Planning for the worst, like it or not

Long Island Business News, Aug 31, 2007 by Laura Theis

Hey, big business owner, thinking of buying a yacht and writing it off as an expense on your company's financials?

Think again.

That may not be so easy now that FIN 48 has been put on the books by the Financial Accounting Standards Board, for fiscal years beginning after Dec. 15, 2006.

FIN 48 - an interpretation of a section of FASB 109, "accounting for income taxes" - accounts for a number of uncertainties that would have formerly been overlooked, including entertainment expenses, chief executive expenses and income taxes in other states. It applies to both public and private companies, according to Vince Paolucci, head of the tax department at Grassi & Co. in Lake Success.

The idea is to create a reserve on the company's financials for the possibility that, if audited, the company would owe tax on these uncertainties. For example, if a company developed a bogus expense account for its chief executive, who used $1 million to build a new house, it would not be questioned with FASB109, Paolucci said.

With FIN 48, if there is an over 50 percent chance that a company would lose in an Internal Revenue Service audit, it must put aside the $400,000 it would pay in taxes to account for that uncertainty, he added.

The big question is this: "If the government came in - this whole thing is premised on the if - and audited the company, where would it be financially?" Paolucci said. "Would it owe more money?"

He noted that the funds owed must be accrued as a debt on financial statements.

"On paper, this accrual makes your financial position look weaker," said Adam Wolf, marketing director at Grassi.

FIN 48 also comes into play when a company does business in other states or countries and did not pay taxes to all those places in the past, said Rich Daniele, tax partner at PricewaterhouseCoopers Private Company Services. Now, that company must go back and establish what it would owe in taxes to all those states, plus penalties and interest, and reserve funds to pay that figure if it is ever audited, Paolucci said.

The purpose of the new standard was to establish consistency around accounting for uncertainties because "some companies were very aggressive in their accounting and some conservative," Daniele said.

The FIN 48 analysis must be done either internally or by an independent accountant - not the company's usual auditor, because of independence issues, Paolucci said. This is creating a burst of business for accounting firms like Grassi; Paolucci said he has already done this analysis for over 100 companies and will have done several hundred by the end of the year.

"There are literally thousands of companies on Long Island that this affects," Wolf said.

From a company standpoint, this new standard means more in-depth reporting, more costs to hire independent firms and a possible problem from lower-than-expected financials. "It's going to be more time-consuming for companies," Daniele noted. "They will need more internal controls and accounting policies and have to be more diligent in data gathering process."

The cost of FIN 48 per company is entirely on an individual basis; it depends on the size of the company, the state of its financials and its profits for the year or quarter, Wolf said.

For a private company, disclosing a potential liability on financial statements may also mean banks will be stricter in their loan and line of credit offerings, he added.

Public companies will have to deal with lower-than-expected quarterly statements, which will shake shareholders and lower stock prices, Daniele said.

The IRS is pleased, though, because now it has "a roadmap to a company's potential problems," said Paolucci, adding that this FIN 48 red flag can mean more IRS involvement when a company discloses its financials.

Essentially, "FIN 48 made accountants and tax people policemen for the IRS," Paolucci said.