SEC Chief Notes Income Tax Disclosure Is Most Frequent Material Weakness In Financial Reporting

by Leroy Baker, Tax-News.com, New York

13 February 2006

A large percentage of the material weaknesses discovered during Section 404 audits of internal controls are linked to accounting for the provision of income taxes, particularly in smaller firms, according to the chairman of the US Securities and Exchange Commission Christopher Cox.

Cox, who was addressing the Tax Council Policy Institute last week via videotaped remarks, stated that almost one-third of the companies that have reported material weaknesses cited income tax problems in their internal controls.

Cox explained that the burden of dealing with income tax related material weaknesses falls disproportionately on small and medium-sized companies; around 80% of the companies with these problems had under $500 million in revenues. This stems from the fact that these companies rarely have staff appropriately qualified to deal with these issues, Cox noted.

After reviewing data from SEC filings Cox concluded that there were a number of common causes at the root of these material weaknesses.

"The most likely cause is an inadequate application of GAAP for income taxes, such as FAS 109," noted Cox.

"The next likeliest is inadequate documentation to support the amounts recorded for such things as valuation allowances and foreign subsidiaries. Other causes are inadequate controls on calculations and reconciliations, and inadequate policies and procedures to review complex or non-routine transactions," he added.

According to Cox, the SEC and the Public Company Accounting Oversight Board (PCAOB) must work to simplify accounting rules in order to help prevent the repeat of corporate scandals such Enron.

"One of the ways that the Enron culprits were able to camouflage their schemes was by taking advantage of the sheer complexity of accounting rules," Cox observed.

"What we’re after is quality and results, not bureaucracy. It should be the furthest thing from our minds to encourage a ‘check-the-box' approach, where a company’s compliance officers simply try to figure out what’s the least they can get away with," he added.

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