Intraperiod tax allocation after ASU 2019-12

In this lesson you will

Apply the incremental approach to allocate tax to continuing operations first
Allocate the remaining tax to discontinued operations, OCI and equity
Explain the exception ASU 2019-12 removed and its effect on loss years
Identify changes in deferred taxes that go to continuing operations regardless of origin

What intraperiod allocation does

Total income tax expense for a year is one number. The financial statements present income in several places: continuing operations, discontinued operations, other comprehensive income and, occasionally, direct entries to equity. Intraperiod tax allocation, in ASC 740-20, decides how much of the total tax belongs to each.

The incremental approach

ASC 740-20-45-7, as amended by ASU 2019-12, states the rule: the tax effect of pretax income or loss from continuing operations is determined by a computation that does not consider the tax effects of items that are not included in continuing operations.

The steps:

Compute total tax expense or benefit for the year, all items included.
Compute the tax on continuing operations as if the other items did not exist. Use the same realizability analysis you would use if continuing operations were the only income.
Allocate the remainder (total minus continuing operations) to the other items. When there is more than one other item, ASC 740-20 provides further steps to split the remainder among them.

Because continuing operations is computed first and in isolation, every other component absorbs whatever is left.

The exception that ASU 2019-12 removed

Before ASU 2019-12, there was an exception when continuing operations had a loss and another component (for example, discontinued operations or OCI) had income or a gain. The entity had to consider that other income when determining the benefit allocated to the continuing operations loss. In practice, a company with a full valuation allowance could record a tax benefit in continuing operations just because it had a gain in OCI, offset by tax expense in OCI.

ASU 2019-12 removed that exception. Its amended illustration in ASC 740-20-55-10 through 55-12C shows the result. With a $500 continuing operations loss, a $900 capital gain in discontinued operations and $120 of total tax:

If the loss would have been realizable without the gain, continuing operations gets a benefit at the ordinary rate and discontinued operations absorbs the rest.
If a valuation allowance would have been needed without the gain, continuing operations gets zero benefit and discontinued operations gets all $120.

ASU 2019-12 is effective for PBEs for fiscal years beginning after December 15, 2020, and interim periods within those years. For all other entities it is effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. It now applies to every entity.

Later changes go to continuing operations

Statement 109 paragraph 26 sends the effect of a change in judgment about beginning-of-year valuation allowances to continuing operations, with narrow exceptions. Paragraph 27 does the same for the effect of a change in tax law on deferred balances. That applies even when the deferred tax arose from an OCI item such as an unrealized gain on securities. The result can leave tax effects in accumulated OCI that no longer match the pretax balance, which entities track and release under their policy.

Disclosure and audit focus

ASC 740-10-50-10 requires disclosure of the tax allocated to continuing operations and the amounts separately allocated to other items for each year presented. Expect the entity to support its intraperiod allocation, and keep that support in the file. In the file:

Confirm continuing operations was computed without the other items, including in the realizability analysis.
Confirm each OCI component's tax ties to the statement of comprehensive income.
Watch for loss years with OCI gains, where pre-2019-12 habits still produce a continuing operations benefit.

The discontinued operations guide covers presentation of the disposal group itself.

Worked example

Allocating tax at Pinecrest Home Goods, Inc.

Pinecrest Home Goods has a pretax loss from continuing operations of $800,000 and a pretax gain on discontinued operations of $2,000,000. Both are ordinary income for tax purposes, taxed at 21 percent. There are no temporary differences.

Total tax: (2,000,000 - 800,000) x 21% = 1,200,000 x 21% = $252,000.

Case 1: loss realizable on its own. Without the gain, the $800,000 loss would create a carryforward that Pinecrest's history of profits shows is realizable. Continuing operations is computed in isolation:

Continuing operations benefit: 800,000 x 21% = ($168,000)
Discontinued operations: 252,000 - (-168,000) = $420,000, which equals 2,000,000 x 21%

Case 2: loss not realizable on its own. Pinecrest has cumulative losses in continuing operations and would need a full valuation allowance without the gain.

Continuing operations benefit: $0
Discontinued operations: 252,000 - 0 = $252,000

Before ASU 2019-12, Case 2 would have allocated a $168,000 benefit to continuing operations because the gain made the loss usable. Under the amended ASC 740-20-45-7, the gain is ignored when computing continuing operations, so the loss gets no benefit and continuing operations shows the full $800,000 pretax loss with no tax.

Self-check

Answer each question before you open the answer.

What is the first step in intraperiod allocation?
Show answer
After computing total tax, compute the tax on continuing operations without considering items outside continuing operations (ASC 740-20-45-7). The remainder is then allocated to the other components.
A company with a full valuation allowance has a loss from continuing operations and an unrealized gain in OCI. After ASU 2019-12, does continuing operations get a tax benefit?
Show answer
No. The exception that required considering the OCI gain was removed. Continuing operations is computed alone, and because its loss would need a full allowance, it gets no benefit.
A valuation allowance on a deferred tax asset that arose from an OCI loss is released because of improved profitability. Where does the release go?
Show answer
To income from continuing operations. Statement 109 paragraph 26 allocates the effect of a change in judgment about beginning-of-year allowances to continuing operations, with limited exceptions.

Sources

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Standards are paraphrased from the primary sources listed above; read the source before relying on a requirement. This lesson is training material, not professional advice. Report an error