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Accountants Flag Tax Rates, Coronavirus Ahead of Q1 Results

Posted on Mar. 16, 2020

Estimating annual effective tax rates and evaluating the financial effects of the coronavirus are among the myriad considerations companies face ahead of quarterly reporting deadlines.

For the coming quarterly financial statements, companies need to consider several developments in determining their “best estimate” of what their effective tax rate will be for the fiscal year, Michael Gonzales of EY said during a March 12 webcast sponsored by his firm.

That estimate typically involves predicting year-end temporary book-tax differences and determining whether a deferred tax valuation allowance will be necessary, Gonzales explained.

The Financial Accounting Standards Board’s guidance on accounting for income taxes requires that business entities recognize taxes payable or refundable for the current year in the income statement and recognize deferred tax liabilities and assets in the balance sheet.

Deferred tax assets include temporary deductible differences and tax attributes, such as net operating loss and disallowed business interest carryovers, that may be used to reduce the amount of tax due in a future period.

If a company determines that it is likely that a deferred tax asset’s value won’t be fully realized, a valuation allowance must be determined and disclosed.

For interim financial reporting periods, a business entity applies its estimated annual effective tax rate to year-to-date operating results to determine the income tax or benefit applicable to its ordinary income or loss. Management also needs to determine “discrete items” that are recognized in the period in which they occur and not through the rate calculation.

Jennifer Todling of EY emphasized that companies should ensure that they have appropriate controls in place each quarter to monitor and update their inputs to the effective tax rate calculations. That means having mechanisms to assess, for example, forecasts of income and changes in the projections.

Companies should also establish controls for determining which items are discrete, because that is an important factor in determining whether items are captured individually or within the annual rate calculation, Todling said.

Distinguishing Discrete

Gonzales noted that discrete items are generally “significant, and either infrequent or unusual,” such as changes in tax laws or tax rates.

“For example, if the IRS were to issue guidance that would change how you would apply the Tax Cuts and Jobs Act,” that would be a discrete item, which is booked in the period in which the change occurred, Gonzales said. He added that changes in a company’s accounting for an uncertain tax position would fall into that classification.

Gonzales said early adoption of FASB's 2019 standard update that simplifies some aspects of accounting for incomes taxes “will have a direct impact on how you calculate your annual estimated tax rate.”

But Gonzales cautioned that companies “can’t cherry-pick the simplifications,” and must adopt all provisions at the same time.

The amendments are effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2020. For all other entities, the changes are effective for fiscal years beginning after December 15, 2021, and for interim periods within fiscal years that begin one year later.

Coronavirus Effects

The coronavirus outbreak undoubtedly will be prominent in some first-quarter financial statements and disclosures, but that depends on the company’s business, Gonzalez said. “We’re seeing obviously very divergent impacts around the world,” he added.

Some business sectors are affected “more directly by adverse changes in consumer demand, [while] others are going to be impacted because of disruptions in business continuity” and supply chains, or a combination of those things, Gonzalez said.

Meredith Taylor of EY emphasized that companies need to assess the accounting and financial effects of the operational challenges resulting from the coronavirus.

Gonzalez said companies may need to add to or otherwise enhance disclosures concerning risk factors and forward-looking information. He suggested that disclosures on critical accounting estimates might need “beefing up . . . with additional quantitative and qualitative information.”

With first-quarter reporting deadlines looming, some businesses are concerned about their ability to close the books and issue financial statements on time, Taylor said. “And we don’t know what is going to happen over the next few weeks,” she warned.

For companies experiencing those difficulties, Gonzalez pointed to the SEC’s March 4 guidance regarding reporting relief, which allows affected entities a 45-day deferral in their filings. He also noted that SEC staff have said any registrant needing additional assistance should reach out to them.

According to the SEC’s order, registrants unable to meet a filing deadline because of circumstances related to the coronavirus are exempt from that requirement if they file the applicable form (e.g., Form 8-K) by March 16 or the report’s original filing deadline, whichever is later.

Companies must explain why they couldn’t file on a timely basis and indicate when the reports are expected to be filed.

The relief applies from March 1 to April 30.

Critical Audit Matters

Todling also provided an update on critical audit matters (CAMs) that auditors must include in their annual reports according to standards established by the Public Company Accounting Oversight Board.

The first phase of CAM reporting is essentially complete now that most large accelerated filers have issued 2019 financial statements, Todling said.

CAMs are intended to provide information to investors and other financial statement users about matters that arose during the financial statement audit; that have been or are required to be communicated to the audit committee; that concern accounts or disclosures that are material to the financial statement; and that involve especially challenging, subjective, or complex auditor judgments.

Over 1,500 companies’ audit reports included at least one item, Todling said, noting that the average was two and the maximum was five per report.

The results are generally consistent with earlier analysis of companies that filed Forms 10-K in 2019 for fiscal years ending on or after June 30, 2019, Todling said.

Todling said accounting for income taxes ranks fourth among the most frequently reported CAMs, while revenue recognition, goodwill and other intangible assets, and business combinations appeared more frequently.

According to Tax Notes’ review of annual SEC filings earlier this year, income-tax-related matters that required a particularly high degree of auditor judgment included determining deferred tax assets and related valuation allowances and assessing uncertain tax positions.

Todling advised companies with CAMs to work with their auditors to establish a protocol for responding to questions from investors and other stakeholders.

Management might not be appropriate contacts because they are responsible for the financial statements, but the auditors “might be sensitive to releasing confidential client information,” Todling said.

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