The Challenges of Transparency in Corporate Tax Departments

Article excerpt

What Will the New Audit Documentation Requirements and FIN 48 Reveal to the IRS?

In the wake of the accounting scandals of recent years, standards-setters have aspired to improve financial reporting documentation and transparency. In particular, recent guidance with respect to section 103 of the Sarbanes-Oxley Act (SOX), "Auditing, Quality Control, and Independence Standards and Rules," and FASB Interpretation (FIN) 48, Accounting for Uncertainty in Income Taxes, has put pressure on companies and their auditors to better articulate tax risks and exposures. At the same time, the IRS appears to be getting more aggressive in seeking access to tax accrual workpapers.

The confluence of these trends puts in-house corporate tax departments in a very difficult position. First, already overburdened tax departments will have to rise to the challenge of complying with the new documentation requirements. second, the tax accrual workpapers, particularly with regard to tax exposures, must now be more detailed than ever. Should the IRS gain access to such workpapers, a company's tax "secrets," including aggressive tax positions and other tax "soft spots," would be revealed. This disclosure would give the IRS the upper hand in audits and put corporate tax managers at a significant disadvantage.

What follows is a review of the efforts by accounting and auditing authoritative bodies to enhance documentation in the tax function, including the consolidated impact of guidance issued with respect to SOX section 103 and FIN 48; a discussion of how tax departments can cope with these new requirements; and an assessment of the risk posed by these new requirements in light of IRS policies on workpaper access.

Increased Audit Documentation Requirements

Historically, auditing rules for all companies were issued by the Auditing Standards Board (ASB), a private technical group created by the AICPA. Section 101 of SOX created the Public Company Accounting Oversight Board (PCAOB), a new private-sector, nonprofit corporation vested with the authority to issue auditing standards for companies that report to the sec. Audits of companies that do not report to the sec continue to be governed by the ASB's standards.

The PCAOB issued Auditing Standard 3 (AS3), Audit Documentation, on August 25, 2004. The standard is effective for audits of financial statements for fiscal years ending on or after November 15, 2004. The standard was the result of SOX section 103(a)(2)(A)(i), which required the PCAOB to establish standards regarding audit documentation. It is one of the few specific items that SOX requires of the PCAOB, demonstrating the significance the law places on documentation and transparency. AS3 indicates that documentation includes "evidence obtained, and conclusions reached by the financial statement auditor" (para. 2). It requires the financial statement auditor to maintain documentation that has sufficient detail to allow "an experienced auditor, having no previous connection with the engagement to understand the nature, timing, extent and results of procedures performed" (para. 6) and "should include identification of the items inspected ... [and] abstracts or copies of the documents" (para. 10). These items are to be maintained for outside reviewers such as "external inspection teams that review documentation to assess audit quality and compliance with auditing and related professional practice standards; applicable laws, rules and regulations" (para. 3).

Similarly, the ASB issued SAS 103, Audit Documentation (included in the AICPA Professional Standards at AU 339), effective for audits of all companies for fiscal years ending on or after December 15, 2006. It states that documentation "should include the identifying characteristics of the specific items tested" (AU 339.20). The documentation should demonstrate "the accountability of the audit team for its work by documenting the procedures performed, the audit evidence examined and the conclusions reached" (AU 339. …