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6.3 Changes in accounting estimates and errors
Publication date: 31 Dec 2022
us Income taxes guide
The ASC Master Glossary definition of “change in accounting estimate” refers to changes resulting from “new information.” In contrast, the ASC Master Glossary definition of “error in previously issued financial statements” indicates that errors result from “mathematical mistakes, mistakes in the application of accounting principles, or oversight or misuse of facts that existed at the time the financial statements were prepared.”
As it relates to accruals for income taxes, we believe that, in general, an adjustment of a prior-period tax accrual that results either from new information (including a change in facts and circumstances) or later identification of information that was not reasonably knowable at the original balance sheet date and that results in improved judgment would lead to a change in estimate. However, an adjustment that arises from information that was reasonably knowable during the prior reporting period (or represents a reconsideration of the same information) may constitute “oversight or misuse of facts” and, therefore, may be an error. In this regard, consideration should be given to whether the information was (or should have been) readily accessible from the reporting entity’s books and records in a prior reporting period and whether the application of information commonly known by competent corporate tax professionals at that time would have resulted in different reporting.
The distinction between a correction of an error and a change in estimate is important because each is reflected differently in the financial statements. In accordance with ASC 250-10-45-23, a correction of an error is typically accounted for by restating prior-period financial statements. However, ASC 250-10-45-17 specifies that a change in accounting estimate is accounted for prospectively "in the period of change if the change affects that period only or in the period of change and future periods if the change affects both.”
The guidance in TX 6.3.1 and TX 6.3.2 is intended to help evaluate when changes in tax positions reflected in prior periods or changes in income tax amounts accrued in prior periods constitute financial reporting errors rather than changes in estimate.
In addition to a correction of an error and a change in estimate, changes may be recognized related to a change in accounting principle. Refer to FSP 30.4.2 for further guidance on the appropriate presentation and disclosure.
6.3.1 Tax provision errors
The following are examples of errors:
- A tax accrual is intentionally misstated (without regard to materiality).
- A mechanical error is made when calculating the income tax provision (e.g., if meals and entertainment expenditures were deducted twice instead of being added back to taxable income or if the wrong disallowance rate was applied).
- Misapplications of ASC 740 and related accounting principles and interpretations are made. For example, the reporting entity failed to record a tax benefit or contingent tax liability at the balance sheet date that should have been recognized considering the facts and circumstances that existed at the reporting date and that were reasonably knowable at the date the financial statements were issued.
- The reporting entity chose to estimate rather than obtain an amount for tax provision purposes at the balance sheet date that was “readily accessible” in the reporting entity’s books and records, and the actual amount differs from the estimate.
6.3.2 Changes in estimates in the tax provision
A change in accounting estimate may occur when an event results in a change in judgment that impacts the tax provision. Changes in estimate may be triggered by: (1) a settlement being reached with the taxing authorities related to a previously identified uncertain tax position; (2) a change in interpretation of tax law or new administrative ruling; (3) additional expert technical insight obtained with respect to complex, highly specialized or evolving areas of tax law interpretation and knowledge; or (4) additional information becomes known based on other taxpayers with similar situations that provides better insight into the sustainability of an uncertain tax position.
To close its books on a timely basis, a reporting entity may need to estimate certain amounts that are not readily accessible based on information available at the time. In assessing whether information was (or should have been) readily accessible, consideration should be given to the nature, complexity, relevance, and frequency of occurrence of the item. Assuming the reporting entity had a reasonable basis for its original estimate, we believe any subsequent adjustment is typically a change in estimate.
Distinguishing when information was (or should have been) readily accessible will often be judgmental and will need to be based on the facts and circumstances of each situation.
Examples of changes in estimates include:
- The reporting entity, with the assistance of highly specialized tax experts, obtains a new insight or point of view in relation to the application of the tax law with respect to prior tax return positions involving nonrecurring or complex transactions or technical tax issues.
Because of the level of sophistication and expertise required, and recognizing that insight with respect to complex tax laws is continually evolving both on the part of tax professionals and the taxing authorities, these circumstances would typically suggest a change in estimate rather than an error. - The reporting entity makes a retroactive tax election that affects positions taken on prior tax returns (as is sometimes permitted under the tax code), as long as the primary factors motivating such change can be tied to events that occurred after the balance sheet date. For example, based on subsequent-year developments, such as lower than expected operating results in succeeding periods, a reporting entity concludes that it is more tax efficient to deduct foreign income taxes paid than to claim a foreign tax credit for foreign taxes paid.
- Due to a change in facts and circumstances, there is an economic basis to pursue a tax credit or deduction retroactively that was previously considered not to be economical. This is premised on the reporting entity having evaluated the acceptability of the tax position at a previous balance sheet date, having performed a reasoned analysis of the economics, and reaching a conclusion that it was not prudent to pursue such benefit. For example, a reporting entity may consider the potential tax savings associated with pursuing tax credits for certain research activities. Based on the company’s lack of current taxable income, it may conclude that the additional administrative burden of pursuing such credits is not economical. Then, in a subsequent period, based on a change in the company’s operating results and perhaps due to an increase in the amount of the potential credits, the reporting entity may decide to put in place the necessary infrastructure to be able to claim the credit, including for retroactive periods.
- New tax software that makes it economical to pursue a tax benefit.
If it is reasonably possible that the estimates used could change materially within the next 12 months, the reporting entity should disclose the nature of the uncertainty and include an indication that it is at least reasonably possible that a change in the estimate will occur in the near term as prescribed by ASC 275-10-50-8 through ASC 275-10-50-9. If a change in estimate has occurred, ASC 250-10-50-4 requires disclosure if the effect of the change is material.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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