Chapter 5

INCOME TAXES

LEARNING OBJECTIVES
x Recognize the major similarities in accounting for income taxes.
x Distinguish the differences in tax rates used to calculate deferred taxes.
x Compare calculation and disclosure of uncertain tax positions.
x Analyze the differences of allocating income tax expense within financial statement line items.

SIMILARITIES IN ACCOUNTING FOR INCOME TAXES

Accounting for income taxes under FASB ASC 740, Income Taxes, and IAS 12, Income Taxes, is more
similar than it is different. Both use an asset and liability basis approach to compute a base against which
to apply tax rates. This means that deferred tax assets and liabilities are recognized when the tax and book
basis of financial statement items differ. Both standards use rates expected to be effective when
temporary differences are realized. In addition, both standards only recognize deferred tax assets to the
extent that expected future taxable income will be available to reduce future tax payable. Additionally,
under both sets of standards, entities must disclose a rate reconciliation table. Lastly, deferred tax assets
and liabilities are classified as non-current and are not discounted under either standard.

Example: US GAAP and IFRS³Calculation of Deferred Tax Assets and Liabilities

Chi Corporation depreciates its fixed assets for income tax purposes using an accelerated method. The
accelerated life is shorter than the useful life used for book purposes. This results in the following basis
differences for its fixed assets:
Book: USD 100 million.
Tax: USD 80 million

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Consequently, the basis for income tax is USD 20 million lower than for book purposes. This is a
deductible temporary difference that results in a deferred tax liability. Chi determines that the income tax
rate in future periods over which the difference will equalize will be 30 percent. The deferred tax liability
for the book versus tax temporary difference is calculated as follows:
USD 100 - USD 80 = USD 20 × 30% = USD 6 million

Chi Corporation receives payment for future services that it must recognize in its taxable income in the
year of receipt, but is not recognized for book purposes until a later year. This results in a taxable
temporary difference and produces a deferred tax asset. Chi Corporation has the following book and tax
basis for deferred income:

Book: USD 50 million

Tax: USD 0 million

The tax basis of deferred income is zero because it has already been included in taxable income, whereas
for book purposes, USD 50 million has yet to be recognized. Because the company has already paid tax
on the deferred revenue, it recognizes a deferred tax asset (DTA) for USD 15 million (30% tax rate ×
USD 50 million).

When Chi Corporation recognizes the income for book purposes it will reduce the DTA.
However, if Chi Corporation is experiencing losses and determines it is more likely than not (50 percent)
that it will not have the future income to benefit from the asset, it will need to reduce the DTA.

Chi determines that only USD 20 million of the DTA will be realized. Consequently, it must reduce its
DTA by USD 30 million. Under US GAAP, entities must record a valuation allowance and contra-asset
to reduce the DTA balance and reverse the tax benefit. IFRS does not require a valuation allowance. All
other things being equal, the following are the respective journal entries under IFRS and US GAAP:

IFRS US GAAP

Deferred tax expense 30 Debit Deferred tax expense 30

Deferred tax asset 30 Credit DTA valuation allowance 30

TAX RATE DIFFERENCES

Despite these similarities, there are a few differences between US GAAP and IFRS that can result in

x different tax rates to be applied to temporary differences,

x inconsistent presentation of tax expense in the statement of income, and
x differences regarding the extent of disclosure requirements.

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Legal Status of Tax Rates
FASB ASC 740 permits only enacted tax rates to be applied to deferred or current taxes items. In
contrast, IAS 12 allows the use of enacted or substantially enacted rates.

This difference may not have a significant impact as IAS 12 states that substantially enacted rates are to
be used in jurisdictions where announcement of the rates by the government is equivalent to enactment.
Presumably, this describes countries where legislative or judicial powers in the area of tax law are not
typically effective in diverging from the FRXQWU\·V primary executive.

KNOWLEDGE CHECK
1. Under both FASB ASC 740 and IAS 12, which statement is accurate about deferred tax assets?

a. To continue to recognize a deferred tax asset, there must be a 50 percent or greater

likelihood that the entity will have taxable income against which to use the deduction.
b. A deferred tax valuation account is used.
c. Deferred tax assets are calculated based on the difference of the current SHULRG·V tax-basis
and book-basis expense.
d. They cannot exceed the current year income tax loss.

2. Disclosures under IAS 12 and FASB ASC 740 include

a. A rate reconciliation table.

b. A valuation allowance schedule.
c. The manner of settlement used to calculate the effective rate.
d. Gross temporary items.

UNCERTAINTY IN TAX DUE

Under FASB ASC 740, a reporting entity must make a provision for a tax position(s) it takes or will take
on its tax return(s) that reduces current or future taxes payable considered more likely than not to be
rejected by the taxing authority. The provisions are called unrecognized tax benefits because the entity is
effectively ´XQ-UHFRJQL]LQJµ a benefit that it reported on its tax returns and in its deferred tax assets. This
position presumably affects the amount of cash it uses to settle current year tax liability as calculated on
the returns.
FASB ASC 740-10-20 defines a tax position as including, but not limited to

x a decision not to file a tax return.

x an allocation or a shift of income between jurisdictions.
x the characterization of income or a decision to exclude reporting taxable income in a tax return.
x a decision to classify a transaction, entity, or other position in a tax return as tax-exempt.
x an HQWLW\·V status, including its status as a pass-through entity or a tax-exempt not-for-profit entity.

