Hearings conducted by the House Ways and Means
Committee on the interaction of tax and financial accounting have revealed a certain
coolness towards conforming companies’ financial accounting and tax accounting
as part of any tax reform legislation. Committee Chair Dave Camp (R-MI) said
Congress must consider how
public companies evaluate tax policy options in light of financial accounting
or book considerations. This will allow the Committee to examine whether tax
legislation works as intended when Congress does not consider the effects of
financial accounting. When companies report profits in SEC-filed financial
statements the primary purpose is to convey information about the company’s
financial condition to investors and creditors, he noted, but, conversely, the
primary purpose of tax accounting is to measure income for the purpose of
levying the federal income tax. These two functions are not necessarily
consistent, he emphasized, and may even be at odds in some cases.
Rep. Lynn Jenkins (R-KN) askedpanelists to address the issue of moving towards having less differences in book and tax
accounting as part of legislation reforming the US Tax Code. While seeing some
benefit of simplification to book-tax conformity, Michael Fryt, Vice President,
Tax, FedEx Corp., cautioned about putting control of the tax revenues in the
hands of FASB. Mark Schichtel, Chief Tax Officer, Time Warner Cable, agreed
that ceding control to FASB would not be a good idea, nor would efforts to
achieve conformity with GAAP and international accounting standards, because
they are not necessarily reflective of real economic lives. When you examine
different industries and classes of
assets, he continued, the lives for tax
purposes are much more consistent with reality than what you see from a GAAP
perspective.
Noting that she has done a lot of research on book‑tax conformity, Michelle
Hanlon, Assoc. Professor of Accounting, MIT Sloan School of Management, said it
would be a bad idea. The first thing is that accounting rules are very
conservative, she noted, which means that expenses are accrued very early
before they actually happen in cash flow, for example, bad debt expense and so
forth, while the federal tax code generally has not favored such
treatment. Also, she observed that there is a lot of evidence in the
literature that book‑tax conformity would reduce the information that is
contained in financial accounting earnings. The rules are set up for two
different purposes, she noted, and basically accounting rules are set in order
to inform stakeholders. Further, evidence based on the 1986 Tax Reform
Act, when a certain set of reforms were required to increase their conformity,
the international evidence and several other studies basically show that the
information that is in accounting earnings will go down if you conform those
earnings.
Professor Hanlon was also concerned about who
would make the rules after the book-tax conformity happens, would it be
Congress, FASB, or the International Accounting Standards Board. She believes
that it would be very hard for the U.S. to handle the International
Accounting Standards Board determining the federal tax base.
In
her prepared testimony, Professor Hanlon noted that public companies compute
two different measures of income every year: taxable income and financial
accounting (book) income. The two measures of income are computed for different
purposes. Financial accounting is intended to measure economic performance for
external stakeholders. The rules for computing accounting income are conservative
in nature, requiring the recognition of expenses and losses earlier than the recognition
of income and gains.
Tom Neubig, an
Ernst & Young National Director, said that the discussion about moving to
IFRS has impacted the discussions about U.S. tax reform. Because if
you move to IFRS, he noted, then LIFO would not be allowed, and so it would
automatically eliminate the current ability of some firms to use last‑in, first‑out
accounting. Also there are clearly different goals for the accounting
rules as opposed to tax writing committees, who have different goals, including
revenue.
Similarly, Timothy Heenan,
VP, Treasury and Tax, Praxair, Inc., said that the financial accounting rules
are there for something completely different than what the tax accounting rules
should be there for. The tax rules are designed to get revenue, he emphasized, but
it should be done in a manner that promotes growth, investment, and jobs. Financial
reporting and tax accounting rules are just two completely different worlds, he
said, and they should be kept separate.