FIN 48, a FASB accounting standards interpretation intended to increase relevance and comparability in financial reporting information about income tax uncertainties, generally achieves that purpose, although some stakeholders believe the standard could be improved. The broad consensus is that, on balance, the benefits of FIN 48’s improved consistency and reporting of income tax uncertainty information outweigh its costs. These were the conclusions of the first formal post-implementation review of an accounting standard set by FASB under a new review process established by the Financial Accounting Foundation, FASB’s oversight body. FIN 48 is Codified in Accounting Standards Codification Topic 740, Income Taxes.
FASB Chair Leslie F. Seidman said that post-implementation review is an important feedback loop in the standard-setting process. Chairman Seidman believes that the report on FIN 48 affirms the overall effectiveness of the reporting requirements and the FASB’s processes, while identifying suggestions for improvement. FASB will consider the reported findings and provide a written response in the coming weeks.
The review found that more information about income tax uncertainties is reported using FIN 48 than using prior accounting guidance. Investors are using that information in some manner in their investment decision process. Investors use the information in different ways, from predicting income tax cash flows to assessing how aggressive managements are in their income tax strategies. Preparers might not disclose sensitive income tax uncertainty information if they perceive it to be detrimental to tax settlements.
It was further found that uncertain income tax positions are recognized and measured more consistently using FIN 48 guidance than using prior accounting guidance. However, consistently applying FIN 48 may not increase the comparability of information about income tax uncertainties across companies and other reporting entities. The principal reasons comparability may not be increased are managements’ judgments and the complexity of the tax code. Management has to assess each tax position separately on its technical merits, assuming taxing authorities’ full knowledge of the positions. Different judgments may result in different reported outcomes, even for similar uncertain income tax positions.
The review also concluded that reported information about income tax uncertainties is more relevant since FIN 48 was issued. However, such information may not be predictive or confirmatory of future cash flows because FIN 48 employs a benefit-recognition approach, not a best-estimate approach for liabilities to be settled.
Investors and other financial statement users believe FIN 48 generally provides useful information. Public companies have increased the amount of information provided about income tax uncertainties. Preparers said, however, that they are concerned that the judgments involved in accounting for income tax uncertainties result in information that is not comparable, and may not represent amounts expected to be paid. Further while preparers generally understand FIN 48’s provisions and are able to apply them, they said that difficulties arise in making judgments about outcomes applied to complex, and often vague, tax code and practices.
Preparers and practitioners said that they changed some operating practices to implement FIN 48. The most common changes were employing additional tax specialists, engaging tax advisors, and changing the level of coordination between tax and other functions. Relatively few preparers said that they changed their tax strategies for FIN 48 reasons.
The FASB issued FIN 48 in 2006 to reduce diversity in practice in recognizing, measuring, and reporting uncertainties relating to income tax positions. Generally, an income tax position is a deduction or credit taken or expected to be taken in an income tax return that is recognized, measured, and reported in an entity’s financial statements. A tax position also includes a decision not to file an income tax return, or to classify transactions or entities as tax exempt. Taxing authorities may challenge income tax positions, thus creating uncertainties about the taxes ultimately to be paid.
FIN 48 was partially a reaction to SEC concerns about earnings management and financial press reports that companies could manage earnings by determining the amount and timing of income tax reserves. The IRS was concerned about aggressive and abusive income tax positions.
In addition, one of the most common material weaknesses reported in the first round of Sarbanes-Oxley Section 404 filings related to income taxes. The PCAOB 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 review found that preparers did not experience unexpected changes in taxing authority behavior in selecting entities for audit or in settlement negotiations. Preparers are concerned, however, that IRS Schedule UTP, Uncertain Tax Position Statement, introduced in 2010 and directly related to FIN 48, could lead to adverse audit and settlement consequences. The report concluded that it is too soon to determine the economic consequences of IRS Schedule UTP, if any.
Feedback gathered by the review team also indicated that most preparers did not incur significant FIN 48 implementation and continuing compliance costs. However, some preparers, particularly those from smaller organizations said they incurred significant costs such as additional audit fees, external legal and accounting expertise, and documenting existing tax positions
Preparers said that they did not experience any significant capital market effects or effects on entity valuations attributable to FIN 48’s implementation and disclosures. Users said that they did not perceive any significant capital market effects, or effects on entities’ valuations, attributable to FIN 48.
Preparers and practitioners think that the FIN 48 disclosures reveal sensitive information to taxing authorities, particularly when an entity has limited uncertain income tax positions. They also question the reliability of certain disclosures of sensitive information, such as significant changes that could occur in the next 12 months. They reason that a requirement to disclose sensitive information leads to ambiguous disclosures.