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More likely than not is defined as a likelihood of more than 50 percent. However, the amount provided for
is the largest amount that has a cumulative probability of greater than 50 percent of being realized upon
settlement. This likelihood assumes that the tax authority will have full knowledge of all relevant
information concerning the position. Consequently, an entity cannot include in its probabilities the
likelihood that the company can withhold information.

For example, an entity takes a $100 credit on a tax return in a jurisdiction. Based on its analyses, it
estimates the following probability distribution regarding how much the entity will be able to claim:

Amount of credit Probability of Cumulative

permitted (USD) outcome probability

100 15% 15%

90 20% 35%

50 25% 60%

30 30% 90%

10 5% 95%

0 5% 100%

Because USD 50 is the greatest amount that has over a 50 percent cumulative probability of being
realized, the entity provides for USD 50 regarding the position.
The entity must remeasure its unrecognized tax benefits based on evolving circumstances.

Tax positions are aggregated into units-of-account based on judgement applied to facts and
circumstances surrounding the positions. The entity must change the unit-of-account based on how
circumstances concerning the positions change.
An entity must disclose a roll-forward table of unrecognized tax benefits in the following format:

x Beginning balance
x Gross amount of increases and decreases based on tax positions related to prior years
x Gross amount of increases and decreases based on tax positions related to the current year
x Amounts of decreases relating to settlements with tax authorities
x Reductions as a result of the lapse of statutes of limitation
x Ending balance (balance sheet date)

Additionally, entities must disclose the amount of change in unrecognized tax benefits that would cause a
change in the effective tax rate.

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Comparison to IFRS
IFRIC 23, Uncertainty Over Income Tax Treatments is effective January 1, 2019, and is largely aligned with the
accounting and disclosure requirements for uncertain tax positions under FASB ASC 740. However, it is
less detailed in its guidance.

When calculating uncertain tax positions, IFRIC 23 uses either an expected outcome (probability
weighted) or the most likely amount for circumstances in which it would better predict the outcome, such
as a binary situation. Either the deduction or credit will be upheld or it will not.

Entities reporting under current IFRS would need to rely on IAS 37, Provisions, Contingent Liabilities and
Contingent Assets for guidance on material unrecorded liabilities. IAS 1, Presentation on Financial Statements,
also includes general guidance (to which IFRIC 23 refers in its disclosure requirements) that an entity
should disclose sensitivities of assumptions and uncertainties in carrying amounts in the financial
statements. This is analogous, if not prescribed, under current IFRS, to the FASB ASC 740 requirement
to disclose the amounts that would result in a change in the effective tax rate.
Example: Comparison of Accounting for Uncertain Tax Positions
Argo Company has taken a position on its US income tax return that its dividends from a non-US
company will be eligible for a full credit of foreign taxes paid. Under the US tax code, there is a possibility
that only part of the dividend will be eligible for the full credit. Based on the facts and circumstances, the
entity estimates the following probabilities for settlement amounts:

A B C A×B

Amount of credit Probability of Cumulative Probability

permitted outcome probability weighted
amount

100 25% 25% 25

60 30% 60% 18

50 30% 85% 15

0 15% 100% 0

58

Under FASB ASC 740, USD 60 is the largest amount with a cumulative probability of over 50 percent,
and accordingly, Argo Company recognizes an unrecognized tax position liability of USD 60. Under
IFRIC 23, and possibly under currently effective IFRS (IAS 37), Argo Company would record the
expected value outcome of USD 58. Conversely, if Argo Company under IFRS concluded that one value
was the most likely, that outcome would be recognized.

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KNOWLEDGE CHECK
3. Under FASB ASC 740, an unrecognized tax benefit

a. Is accrued if the likelihood of the deduction being sustained upon settlement has a weighted
probability of greater than 50 percent.
b. Is only applicable to certain types of deductions.
c. Can include consideration of how much information the taxing authority asked for in a
previous similar examination.
d. Must be assessed for a decision not to file a tax return in a jurisdiction.

INTRAPERIOD TAX ALLOCATION

Both FASB ASC 740 and IAS 12 contain guidance on allocating tax expense or benefits to selected
financial statement line items. These include operating income, discontinued operations, income before
taxes, and components of other comprehensive income. These allocations under FASB ASC 740 are
called intraperiod tax allocations.

IAS 12 requires allocation among the various subtotals to be representationally faithful. IAS 12 notes that
changes from past taxable events may be difficult to allocate precisely; thus, judgment is required in these
situations.

FASB ASC 740 establishes the following precedence of allocating income tax expense or benefits for a
year:

x Recognize current year tax effects and changes in deferred asset valuation allowances of components
of other comprehensive income in other comprehensive income.
x Allocate tax benefits or expenses to continuing operations.
x Allocate the remainder of tax benefits or expenses to other line items in the income statement in
proportion to their individual effects on income tax benefits or expenses for the year.

