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Financial Accounting Foundation completes review of accounting for income taxes
In brief
On November 19, 2013 the Financial Accounting Foundation (FAF) completed its post-implementation review (PIR) of Financial Accounting Standards Board (FASB) Statement No. 109, Accounting for Income Taxes (FAS 109) (codified in Accounting Standards Codification Topic 740, Income Taxes). The FAF concluded that FAS 109 adequately achieved its intended purposes, although the complexity associated with accounting for income taxes has not been reduced. Additionally, the FAF concluded that FAS 109 provides investors with decision-useful information noting, however, that investors struggle to assess cash tax effects and find it difficult to understand the potential tax costs associated with foreign earnings considered to be indefinitely reinvested. The FAF further indicated that preparers have difficulty with 'intraperiod tax allocation', accounting for intercompany transfers of assets, and indefinitely reinvested foreign earnings.
In detail
What happened?
On November 19, 2013 the FAF completed its PIR of FAS 109.
As part of the PIR process, the FAF set out to address the following three main objectives:
- Determine whether the standard is accomplishing its stated purposes
- Evaluate the standard's implementation and continuing compliance costs and related benefits
- Provide feedback to improve the standard- setting process
When assessing the first objective the FAF considered the following:
- Whether the standard has resolved the issues underlying its need
- Whether the standard provides decision-useful information to its users
- Whether the standard is operational and understandable
- Whether there have been significant unexpected changes to financial reporting or operating practices
- Whether there have been significant unanticipated consequences from applying the standard
The PIR process included the use of surveys, which elicited
875 responses from a cross- section of stakeholders.
Has the standard resolved the issues underlying its need?
The FAF concluded that FAS 109 adequately resolved the issues underlying its stated need. However, the standard may not have reduced complexity in accounting for income taxes. The report indicates that is not clear whether the complexity is driven by the standard.
It suggests that continued complexity may be as much attributable to significant changes in the business environment and tax laws, coupled with the increased foreign operations of US companies since the standard was issued.
Does the standard provide decision-useful information to its users?
The FAF found that the application of FAS 109 provides decision-useful information. In particular, information relating to a company's effective tax rate, the future earnings impact of income taxes, and components of a company's income tax expense. However, the FAF's report notes that the financial statements may not provide enough detailed information to:
- Analyze the cash effects associated with income taxes, particularly current period taxes paid by jurisdiction
- Estimate future tax payments and the effect on cash flows
- Analyze earnings determined to be indefinitely reinvested in foreign subsidiaries
- Determine what the tax effects of foreign earnings deemed to be indefinitely reinvested would be if those earnings were repatriated
Is the standard operational?
In general, the FAF found that most of the requirements under FAS 109 are understood, can be applied as intended, and produce reliable income tax information. The following aspects of income tax accounting were identified as challenging for
preparers:
- Intraperiod tax allocation (the process of allocating income tax expense among continuing operations, other comprehensive income and any other financial statement components)
- Accounting for intercompany transfers of assets (the exception which defers the reporting of income taxes from intercompany sales or transfers)
- Accounting for earnings determined to be indefinitely reinvested in foreign subsidiaries
- The report also noted that the following areas of FAS 109 result in some application difficulties for preparers and practitioners:
- Accounting for valuation allowances
- Computing deferred tax liabilities and deferred tax assets
Based on feedback received from respondents, the FAF noted that companies with under $100 million in revenue and practitioner firms with under $500 million in revenue have more difficulty applying and interpreting FAS 109 than
respondents from larger companies and practitioner firms.
The FAF's review also found that FAS 109 did not result in any significant changes in operating or financial reporting practices and did not have
any significant unanticipated consequences.
Have costs of implementation exceeded expectations?
In general, while the FAF noted that views were evenly split among respondents, the FAF concluded that implementation costs incurred by stakeholders were consistent with what was expected for this complex area of accounting. The FAF noted that costs of complying with FAS 109 have been significant, including increased need for internal and external resources, but concluded that some of these costs may relate to:
- Introduction of the Sarbanes-Oxley Act of 2002
- Complexity of business transactions
- Complexity of US and foreign tax laws
- Increase in business conducted in foreign jurisdictions by US companies as a result of continued global expansion
The takeaway
While the PIR of FAS 109 did not suggest any changes to the standard, organizations should watch for further developments. It is possible that areas of noted concern may be given attention by standard setters.
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