What tax reform means for audit committees

Any new development that has a significant impact on company financial statements and risk profiles requires serious attention from audit committees.

One such development is the enactment of P.L. 115-97, known as the Tax Cuts and Jobs Act. Depending on the company, the law may result in changes in cash flow and liquidity, new business opportunities to evaluate through effective enterprise risk management, and new company strategies.

“Most audit committees are heavily involved with risk management as well as their oversight over the financials,” said Stephen Klemash, CPA, the Americas leader for the EY Center for Board Matters and author of a report on the accounting implications of U.S. tax reform.

“So as decisions are being made, they’re really thinking, there’s opportunity on one side and risk on the other. And they’re thinking, what needs to change as a result of the risk profile, and how does it align with risk appetite? And so forth,” he said.

One of the first considerations for audit committees related to the new law is whether management, the finance department, and even internal audit have enough resources to handle a challenging period of transition. In addition to ordinary day-to-day duties, companies are implementing important accounting standards on revenue recognition, leases, and financial instruments. Handling the changes associated with the new tax law adds to an already pressure-filled time.

To make sure the company is prepared to meet the challenge, Klemash suggested that audit committees ask the CEO and CFO if enough resources exist and make similar queries of the chief accounting officer during executive session. At least annually, Klemash said, it’s also good to benchmark with similar companies on the number of employees devoted to finance and internal audit.

While all that is going on, the audit committee also may wish to consider the technology that finance and internal audit are using. Enterprise resource planning systems can deliver substantial benefits to finance/accounting and risk management, and technology-enabled continuous auditing can help internal audit accomplish its goals.

“For some companies this may be simpler than for others,” said Rich Jones, a partner in EY’s national accounting office in New York City. “But the key analysis there is, what are the company’s resources available to address tax reform? Because sometimes the more complicated implementations have large tax departments and accounting groups that are steeped in dealing with international and other tax issues. Evaluating the resources that the company has to address that complexity, that’s the key part of this.”

A significant break

Company accounting personnel got a significant break when the SEC issued Staff Accounting Bulletin No. 118 shortly after the new tax law was enacted. The bulletin gives companies the option of providing provisional accounting estimates related to the new tax law if they are unable to arrive at concrete answers.

Companies that don’t even have enough information to make estimates related to the tax law are permitted to forgo adjusting their current or deferred taxes for the new law’s tax effects in their financial statements until a reasonable estimate can be determined. (The bulletin also says that there are no circumstances under which companies should take more than one year beyond the new law’s enactment date to complete their accounting for the effects of the new tax law.) In a subsequent Q&A, FASB’s staff said it would not object if private companies and not-for-profits followed the guidance in the SEC bulletin.

Klemash said many companies still are deciding whether they will be able to complete accounting under the new tax law for their yearly financial statements for 2017, or whether they will perform the provisional accounting permitted by the SEC bulletin. Either way, he said, audit committees will need to be highly focused on the disclosures that finance departments are making with respect to the new law.

“Given the liquidity and capital resource issues and the broader business implications, that all needs to get disclosed,” Klemash said. “It’s not just the debits and the credits and the tax footnote. You’ve got liquidity and capital resources, you’ve got MD&A, you’ve got risk factors. And this is going to affect compensation. And then, depending upon the overall change in the cash flows of the organization, particularly if they have significant international operations, you need to talk about what you’re going to do with it.”

In their supervision of the external audit firm, Klemash said, audit committees should expect additional audit efforts — which are likely to lead to additional fees — as a result of the new tax law. He said it’s important for all parties to communicate about what to expect as a result of the law.

“What typically happens is that, whenever those hours and times come in, audit committees will talk to a chief accounting officer or controller and say, ‘Does this seem reasonable to you considering the time you spent on the matter, and are there any issues?’ And, typically, you have a good working relationship between management, the audit committee, and the external auditor, and if there are no surprises and things are communicated upfront, there’s typically not any issues.”

Ongoing process

The issue of the new tax law’s effects appears likely to continue for some time. That’s partly because of the law’s significance, as it is perceived as the most substantial change to the Internal Revenue Code in more than 30 years.

It’s also partly because such a high-impact change does not get implemented overnight. For example, the IRS is expected to issue guidance related to the law as 2018 unfolds, and the specifics of that guidance could affect the financial statements.

“As issues develop, you will work through them,” Jones said. “I can’t tell you I can anticipate what they will all be. But there are issues that will come up over the next year or so.”

—Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is a JofA editorial director.