The Financial Accounting Foundation (FAF), which oversees the Financial Accounting Standards Board (FASB), conducted its first post-implementation review of an accounting standard, starting with FIN 48, “Accounting for Uncertainty in Income Tax Positions.” In its report, the FAF concluded that the 2006 standard generally meets its goal of increasing the “relevance and comparability” in reporting information about income tax uncertainties, but the interpretation still needs improvement.
The objectives of the review were three-fold: (1) to determine whether FIN 48 is accomplishing its intended purposes; (2) to evaluate its implementation, continuing compliance costs, and benefits; and (3) to provide recommendations to improve the FASB’s standard-setting process.
Background
In the years leading up to the issuance of FIN 48, the SEC and others were concerned about earnings management, particularly what was referred to as “cookie jar reserves.” The financial press reported concerns that companies could manage earnings by determining the amount and timing of income tax reserves. At about the same time, the IRS was concerned about aggressive and abusive income tax positions and, as a result it amended its regulations to improve practitioners’ ethical standards and curb abusive tax avoidance transactions. The PCAOB also introduced new audit documentation requirements that went into effect shortly before the initial adoption of FIN 48. Those requirements, along with the requirements of FIN 48, resulted in much more information and detail in income tax accrual work papers.
The implied needs for FIN 48’s guidance are based on investors’ desire for useful information about entities’ income tax risks and uncertainties. Investors also need to be able to compare such information across entities and from period-to-period. The information needs to be relevant (i.e., have predictive and confirmatory value) and preparers need to use consistent methods to determine and report this information.
The FAF report is based upon 199 survey responses from principal stakeholder groups -- 45% from users, 29% from preparers, 18% from accounting practitioners, and 8% from academics, as well as responders from not-for-profit entities and privately held entities.
The Results
The report concludes that investors and other financial statement users believe FIN 48 generally provides useful information, although some believe the information is not a reliable or verifiable predictor of risks from income tax uncertainties. They believe income tax reserves are determined more consistently and are more comparable across reporting entities since FIN 48 was issued. Generally, investors use FIN 48’s income tax uncertainty information in their investment decision process to predict income tax cash flows or earnings impact or to assess managements’ tax strategies.
Preparers generally believe that information about income tax uncertainties is reported using consistent methods. However, they generally do not believe FIN 48 provides “decision-useful” information. They are concerned that the judgments are not comparable and may not represent amounts expected to be settled. Investors as well, believe FIN 48 may not be useful for predicting income tax cash flows because of its recognition and measurement provisions and the judgments involved.
FIN 48 uses a benefit-recognition approach. Under it, an entity assesses whether it is “more likely than not” (the MLTN threshold) it will sustain an uncertain position taken on an income tax return based on its technical merits. If the uncertain position meets the MLTN threshold, then the entity measures the tax benefit to be realized, considering the amounts and probabilities of outcomes that could be realized on settlement. The entity records a liability for the uncertain position as the difference between the amount taken in the tax return and the benefit recognized and measured using the MLTN threshold. Thus, the entity records the benefit expected to be realized, not necessarily the amount to be settled. FIN 48 does not purport to represent the best estimate of income tax cash flows.
Preparers and practitioners think that the reported liabilities are larger than the settled amounts because of (a) the presumption that taxing authorities will examine each uncertain tax position, rather than settle in the aggregate; (b) the presumption that each uncertain position will be evaluated on its technical merits assuming taxing authorities’ full knowledge of the facts and issues (many positions are either not reviewed or the issue/position is not raised during the review); and (c) no value being given to uncertain positions that do not meet the MLTN threshold (i.e., no offset for settling amounts in the aggregate).
While preparers generally understand FIN 48’s provisions, they have difficulty in applying its recognition and measurement provisions because they require judgments about outcome probabilities applied to complex, and often vague, tax laws and practices. Preparers are being asked to quantify complex and potentially unsettled tax positions on a global basis. As a result, preparers and practitioners often need to engage a tax advisor from a law or accounting firm and change the level of coordination between tax and other functions.
Preparers also expressed concerns about FIN 48’s subsequent recognition and de-recognition requirements. They note that those requirements, when coupled with other guidance in FIN 48, can result in liabilities being reported for longer periods and in greater amounts than experience would justify. Thus, because of the extensive judgments involved, some preparers and practitioners are concerned that FIN 48 does not provide comparable information across entities and question FIN 48’s usefulness to investors.
Preparers and practitioners also think that the FIN 48 disclosures might reveal sensitive information to taxing authorities, particularly when an entity has a limited number of uncertain income tax positions. Preparers and practitioners also question the reliability of certain disclosures of sensitive information. They reason that a requirement to disclose sensitive information leads to ambiguous disclosures.
A number of stakeholders were concerned that entities would experience adverse consequences from implementing FIN 48, such as reduced leverage in settlement negotiations with tax authorities (the “road map effect”). The road map effect appears to be more of a concern for smaller entities that have fewer tax jurisdictions to aggregate, and thereby to mitigate, the disclosure risks pertaining to any single tax jurisdiction. Preparers are concerned, however that IRS Schedule UTP (Form 1120), Uncertain Tax Position Statement, when combined with FIN 48 could lead to adverse IRS examination and settlement consequences. However, according to the report, it is too soon to determine the economic consequences of IRS Schedule UTP. In 2010, the IRS agreed to relax some of its requirements and phase them in over five years.
Preparers and practitioners generally do not believe that FIN 48 resolves the issues underlying the need for the standard. Therefore, they do not believe the costs of applying FIN 48 are reasonable compared to its benefits. FAF’s research, though, indicates that most preparers did not incur significant incremental FIN 48 implementation and continuing compliance costs. Some smaller entities, however, did incur significant implementation costs such as additional audit fees, external legal and accounting expertise, and documenting existing tax positions.
Several private and not-for-profit entity stakeholders commented that FIN 48 indicated a standard-setting bias to large public company issues. These stakeholders believe that FIN 48 deals with issues generally not relevant to many private and not-for-profit entities. Others perceived that private and not-for-profit entities’ views were not sought or considered thoroughly earlier in the standard-setting process. Earlier consideration of input from these stakeholders may have reduced both the FASB’s deliberation time and the need to delay FIN 48’s effective date for these entities. There was no specific discussion of Accounting Standards Update 2009-06 (September 2009), which considers the application of FIN 48 to certain not-for-profits and flow-through entities.
The report on FIN 48 is the first in a series of post-implementation review that the FAF plans to conduct of standards set by both FASB and the Governmental Accounting Standards Board (GASB), which the FAF also oversees.
“The issuance of this report is really a milestone for our organization,” FAF president and CEO Terri Polley said in an interview with Accounting Today. “It’s a really good example of the FAF board of trustees’ oversight. They had decided to create this independent process for looking at the FASB and GASB standards after they’ve been issued to check on their effectiveness and how the standards are being used. It shows our willingness to take a look at what we do and how we can improve upon our process.”
Any changes in FIN 48 are still unclear. FASB will look at the post-implementation review report and provide a written response in the next few weeks on what the board plans to do. The post-implementation review process itself was also something that the FAF wanted to try out. The FAF has not yet decided which standards from FASB and GASB will be the next ones slated for a post-implementation review, but Polley expects to announce in the next few weeks which standards have been selected.
by Mark Zilberman, CPA, CFE
Principal, Assurance Services
mzilberman@mfrpc.com | 