Under FASB ASC 740, tax expense or benefit allocated to continuing operations is calculated as the tax
effect of the pretax income or loss from continuing operations for the year, plus or minus income tax
effects of:

x Changes in circumstances that cause a change in judgment about deferred tax assets in future years
x Changes in tax laws or rates
x Changes in tax status
x Tax deductible dividends paid to shareholders.

The net amount of income tax expense benefit or expense for the year can differ from the tax effect of
the items to which effective rates are applied. This can arise from assumptions underlying the calculation
of deferred tax and current year tax characterization. For example, capital gains and losses sometimes
attract a lower rate than ´RUGLQDU\µ income or loss. Because of this potential disparity, FASB ASC 740
states the following:

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In the case of two or more captions, the tax benefit or expense that remains after allocating to tax effect
to continuing operations is allocated as follows:

x Determine the effect on income tax expense or benefit for the year of the total net loss for all net
loss items,
x Apportion the tax benefit determined in (1) ratably to each net loss item,
x 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,
x Apportion the tax expense determined in (3) ratably to each net gain item.
Exhibit: Intraperiod Tax Allocation Under FASB ASC 740
Beta &RPSDQ\·V current year income from continuing operations is USD 50 million. Its results from
discontinued operations are a loss of USD 10 million. In other comprehensive income, it has USD 5
million income from hedging, USD 3 million loss from foreign exchange effects, and a revaluation effect
of defined benefit pension plans of USD 10 million loss. Additionally, in one of the tax jurisdictions in
which Beta operates, tax rates on all types of income were cut by five percent. For example, if the rate on
ordinary business income was 25 percent, the rate is now 20 percent. If the rate on capital gains was 10
percent, the rate is now 5 percent.

Caption Income Current Rate To be Allocated Tax

(loss) Year Change Allocated
millions
ASC IAS 12 Notes
USD
740

Income from Continuing Operations 50.0 (15.0) (1.0) (16.0) (18.7) (16.7) 1

Results Discontinued Operations (10.0) 1.8 (0.1) 1.7 1.1 1.7

Income Before Taxes 40.0 (13.2) (1.1) (14.3) (17.6) (15.0)

Other Comprehensive Income

Hedging 5.0 (0.8) (0.1) (0.8) (0.8) (0.8)

Foreign Exchange Effect (3.0) 0.8 - 0.8 0.8 0.8

Pension Revaluation (10.0) 3.0 (2.5) 0.5 3.0 0.5

Other Comprehensive Income (8.0) 3.1 (2.6) 0.5 3.1 0.5 2

32.0 (10.1) (3.7) (13.8) (14.5) (14.5)

Total Tax Expense (14.5) Note 3

Remaining to be allocated (0.7)

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 Caption Income Current Rate To be Allocated Tax
(loss) Year Change Allocated
millions
ASC IAS 12 Notes
USD
740

Continuing operations

Current year continuing operations (15.0)

Changes in tax laws (3.7)

Allocation of difference between total - Note 4

tax expense and allocated

(18.7)

Discontinued Operations

Current tear tax effect 1.8

Allocation of difference between total (0.7) Note 4

tax expense and allocated

1.1

Note 1: For simplicity, for IFRS, difference between allocated tax expense and benefit and total expense is added to
continuing operations. IAS 12 includes a proviso that full allocation to tax effects of each caption may not be
feasible.

Note 2: The qFXUUHQW\HDUq column amounts allocated to components of other comprehensive income includes any
changes in the valuation allowance for deferred tax assets.

Note 3: As a result of assumed effective tax rates for allocating tax expense, the actual tax expense may differ from the
sum of the amounts allocated.

Note 4: Because there is only one caption other than operating income in profit and loss, discontinued operations is
allocated the difference as defined on Note 3.

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KNOWLEDGE CHECK
4. Which statement accurately describes how changes in tax expense or benefit are allocated?

a. Changes in deferred tax assets are allocated to ´LQFRPH from continuing RSHUDWLRQVµ under
both IAS 12 and FASB ASC 740.
b. Changes in tax rates are allocated to ´income from continuing operationsµ under
FASB ASC 740.
c. Changes in tax rates are allocated to ´income from continuing operationsµ under IAS 12.
d. Changes in tax benefit or expense are allocated to ´LQFRPH from continuing RSHUDWLRQVµ
under both IAS 12 and FASB ASC 740.

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 Chapter 7

SHARE-BASED PAYMENTS

LEARNING OBJECTIVES
x Identify the major similarities for accounting for share-based payments.
x Distinguish between accounting for awards with non-employees under IFRS and US GAAP.
x Differentiate the accounting for excess tax benefits and costs related to share-based compensation
under IFRS and US GAAP.
x Identify the use of intrinsic value for share-based payments under IFRS and US GAAP.
x Distinguish between the treatment of targets that can be reached after the requisite vesting period
under IFRS and US GAAP.
x Apply the option under US GAAP to account for forfeitures of share-based awards.

