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Taking a Closer Look at Interim Provisioning

Four key interim provisioning processes and areas of concern revealed.

August 28, 2008
by Bob Norton, CPA

Since 2002 and the enactment of Sarbanes-Oxley Act of 2002 (SOX), the world's accountants have been laser focused on annual provisioning and accounting for income taxes under FAS 109 in the U.S. and IAS 12 in the European Union (E.U.). All eyes have been on the internal controls (or the lack thereof) and processes surrounding the calculation and reporting of a company's global tax position.

Section 404 of SOX marked the beginning of stringent internal reviews, as well as documentation of internal controls and tax processes, required of corporations and scrutinized by auditors. Many auditors found rampant material weaknesses in their reviews, causing audit committees to demand answers and remediation plans from CFOs, who then went to controllers and vice presidents of tax to handle the details. This cycle repeated itself for several years, during which all parties involved gained a better understanding of, and appreciation for, the challenges and complexities global corporations face with regard to income taxes. This is the case regardless of whether the company conforms to U.S. GAAP or IFRS as its accounting standard.

However, corporations and auditors has been focusing primarily on annual tax reporting under FAS 109 and FIN 48 in the U.S. and IAS 12 (now IAS 12R) in the EU. With four years of practice under their collective belts, auditors who previously knew little about the complexities of income tax accounting and processes have evolved their understanding of the subject. They now know how to audit a company's complex global year-end tax accruals. They are finding that the year-end accrual is largely the culmination of forecasting, reviewing and updating the entire year's periodic tax provisions. They have also found that by doing a more in-depth review of a company's quarterly provision, year-end audits at crunch time can be more efficient, as potential audit issues and financial reporting risks can be identified before audit "prelim" and the year-end tax audit. Couple this trend with FIN 48's requirement to update and disclose changes in uncertain tax positions quarterly, and it is no surprise that in-depth reviews of interim provisions are on the rise.

As auditors start to take a closer look at quarterly provisions, they are learning that the accounting standards and methods for calculating these provisions are different, perhaps even more complex than FAS 109, and typically not adequately followed by many companies. CFOs, controllers and tax executives must get their interim provisioning processes under control in anticipation of this trend on the audit of tax provisions.

Overview of the Interim Provision Accounting Standards

Separate from the standards that govern annual income tax accounting, quarterly or "interim" tax accounting is largely directed by APB 28 and FIN 18 for companies reporting in US GAAP, and by IAS 34 for companies reporting in IFRS. There are some specific areas in FAS 109 that address interim provisioning, but they are largely the exception, rather than the rule.

APB or "Accounting Principles Board" Opinion 28 addresses Interim Financial Reporting, requiring companies to annually estimate their effective tax rate for the year and apply that to year-to-date pretax income. As with all accounting issues, the devil in this accounting standard is in the details. What appears to be a fairly straightforward requirement becomes more complex due to the additional guidance requiring that the tax impact of unusual or extraordinary items be excluded from a company's best estimate of the effective tax rate, and reported separately each year. These separate items are commonly known as "discrete" tax provisions in the industry, some of which are specifically outlined in the various accounting standard authoritative guidance.

Essentially, APB 28 says that when calculating interim tax provisions, a company must forecast its ordinary annual pretax book income, as well as all permanent book to tax differences to this income in order to arrive at current-year, ordinary book-taxable income on a global basis. FASB Interpretation No. 18, known as FIN 18, is an interpretation of APB 28 and focuses solely on accounting for income taxes during interim periods. It says that for companies operating in multiple jurisdictions, their annual effective tax rate should to be calculated by legal entity and by jurisdiction, in order to arrive at the best overall composite estimate.

Excluding the nuances of discrete items that are not included in the estimated annual effective tax rate, the typical interim provisioning process and areas of concern are:

  1. Forecasting pretax income by legal entity for all of a global multinational company's entities.
  2. Forecasting local statutory pretax profit in functional currency versus reported GAAP in reporting currency.
  3. Forecasting permanent differences by legal entity between GAAP reporting and each jurisdiction's tax reporting.
  4. Forecasting temporary differences by legal entity between GAAP reporting and each jurisdiction's tax reporting.

To read more about interim provisioning and the areas of concern listed above, please view the full article: Interim Provision — a Closer Look at Quarterly Provisions.

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Bob Norton, CPA, Chief Income Tax Officer, Vertex, Inc. Mr. Norton brings 25 years of corporate tax experience from both public accounting and global industry to his role as Chief Income Tax Officer. He is responsible for leading Vertex’s Income Tax Technology business aimed at improving the efficiency, accuracy and controls surrounding the corporate income tax process of today’s Fortune 2000 multinational corporations. He recently joined Vertex to broaden their best of breed US e-file compliance technology to include global provisioning and other tools to automate the end-to-end corporate income tax process. Prior to joining Vertex, Norton led the tax technology business of Longview Solutions after holding several senior financial management positions running global tax, treasury and M&A functions for Siemens’ Medical IT division. Norton has authored many articles and speaking events on corporate tax automation, tax governance and the impact of technology on the corporate tax process. He is a CPA and received a B.S. in Accounting from Penn State University and an M.S. in Tax Law with honors from the Villanova University School of Law. He is a member of the AICPA, PICPA and the Association for Computers and Taxation.