of a valuation allowance that results from a change in circumstances that causes a change in judgement about the realizability of the related deferred tax asset in future years.
EXAMPLE TX 12-12
Intraperiod allocation related to reclassifications from AOCIIn Year 1, USA Corp purchased debt securities for $210 accounted for as AFS. At the end of Year 1, the AFS debt securities had a fair value of $150, resulting in an unrealized loss of $60 recorded through OCI. In Year 2, USA Corp sold all of the AFS debt securities for $150, which resulted in reclassification of the pre-tax loss of $60 (from Year 1) from AOCI to earnings.
USA Corp reported pre-tax income from continuing operations of $200 inclusive of the loss realized on the AFS debt securities and a reclassification gain of $60 in OCI (thus, the effect on comprehensive pre-tax income from the disposition of the AFS debt securities is zero). USA Corp’s tax rate is 25%.
Does the reclassification adjustment of $60 from AOCI to earnings impact the intraperiod tax allocation given that the net effect on comprehensive net income is zero?
AnalysisYes. Reclassification adjustments, such as gains and losses on AFS debt securities reclassified from AOCI to earnings, form part of the current period income (loss) from continuing operations and current period income (loss) in OCI. Therefore, their income tax effect should be evaluated in the same manner as any other item of income or loss reported in the current period. They should be considered in ASC 740’s three-step intraperiod allocation approach.