MAJOR SIMILARITIES IN ACCOUNTING FOR SHARE-BASED PAYMENTS

IFRS 2, Share-Based Payments and FASB ASC 718, Compensation-Stock Compensation share many of the same
features. In many cases, the theory and application are identical. However, there are differences from US
GAAP that have existed since IFRS 2 was first issued. Additionally, several Accounting Standard Updates
(ASUs) have been issued by FASB since the issuance of FASB ASC 718 that have created divergence
from IFRS 2.
IFRS 2 and FASB ASC 718 have the following in common:

x Compensation to employees of the issuer are generally based on the fair value of the equity awards at
the measurement date (some exceptions regarding intrinsic value are covered later in this chapter).
x Valuation methods vary under US GAAP and IFRS; however, these methods often use the same
variables.

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x Compensation expense is recognized over the vesting period.
x Performance-based or market-based (based on the underlying share price) conditions require the
vesting period to be estimated based on the probability of reaching the targets.
x Market conditions affect the fair value of the equity award.
x Compensation expense that is forfeited before the end of the vesting period is reversed.
x Generally, both IFRS 2 and FASB ASC 718 classify cash-settled awards as liabilities and share-settled
awards as equity. However, under FASB ASC 718, an award is classified in whole as either equity or
liability, whereas under IFRS 2, an award can be bifurcated between equity and liabilities.

ACCOUNTING FOR EMPLOYEE SHARE-BASED AWARDS

IFRS 2 requirements apply to employees, as well as individuals performing services similar to employees.
FASB ASC 718 requirements apply only to employees who are considered as such under US law.
Typically, this means that US employers are accountable for collecting and remitting employment taxes.

ACCOUNTING SHARE-BASED AWARDS WITH OTHER THAN EMPLOYEES

Share-based compensation to non-employees is based on commitment date under US GAAP. FASB
ASC 505, Equity, defines commitment date as the date at which an agreement is reached with a non-
employee to receive equity awards as compensation. The agreement includes a disincentive for non-
performance large enough to consider performance probable.

For services, expense is recognized each period for progress to date. For goods in which the awards are
immediately vested, the cost is recognized when issued.

If there is a commitment date within an agreement, and the terms of the awards are known up front,
compensation expense is measured as of the commitment date and amortized over the performance
period, similar to employee awards. Under both US GAAP and IFRS, the award is recognized over the
period the services are performed.

If there is a commitment date within an agreement, and not all the terms of the awards are known up
front, compensation expense is measured as of the commitment date and amortized over the
performance period for the lowest amount expected. When performance is complete, the entity will
recognize compensation expense for the total of the awards earned less what it has recognized up to the
date of performance (in other words the final cost of the awards less the amount that has been amortized
to date).
If the agreement does not contain disincentives large enough to consider performance probable, then
there is no commitment date. Under this circumstance, if US GAAP requires recognition of the cost of
performance (for example, accruing cost for services rendered), then the value of the awards, taking into
account the market value of the award on the reporting date, is remeasured. Cost is recognized based on
performance through the reporting date.

If an agreement with a non-employee includes awards that does not have a commitment date and the
agreement includes additional awards based on reaching additional performance conditions, the value of
the lowest of the outcomes is recognized. At each reporting date before achievement, the value of the

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awards, taking into account the market value of the award on the reporting date, is remeasured and cost is
recognized based on performance through the reporting date. Upon successful delivery according to the
terms of the agreement, the final cost is recognized as an adjustment to cost recognized before delivery
taking into account the market value of the awards on the date performance is complete and the awards
are earned.

If an agreement with a non-employee includes awards with market-based conditions, on each reporting
date through to the date on which delivery occurs, modification accounting must be applied. Similar to
IFRS 2, modifications of share-based awards are accounted for as a termination of the original award, and
the issuance of a new award. The incremental fair value of the new award is recognized on the
modification date.

Example: Share Awards with Non-Employee

Pi Corporation contracts with a consulting firm to implement procurement software. In addition to the
cash fee, the company agrees to a two-level incentive whereby if all the functions as defined in the
scoping document are met, the firm will receive 10,000 options for no cost. Additionally, if the project is
complete at least two weeks before the target date, it will receive an additional 5,000 shares at no cost.
The contract contains an incentive significant enough to make performance probable. The target date for
completion is 24 months from the date of the contract.
Under FASB ASC 718, this arrangement is a share award with a non-employee and the terms are not
known up front. The terms are not all known because the share price on the performance date is not
known and the number of shares is not known. Because the incentive for performance is high enough to
make performance probable, the commitment date is the date that the contract is signed. See the
following for compensation expense per period:

Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

Period-end
Price/Sh 50 55 40 45 60 50 55 65

Period-end
Option Price 10 15 0 30 20 10 15 20

Shares 5,000 250,000 275,000 200,000 225,000 300,000 250,000 275,000 325,000

Option 10,000 100,000 150,000 - 300,000 200,000 100,000 150,000 200,000

Potential Total
to Date 350,000 425,000 200,000 525,000 500,000 350,000 425,000 525,000

Minimum 100,000 150,000 - 225,000 200,000 100,000 150,000 200,000

Percent 12.5% 12.5% 12.5% 12.5% 12.5% 12.5% 12.5% 12.5%

Complete

Cumulative 12.5% 25.0% 37.5% 50.0% 62.5% 75.0% 87.5% 100.0%

Completion

Period Cost 12,500 25,000 (37,500) 225,000 (25,000) (100,000) 50,000 375,000

Cumulative Cost 12,500 37,500 - 225,000 200,000 100,000 150,000 525,000

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In the last period when the awards are earned (assuming both incentives were met), the total cost is
adjusted one last time. That total cost less the expense recognized in prior periods is the cost recognized
in the period in which the awards are earned. Alternatively, if the firm only achieved the incentive for the
shares to vest, the final period cost would be USD 175,000 which is equal to USD 325,000 total share
cost less USD 150,000 cumulative recognized through prior period. The difference from the illustrated
scenario is equal exactly to the value of the options that the firm failed to earn.

