Question

In the current year, Dickinson, Inc., reports an effective tax rate of 36%, and Badger, Inc., reports an effective tax rate of 21%. Both companies are domes- tic and operate in the same industry. Your initial examination of the financial statements of the two companies indicates that Badger apparently is doing a better job with its tax planning, explaining the difference in effective tax rates. Consequently, all else being equal, you decide to invest in Badger. In a subsequent year, it comes to light that Badger had used some very aggres- sive tax planning techniques to reduce its reported tax expense. After an examina- tion by the IRS, Badger loses the tax benefits and reports a very large tax expense in that year. Over this multiple-year period, it turns out that Dickinson had the lower effective tax rate after all. Do you believe Badger was ethical in not fully disclosing the aggressiveness of its tax positions in its current financial statements? How does ASC 740-10 (FIN 48) affect Badger’s disclosure requirement? Does ASC 740-10 (FIN 48) still leave room for ethi- cal decision making by management in determining how to report uncertain tax positions? Explain.

Answer 1

Do you believe Badger was ethical in not fully disclosing the aggressiveness of its tax positions in its current financial statements?

No, Badger was not ethical because it violated the basic of the financial statements objective that all the information relevant for a stakeholder to make decision should be disclosed.

How does ASC 740-10 (FIN 48) affect Badger’s disclosure requirement?

As per ASC 740-10, company must at the footnotes of the financial statements provide details of tax calculation viz reconcilliation of tax profit and book profit, what reasons were taken for ascetaining that the items are recognized only if it is more likely than not. Because of ASC 740 compliance requirement, Badger have to provide details of the tax treatment they have undertaken which have reduced their effective tax expenses

Does ASC 740-10 (FIN 48) still leave room for ethi- cal decision making by management in determining how to report uncertain tax positions

Yes, as a general rule when the likely outcome is more than 50% we recognise it as more likely than not that the deductions will be allowed by IRS. However, in some cases there are scenarios when 2 uncertain tax position have cumulative certainity of more than 50%. In such cases we would take the effect of those cumulative uncertain tax positions. Example, Management determines that it is 25% likely that $500 of profit will be made, and 26% likely that $300 of profit will occur. The business must accrue only $300 of profit