13.3 Income Statement
13.3.1 Classification of Interest and Penalties in the Financial Statements
ASC 740-10-45-25 permits an entity, on the basis of its
accounting policy election, to classify interest (on an underpayment of income
taxes) in the financial statements as either income taxes or interest expense
and to classify penalties (related to a tax position that does not meet the
minimum statutory threshold to avoid payment of penalties) in the financial
statements as either income taxes or another expense classification.
An SEC registrant that changes its financial statement classification of interest
and penalties should provide the disclosures specified by ASC 250-10-50-1
through 50-3. Such a change in accounting principle should be retrospectively
applied beginning with the first interim period in the year of adoption. In
addition, the SEC staff has indicated that a preferability letter is required
for classification changes.
An entity’s balance sheet classification related to the accruals for interest and
penalties (as part of accrued liabilities or as part of the liability for UTBs)
must be consistent with the income statement classification (above the line or
below the line). For example, an entity that classifies interest as a component
of interest expense should classify the related accrual for interest as a
component of accrued expenses. Likewise, an entity that classifies interest as a
component of income tax expense should classify the related accrual for interest
as a component of the liability for UTBs; however the amounts are classified,
they should be presented separately from the UTB in the tabular rollforward
required by ASC 740-10-50-15A.
13.3.2 Capitalization of Interest Expense
Interest expense recognized on the underpayment of income tax is not eligible for
capitalization under ASC 835-20. ASC 835-20-30-2 indicates that the amount of
interest cost to be capitalized is the amount that theoretically could have been
avoided if expenditures for the asset had not been made. An entity has two
alternatives: (1) repay existing borrowings or (2) invest in an asset. The entity
could avoid interest cost by choosing to repay a borrowing instead of investing in
an asset. Once the decision to invest in the asset is made, the relationship between
the investment in the asset and the incurrence of interest cost makes the interest
cost analogous to a direct cost in the asset (i.e., the two alternatives are
linked).
The liability for UTBs recognized under ASC 740 is not a result of the investment
alternatives above; rather, it is a result of a difference in the amount of benefit
recognized in the financial statements compared with the amount taken, or expected
to be taken, in a tax return. The liability for UTBs is not a borrowing, as
contemplated in ASC 835-20, and should not be considered a financing activity.
Therefore, the related interest expense should not be capitalized but should be
expensed as incurred.
13.3.3 Interest Income on UTBs
ASC 740 does not discuss the recognition and measurement of interest income on UTBs;
however, an entity should recognize and measure interest income to be received on an
overpayment of income taxes in the first period in which the interest would begin
accruing according to the provisions of the relevant tax law.
It is preferable for a public entity to present interest income
attributable to an overpayment of income taxes as an element of nonoperating income,
separately stated in the income statement or in a note to the financial statements
as interest on refund claims due from tax authorities.
On the basis of informal discussions with the SEC staff, we understand that the staff
currently does not have a view on this matter and may not object to an entity’s
including interest income attributable to overpayment of income taxes as an element
of its provision for income taxes. Accordingly, the SEC staff has advised us that if
an entity’s accounting policy is to include interest income attributable to
overpayment of income taxes within the provision for income taxes, this policy must
be prominently disclosed and transparent to financial statement users. The SEC staff
has also indicated that it believes that a public entity that has an accounting
policy to include interest income or expense on overpayments and underpayments of
income taxes should consistently display such amounts as income tax in the balance
sheets, statements of operations, statements of cash flows, and other supplemental
disclosures. Further, we believe that companies should present interest income in a
manner consistent with the policy election related to interest expense on UTBs.
See Section 14.4.4.1 for more information
regarding disclosures related to interest income.
13.3.4 Presentation of Professional Fees
Entities often incur costs for professional services (e.g., attorney
and accountant fees) related to the implementation of tax strategies,2 the resolution of tax contingencies, assistance with the preparation of the
income tax provision in accordance with ASC 740, or other tax-related matters.
It is not appropriate for an entity to include such costs as income tax expense or
benefit in the financial statements. ASC 740 defines income tax expense (or benefit)
as the sum of current tax expense (benefit) and deferred tax expense (benefit),
neither of which would include fees paid to professionals in connection with tax
matters.
Further, SEC Regulation S-X, Rule 5-03(b)(11),3 specifies that an entity should include only taxes based on income within the
income tax expense caption in the income statement. Therefore, it is inappropriate
to include professional fees within the income tax caption.
Footnotes
2
If a tax-planning strategy is identified to support
realization of DTAs, the entity should consider the cost of implementing the
strategy (inclusive of professional fees) when measuring the incremental
benefit such a strategy would provide.
3
Rule 5-03 applies to commercial and industrial companies
only. However, Regulation S-X, Rules 6-07 and Rule 7-04, contain similar
guidance and apply to registered investment companies and insurance
companies, respectively.