Accounting News

March 2007

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Welcome to the first issue of our new Accounting News. This newsletter is intended to keep you up-to-date on the latest developments in Czech Accounting, International Financial Reporting Standards (IFRS) and generally accepted accounting principles in the USA (US GAAP). As well as providing information directly relating to new or amended accounting standards, we will also present our experience with their application. In addition, the Accounting News will provide information about upcoming seminars from Deloitte’s successful seminar series on these issues.

This newsletter is the result of merging our previous Accounting News and IFRS News bulletins, as well as incorporating US GAAP issues. We hope you will find the format of the newsletter informative and easy to use.

Soňa Plachá

+420 246 042 357

FIN 48 Accounting for Uncertainty in Income Taxes

In July 2006 the Financial Accounting Standards Board released Interpretation No. 48 (FIN 48) Accounting for Uncertainty in Income Taxes. The new accounting standard, which generally becomes effective for fiscal years beginning after 15 December 2006, prescribes a uniform standard for evaluating uncertainties in income taxes and reporting them in the financial state- ments. Specifically, FIN 48 mandates a consistent approach in evaluating tax positions and reporting the effect of uncertain tax positions (UTPs). UTPs are tax positions (such as the deductibility of certain expenses, allocation of income among various taxing jurisdictions, and the decision to file or not to file a tax return at all, among others) for which the application of the tax law may be unclear. FIN 48 gives companies a standardized method of reporting the effect of the UTPs in their current financial statements, even though it may be many years before the actual outcome will be known. The requirements of the new interpretation are briefly summarized below.

FIN 48: Some Basic Rules

FIN 48, which applies to all material income tax positions, mandates a two-step process for determining the proper financial statement reporting of UTPs.

Step 1: Recognition

According to FIN 48, a tax benefit associated with a tax position may only be recognized on the financial statements if it is “more likely than not” that, if challenged, the position would be sustained in a court of last resort (such as the Supreme Court of the United States). The evaluation is based solely on the technical merits of the tax position under the assumption that examiner will have full knowledge of all relevant information. On the other hand, if it is not at least 50 percent likely that a court of last resort would sustain a position, then no tax benefit at all may be recognized on the financial statements.

Step 2: Measurement

If the more-likely-than-not recognition threshold is met in step 1, FIN 48 specifies that the amount of the benefit to be recognized on the financial statements should be the largest amount of tax benefit that is more than 50 percent likely of being realized upon ultimate settlement with the taxing authority.

In making these determinations, the company must assume that the issue will be identified and fully challenged by the appropriate taxing authority. In other words, the standard does not permit companies to take into account any potential benefit from detection risk (i.e., the “audit roulette”).

Example:

For a particular $100 tax position (say, a $100 tax credit), a company believes that the tax position to claim the tax credit is more likely than not (i.e., more than 50 percent likely) to be sustained by a court of last resort based on the technical merits of the tax position. However, the company also believes that the largest amount of tax benefit that is more likely than not to be realized upon ultimate settlement with the Internal Revenue service will Result in the company repaying the taxing authority $20 of the previous $100 tax benefit taken. As a result, the company may recognize the tax benefit from the credit on its financial statements; however, it must record the amount of the tax benefit as $80, not $100. The $20 difference between the tax benefit taken on the tax return and the amount recognized on the financial statements is generally recorded as a FIN 48 liability for unrecognized tax benefits.

FIN 48 will require companies to set up rigorous processes to identify, evaluate, and track all material income tax positions. One outcome of these processes will be an inventory of tax positions that includes information regarding the nature of each risk, the dollar amount at risk, the likelihood of loss, and the expected timing of the loss.

Though FIN 48 allows the FIN 48 accounting results to be presented on a somewhat summarized basis in the financial statements, companies will clearly have to develop information on a very detailed basis to support its assertions regarding its tax positions for auditors and regulators and to properly prepare its financial statements.

Companies can utilize the information produced by the FIN 48 process to their advantage for example in merger integration situations. The detailed “FIN 48 inventory” of tax risks of target companies may be an excellent resource for acquiring companies to assess tax risk and allocate tax-department effort in all phases of the transaction.