KNOWLEDGE CHECK
1. What is the term that refers to the date at which a non-employee enters into an agreement where
performance is probable because of sufficiently large disincentives for nonperformance?

a. Measurement date.
b. Grant date.
c. Exercise date.
d. Commitment date.

EXCESS TAX BENEFITS AND COSTS

In many tax jurisdictions, the deductible amount of share-based compensation can be different than the
amount recognized for book accounting purposes. When the amount of share-based compensation
deductible from taxable income is greater than the amount recognized for book, the tax effect of that
difference under both IFRS and US GAAP is called an excess tax benefit. Conversely, when the amount
of share-based compensation that is deductible for income tax is less than the amount recognized for
book, the tax effect of that difference under IFRS and US GAAP is called an excess tax cost. Both IFRS
and US GAAP prescribe the accounting for excess tax benefits and costs.

In accordance with FASB ASU No. 2016-09, Compensation³Stock Compensation (Topic 718): Improvements to
Employee Share-based Payment Accounting, excess tax benefits or costs based on the difference between
compensation expenses recognized for tax purposes and book purposes are recognized in profit and loss.
ASU No. 2016-09 is currently effective for public companies and for non-public companies for financial
statements issued after December 15, 2017.

Prior to the effective date of ASU No. 2016-09, excess tax benefits were recognized as an increase in
additional paid-in capital (APIC). Excess tax cost was recognized in APIC to the extent benefits were
recognized in APIC (this was called an APIC pool). Once credits in the APIC pool were drawn down to
zero, or if no APIC pool existed, excess tax cost was recognized in profit and loss.

Under FASB ASC 718, excess tax benefits and costs can only occur during a reporting period in which an
entity deducts the share-based compensation on its tax return. In other words, the estimated tax
deduction is not anticipated. Therefore, prior to the actual tax deduction, there are no excess tax benefits
and costs.

Under IFRS 2, excess tax benefits are measured at each reporting period and recognized in equity to the
extent the inception-to-date projected tax benefit is greater than the inception-to-date book cost. Excess
tax costs are recognized in income.

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Excess tax benefits and costs under IFRS 2 are based on the projected tax effect using the market value
on the reporting date. Conversely, excess tax benefits and costs are not recognized under FASB ASC 718
XQWLOWKHGHGXFWLRQLVUHSRUWHGRQWKHHQWLW\·VWD[UHWXUQ

INTRINSIC VALUE OPTION

Under US GAAP, effective for financial statements issued after December 15, 2017, a nonpublic entity
can make a one-time accounting policy election to measure all liability-classified awards at intrinsic value.
This election is not available for public companies.

Intrinsic value is the fair value less the cost of the award. At each reporting date, a nonpublic entity using
this election must update the intrinsic value and resulting impact on compensation expense. The expense
for the period is the intrinsic value at the reporting date less the expense recognized in prior periods.

Under current US GAAP, intrinsic value can only be used to value share-based awards when an entity
cannot reasonably estimate the fair value.

Under IFRS 2, intrinsic value is used to value equity instruments in a share-based payment arrangement
only when an entity cannot reliably estimate its fair value. Like FASB ASC 718, when intrinsic value is
used, the value per award is the intrinsic value at the reporting date. The expense for the period is the
intrinsic value at the reporting date less the expense recognized in prior periods.

TARGET REACHED AFTER VESTING PERIOD

Under both IFRS 2 and FASB ASC 718, an entity must estimate the vesting period of awards based on
an achieved target rather than time period of service. Additionally, throughout the vesting period, the
total value of the award can change as the probability of the target achievement changes.

If the target is binary, meaning the award is expected to be achieved or not, compensation cost related to
these share-based awards alternates between full compensation attributed to date and zero. This leads to
negative compensation expense in periods where the probability of achieving the award is determined to
be zero.

Some awards include conditions that convey a variable number of awards based on a certain measure of
the target achieved. For example, if operating income increases 2 percent, each awardee is granted 100
equity instruments. If operating income increases 4 percent, each awardee is granted 200 equity
instruments. In cases where there is more than one outcome and awards granted are based on achieving
various levels, compensation cost can fluctuate among levels as the probability of achieving that level
increases or decreases. These types of awards can also result in negative compensation expense, or
reduced compensation expense as compared to prior periods if the probability of achieving a high-level
target decreases.

If the performance target becomes probable before the requisite service has been rendered,
compensation cost must be recognized in that period for the service rendered to that point. The
remainder of the compensation is recognized prospectively over the remaining service period.

