Accounting for Income Taxes Poses Opportunities for Risk Mitigation

Albert Einstein said, “The hardest thing in the world to understand is the Income Tax.” The complexity of tax draws professionals to the field, and most tax directors agree that one of their most important and complex responsibilities is accounting for income taxes. This is particularly true for public companies that are required to submit financial statements to the Securities and Exchange Commission. SarbanesOxley (Sox), introduced in 2002, remains an important measure of a company’s ability to demonstrate controls and give investors the comfort of reliable financial reporting, greater transparency, and accountability. Accounting for income taxes is so complex that a recent BDO study identified taxes as the fourth most common reason for restatements, accounting for approximately 13 percent of all restatements. Restatements undermine investor confidence and have negative impacts on market capitalization. Mitigating the risks associated with accounting for income taxes and providing transparent and well communicated results requires attention to people, processes, and systems.

Accounting for income taxes requires a specific set of advanced skills, including problem solving, communication, and judgement. Tax staff must be trained in these skills as well as the accounting guidance governing income taxes. Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 740, Income Taxes, requires the asset/liability method to record taxes in financial statements. FASB issued Interpretation 48, (FIN 48), Uncertain Tax Positions, governs the measurement and disclosure of tax filing positions. Uncertain tax positions, by their nature, require management to exercise judgment around a tax position’s success. Taxes are considered high risk for financial audits because they entail judgment where there is judgment, there is risk and associated scrutiny. Tax professionals’ must understand how tax strategies and filings are reflected in financial statements and communicate taxes simply & effectively to stakeholders.

A strong, consistent process eases the path for tax staff. Clear work paper format that walks through each step of the process creates a solid path for demonstrating controls. To improve, tax departments should map the process and make a checklist of each step, thereby identifying opportunities to eliminate redundancies. A significant portion of time preparing tax provisions is spent on data collection and cleansing. Creating standardized templates to request non-automated information helps streamline the data gathering process. Another way to streamline is to right-size the Sox controls, striving to provide governance and accountability within a reduced number of controls.

Controls and accountability are easier when systems used for tax accounting are linked with enterprise resource planning (ERP) systems. Better collaborating and sharing systems within finance significantly reduces data gathering time. System integration provides direct feeds of data for accounting for income taxes and facilitates data for other tax activities such as transfer pricing, sales & use tax, and digital tax requests. Companies invest millions in ERP implementations, so they happen rarely. When an ERP implementation happens, tax teams should jump on the opportunity to ensure their data needs can be met more easily.

Accounting for income taxes entails management judgment and where there is judgment there is risk. Companies are well served to reduce the risk in this activity with proper staff training, streamlined processes and integrated tax and financial systems. Understanding tax information and communicating it effectively in financial statements is a worthy goal. As Albert Einstein said, “If you can’t explain it simply, you don’t understand it well enough.”