Investors rely on financial statements and all the disclosures that come with them. It is
important to know any material changes that may occur or are affecting the business, such as
uncertain tax positions and litigations. The ASC740-10 requires companies to recognize the
benefit of the tax position on the financial statements if it is determined to be more likely than
not (50% or more) that the position would be sustained upon an examination. If a decision
involving uncertain tax positions from prior years potentially omitted more than a 25% of
gross income, then there is a six-year statute of limitations rather than the standard three-year
statute of limitation for amounts lower than 25%. These disclosures provide a clear and
transparent view of the financial position of the business and how it affects them and their
confidence in the business.
The public/investors rely on companies to report accurate and reliable information in
accordance with GAAP. The data reported on financial statements may be used by the public
to decide on if someone should invest in a company or to discontinue investing in a company.
Disclosing material items in financial statements is important because a company needs to
make sure an investor has all the necessary information needed to make a sound decision on
investing or not investing in a company. If the investor is not given the necessary information
and leaving out the information would be perceived as extremely altering can be viewed as
fraud and deceit.
FASB states uncertain tax position either should be recognized or partially recognized. Before
a decision is made on recognizing or partially recognizing one must determine if it has a more
than not chance of being sustained upon an IRS examination. Upon determining that a tax
position meets the "more likely than not" threshold, the firm is required to assess the amount
of benefit it can recognize for financial reporting purposes. This measurement represents the
maximum tax benefit that surpasses a 50% probability of realization upon settlement with the
taxing authorities.
Federal securities laws require public companies to disclose certain information in their
financial statements to protect investors. Disclosing this information is important because it
provides investors with complete and accurate information to make an informed decision,
especially if it relates to material items. Items are material if there is a substantial likelihood
that it is important to the reasonable investor, or in other words, would have significantly
altered the information available and/or decision of the investor. ASC 740-10 (uncertain tax
positions) plays an important role within the disclosure process because it provides guidance
on recognizing and measuring tax positions or expected tax positions to be taken. There are
two primary objectives of ASC 740: “(a) To recognize the amount of taxes payable or
refundable for the current year (b) To recognize deferred tax liabilities and assets for the
future tax consequences of events that have been recognized in an entity's financial statements
or tax returns.” (ASC 740-10-10-1). The application of this guidance can give investors an
idea of the tax risk a company is willing to take. b
ASC 740-10 requires public companies to record reserves in the financial statements for
future tax burdens of uncertain tax positions taken on prior years' returns. New information
can arise that changes the tax positions that or other circumstances may occur that negate
booking a reserve. ASC 740-10-25-8 states “If the more-likely-than-not recognition threshold
is not met in the period for which a tax position is taken or expected to be taken, an entity
shall recognize the benefit of the tax position in the first interim period that meets any one of
the following conditions:
The more-likely-than-not recognition threshold is met by the reporting date.
The tax position is effectively settled through examination, negotiation, or litigation.
The statute of limitations for the relevant taxing authority to examine and challenge the tax
position has expired.”
If the UTP is settled or new information pushes the UTP over the “more-likely-than-not”
recognition threshold (more than 50% likely) then no reserve is required. The third condition
can be met without new information or settling the UTP. Under section 6501(a) the IRS has 3
years from the later of the due date of a return or date filed to assess and impose tax with
some exceptions. The statute of limitations is extended to 6 years in the event of a substantial
omission (more than 25% of gross income on the return) under section 6501(e) or indefinitely
in the case of fraud (section 6501(c).
It is important to disclose material items in the financial statements because the financial
statements are what investors use to make educated decisions on which companies, they
choose to invest in. An investor is more likely to invest in a company that is performing well
rather than a company that is not, and they make their decisions largely on how the company
states they are performing in the financial statements.
ASC 740-10 states that companies must report uncertain tax positions on their financial
reports. An uncertain tax position takes place when uncertainty from law, regulations, facts,
and guidance is available, indicating that there is no set rule or procedure in how to move
forward with this transaction in terms of how it should be taxed. ASC 740 initiates a
recognition test and a measurement test and discusses how the accounting can be initiated and
how carry forwards might be handled in the future.
If clients do not want to set up a reserve for uncertain tax positions, other options include
filing a schedule UTP with their income tax return.
A material item is something that is of some significance within the financial statements. If
users of financial statements could have changed their actions based on that information, had
it been included or omitted then that would be considered material. Material misstatements
must be disclosed to investors and other users of financial statements, as it can affect further
financial decisions they may make.
