Who is an April fool then?

24 March 2017

I’m a little bit vulnerable to the odd April fool.  My Dad tells the story of our response to his shout of, “Lads, come quick, the porridge has gone green!”.  My brother and I ran downstairs in 10 seconds flat (I just beat him) to be greeted by non-verdant porridge and a smirking father muttering, “April Fool!”.  The more things change, the more they stay the same.

A colleague rushed into my office on April 1st last year and said, “Dave, have you heard, the IASB are abolishing deferred tax, equity accounting and banning the word ‘underlying’ from financial statements.”  I’d been taken in until the last point and tried in vain to turn my victory dance to an elegant stretch and wave of the arms.   

My hopes were dashed!   But is it really so outlandish to abolish deferred tax in its entirety?  I turned to a recent investor survey on the topic of tax disclosures (linked here).   Here’s what they want.

Firstly, they want to know about the company’s approach to tax; tax policies, strategies and governance.  Not a mention of deferred tax.   Investors want clarity not confusion - they are demanding that way.

The next item on the investor’s wish list was understanding the long-term sustainable income tax rate. It’s not obvious how deferred tax disclosures help here either.  What they want, for modelling purposes, is to understand the expected cash taxes to be paid.  So, disclosures talking about long term effective cash tax rates would meet the bill. Still no mention of deferred tax.

What next? How about a meaningful tax rate reconciliation.  Sufficient information to understand why the tax rate isn’t simply the weighted average rate of tax for all the jurisdictions that an entity trades in.  Again - looking at understanding the long term sustainable tax rate and I think they are still talking primarily about cash tax for modelling purposes.   Still no mention of deferred taxes.

Finally, investors refer to deferred tax and say “Deferred tax is a mystery”.  Please let us have a breakdown of “reversals” and understanding those which will have a cash tax impact or not.  Back to cash tax…..

Investors also want to know about the effects of future tax law and reporting changes.  Again, I think it is because they want to know about cash tax.

If we’re listening to what users actually want, how about abolishing deferred tax?  Require companies to disclose their tax policies, strategy and governance.  Disclose expectations about their sustainable cash tax rate and how this differs from the weighted average tax rates of the jurisdictions they operate in. Focus on explaining significant changes over the next few years and highlighting the key assumptions made.  Sensitivity analysis might be appropriate here.   Explain the main implications of forthcoming future tax laws and changes on tax cash flows.

This approach would cut 4 or more pages from every set of accounts.  Its’ advocate would become the hero of every accounting student and technical accountants everywhere.  If only you could figure out how to monetise it, you could then retire (to a cottage in a country with a low tax rate) and write your memoirs.  You know you want to.

Mary Dolson has suggested in the past that we take an axe to equity accounting, maybe we can borrow her axe to apply to IAS 12.

Anyway, back to april fools. Did you know that if you say the word gullible very slowly, it sounds like oranges? Try it!”

Dave

This week's blogger is Dave Walters, PwC Partner. Connect to him on Linkedin here.

Comments

I wholeheartedly agree with you Dave. Scrap deferred taxes and replace it with meaningful disclosures.

While I can see the academic argument for accounting for the future tax consequences of current transactions and balances, the current model doesn't actually tell readers whether there is a future cash tax impact or when any impact will occur.

I also fear that too many preparers, auditors and readers don't fully understand the model (especially the initial recognition exception or the expected manner of recovery). If incorrect numbers are being prepared and incorrectly interpreted, how can economic decisions be made effectively except by chance.

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