Term Paper on "Accounting for Income Taxes"

Term Paper 10 pages (2863 words) Sources: 5

[EXCERPT] . . . .

Accounting for Income Taxes

The role of the tax professional has changed substantially in the past decade. Previously, the focus was on tax planning and the marketing of tax products. The focus today is more on the corporation's tax provision and compliance work. This shift has occurred as the result of changes in the regulatory environment. In particular, the enactment of Sarbanes-Oxley (SOX) has shifted emphasis towards the compliance side of the business. This paper will analyze the changes in the tax accounting profession over the past decade with particular attention to the increase in emphasis on compliance. Not only did SOX change the operating environment for tax professionals, but another concern arose concerning the use of abusive tax shelters. In the mid-1990s the use of such shelters was common and laws were enacted to bring the profession back into line with common ethics (Rostain, 2006). The scandals that lead to Sarbanes-Oxley and the legislation itself have change the tax accounting profession significantly since the law's enactment.

The industry, having adjusted to SOX, must now contend with the changes expected by the International Financial Reporting Standards (IFRS). The expected changes coming to the industry as a result of the implementation of IFRS will be examined as well.

Pre-SOX

Before Sarbanes-Oxley, tax professionals were focused on two key areas of business -- the marketing of tax products and on tax planning. Tax planning was the process of minimizing a corporation's tax burden, essentially using any techniques that were allowed under Generally Accepted Accounting Principles (GAAP). Tax products consisted of software to analyze the firm's taxation burden, consultancy fees to find ways to lower the firm's tax burden and other similar services. Sales of this software and other ancillary services were at $2.3 billion in 2001, indicating a robust industry (Ciesielski & Weirich, 2006).

Major tax firms derived a substantial amount of their income from consultancy. Accounting firms typically performed both consulting and auditing for the same company. This created an ethical dilemma whereby strict auditing could compromise the client's willingness to hire the accounting firm's consultancy business. The accounting firms were supposed to have clear separation between the auditing and consultancy businesses, but this was often not the case.

Multiple accounting scandals and outright frauds during the early 2000s became a source of concern among regulators. The apparent ethical conflict between auditing business consulting business was believed by many to be one of the underlying causes of some of the scandals. It was felt by many regulators that the accounting firms failed to perform their auditing duties adequately in order to secure additional consulting business. The result of these regulatory concerns was the creation of the Sarbanes-Oxley Act.

Another concern for regulators was the rampant use of abusive tax shelters. This practice was common in the mid-1990s and resulted in tens of millions of dollars worth of losses for the Treasury. In that case, the tax bar supported legislative reform (Rostain, 2006). This shut down some of the abusive practices that had been supported by tax lawyers and tax accountants, instilling in these professions a greater ethical standard.

The use of legislative action to instill in the tax profession a greater sense of ethics has resulting in a shift in emphasis on the profession. Prior to the scandals and SOX, saving companies money on their taxes was the primary emphasis of the job. Following SOX, ensuring compliance has become the primary focus of tax accounting professionals.

Sarbanes-Oxley

In response to the accounting scandals and the perceived lack of oversight both on the part of senior executives and accounting firms, Congress passed the Sarbanes-Oxley Act in 2002. The Act resulted in numerous changes to the tax accounting industry. SOX created the Public Company Accounting Oversight Board to provide oversight of public accounting firms and established standards for external auditor independence. The PCAOB was created with a mandate to "protect investors and the public interest" (AICPA, 2009).

Tax accountants found that their role increased as a result of Sarbanes-Oxley. Tax specialists became more involved in the audit process. These tax specialists are called upon to scrutinize the tax position of public companies during the audit procedure. This emphasis comes from the attention that the PCAOB gives the accounting firms in the new operating environment. Sarbanes-Oxley essentially added the tax audit function to the role of the tax accountant, in addition to the traditional roles in tax compliance, planning and representation in examinations (Durst, 2003).

Another provision of SOX to influence the tax accounting profession is the demand that public companies and accounting firms distinguish between audit and non-audit tax services. This is required because firms must disclose the fees that they pay to the audit company for non-audit tax services must be disclosed specifically. There was no guidance in the legislation as to how to distinguish between these types of services. There was also no guidance from the SEC, which oversees the PCAOB. Despite this lack of definition, there are steep penalties for non-compliance under Sarbanes-Oxley (Durst, 2003).

Sarbanes-Oxley also shifted emphasis to the audit function. This function was in the pre-SOX days almost an afterthought for many accounting firms. It was necessary, but it did not generate a high percentage of revenue. Sarbanes-Oxley implemented stringent requirements on public corporations. For example, executives needed to sign financial statements and would be held accountable for errors or fraud contained therein. As a result, officers placed increase importance on the audit function in order to mitigate the risks to themselves. This compelled audit firms to add additional services to their audit function. Since regulators often focus on tax issues -- tax avoidance in particular -- tax accountants were added to the audit teams in order to meet the new needs of the public corporations.

Shift in Emphasis

Sarbanes-Oxley marked a strong shift in emphasis towards compliance for the tax accounting profession. The provisions with respect to differentiating audit services from non-audit services exemplify the rationale for the shift. There are high consequences for non-compliance with this regulation, yet there are few guidelines to help companies determine the actual definition of the terms "audit" and "non-audit." As a result, firms in the industry are won't to err on the side of caution. Tax services that may not otherwise have been classified as audit services will be so in response to the vagueness of the law. This impacts the marketing function for tax accountants, and it impacts their specific role to the client company.

Tax accountants saw their business shift towards the now high-profile audit function. Table 1 illustrates the changes in the revenue streams in the industry. The increased emphasis on audit services has resulted in a sharp increase in audit fees in recent years. These fee increases were intended to offset both the increased cost of SOX-compliant auditing and the decrease in consulting business. Between 2001 and 2004, total audit-related fees increased 103% for S&P 500 companies, with an increase of 41% just in 2004 (Ciesielski & Weirich, 2006).

Concurrent to the increase in audit fees was a decrease in total tax-related fees. While tax services fees increased 28% over this time, fees for tax products decreased precipitously. This category included fees for financial reporting systems and design engagements. Figure 2 shows the decrease in "other" fees earned by accounting firms, as presented in the Ciesielski & Weirich article. The latter now prohibited under SOX, these fees in total dropped from $2.3 billion in 2001 to $100 million in 2004 (Ciesielski & Weirich, 2006). These figures spell out the shift in emphasis in the tax accounting position quite clearly. Tax services remained relatively flat (when adjusted for inflation) while audit fees increased substantially. Tax accountants began playing a more significant role in the auditing procedure. The marketing of tax products, which was prior to SOX a major source of income for accounting firms, became an afterthought. Tax accountants shifted their focus directly from marketing tax products to assisting with the tax portion of the financial audit.

This shift was the direct intent of the Sarbanes-Oxley legislation. The law wanted to improve the audit function of accounting firms in order catch corporate impropriety before it began to ruin entire firms and to discourage future scandalous behavior. The marketing of tax products was not specifically de-emphasized by the intention, but the intent of SOX was to reduce the conflict of interest between the auditing function at accounting firms and other functions those firms performed. It stands to reason that this marketing was one of the practices that the authors of SOX intended to be reduced by their legislation.

IFRS

While the United States and Canada have long operated with their own Generally Accepted Accounting Principles, most of the rest of the world utilizes a system known as the International Financial Reporting Standards (IFRS). There is an active process of converging GAAP to IFRS. The result of this process will be a widespread change in the standards used by tax accountants. In 2002, the IASB and FASB made… READ MORE

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