Solving the Toughest Audit Challenges to Your Tax Provision
or… How to Make Your Auditors Love You and Your Tax Provision Audit Challenges to the Provision
ASC 740 are the rules governing how we show income taxes on the financial statements
Goal: Accurately represent what will end up on tax returns in the balance sheet
Audits are performed to provide independent verification that the rules have been followed and the procedures are sufficient to accurately represent the financial position
Goal: Identify incorrect application of the rules Goal: Identify procedures that create risks to the results Audit Challenges to the Provision
Toughest ASC 740 Technical Challenges: Balance sheet approach Required detail
Toughest ASC 740 Process Challenges: Tax is last Estimates Controls Technical Challenge – Balance Sheet Approach
ASC 740-10-10-1 The entity’s overall objectives in accounting for income taxes under ASC 740 are to:
1. “…recognize the amount of the taxes payable or refundable for the current year” and
2. “recognize deferred tax liabilities and the assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns.”
Challenge is that tax returns are a P&L approach
Keys to embracing the Balance Sheet Approach
1. Understand it: Focus on and orient to the payable and deferreds
2. Trust it: Let the rate “fall out”
3. Embrace it: Get rid of your FAS 109 processes and tools that trick you into starting at the wrong end Technical Challenge – Required Detail
ASC 740-10-55-25 “…ASC 740-10 requires a separate deferred tax computation when there is a significant difference between the tax laws of that and other tax jurisdictions that apply to the entity.”
Challenge is the diminishing returns of detail; at what risk?
Keys to embracing the detail 1. Recognize the work you are already doing to avoid the detail 2. Identify the specific items which make a jurisdiction different
o Rates o Pre/Post NOL c/f o Credits o Consolidations 3. Leverage work you have to do anyway… the returns 4. Work the detail from the small bits; isolate the calculations Process Challenge – Tax is Last
ASC 740-10-20 indicates that only “income taxes are within its scope and defines income taxes as… “…domestic and foreign (national), state and local (including franchise) taxes based on income… [which is] the excess of taxable revenues over tac deductible expenses and exemptions for the year as defined by the governmental authority.” Challenge with income tax is you need income to begin Keys to being successful when you’re last 1. Deconstruct the calculation to the smallest relevant parts which will all you to be more nimble in the calculation 2. Calculate and aggregate separately 3. Effectively use of estimates Process Challenge - Estimates
ASC 740-10-05-5 considers the uncertainty through the application of measurement and recognition criteria… “There are two basic principles related to accounting for income taxes which considers the uncertainty through the application and measurement criteria:
1. To recognize the estimated taxes payable or refundable…
2. To recognize a deferred tax liability or asset for the estimated future tax effects attributable to temporary differences…”
Challenges with estimates is making the estimate
Keys to the effective use of estimates
1. Decide which items are estimates (and don’t pretend it’s real…)
2. Correction of error v. change of estimate? Often the decision lies with how you approached computation (see ASC 250-10-20)
3. Document the assumptions that make the estimate reasonable Process Challenge - Controls
COSO Internal Control - Integrated Framework (May 2013) – outlines how an effective control environment can be established with one of the primary objectives being to… “A means to identify and analyze risks, and to develop and manage appropriate responses to risks within acceptable levels and with a greater focus on anti-fraud measures”
Challenge with tax internal controls is the timing and complexity of ASC 740 calculations
Keys to successful tax internal controls are 1. Identify the items that move the needle 2. Control as you go 3. Integrated and embedded documentation including evidence of review Summary & Take-Aways
Embrace the Balance Sheet approach o More accurate o Supports the mental shift from tax returns to financial statements o Focuses effort on those things that matter Embrace the detail o Small things matter; combinations of small things become big o You have returns for each item, provision should not be different Deconstruct the calculations (and tools) o Understand the difference between integrated and kludge Make the call before you start: estimate or actual o “Best way to get chaffed is riding the fence” Control is a way of life not an addendum o You are already doing everything you need to do from a technical and procedural standpoint. Document it as you go so you get credit! Case Study – ACT Corp examples
Contact Stephen or Nick for detail on the case study or a demo of how Tax Prodigy Provision helps solve these challenges