Preparing the income tax footnote: A comprehensive study in Excel.

Author:Nellen, Annette

Income tax expense represents a large dollar amount on the income statement of most companies, and it can have a significant impact on company net income and earnings per share. It is also a primary driver of a company's effective tax rate (ETR), which has steadily risen in importance to investors, analysts, and regulators. Despite the heightened scrutiny on income tax reporting and disclosures, a majority of new entrants into the accounting profession have only basic-level training in this complex area. The lack of detailed knowledge manifests itself year after year as a significant (and increasing) area of weakness in financial reporting, where tax accounting errors continue to be a primary cause of both restatements and accounting-related ineffectiveness in internal controls (Audit Analytics report, 2016 Financial Restatements: A Sixteen Year Comparison (May 2017)).

The accompanying Microsoft Excel-based case study is designed to give accounting students and entry-level accounting staff experience in working with the requirements of FASB Accounting Standard Codification (ASC) Topic 740, Income Taxes. The comprehensive nature of the case study allows the user to move beyond the basic study of book-tax differences and deferred tax assets and liabilities by incorporating higher-level situations. Users must identify multiple temporary and permanent differences, prepare a book-tax reconciliation, calculate deferred tax assets/liabilities, enter the tax provision journal entries, and produce the effective tax rate reconciliation. Students must also evaluate and record a valuation allowance and perform and properly report an intraperiod tax allocation. Though this case offers a comprehensive application of Topic 740, instructors who cover portions of this material in undergraduate courses may use it, as well, by omitting the more advanced portions of the exercise.

The advantages of using Excel to complete the case study are twofold. First, the AICPA emphasizes as part of its Model Tax Curriculum (available at the need for students to leverage technology to enhance their functional competencies. Beyond using Excel to create and reinforce fundamental skills, discussions with CPA firms reveal that a majority of companies (especially smaller ones) still use Excel to perform their tax provision work (see EY report, Tax Provision Process and Technology Trends, available at

Tax-related financial statement deficiencies

In its May 2017 report, Audit Analytics revealed that tax expense and other tax-related issues increased to the second-largest cause of financial restatements in 2016 (2016 Financial Restatements: A Sixteen Year Comparison, May 2017). Tax issues caused the third-largest number of restatements in 2014 and 2015, and varied between third and fourth from 2011 to 2013. In another report, Audit Analytics found that the tax expense/benefit/deferral and related FASB Statement No. 109, Accounting for Income Taxes (now incorporated into the ASC as Topic 740), issues were the second-highest accounting reason for adverse auditor attestations of ineffective internal controls over financial reporting in 2015 (SOX 404 Disclosures: A Twelve-Year Review (August 2016)). Both reports note that the tax-related issues include errors in approach, understanding, or calculation. Public accounting firms also cite lack of understanding of the tax provision as a reason for these deficiencies (see the EY report, Tax Provision Process and Technology Trends, and the Deloitte report, Accounting Roundup--Special Edition: Changes in the Tax Landscape, available at tinyurl. com/y87s9kcr). Developing a strong understanding of how to apply the rules under Topic 740 will benefit companies and...

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