U.S.

GAAP and IFRS Deferred Tax

Running head: U.S. GAAP and IFRS Deferred Tax Analysis

U.S. GAAP and IFRS Deferred Tax Analysis

Brandon Ta Exam 1 October 26, 2011 International Accounting ACG 6627-001 Dr. Borgia

U.S. GAAP and IFRS Deferred Tax

Table of Contents

Introduction Income and Deferred Tax History .. Deferred Tax Debate Deutsche Telekom Financial Analysis. Conclusion References .. .. .

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U.S. GAAP and IFRS Deferred Tax

Introduction There have been great advancements by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) with the convergence of standards between U.S. GAAP and IFRS. The goal of the FASB and SEC to have U.S. publicly traded companies reporting under IFRS is slowing moving forward. Most of the key differences have been resolved over many meetings and the specific differences between IFRS and U.S. GAAP are shrinking. However significant differences do remain between the two standards, which have caused numerous debates over the years. The most common differences between U.S. GAAP and IFRS are asset valuation, pension plans, goodwill, and deferred taxes (Amir et al., 1993). The debate concerning deferred taxes within income tax rules have been ongoing in the professional and political environment. Corporate tax laws often differ from the recognition and measurement requirements of financial accounting standards. A company s taxable income may be different than its pretax financial income for the year partly due to deferred tax. The deferred tax debate is all about the different methods of accounting for these differences and their effects on profitability. This paper will examine the topic of deferred taxes as it effect on the corporate financial reporting. The examination of the deferred tax taken by Deutsche Telekom s 2006 20-F reconciliation will help explain the significance of deferred tax on the company financial reporting.

Income and Deferred Tax History Income tax accounting is just one of the convergence projects on which the FASB and IASB are collaborating as part of their convergence plan. FAS 109 and IAS 12 provide the

U.S. GAAP and IFRS Deferred Tax

guidance for income tax accounting under U.S. GAAP and IFRS. Both rules require companies to account for both current tax effects and deferred taxes using an asset and liability approach. Under U.S. GAAP and IFRS, the financial statements are to report the tax effects of income and expense reported in the current period. In February 1992, the FASB issued Statement no. 109, Accounting for Income Taxes, which requires a revised version of the asset-liability method of interperiod income tax allocation (Colley et al., 2005). FASB Statement no. 109 supersedes Statement no. 96. FASB s change from the deferred method to the liability method in FAS 109 require the recognition of deferred tax assets (DTA) for all deductible temporary differences, operating loss carryforwards, and tax credit carryforwards (Antognini & Chung, 1992). Additionally, SFAS 109 requires firms to re-measure deferred tax assets and liabilities when enacted tax rates change (Ayers, 1998). Under IAS 12, the reporting company is to recognize a deferred tax liability for all taxable temporary differences associated with all investments (Epstein and Macy, 2011). The creation of value allowances for deferred taxes assets and the adjustment of deferred tax accounts for enacted tax rate changes provide value-relevant data to financial users (Ayers, 1998). The primary differences has been the exceptions in each standard to providing deferred taxes on certain temporary differences, mainly the tax basis of an item and the amount recorded for financial reporting (Kissinger, 2006).

Deferred Tax Debate There have been accounting and financial reporting controversies concerning deferred taxes when reporting income tax. Critics have complained about the inconsistent treatment of the deferred tax asset and liability (Colley et al., 2005). Companies are required to use the

U.S. GAAP and IFRS Deferred Tax

asset/liability approach and the current tax rate to accumulate the deferred tax assets and liabilities that resulted when the financial accounting and tax accounting bases of their assets and liabilities diverged (Herborn, et al., 2010). The criticism of this approach is that it ignores the timing of the increase future tax payments when the deductions subside (Lundholm, 2001). While many typical business transactions are accounted for identically for income tax and financial reporting purposes, there are many others subject to different income tax and accounting treatments, often leading to their being reported in different periods in financial statements than they are reported on income tax returns. The article by Trapp (1995) states that deferred tax debate is all about the different methods of accounting for these differences and their effects on profitability. There are concerns about complex rules about the treatment of loss carry-forwards, tax planning strategies and their use in determining the balance in the allowance account. According to Chao, Kelsey, Horng and Chiu (2004) appropriate level of valuation allowance depends on manager s expectations and judgments about the future realization of the deferred tax asset. Deferred tax positions will become more prevalent and increase as GAAP increases its reliance on fair-value accounting over transaction-driven cashbasis accounting (Poterba, et al., 2007). The political economy of corporate tax reform is important since companies are very sensitive to the impact of tax reform on their reported earnings, including revaluations of DTAs and DTLs (Poterba et al., 2007). The differences of deferred tax positions of large corporations create substantial variation in the short-run effects of tax rate changes on reported earnings (Poterba et al., 2011).

U.S. GAAP and IFRS Deferred Tax

Deutsche Telekom Deferred Tax Analysis Deutsche Telekom (DT) AG is a German telecommunications company. It is the largest telecommunications company in Europe. Deutsche Telekom uses IFRS in its annual filings. The company 2006 20-F reconciliation to U.S. GAAP reports a deferred tax adjustment with a material effect on income. The company does not provide reconciliation to U.S. GAAP in their latest annual financial statements. According to the company 2006 20-F, the company s income taxes are specific calculation of the expected actual income tax exposure for each taxable item and an assessment of temporary differences resulting from the different treatment of certain items (Harris & Muller III, 1999). The creation of value allowances for deferred taxes assets and the adjustment of deferred tax accounts for enacted tax rate changes provide value-relevant data and is material to financial users (Ayers, 1998).

