Public Companies Get Unexpected Surprise During Audits Of Their Tax Provisions

Word on the street is that CFOs and corporate controllers have been commenting that their external auditors are requesting more documents and details than usual on every aspect of financial reporting, including the area of accounting for income taxes. These new and unanticipated demands are adding time, cost and confusion to the audit process.

The more rigorous audits are in reaction to an alert issued from the government accounting watchdog. On October 24, 2013, the Public Company Accounting Oversight Board (“PCAOB”) warned that it had observed a number of deficiencies in audits of internal controls over financial reporting, including the area of income taxes. These internal controls are important to a company since they act as a company’s first line of defense against fraud and financial mismanagement.

The PCAOB warnings have pushed audit firms to make rapid changes to test management’s oversight controls. For example, in the past, the audit firm’s focus may have been to note a management sign off. Now auditors are requesting more documentation, going line by line over budgets, projections, etc., and sitting in on meetings to observe the internal controls over tax in action. In addition, the auditors are meeting with company personnel and consultants to fully understand their analysis behind their conclusions.

Auditors are spending more time analyzing the details and documentation that companies maintain to challenge the companies’ conclusions on transactions, for example, attempting to determine if the documentation provides that the transaction has real financial substance or is merely designed to achieve a tax result.

Such scrutiny will bring a new sharper focus on the company’s ASC 740 tax team to insure such teams, including outside consultants, have the background, depth and capabilities to assess the various tax treatments of domestic, multistate and international exposures (such as the value-added tax). In addition, the tax provision team must have a strong background in ASC 740 financial reporting, footnote disclosures and related issues. An SEC public registrant clearly wishes to avoid the restatement of financial statements for any tax items including deficiencies of internal controls over tax and, of course, any material weaknesses.

Bottom line is that due to the increased scrutiny by the PCAOB over audit firms on substantiating documentation and effective internal controls, including those covering the tax function, public companies will likely have much more substantial requests for documentation. It is imperative that a company has a qualified tax team to ensure both the ability to reach proper conclusions and the ability to provide comprehensive documentation supporting the positions taken.

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