Case studies for book-tax differences in the classroom.

• Author: Hennig, Cherie J.

FINANCIAL ACCOUNTING AND TAX PROfessionals today face a bewildering maze of computational, disclosure, and reporting requirements related to income tax accrual. GAAP financial statements must comply with Accounting Standards Codification (ASC) Topic 740, Income Taxes (formerly FAS 109, Accounting for Income Taxes, and FIN 48, Accounting for Uncertainty in Income Taxes), which requires accruals for the tax benefit (liability) of temporary book-tax differences and footnote disclosure of uncertain tax positions. In addition, the effective tax rate footnote must disclose the tax benefit (liability) of permanent book-tax differences. For corporate and passthrough entities with assets greater than $10 million, the IRS requires disclosure of both permanent and temporary book-tax differences on Schedule M-3. The IRS recently released a draft of Schedule UTP, Uncertain Tax Position Statement, which will also require corporate Schedule M-3 filers to provide a detailed analysis of current and prior tax year uncertain tax positions. These disclosure and reporting requirements raise questions as to how to most effectively cover book-tax differences in financial accounting and tax courses and how to prepare accounting graduates for this type of work in the profession.

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The Challenge

While the basics of ASC Topic 740 principles are covered in intermediate accounting, the emphasis there typically is on financial reporting disclosure requirements rather than on the identification and measurement of book-tax differences, and those requirements are but one of many balance-sheet deferral items covered. Book-tax differences are usually covered in the second undergraduate tax course or in a graduate tax course, with primary emphasis on how to report such differences on Schedule M-1 or M-3, not on how to determine the deferred tax benefit or liability. Little attention is given to tax accruals for uncertain tax positions in either financial or tax accounting courses.

Spotty coverage of this sort can be traced to several difficulties. While the tax instructor likely is more comfortable working with technical tax content, the financial accounting instructor is likely more comfortable working with the footnote disclosures and may not be current on tax law. This is reflected in the coverage of book-tax differences in financial accounting and tax texts. While the typical financial accounting text has a chapter or two on tax accrual accounting, typically late in the book and too often OMITTED or shortchanged in the classroom, only a few of the major tax texts devote a chapter to this topic. In the collection PricewaterhouseCoopers Case Studies in Taxation, there are five full cases of varying difficulty that address book-tax differences on financial statements and/or tax returns, but only one case (Estabrook) reviews ASC Topic 740-10, FIN 48 adjustments.

With the likely implementation of the new Schedule UTP for all corporate Schedule M-3 filers, effective for the 2010 tax year, there is a new urgency to have more coverage of tax accrual in both financial and tax courses. The complexity of preparing realistic case studies dealing with uncertain tax positions cannot be underestimated, yet this seems to be the most practical way to tackle the problem. One starting point is Hennig, Raabe, and Everett, "FIN 48 Compliance: Disclosing Tax Positions in an Age of Uncertainty," 39 The Tax Adviser 24 (January 2008), which illustrates various book-tax differences and how FIN 48 (now ASC Topic 740-10) applies to each difference. Still, the tax accrual for an uncertain tax position requires the exercise of professional judgment, which most students lack.

Thus, it would appear that the best way to teach the topic in an advanced tax course is to use the case method, in which the most basic book-tax differences are illustrated and the student is sequentially walked through tax accrual and ASC Topic 740-10 computation. The timing of this course puts the student close to graduation and entry into the profession, where the new graduate could quickly apply the information.

In this column, the authors use a multistep process to identify and explain:

* Tax accrual for a temporary difference for a deferred tax asset that is not an uncertain tax position;

* Computation of a valuation allowance when there is a more likely than not (MLTN) belief that the tax benefit will not be recognized in the future;

* Tax accrual for a temporary difference for a deferred tax liability that is an uncertain tax position;

* Tax accrual for a temporary difference for a deferred tax asset that is an uncertain tax position;

* Tax accrual for a permanent difference and computation of the effective tax rate;

* Accrual for an uncertain tax position when there is no book-tax difference; and

* Disclosures on Schedule M-3, Schedule UTP, and...