FASB Acts On Taxes; Japan Rebukes PwC

The Financial Accounting Standards Board is planning to finalize its position on how companies should present uncertainties about tax issues in a way that gives companies some more flexibility than originally planned.

At a recent board meeting, members wrestled with how a company should show the financial impact of a position they are taking with tax authorities if they aren’t certain whether agencies like the Internal Revenue Service will allow the tax benefit the company claims. The question applies when a company is seeking a tax benefit that may be subject to challenge or debate, such as with an aggressive tax shelter.

The board plans to allow companies to show the impact of an expected tax benefit if they are “more likely than not” to realize the benefit once tax authorities have passed their judgment. That’s a step back from the original threshold the board planned to set, which was that companies would have to expect the benefit was “probable” before reflecting it in financial statements.

With the “more likely than not” threshold, however, FASB plans to require companies to make some additional disclosures. It is establishing a tabular presentation system that would enable users of financial reports to see how much of the tax benefit a company is claiming remains uncertain at the time of reporting, and how the amount flagged “uncertain” may change from period to period.

FASB staff pointed out that their research shows tax experts are concerned that disclosures in financial statements reflecting some measure of uncertainty will tip the hand of tax authorities, giving them a “roadmap” to question companies’ tax positions more closely. FASB member Don Young liked the tabular presentation system, but added, “I am troubled by the roadmap issues.”

Schipper

FASB member Katherine Schipper questioned whether the concern is legitimate. The disclosures would allow companies to group unrecognized or uncertain tax benefits on a worldwide basis, making them “so highly aggregated,” it would be impossible for any single tax authority to pinpoint uncertainties to their own jurisdictions, she contended.

FASB staff said they hope to have a draft interpretation ready for a board vote no later than the end of June but perhaps as early as the end of May.

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Japanese Regulators Rebuke PricewaterhouseCoopers Partner

PricewaterhouseCoopers, stung by a sanction from Japanese regulators that essentially shuts down its public company auditing in that country for months, is scrambling to pull together a new Japanese subsidiary with improved governance.

Japan’s Financial Services Agency meted out the unusually severe punishment last week against ChuoAoyama PwC, for certifying five years' worth of false financial statements by Kanebo Ltd., a cosmetics conglomerate that collapsed last year after admitting years of hidden losses. The FSA’s disciplinary order also revoked the CPA credentials of two engagement partners at ChuoAoyama, and barred a third from doing any audit work for a year.

The FSA suspended ChuoAoyama PwC from upcoming audit work in July and August, but also carved out several exceptions that effectively bar the firm from providing audit services for only about half of its audit client load.

PwC spokesman Mike Ascolese said exceptions focus most notably on global companies with subsidiaries in Japan and companies registered on exchanges outside of Japan. The exceptions also carve out companies whose accounting year ends in March—the most common closing period for Japanese companies, according to the FSA.

With the exceptions taken into account, the audit sanction effectively bars ChuoAoyama from auditing domestic companies with a fiscal year other than the calendar year, Ascolese said. All told, it bars ChuoAoyama from serving about 2,300 audit clients, representing about half the firm’s audit load, he said.

Gomi

The ChuoAoyama sanction is the latest signal of a more muscular, no-nonsense attitude on the part of the FSA, in the wake of last year’s LiveDoor accounting scandal that deeply rattled Tokyo stock markets. Earlier this year, FSA chief Hirofumi Gomi pledged more cooperation between his agency and the U.S. Securities and Exchange Commission, so Japanese regulators could learn from American experiences with fraud.

The FSA disciplinary action cites three specific problems with ChuoAoyama’s audit processes. The review process was “excessively dependent” on review partners, the FSA said. The firm did not appropriately develop the standards, manuals and other materials on which the review partners would base their judgment, and no verification procedure was in place to handle whistleblower information regarding audit practices.

Following the sanction, PwC said in a statement it “regrets the actions of the former ChuoAoyama partners in connection with the Kanebo fraud and will respect fully the requirements and the intent of the order by the Financial Services Agency.”

PwC said it will work with ChuoAoyama to execute a reform plan to improve audit quality, but it also jumped into action to establish a “permanent new and independent audit firm” in Japan that would operate under the PwC umbrella. PwC said the firm will operate under a new management and governance structure and will be “of a sufficiently large scale to serve its clients.”

Ascolese said PwC is not acquiring an existing firm in Japan, but assembling a complete firm from scratch, with the intent to serve displaced ChuoAoyama clients.

“It would be up to the clients to decide,” he said, but PwC “would conceive of two firms operating in separate segments of the market.” One firm would serve domestic companies displaced by the ChuoAoyama sanction, the other global companies that ChuoAoyama can continue to serve.