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At each reporting date, the inception-to-date compensation cost must reflect the number of awards that
are expected to ultimately vest.

Some share-based awards include performance targets that can be achieved after the requisite service
period has ended. These vesting conditions, under FASB ASC 718, are not considered in calculating the
fair value of the award at grant date. Compensation cost continues to be estimated up to and if the target
is achieved. This can result in sudden reversal of previously recognized expense if the award is no longer
probable after the service period ends, meaning the compensation could have been recognized.
Conversely, if an award is considered probable again after a period in which the award was not probable,
compensation cost related to share-based awards may now be recognized.

Example: Target Achieved after the Requisite Service Period

Delta Corporation granted awards to its employees under the condition that they remain employed with
Delta for 3 years and that the number of awards will vary from 0 to 400 based on growth in operating
income, with 2017 as the base year. The following chart outlines shares eligible to grantees based on
operating income growth:

Operating income growth # of shares eligible to grantees

3% 100 shares

6% 200 shares

9% 300 shares

12% 400 shares

,I'HOWD·VRSHUDWLQJLQFRPHJURZVOHVVWKDQthree percent, no awards are given. The growth targets can be

achieved at any time over a five-year period from date of grant. Consequently, it is possible that the
targets can be achieved after the three-year requisite service period. The grant date fair value of each
award is USD 12. 1,000,000 awards were granted to 2,500 employees. It is assumed that no employees
will leave during the vesting period.
At the end of year two, Delta determines that it is probable (high degree of certainty, not just 50 over
percent) that the three percent growth target will be achieved. Consequently, it recognizes compensation
expense of USD 2,000,000, which is calculated as (2,500 × 100 awards × USD 12 × 2 years)/3 years total
vesting period.

At the end of year three, Delta determines that it is probable that it will achieve six percent operating
income growth. Consequently, it recognizes USD 3,000,000 in compensation expense (2,500 × 100 × 12
for the 6 percent awards) + (remaining USD 1,000,000 for 3 percent awards).

In year 4, Delta determines that none of the growth targets will be achieved. Consequently, it reverses the
USD 6,000,000 compensation expense it recognized in years 2 and 3.

During year five, Delta introduces a new product that takes the world by storm. It expects full year
operating income in year 5 to be 15 percent higher than 2017 income (in fact, through third quarter,
operating income is 12 percent higher than full year 2017 operating income). As a result, Delta recognizes

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USD 12,000,000 of expense because it expects growth to be higher than the highest level in the share
program (1,000,000 × USD 12).

The following LVDVXPPDU\E\\HDURIWKHFRPSHQVDWLRQH[SHQVHUHODWHGWR'HOWD&RUSRUDWLRQ·V

performance share-based compensation program.

Delta Coporation

Target achieved after vesting period.

Year 1 -

Year 2 2,000,000

Year 3 4,000,000

Year 4 (6,000,000)

Year 5 12,000,000

12,000,000

Under IFRS 2, a target that can be reached after the requisite service period is included in the calculation
of grant-date fair value, not in the calculation of the awards that will ultimately vest as is the case under
FASB ASC 718. If IFRS 2 were applied, the USD 6,000,000 recognized would not be reversed in year 4
nor would the additional compensation expense be recognized in year 5. Additionally, it is likely that the
fair value of the award would have differed from the USD 12 used in this example because, under IFRS
2, conditions other than vesting conditions are incorporated into the calculation of the grant date fair
value of the award.

KNOWLEDGE CHECK
2. Under FASB ASC 718, excess tax benefits are

a. Recognized based on projected tax deductions.

b. Recognized based on deductions taken on the tax return.
c. Recognized in profit and loss.
d. Limited to the difference between book and taxable income multiplied by the highest
marginal rate.

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ELECTION TO RECOGNIZE FORFEITURES AS THEY OCCUR
Currently effective for public companies and effective for non-public companies for financial statements
issued after December 15, 2017, an entity can make an entity-wide election to recognize forfeitures as
they occur rather than calculate estimated forfeitures as part of computing share-based compensation
expense. See the following example for the accounting treatment when recognizing forfeitures as
incurred.

Example: Election to Recognize Forfeitures in Share-Based Compensation as Incurred

Grant date 3/1/2018

Grant date fair value (USD) 52.16

Type Equity

Number of awards 100,000

Attrition rate 3%

Vesting type Cliff

Service (vesting) period 3 years

Year 1 Year 2 Year 3 Year 4 Totals

Awards expected to vest 0.97 x 0.97 x 0.97 x N/A

100,000 97,000 94,090

97,000 94,090 91,267 N/A

Actual number of awards 2,500 3,500 800 200 7,000

forefeited (by end of
calendar year)

Actual number of awards 93,000

vested

Total value of awards fair value x number of 5,216,000

awards

Compensation cost to 91,267 x 52.16 4,760,502

attribute (if estimating
forfeitures)

Final compensation cost 93,000 x 52 4,850,880

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 Year 1 Year 2 Year 3 Year 4 Totals

Estimating forefeitures Expense

model Recognized

Year 1 (2018) 1,322,362 Ten months of amortization - March through

December

Year 2 1,586,834

Year 3 1,586,834

Year 4 354,850 Includes adjustment for awards actually vested

Total Recognized 4,850,880

Actual forefeitures model Net Gross Forfeitures

Year 1 1,318,489 1,448,889 (130,400)

Year 2 1,556,107 1,738,667 (182,560)

Year 3 1,696,939 1,738,667 (41,728)

Year 4 279,346 289,778 (10,432)

Total Recognized 4,850,880 5,216,000 (365,120)

Note 1: Entities may revise estimated forfeiture rate. Consequently, the recognized compensation
expense under the estimated forfeiture model can be uneven through the vesting period.

