Divider
Divider

Charles Swenson
Namryoung Lee
  How Will IFRS Affect Accounting for Income Taxes?

The first wave is coming.

July 30, 2009
by Charles Swenson, CPA/PhD and Namryoung Lee, CPA/PhD

Previously published in the AICPA Tax Insider.

Bowing to pressure to standardize financial reporting around the globe, the U.S. is considering switching form U.S. Generally Accepted Accounting Principles (GAAP) to International Financial Accounting Standards (IFRS) starting in 2012. In November 2008, the SEC created a roadmap that outlined a plan that would require large companies to adopt beginning 2014. In addition, it appears the SEC will begin allowing about 100 companies to adopt IFRS voluntarily earlier, beginning in 2010. According to the SEC, it will decide a final timeline in 2011, so the required transition will be unknown until 2011. In addition, the new SEC chairman recently supported the transition, but hinted that the timeline may change.

Can we expect dramatic effects on reported earnings in the future? One significant change would be the accounting for income taxes. Because such changes could affect (the variability of) reported earnings, it is worth looking forward to the potential impact of this new standard.

Accounting for Income Taxes: Differences Between GAAP and IFRS

Major differences are cash taxes, LIFO (a historical method of recording the value of inventory, a firm records the last units purchased as the first units sold)-FIFO (is a common method for recording the value of inventory, in which the next item to be shipped is the oldest of that type in the warehouse), fair value measurement and uncertain tax positions.

  • Cash Taxes
    The move to IFRS may have a significant impact on both U.S. and foreign cash taxes of a company. In most jurisdictions, financial reporting is often the starting point in determining taxable income for tax filing purposes. As financial accounting policies change from existing GAAP to IFRS, companies will need to consider the implications of such changes on cash taxes.
  • LIFO vs. FIFO
    IFRS also is a major tax issue for companies using the LIFO method to value inventories. IFRS does not permit the use of LIFO and the tax law does not permit the use of LIFO unless the method is used for financial reporting purposes. Unless this LIFO conformity requirement is changed through legislation, U.S. companies currently using LIFO will face a tax cost with a change to IFRS for financial reporting. Under current law, the effect of the change from LIFO to FIFO (known as the §481(a) adjustment) may be spread over four years, though Congress is considering repealing the LIFO method and allowing a longer spread period. Unless there is new legislation, U.S. companies now using LIFO will face a tax cost with a change to IFRS for financial reporting.
  • Fair Value Measurement
    Under IFRS, companies can elect to measure property, plant equipment and investment property at fair value and certain financial instruments may be required to be carried at fair value. These measurement concepts could have a significant impact on debt-to-equity and other balance sheet ratios, potentially resulting in limitations on interest deductibility for tax purposes.
  • Uncertain Tax Positions
    The International Accounting Standards Board currently does not intend to adopt a standard similar to Financial Accounting Standards Board (FASB) Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxes (which on July 1 was codified to FASB Accounting Standards CodificationTM (ASC) 740, Income Taxes). Under IFRS "a liability for tax uncertainties is based on the amount of taxes expected to be paid to the tax authorities," and the GAAP two-step process for recognition and measurement is not specified. IFRS currently has nothing like the GAAP requirements. The International Accounting Standards Board is working on revisions that would add a similar requirement, but it would probably require companies to book such prospective liabilities only to the extent they deem them certain — which is a lesser standard than what exists under GAAP.

Other differences between GAAP and IFRS accounting for taxes are shown in the table below.

Conclusion

The changes in accounting for income taxes resulting from IFRS will be significant. While a timetable for mandated IFRS is not clear, tax practitioners should nonetheless become familiar with the new rules, especially if clients inquire as to its potential impact. It is also important to know that the IFRS rules will only govern income taxes.

Rate this article 5 (excellent) to 1 (poor). Send your responses here.

Charles Swenson, CPA, PhD is professor of Accounting at the University of Southern California and co-Founder of the national Tax Credit Group. Namryoung Lee is visiting scholar, both at the Marshal School of Business at the University of Southern California.