Tax, Complexity, Restatements

Companies have made some strides toward improved reporting of tax assets and liabilities in their financial statements, but they still face a long journey to eradicate this common tripping point that leads to material weaknesses and restatements.

Taxes are complicated enough by themselves, given the multitude of jurisdictions at the local, state, national, and international levels the typical public company operates in. Add the complexity of applying accounting rules to taxes, and it’s no wonder that taxes are a persistent cause of restatements, says Pete Bible, a partner at regional accounting firm Amper, Politziner & Mattia.

“What you’re trying to do is take the differences between the financial statements and the tax returns, determine which of those differences are temporary, and give the economic effects of those,” he says. “You have to have a good understanding of what’s in the financial statements and the tax returns to do that. It takes knowledge of both to get it right.”

In a recent Webcast analyzing tax-related restatements, Deloitte & Touche Partner Rita Benassi said corporate tax departments continue to struggle with various elements of accounting for taxes, and the result is a steady stream of material weaknesses and restatements. Regulators, in turn, are watching the subject closely, she said. Accounting staff at the Securities and Exchange Commission has signaled that tax accounting remains “one of the top areas of focus in SEC reviews of filings,” she said.

Still, taxes aren’t a leading cause of restatements. According to Deloitte Partner Randall Sogoloff, only 4 percent of the 839 restatements filed in 2008 were caused by tax issues alone. But the likelihood of ending up with a restatement related to taxes is still a concern. “You can have a material error in just about any aspect of income tax accounting—and that error, if material, will lead to a restatement,” he said.

One of the leading causes for tax-related restatements, Sogoloff said, is the reporting of deferred taxes and valuation allowances. Deferrals result from timing differences between tax and accounting requirements, while valuation allowances focus on the likelihood that some portion of a deferral won’t be realized.

Those issues are fraught with complexity and judgment, and Sogoloff believes they will be particularly significant in the coming year. “We are likely to see, given the current economic circumstances, even more restatements with respect to deferred tax assets and valuation allowances in the near future,” he said.

Robason

Randy Robason, a partner at Grant Thornton, attributes some of the challenge to the long-term trend of tax experts increasingly becoming specialists rather than generalists—leaving them less likely to see the overall effect of taxes on the financial statements. The Sarbanes-Oxley Act has also put a big emphasis on the independence of auditors, prohibiting audit firms from helping their clients with taxes.

“You have to know tax rules, and you have to know how taxes affect earnings. That’s a much broader job description than has historically been the case.”

—Randy Robason,

Partner,

Grant Thornton

Those forces have hamstrung corporate tax departments, steering staff expertise away from the very skills they now need to meet more current requirements, Robason says. Corporate restatements often cite staff skill (or the lack thereof) as an underlying cause that led to the restatement in the first place.

Deloitte’s review of restatements found that nearly half of companies that restated because of taxes cited a lack of personnel or a lack of expertise as the driving factor behind tax mistakes. They also cited problems with a lack of adequate review, inadequate reconciliations, and general procedural or process errors as leading factors.

“The bottom line is people and process are still a challenge,” Deloitte partner Kathy McEligot said during the firm’s Webcast. “We still need to focus on just training and educating staff, finding enough of them, and getting them working together as a well-oiled team.”

Robason says some corporate departments are dismissing tax staff who made mistakes that led to restatements, but that may be shortsighted. “You have to know tax rules, and you have to know how taxes affect earnings,” he says. “That’s a much broader job description than has historically been the case … Assess whether the individual has the motivation to understand a different job description than before and the skills to fulfill that position.”

The good news, McEligot said, is that companies appear to be making progress in proper application of accounting rules—which declined as a stated cause for restatements from 2007 to 2008. Companies also have made progress in improving the process for closing a period and in accounting for non-routine transactions, she said.

Blame the System

Robason says systems and processes remain a challenge for the financial reporting of taxes. In many cases systems and controls are driven by audit needs that aren’t necessarily consistent with tax concerns, he says.

TAX IN THE HOT SEAT?

The following information was provided by Deloitte from its presentation, “Material Weaknesses and Restatements: Is Tax Still in the Hot Seat?&rdquo

Leading Causes of Tax Material Weaknesses in 2008

Personnel (lack of/not trained) 27%

Lack of Review 26%

Inadequate Reconciliation 14%

General Procedure/Process 12%

Improper Treatment/Recording 8%

Period End Process 3%

Lack of Documentation 3%

Non-Routine Transactions 2%

Systems/Technology 2%

Other 3%

Source

Deloitte: Is Tax Still in the Hot Seat? (Aug. 3, 2009).

Deloitte polled its 3,300-strong Webcast audience and asked what is most challenging about tax accounting. Staffing topped the list, with 24 percent saying it’s the toughest part about meeting current requirements. “I don’t know what to tell you other than keep looking,” McEligot said at the time. “Quality people are out there.” Deloitte is constantly trying to steer more folks into training, she said.

Robason says Grant Thornton conducts extensive training among its staff to better equip tax folks for the current demands. “Think of the process as one where you get a Ph.D. for accounting for income taxes,” he quips.

Carter

Bill Carter, director at national firm CBiz MHM, says companies that struggle with tax accounting increasingly hire an outside firm. Smaller companies that can’t justify the staff have already taken that path, he says; now larger companies are starting to follow suit. “You’re seeing companies go into the market now and hire someone other than their attest firm to do their taxes,” he says.

McEligot said Deloitte sees companies continuing to hire and train tax staff, but the firm also sees companies moving the financial reporting of taxes—entirely or in part—out of the tax department and into the finance department. They reason that the finance department has a better grip on what the company needs to complete the financial statements.

“It has everything to do with having more people,” she said. “Finance knows how to close the books to get the overall consolidated financial statements done.”