Note 2: Since the awards are classified as equity, not change to the fair value of the award is
permitted. If awards were classified as liabilities, the fair value of the award would change
each period. Therefore, negative expense can result of fair value of award drops
substantially. This applies to both IFRS and US GAAP.

Note 3: This example is for time-based vesting only. If the awards were based on achieving a
target, the expense could reverse if probability of achieving taget decreased from the
previous period. This applies to both IFRS and US GAAP.

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KNOWLEDGE CHECK
3. Under FASB ASC 718, if targets for share-based compensation programs can be reached after the
requisite service period,

a. The effect is used to measure the number of awards that will ultimately vest.
b. The effect is incorporated into the calculation of the grant date fair value.
c. The effects are ignored.
d. Deferred tax effects are only booked until the end of the requisite service period.

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 Chapter 8

EMPLOYEE BENEFITS

LEARNING OBJECTIVES
x Recognize the major similarities in accounting for employee benefits.
x Distinguish the accounting treatment under both standards for various components of net periodic
benefit cost in defined benefit plans.

SIMILARITIES IN ACCOUNTING FOR EMPLOYEE BENEFITS

Both IFRS and US GAAP require accruing the cost of benefits such as paid time off, pension, medical,
and other post-retirement benefits as those benefits are earned. The accounting treatment for paid-time
off, which encompasses holidays and vacation, illness leave, and other compensated absences, is largely
the same under both sets of standards. However, because US GAAP and IFRS have different methods of
recognizing provisions, the timing of expense recognition may be slightly different.
Paid time-off is the simplest form of employee benefits. Next in level of complexity are defined
contribution plans. In these plans, employees and possibly employers contribute cash to an investment
trust. The amount of benefits received by the employee, usually upon retirement, are limited to the gain
or loss plus remaining principle on the invested assets. There is no guaranteed stream of payment to
employees. Both IAS 19, Employee Benefits and FASB ASC 715, Compensation³Retirement Benefits, require a
company to accrue contributions due, if not paid by the end of a reporting period. Aside from this
accrual, there are no other accounting requirements for defined contribution plans other than disclosures.

Employee benefits with the most complex accounting requirements are defined benefit plans, which
promise a beneficiary a definite stream of cash payments (pension or disability) or a certain percentage of
coverage of medical costs. The complexity arises from the high degree of uncertainty of the following:

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x Components of the cost of the benefits
x The long time period over which the benefits accrue and are disbursed
x The life expectancy and benefits needs of beneficiaries
x The risk of returns on plan assets

All this uncertainty and risk involve assumptions that drive variability in the funded status of the plans;
that is, the obligation to the beneficiaries offset by the availability of plan assets to pay for those benefits.

DEFINED BENEFIT PLANS: STATEMENT OF FINANCIAL POSITION

The following are requirements of both IAS 19 and FASB ASC 718.

A plan sponsor must measure the obligation and assets of defined benefit plans as of the financial
statement reporting date.
The projected benefit obligation (PBO) is the gross liability based on projected costs related to salary,
wage, and cost increases or decreases. Cost decreases are highly unlikely; however, they may exist due to
increased employee contributions to benefits.
The PBO increases for service cost, which is the present value of the benefits earned by the employee for
the services rendered during the reporting period. The measurement of service costs includes the
probability that employees will remain employed and alive long enough to qualify and receive benefits,
respectively. If employees only receive benefits after a certain number of years of service, service cost is
accrued for an employee from the first day of employment even though they do not qualify; however,
probabilities of employment duration decrease the cost to less than full present value because of expected
employee turnover before eligibility. In a broad sense, the service cost is smoothed over the period of
service by using this method, known as the projected unit credit method.

Plan assets are measured at fair value. However, FASB ASC 718 permits the use of market-related value
for calculating the return on plan assets. Market-related value recognizes changes in fair value in a
systematic and rational manner over a period not to exceed five years. In other words, the effect of
increases or decreases in plan assets are spread over several years. This consequently decreases the
volatility of returns.
Both IAS 19 and FASB ASC 718 require that the funded status (plan assets less the projected benefit
obligation) is recognized as a liability or asset on the statement of financial position. Voluminous tabular
and narrative disclosures are required under both standards.

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DEFINED BENEFIT PLANS: COMPREHENSIVE INCOME
IAS 19 and FASB ASC 718 require service cost to be recognized in profit and loss. However, several
other items differ in treatment.

