Financial Reporting Newsletter

February 2005

Issues Covered

Executive Summary

Accounting for the American Jobs Creations Act of 2004

Accounting for Share-Based Payment

Accounting for Discontinued Operations

Accounting for Risks and Contingencies

Accounting for Inventory Costs and Nonmonetary Exchanges

Calculating Earnings per Share

Financial Reporting by Private, Small and Mid-sized Companies

Financial Reporting Using XBRL

Other Recent Developments in Accounting and Reporting

Calendar of Key Accounting and Reporting Dates

The Outlook for More Breakthroughs in 2005

Table of Pronouncements

Summary of Effective Dates

For More Information

Print Newsletter

Accounting for the American Jobs Creation Act

Companies with operations in the U.S. must begin now to account for the effects of the American Jobs Creation Act of 2004. The Act will likely cause changes in companies that go far beyond the tax department. Accounting for the effects of the Act will require judgment, and there is a direct impact on financial reporting for public companies. The Act sets stiffer penalties related to tax shelters, and it requires disclosure of such penalties by public companies in SEC filings.

Below are key questions companies should be prepared to answer.

Is the company accounting properly for the tax effects of its production activities?

Questions might arise about accounting for the effects of the Act's tax incentives for manufacturing companies to keep production activities in the U.S.

The Financial Accounting Standards Board (FASB) provided guidance on accounting for the domestic production incentives in FSP FAS 109-1, "Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004."

FSP FAS 109-1 indicates that companies should account for the production incentives as a special deduction rather than as a rate reduction. This means that companies will recognize the tax benefits gradually, year-by-year, not as a large non-recurring adjustment. Any benefit from the deduction should be reported during the year for which the deduction is claimed on the tax return.

There will be no immediate impact on deferred tax balances for most companies, and deferred taxes will continue to be provided at the statutory tax rate. But accounting for the Act requires judgment. Companies should be prepared to answer these questions:

Does your company need to provide a larger valuation allowance on its net deferred tax assets due to lower future taxable income?
Did you consider the impact on the company's effective tax rate when determining the estimated annual rate used for interim financial reporting?
Did you consider separate disclosure in the effective tax rate reconciliation?
Did you consider recording an accrual for a potential disallowance of production deductions? This could be necessary due to the need for interpretations on a variety of issues.

Is the company accounting properly for the tax effects of its foreign earnings?

Questions may arise about the tax effects on foreign earnings because the Act provides incentives for companies to return more funds to the U.S. These incentives allow a one-time exclusion from taxable income for 85% of repatriated foreign earnings.

Guidance on accounting for the repatriation incentives is provided in FSP FAS 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004."

FSP FAS 109-2 gives companies more time to evaluate the impact of the Act on their plans for reinvestment or repatriation of certain foreign earnings for purposes of applying Statement 109. Without this added time, companies would have been required to apply Statement 109 in 2004, even if they had not yet decided whether to keep funds from foreign earnings permanently reinvested outside the U.S. or to return them to the U.S. This decision is critical when applying Statement 109, which provides that:

A deferred tax liability must be recognized for the excess of the book over the tax basis of investments in foreign subsidiaries or joint ventures.
An exception is made for the excess attributable to undistributed earnings, if the parent company affirmatively asserts that the earnings are indefinitely reinvested outside its home tax jurisdiction.

These provisions require the recognition of an appropriate deferred tax liability when a company decides to take advantage of the tax incentives and return to the U.S. earnings previously earmarked for reinvestment abroad. The keys to proper accounting:

Make an accurate determination of the exact time the decision is made so you can record the accrual in the proper accounting period. Don't delay accruing a tax liability until a dividend has been declared or paid.
Start early to ensure compliance with the disclosure requirements. Some disclosures apply while a company is deciding whether to repatriate earnings under the Act.

Has management put in place proper processes and controls?

The number one question on the minds of many companies is, "Do we have the right processes and controls in place to comply with the new tax law and report its effects accurately?"

The Controls Breakthrough:
How Your Company Can Benefit

Early efforts by large public companies to comply with the internal control reporting requirements of Section 404 of the Sarbanes-Oxley Act fueled an awareness that controls over spreadsheets may be missing or inadequate. Because this lack of controls increases the potential for errors, (e.g., in input, logic or interfacing with other systems), an understanding of the risks and mitigating controls over spreadsheets can be critical to accurate financial reporting, especially for non-recurring decisions or transactions.

Companies of all sizes can benefit from the knowledge gained by large companies in documenting and evaluating internal controls. In reviewing the accounting changes that apply for the first time to your company's financial statements for 2004 and 2005, be mindful of the need for additional controls and consider discussing the effectiveness of these controls in your ongoing dialogue with auditors and audit committees.

Auditors and audit committees may phrase the question differently to drill down to specific areas. For example, an audit committee may question whether controls are in place to ensure that repatriated earnings qualify for beneficial tax treatment.

The repatriations won't qualify unless the dividends are invested in a plan approved by the CEO (or comparable official) or the board of directors. In addition, the repatriated funds must be used for certain qualifying activities. Examples of qualifying activities include funding of worker hiring and training, research and development, and capital investments that help stabilize the corporation for purposes of job retention and creation.

Importantly, in making and monitoring reinvestment and repatriation decisions, management may rely on cash flow projections and other records that are neither automated nor a routine part of the company's financial reporting system. For example, many companies use spreadsheets to support management decision-making. The awareness of the need for controls over these informal systems was an important breakthrough in 2004.

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Copyright © 2005, BDO USA,LLP. Material discussed in this Financial Reporting newsletter is meant to provide general information and should not be acted upon without first obtaining professional advice appropriately tailored to your individual facts and circumstances.