Table. 1 Deutshce Telekom 2006 20-F Reconciliation Profit before Profit after Income Deferred Tax Non-current Assets Income Taxes Income Tax Taxes (millions in Net Profit Assets (millions in Deferred Tax (millions in Euro) Euro) (millions in Euro) (millions in Euro) Euro) Liability (millions) Consolidated BS 2005 Consolidated BS 2006 6,219 2,604 -198 970 6,021 3574 5,589 3,165 8,140 8,952 8,331 8,083

In 2006, DT s net profit decreased to EUR 3,165 million from EUR 5,589 million in 2005. The company 2006 income taxes changed from an expense of EUR 198 million in 2005 to an income tax benefit of EUR 970 million in 2006, a difference of EUR 1,168 million. DT management determined that EUR 1.2 billion of the previously unrecognized deferred tax

U.S. GAAP and IFRS Deferred Tax

assets at T-Mobile USA relating primarily to federal income tax net operating loss carryforwards was realizable in 2006. The company recorded previously unrecognized deferred tax assets resulting in an income tax benefit of EUR 1.2 billion 2006 and EUR 2.2 billion in 2005. In 2006, DT recorded previously unrecognized deferred tax assets resulting in an income tax benefit of EUR 1,219 million. DT accumulated deferred tax liabilities in 2006 offset corporate profits in that year (Gann & Strowd, 1995). Since profit before income taxes decreased significantly compared to the prior year, a negative tax expense, i.e., a tax benefit, was recorded in 2006. Despite losses in the current and the prior year, deferred tax assets in the amount of EUR 4,684 million were recognized on loss carryforwards and temporary differences for 2006, as the company expects to generate future taxable profits.

Conclusion The convergence plans by the FASB and IASB over income tax reporting has shrunk some of the debates over deferred tax. The controversy over whether the tax effects of temporary differences between pretax accounting income and taxable income should be discounted is a longstanding one. Whether or not discounting is appropriate depends upon whether the cash flow associated with the tax effect of a temporary difference occurs when the difference arises or when the difference reverses. The exceptions in each standard to providing deferred taxes on certain temporary differences are being converged.

U.S. GAAP and IFRS Deferred Tax

U.S. GAAP and IFRS Deferred Tax

References Amir, E., Harris, T.S., Venuti, E.K. (1993). A comparsion of the value-relevance of U.S. verus nonU.S. GAAP accounting measures using form 20-F reconcilations. Journal of Accounting Research, 31, p. 230-264. Retrieved October 19, 2011, from ABI/INFORM Global. Antognini, W., & Chung, W.H. (1992, October). Deferred Tax Accounting for Tax Carryforwards. The CPA Journal, Volume 62, Issue 10, p.58. Retrieved October 20, 2011, from ABI/INFORM Global. Ayers, B. (1998, April). Deferred Tax Accounting Under SFAS No. 109: An Empirical Investigation of its Incremental Value-Revalance Relative to APB No. 11. The Accounting Review, 73,2. Retrieved October 19, 2011, from ABI/INFORM Global. Colley, R., Rue, J., & Volkan, A. (2005, December). FASB Should Revisit Deferred Taxes. The Business Review. Cambridge, 4(2), 29-34. Retrieved October 19, 2011, from ABI/INFORM Global. Epstein, B.J., & Macy, L.G. (2011). The Differential Influence of U.S. GAAP and IFRS on Corporations Decisions to Reatriate Earnings of Foreign Subsidiaries. International Tax Journal, p. 29-40. Retrieved October 20, 2011, from ABI/INFORM Global.

Gann, H., & Strowd, R. (1995, July). Deferred Tax Accounting for Tax reform proposals. Tax Notes, Volume 68, Issue 1, p.111. Retrieved October 20, 2011, from ABI/INFORM Global. Harris, M., & Muller III, K. (1999). The Market Valuation of IAS versus US-GAAP Accounting Measures using from 20-F Reconcilations. Journal of Accounting and Economics 26, p. 285-312. Retrieved October 22, 2011, from ABI/INFORM Global. Herbohn, K., Tutticci, I., & Khor, P.S. (2010). Changes in Unrecognised Deferred Tax Accruals

U.S. GAAP and IFRS Deferred Tax

from Carry-Forward Losses: Earning Management or Signaling? Journal of Business Finance & Accounting, 37(7) & (8), p. 763-791. Retrieved October 20, 2011, from ABI/INFORM Global. Kissinger, J. (2006, November). On Discounting Deferred Income Taxes. Academy of Accounting and Financial Studies Journal, Volume 10, p.1(15). Retrieved October 20, 2011, from ABI/INFORM Global. Poterba, J., Rao, N., & Seidman, J. (2011, March). Deferred Tax Positions and Incentives for Corporate Behavior Around Corporate Tax Changes. National Tax Journal, 64 (1), p. 2758. Retrieved October 18, 2011, from ABI/INFORM Global. Poterba, J., Rao, N., & Seidman, J. (2007). The Signifance and Composition of Deferred Tax Assets and Liabilities. Retrieved October 18, 2011, from ABI/INFORM Global. Lundholm, R. (2001). Discussion of: "On the Aggregation and Valuation of Deferred Taxes". Review of Accounting Studies, 6(2-3), 299. Retrieved October 27, 2011, from ABI/INFORM. Trapp, R. (1995, February). The thorny issue of deferred tax. The Independent, p.27. Retrieved October 20, 2011, from ABI/INFORM Global.

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