Accounting Component US GAAP IFRS

Service cost Recognized in profit and loss using the projected unit credit
method

Plan amendments: non-major Prior service costs amortized Recognized immediately in

changes in benefits out of other comprehensive profit and loss.
attributable to past service income (OCI) over the
remaining service period,
optionally in period of
amendment

Actuarial gains and losses: If net gains or losses (the net Remeasurement adjustments
Increases or decreases in the of actuarial and asset return (actuarial gains and losses and
PBO due to changes in variances) must be amortized return on plan assets) only
assumptions or variance of from OCI into profit and loss if recognized in OCI; never
expected to actual experience the net gain or loss is greater reclassified to profit and loss
than 10 percent of the greater
Difference between actual and of the market-related-value or
expensed returns of plan fair value of plan assets or
assets PBO

Expected return on plan assets Recognized in profit and loss

in period incurred

Interest cost: Unwinding of Recognized in profit and loss Not applicable

discount of PBO

Net interest on the net Not applicable Discount rate multiplied by the
defined benefit liability funded status (expense if a net
liability, income if a net asset)

Curtailments: Significant Recognized in profit and loss in period of curtailment or

reduction in number of termination
beneficiaries or benefits
offered

Terminations: Cessation of
plan

Assumptions used for the discount rate, life expectancy, future increases, and return on assets are
substantially the same under IAS 19 and FASB ASC 718.
The following is a comparison of the effect on the financial statements when accounting for defined
benefit plans under FASB ASC 718 and IAS 19.

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Example: Comparison of Defined Benefit Plan Accounting Between FASB ASC 718 and IAS 19

Pension item Millions USD

Fair market value of plan assets 1,500

Market-related value 1,450

Projected benefit obligation 2,000

Discount rate 3%

Expected return on plan assets 7%

Actual return on plan assets 5%

Actuarial loss 100

Unrecognized prior service cost 75

Unrecognized actuarial loss 50

Service cost 80

Acturial gain in current year 10

ASC 715 IAS 19

Balance Sheet (Debit) Credit

Pension liablity 500 500

Accumulated OCI (125) (50) IAS 19: Amendment recognized in

profit and loss in prior year

Other comprehensive income (5) 40

Net position on balance sheet 371 490

P&L effect (51) (95)

Total balance related to pension 320 395 Difference equals effect of

amendement recognized in prior
year

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 ASC 715 IAS 19

Statement of Income Expense (Income)

Service cost 80 80

Expected return on plan assets (102) N/A IAS 19: never recognized in profit
and loss

Interest cost 60 15 ASC 715: unwinding on PBO,

IAS 19: interest on net obgliation

Amortization of actuarial loss 5 N/A IAS 19: never recognized in profit and
loss

Amortization or prior service cost 7 N/A IAS 19: recognized in year of

amendment

51 95

Effect on comprhensive income (55) (55)

Itemization of effect on other

comprehensive income

Current year actuarial gain 10 10

Difference between actual and (26.5) Includes difference between market-

expected return on assets related value and fair market

Amortization of prior service cost 12.0 value of plan assets

from OCI to profit & loss

Return on plan assets 75

Interest cost on net pension 15 IAS 19: Net interest

obligation recognized in profit

Interest cost on projected benefit (60)

obligation

(5) 40

The largest differences in profit and loss can be summarized as follows:

x Expected return on plan assets is a reduction of expense under FASB ASC 715. Under IAS 19,
return on plan assets is subsumed within other comprehensive income. IAS 19 requires interest cost
or interest income (if plan assets are greater than the PBO) on the funded status of the plan; that is,
the plan assets minus the obligation, to be recognized in profit and loss. This is called the net interest
component of periodic benefit costs.

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x Interest cost on the PBO is recognized in profit and loss under FASB ASC 715. Interest cost is
calculated using a discount rate to reflect the effect of increasing the PBO to the present value at the
reporting date as compared to the present value at the prior reporting date. IAS 19 requires that net
interest cost or income on the funded status of the plan be recognized in profit and loss.
x Because the plan amendment under IFRS 2 was recognized in profit and loss in a prior year, but it is
amortized into profit and loss for FASB ASC 715, profit and loss is USD 12 million less under US
GAAP compared to IFRS.

The difference in the net balance sheet effect when not considering retained earnings is due completely to
a plan amendment which resulted in prior service cost that was recognized in profit and loss in its
entirety under IAS 19 in a prior period, but is being amortized under FASB ASC 715.

It is important to note that the effect on comprehensive income is the same under FASB ASC 715 and
IAS 19. The primary difference is in the allocation of the effect of the pension obligations and assets
between profit and loss and other comprehensive income. This difference is of particular importance
because the effects on profit and loss for the same plan over the same number of accounting periods will
be different between the two standards. This is because under FASB ASC 715, the USD 125 million loss
in accumulated other comprehensive income will eventually be amortized into profit and loss. However,
under IAS 19, the USD 50 million will never be reclassified into profit and loss.

KNOWLEDGE CHECK
1. Under FASB ASC 718,

a. Fewer components of net periodic cost are recognized in profit and loss than under IAS 19.
b. Actuarial gains and losses are required to be immediately recognized in profit and loss.
c. Curtailments are amortized over the remaining life expectancy of the participants.
d. An entity can use market-related value to calculate the return on plan assets.

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