Mention the words ‘tax accounting change’ and you’re guaranteed a lukewarm response. Tax is one of the most complex and least understood areas of accounting, and most IROs leave it to the professionals. ‘Our tax department will handle any change; I won’t deal with it until we focus on closing the quarter,’ notes Sarah Lewensohn, Laidlaw International’s director of IR.
But the latest move by the US Financial Accounting Standards Board (Fasb) may require checking in early with the tax people because it could impact earnings and draw questions from the investment community. ‘This is as major a pronouncement as Fasb has ever made – bigger than stock options,’ says Robert Willens, a Lehman Brothers tax expert, who is fielding more and more Fin 48 questions from analysts.
‘Accounting for uncertainty in income taxes’, or Fin 48, requires companies to put tax reserves on the balance sheet for the first time. The move forces issuers to disclose only tax positions that have a 51 percent chance of surviving an audit, and is effective for fiscal years beginning after December 15, 2006.
The bottom line
Credit Suisse predicts Fin 48 will result in more volatile tax rates that could impact earnings. It also suggests the rule may increase tax liability on the balance sheet and that added disclosure could result in more tax costs for firms. ‘We think investors and analysts should be asking companies about Fin 48,’ says David Zion, a tax and accounting analyst at Credit Suisse.
As with most accounting rule changes, Fasb’s aim with Fin 48 is to increase transparency. Prior to Fin 48, there was no consistency in terms of how companies could measure and report on tax positions. The SEC suspected some issuers were making overly aggressive reserve assumptions and then dipping into them to smooth out rough quarters. ‘Investors overwhelmingly wanted this change,’ says Fasb spokesperson Gerard Carney.
But companies didn’t show the same support, with Fasb receiving over 400 letters requesting a delay in Fin 48’s implementation. Fasb didn’t concede. ‘The board carefully considered each of the recommendations in these letters and decided there was no significant reason to delay,’ Carney says.
Uncertain position
This was a big disappointment for the Tax Executive Institute (TEI), the tax professionals’ trade body that led the call for more time. ‘We wanted an extension because of the uncertainty about everything required to properly identify, document and monitor the uncertain tax position,’ explains Timothy McCormally, executive director of TEI. He thinks there could now be inconsistencies in how companies report tax positions in the first quarter of compliance. One of the major hurdles for assessing the materiality of Fin 48 is the current lack of disclosures on tax reserves. Zion recently looked at the 2005 10Ks of 1,000 companies that mention tax reserves or contingencies. ‘They don’t say much around it other than how the tax reserve is accounted for,’ he notes.
Disclosures around Fin 48 have been similarly light. Zion searched 10Ks and 10Qs filed during the last three months of 2006 and found that 449 companies mentioned the rule change. Of those, most said they were still assessing its impact, with 60 claiming the rule would be immaterial. Only six companies predicted a material impact: Altria, Constellation Energy, Electronic Arts, PPL Energy Supply, Qwest and Tenet Healthcare. And only one S&P 500 firm, BB&T, provided an estimate for the financial impact of Fin 48.
So if most accountants haven’t yet figured out Fin 48, what is IR supposed to do? ‘Find out what your deferred tax assets and credits are that may not be transparent in the first place,’ suggests John Chironna, director of IR at ABB and a certified public accountant (CPA). ‘Companies have different balance sheet levels of disclosure and the tax credit or debit may be hidden in the assets or liabilities.’
Once you know where the numbers are disclosed, it’s important to determine their materiality and whether it will change under the new rule. ‘With tax-related questions, it depends on the interpretation of the company’s tax advisers as to how you report and book certain things. It’s important to make sure you have the correct interpretation,’ advises Robert Borchert, vice president of IR at Per-Se Technologies.
This first quarter of compliance may mean confusion in the market, ‘so IR needs to understand how this has worked in the past and how Fin 48 might change things,’ concludes Zion.
