Accounting for income tax: a student research project.

• Author: Godfrey, Howard

In a research project in the Master of Accountancy Program at the University of North Carolina at Charlotte, students completed an in-depth study of the consolidated financial statements and accompanying footnotes of a publicly traded, multinational company based in the southeastern United States. This project is easily adaptable for use in both undergraduate and graduate accounting and tax programs.

Background of ASC Topic 740

Standards for accounting for income taxes were previously provided in FASB Statement No. 109, Accounting for Income Taxes, which was issued in 1992. This statement was codified mostly in FASB Accounting Standards Codification (ASC) Topic 740, Income Taxes (Topic 740). When the statement was issued, FASB recognized that "income taxes must be computed for complex business transactions within the context of voluminous, complicated, and constantly changing tax laws, rules, and regulations" ([paragraph] 69).

The Financial Accounting Foundation issued its Post-Implementation Review Report on the standard in 2013, in which the review team found that "complying with Statement 109 is more difficult today than when the standard was issued because of increased complexities resulting from changes in the economic environment and the tax laws as well as increased operations by U.S. companies in many different foreign jurisdictions."

The review team found preparers and practitioners had difficulties in applying the standard in the following areas: (1) accounting for valuation allowances and (2) computing deferred tax liabilities and deferred tax assets. Preparers and practitioners also face operational challenges in the following areas: (1) intraperiod tax allocations; (2) accounting for intercompany transfers of assets; and (3) situations in which a deferred tax liability is not recognized for earnings determined to be indefinitely reinvested in foreign subsidiaries. The review team also found that investors who participated in the study had difficulty understanding income tax information provided in the financial statements.

In 2006, FASB issued Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxes, which clarified accounting for uncertainty in recognition of income taxes in financial statements. FIN 48 (which is also incorporated mostly into Topic 740) provided guidance on measuring and reporting the benefits of tax positions taken or expected to be taken on tax returns. However, companies continue to face uncertainty in estimating the probability that a tax position would be sustained on audit. This estimate is necessary because a company may recognize only the amount of a benefit from a tax position that has more than a 50% likelihood of being sustained on examination by the taxing authority in its financial statements.

Purpose of the Student Project

The research project was designed to give students a better understanding of the application of Topic 740 in the real world. Students often find this subject challenging, in part because of the complexities described above. Another reason students fail to fully understand this area of accounting is their lack of experience in reading and analyzing published financial statements, particularly those segments covering accounting principles and reporting practices for income tax expense and related accounts.

Accounting students need to gain an awareness of the variety and complexity of business transactions to succeed in understanding how businesses measure and report income tax expense and related accounts. The study of financial statements and related footnotes in an annual report provides a path for students to gain this awareness and an understanding of Topic 740.

Nature of the Project

The project was an independent study in which graduate students committed...