A liability represents a present obligation by a reporting entity to transfer or provide an economic benefit to others (e.g., pay cash, convey assets, perform services). Many obligations that qualify as liabilities stem from contracts or other arrangements that are legally enforceable by the government or the courts.
For contractual or legal obligations, there is generally no uncertainty about whether a liability exists once the obligating event has occurred (e.g., receiving a product that the reporting entity ordered even though an invoice has not been received or completing a sale that subjects the reporting entity to a tax on that sale). After the obligating event has occurred, probability of the reporting entity potentially settling the liability for an amount other than the calculated legal or contractual obligation is not relevant in measuring the liability.
On the other hand, a contingent liability involves uncertainty about whether a loss has been incurred. A liability for a contingent loss should be accrued only if the loss is both (1) probable and (2) reasonably estimable. See
FSP 23.4.
Question FSP 11-2 Can a reporting entity consider administrative practices and precedents when measuring a liability for an unpaid tax that is not in the scope of
ASC 740,
Income Taxes?
PwC response
Maybe. The concept of administrative practices and precedents is codified in GAAP only in the context of income taxes within the scope of
ASC 740. While there is no explicit authoritative guidance in GAAP that addresses this concept in the context of measuring a liability for an unpaid tax,
ASC 105,
Generally Accepted Accounting Principles, allows reporting entities to analogize to accounting guidance for similar transactions. A legal obligation under the tax law may be considered similar to an income tax obligation under the tax law. Therefore, in limited situations, and subject to sufficient evidence of the relevant taxing authority’s behavior, it may be acceptable for a reporting entity to consider administrative practices and precedents in measuring a liability for unpaid taxes that are not in the scope of
ASC 740. As described in
TX 15.3.1.4, administrative practices and precedents represent situations in which a tax position could be considered a technical violation of tax law, but the relevant taxing authority has a widely known, well understood, and consistent practice of nevertheless accepting the taxpayer’s position (with full knowledge of the position being taken and the taxpayers underlying circumstances). By definition, administrative practices and precedents are specific to each jurisdiction and each type of tax position and they depend on observed behavior by the taxing authority, not merely an expectation of (1) the taxing authority’s willingness to negotiate, or (2) past, ad hoc, amnesty programs. However, if a taxing authority has published administrative procedures or otherwise widely known and well understood consistent practices, we believe it would be acceptable for a taxpayer to consider them when assessing measurement of a liability for unpaid non-income-based taxes. Application of this concept outside of
ASC 740 should be approached with caution and significant judgment will be required to determine whether it is appropriate to consider administrative practices and precedents to reduce the measurement of what is otherwise a legal liability. Alternatively, it would generally be appropriate to assume application of the relevant statute as written until the liability is settled with the relevant taxing authority.
Once recognized, a legal or contractual liability should be derecognized when the liability derecognition guidance in
ASC 405-20-40-1 is met, unless addressed by other guidance.
ASC 405-20-40-1
Unless addressed by other guidance (for example, paragraphs
405-20-40-3 through
40-4 or paragraphs
606-10-55-46 through
55-49), a debtor shall derecognize a liability if and only if it has been extinguished. A liability has been extinguished if either of the following conditions is met:
a. The debtor pays the creditor and is relieved of its obligation for the liability. Paying the creditor includes the following:
1. Delivery of cash
2. Delivery of other financial assets
3. Delivery of goods or services
4. Reacquisition by the debtor of its outstanding debt securities whether the securities are cancelled or held as so-called treasury bonds.
The debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor. For purposes of applying this Subtopic, a sale and related assumption effectively accomplish a legal release if nonrecourse debt (such as certain mortgage loans) is assumed by a third party in conjunction with the sale of an asset that serves as sole collateral for that debt.
Example FSP 11-3 and Example FSP 11-4 illustrate the accounting for interest and penalties resulting from a failure to remit sales tax.
EXAMPLE FSP 11-3
Interest and penalties — legal liability versus loss contingency
FSP Corp appropriately collected sales tax from its customers in State X. However, FSP Corp failed to timely remit the sales tax collected to State X. The relevant statute in State X includes explicit provisions requiring a company to pay interest and penalties in the event sales tax is not appropriately remitted.
Should FSP Corp record a liability for the interest and penalties in the period in which such amounts were incurred or assess as a loss contingency under
ASC 450,
Contingencies?
Analysis
In this example, the characteristics of a liability have been met: (a) FSP Corp has a present obligation to pay interest and penalties once it failed to timely remit the sales tax collected from its customers to the appropriate state taxing authority; and (b) FSP Corp has a legal obligation, in accordance with the statute, to pay cash to the taxing authority as a result of the unremitted sales tax.
Therefore, in addition to the base sales tax amounts, FSP Corp should accrue a liability for statutory interest and penalties as a result of its failure to remit sales tax. The liability for the penalties was incurred at the point in time FSP Corp failed to timely remit the sales tax collected; the liability for interest was incurred at the statutorily specified rate over time as the amounts remained unpaid.
EXAMPLE FSP 11-4
Interest and penalties — accounting for future abatements
Assume the same facts as Example FSP 11-3, but in this case for State Y. State Y’s statutes also include provisions for voluntary disclosure filings to abate penalties (and possibly interest). Based solely on discussions with FSP Corp’s legal and tax departments, FSP Corp expects that the accrued interest and penalties liability balance owed will be reduced by 50% within six months.
Should FSP Corp adjust the interest and penalties liability balance today for anticipated settlements or abatements?
Analysis
In cases where a specific violation of tax law has occurred (e.g., failure to timely remit sales tax collections), the amount of interest and penalties due to the state taxing authorities is generally fixed, determinable, and not subject to uncertainty. The abatement provisions in State Y’s statute do not defease the original liability until a waiver is granted by the applicable state taxing authority. Thus, the abatement of such amounts is not solely within the control of FSP Corp.
As such, liabilities initially recorded for interest and penalties should not be adjusted for anticipated settlements or abatements until FSP Corp is legally released of its obligation to remit interest and penalties, which generally occurs at the time the state notifies FSP Corp of the abated amount due.