ASC 740 requires that all tax positions be evaluated using a two-step process. The first step is
either to recognize or not recognize the tax position; the company must recognize the tax
position when it is more likely to be upheld once examination is complete. The second step is
when a tax position is recognized, then the tax benefit of the tax position is evaluated. The
uncertain tax position is considered the tax reserve, or what the company should account for
in their financial statements should this tax position be held.
A company with at least $10m in assets could provide a UTP (Uncertain Tax Position)
statement as part of audited financial statements and they have recorded a liability for the
unrecognized tax benefits. The first step is to review all open tax positions. They must analyse
each year with a material tax position and decide what impact they have on the company’s
financial position. The statute of limitations is six years when 25% of gross income is
excluded, rather than the typical three-year statute of limitations.
It is important to disclose material items in a business’s financial statements because investors
must be able to make informed decisions about the company. These disclosures inform
investors about issues that may enhance or harm their investment in the company. ASC 740-
10 provides guidance for recognizing and measuring tax positions taken or expected to be
taken in a tax return.
ASC 740 guidance applies to income taxes to account for uncertain tax positions. Under ASC
740-10, the company must identify and evaluate uncertain tax positions. Determining whether
it is more likely than not that the tax position will be sustained upon examination by the IRS
must also happen. They must measure the unrecognized tax benefit as the largest amount of
tax benefit that is greater than 50% likely realized. In addition, the company must record the
unrecognized tax benefit in the financial statements.
Information on a balance sheet such as deferred tax assets and liabilities will give investors
evidence for informed decision making. This evidence includes a history of tax credit carry
forwards; expected losses in upcoming years; and issues that may adversely affect the
profitability or operations of the company. Deferred tax assets and liabilities are financial
items on a company’s balance sheet. Deferred tax assets result from an overpayment or early
payment such as a credit. Deferred tax liabilities are from underpayment or delayed payment
such as a debt.
Public companies have requirements to disclose certain financial and other information to
investors and other users of the financial statements. In fact, it is important for public
companies to disclose material items on financial statements so that investor and other users
of financial statements be presented with timely, accurate, and complete information, that will
allow them to make more informed and intelligent decisions.
FASB ASC 740-10, Accounting for Uncertainty in Income Taxes, applies to GAAP-basis
financial statements, and provides rules for accounting for uncertain tax positions. An
uncertain tax position occurs when a company is unsure if a tax position taken will be
sustained by a taxing authority. In addition, ASC 740-10 requires that each tax position meet
a ‘more-likely-than-not’ test (more than 50% chance) that the tax position will be sustained. If
the tax position is not definite (meaning it does not meet the 50% test) the tax benefits will be
reduced.
Although ASC 740-10 requires a public company to record reserves in the financial
statements for future tax burdens of uncertain tax positions taken in prior years, companies
have alternatives to choose from. Another option a company may choose is to record the
uncertain tax benefit as a noncurrent liability. In this case the company would offset this
transaction by debiting noncurrent income tax expense.
While clients may choose to use other alternatives, such as the one listed above, it is
important to keep in mind the statute of limitations. The statute of limitation sets a specified
timeframe for when a tax can be assessed (taxing authority) or a refund claimed (taxpayer).
Under section 6501(a), the general rule is 3 years after a return is filed. For substantial
omissions (omission of income greater than 25%), this period is increased to 6 years from the
later of the when the return is filed or due.
Munter, P. (2022). Assessing Materiality: Focusing on the Reasonable Investor When
Evaluation Errors. U.S. Security and Exchange Commission.
Swenson, M. (2020). Understanding the mechanics of the FASB ASC Subtopic 740-10. The
Tax Advisor.
Jones, J. P., & Campbell, W. M. (2007, March 1). Financial-reporting effects of uncertain tax
positions. The CPA Journal, 77(3).
Green, H., Mason, C., & Boyer, D. S. (2022). FASB ASC § 740 simplification of income
taxes: An evaluation of the effects on U.S. corporate financial statements from 2015‐present.
Journal of Corporate Accounting & Finance (Wiley), 33(3), 217–228. https://doi-
org.ezproxy.snhu.edu/10.1002/jcaf.22549
Bennecke, J. P. (2018, July 1). Tax Internal Controls in an Era of Transparency and
Disclosure: S0X404, ASC 740, and PCAOB may seem easily managed but pose significant
risks if not closely monitored. Tax Executive, 70(4).
ASC 740-10.
IRS. Instructions for Schedule UTP. https://www.irs.gov/pub/irs-pdf/i1120utp.pdf
