Accounting for Income Taxes: A Misfit in the Convergence of Standards?

By Fleming, Damon M.; Gill, Steven L. et al. | Strategic Finance, May 2011 | Go to article overview

Accounting for Income Taxes: A Misfit in the Convergence of Standards?


Fleming, Damon M., Gill, Steven L., Gillan, Siobhan, Strategic Finance


As management accountants are well aware, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) have been working diligently to converge U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) to develop high-quality, principles-based global standards. As part of this process, the FASB and the IASB identified accounting for income taxes as a key short-term convergence project. In March 2009, the IASB issued an exposure draft (ED) for a new IFRS standard aimed at converging International Accounting Standard (IAS) 12, "Income Taxes," with GAAP.

Despite the Boards' good intentions, several comment letters received during the comment period indicated that the proposed standard had significant problems, including major rules-based changes to IAS 12. In November 2009, the FASB and the IASB scaled back the goal of the project, effectively bringing to a close the three-year effort that culminated in the ED. In March 2010, the IASB announced a limited-scope project, based largely on the ED, aimed at improving IAS 12 without introducing further divergence from U.S. GAAP.

This article analyzes the ED from a principles - and a rules-based standards perspective and demonstrates that converging international guidance on accounting for income taxes presents unique challenges in the movement toward a more principles-based set of global standards.

Principles-Based vs. Rules-Based Standards

Financial accounting regulators, preparers, users, and other interested parties have expressed growing concerns with the prevalence and adverse implications of rules-based standards in GAAP. Section 108(d) of the Sarbanes-Oxley Act of 2002 called for the Securities & Exchange Commission (SEC) to comprehensively study the adoption of a principles-based financial reporting system in the United States. The SEC report, issued in July 2003, found that principles-based accounting standards would be consistent with the "vision of reform that was the basis for the Sarbanes-Oxley Act"--and the FASB concurred with this recommendation. The IASB has often touted itself as taking a more principles-based approach to standards setting, and the standards issued by the IASB are generally considered to be less detailed and more principles-based in form. The debate over these two styles of accounting standards is focused on determining which will produce higher-quality financial reporting.

The SEC study characterized rules-based standards as having three key "commonly accepted" shortcomings: numerous percentage ("bright-line") tests, multiple exceptions to the purported underlying accounting principles, and a need for detailed implementation guidance to apply the standards. Principles-based standards, on the other hand, were defined as having a concise statement of the substantive accounting principle; few, if any, exceptions or internal inconsistencies; an appropriate amount of implementation guidance devoid of bright-line tests; and consistency with a conceptual framework of financial reporting.

The SEC study provided examples for each type of standard. Rules-based guidance is illustrated by the often-cited lease accounting literature (FASB Accounting Standards Codification[TM] (ASC) Topic 840), with its four bright-line tests for classifying a lease as operating or capital (two of which contain stated percentage thresholds). It gave as an example of principles-based guidance the literature for business combinations (FASB ASC Topic 805), which contains few scope limitations, no bright-line tests, and a limited amount of implementation guidance. The SEC study concluded that principles-based standards provide a better foundation for preparers to exercise professional judgment consistent with the intent of accounting standards and should result in more meaningful and informative financial statements.

Despite the appeal of the idea that principles-based accounting standards might avoid the shortcomings of rules-based standards, the SEC's November 2008 Roadmap for the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards by U. …

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