4.5 Subsequent Changes in Recognition and Measurement

ASC 740-10

35-2 Subsequent measurement of a tax position meeting the recognition requirements of paragraph 740-10-25-6 shall be based on management’s best judgment given the facts, circumstances, and information available at the reporting date. Paragraph 740-10-30-7 explains that the reporting date is the date of the entity’s most recent statement of financial position. A tax position need not be legally extinguished and its resolution need not be certain to subsequently measure the position. Subsequent changes in judgment that lead to changes in measurement shall result from the evaluation of new information and not from a new evaluation or new interpretation by management of information that was available in a previous financial reporting period.

35-3 Paragraph 740-10-25-15 requires that a change in judgment that results in a change in measurement of a tax position taken in a prior annual period (including any related interest and penalties) shall be recognized as a discrete item in the period in which the change occurs. Paragraph 740-270-35-6 addresses the different accounting required for such changes in a prior interim period within the same fiscal year.

40-2 An entity shall derecognize a previously recognized tax position in the first period in which it is no longer more likely than not that the tax position would be sustained upon examination. Use of a valuation allowance is not a permitted substitute for derecognizing the benefit of a tax position when the more-likely-than-not recognition threshold is no longer met. Derecognition shall be based on management’s best judgment given the facts, circumstances, and information available at the reporting date. Paragraph 740-10-30-7 explains that the reporting date is the date of the entity’s most recent statement of financial position. Subsequent changes in judgment that lead to derecognition shall result from the evaluation of new information and not from a new evaluation or new interpretation by management of information that was available in a previous financial reporting period.

40-3 If an entity that had previously considered a tax position effectively settled becomes aware that the taxing authority may examine or reexamine the tax position or intends to appeal or litigate any aspect of the tax position, the tax position is no longer considered effectively settled and the entity shall reevaluate the tax position in accordance with the requirements of this Subtopic for tax positions.

40-4 Paragraph 740-10-25-15 requires that a change in judgment that results in derecognition of a tax position taken in a prior annual period (including any related interest and penalties) shall be recognized as a discrete item in the period in which the change occurs. Paragraph 740-270-35-6 addresses the different accounting required for such changes in a prior interim period within the same fiscal year.

Management’s assessment of UTBs is an ongoing process. ASC 740-10-25-14, ASC 740-10-35-2, and ASC 740-10-40-2 stipulate that management, when considering the subsequent recognition and measurement of the tax benefit associated with a tax position that did not initially meet the recognition threshold and the subsequent derecognition of one that did, should base such assessments on its “best judgment given the facts, circumstances, and information available at the reporting date.”

ASC 740-10-25-8 states, in part:

If the more-likely-than-not recognition threshold is not met in the period for which a tax position is taken or expected to be taken, an entity shall recognize the benefit of the tax position in the first interim period that meets any one of the following conditions:

The more-likely-than-not recognition threshold is met by the reporting date.
The tax position is effectively settled through examination, negotiation or litigation.
The statute of limitations for the relevant taxing authority to examine and challenge the tax position has expired.

An entity that has taken a tax position that previously did not meet the more-likely-than-not recognition threshold can subsequently recognize the benefit associated with that tax position only if new information changes the technical merits of the position or the tax position is effectively settled through examination or expiration of the statute of limitations.

The finality or certainty of a tax position’s outcome through settlement or expiration of the statute of limitations is not required for the subsequent recognition, derecognition, or measurement of the benefit associated with a tax position. However, such changes in judgment should be based on management’s assessment of new information only, not on a new evaluation or interpretation of previously available information.

See Section 11.4 for a discussion of subsequent changes in recognition and measurement of uncertainty in income taxes in a business combination.

4.5.1 Decision Tree for the Subsequent Recognition, Derecognition, and Measurement of Benefits of a Tax Position

4.5.2 New Information

New information may result in a change to the recognition or measurement of a tax position. New information may also include, but is not limited to, information obtained from a recently completed examination by the tax authority of a tax year that includes a similar type of tax position, developments in case law, changes in tax law and regulations, and rulings by the tax authority.

An entity that has taken a tax position that previously did not meet the more-likely-than-not recognition threshold can subsequently recognize a benefit associated with the tax position if new information changes the technical merits of the position. The examination of a tax year by the relevant authority in a jurisdiction (e.g., the IRS in the United States) does not mean that all tax positions not disputed by the tax authority meet the more-likely-than-not recognition threshold. An entity cannot assert that a tax position can be sustained on the basis of its technical merits simply because the tax authority did not dispute or disallow the position. This lack of dispute or disallowance may be because the tax authority is overlooking a position.

An entity that has taken a tax position that previously met the more-likely-than-not recognition threshold can subsequently remeasure the benefit associated with the tax position on the basis of new information, without the limitation that the new information must change the technical merits of the position.

Under ASC 740, an entity should not consider new information that is received after the balance sheet date, but that is not available as of the balance sheet date, when evaluating an uncertain tax position as of the balance sheet date. Specifically, paragraph B38 in the Basis for Conclusions of Interpretation 48 (not codified in ASC 740), states:

In deliberating changes in judgment in this Interpretation, the Board decided that recognition and measurement should be based on all information available at the reporting date and that a subsequent change in facts and circumstances should be recognized in the period in which the change occurs. Accordingly, a change in facts subsequent to the reporting date but prior to the issuance of the financial statements should be recognized in the period in which the change in facts occurs.

Note that subsequent events are currently accounted for under ASC 855. The guidance in ASC 740 applies only to situations covered by ASC 740 and is not analogous to other situations covered by ASC 855. ASC 855 prescribes the accounting requirements for two types of subsequent events: (1) recognized subsequent events, which constitute additional evidence of conditions that existed as of the balance sheet date and for which adjustment of previously unissued financial statements is required, and (2) nonrecognized subsequent events, which constitute evidence of conditions that did not exist as of the balance sheet date but arose after that date and for which only disclosure is required.

The examples below illustrate the consideration of new information concerning an uncertain tax position that is received after the balance sheet date.

Example 4-5

As of the balance sheet date, an entity believes that it is more likely than not that an uncertain tax position will be sustained. Before the financial statements are issued or are available to be issued, management becomes aware of a recent court ruling that occurred after the balance sheet date and that disallowed a similar tax position taken by another taxpayer. Because the court ruling occurred after the balance sheet date, the entity should reflect any change in its assessment of recognition and measurement that resulted from the new information in the interim period that includes the court ruling; however, the entity should consider whether the court ruling and an estimate of its impact should be disclosed in accordance with ASC 855.

Example 4-6

Assume that (1) an entity finalizes a tax litigation settlement with the tax authority after the balance sheet date but before its financial statements are issued or are available to be issued and (2) the events that gave rise to the litigation had taken place before the balance sheet date. According to ASC 740, the entity should not adjust its financial statements to reflect the subsequent settlement; however, the entity should disclose, in the notes to the financial statements, the settlement and its effect on the financial statements.

4.5.3 Effectively Settled Tax Positions

A tax position that was included in an examination by the tax authority can be considered effectively settled without being legally extinguished. An entity must use significant judgment in determining whether a tax position is effectively settled.

A tax position is considered effectively settled when both the entity and the tax authority believe that the examination is complete and that the likelihood of the tax authority’s reexamining the tax position is remote (as defined in ASC 450). Although a tax position can be considered effectively settled only if it was part of a completed examination, a tax position that is part of an examination does not need to be specifically reviewed by the tax authority to be considered effectively settled; however, the fact that an issue was not examined will affect the assessment of whether examination or reexamination is remote.

For a tax position to be considered effectively settled, it must meet all of the following conditions in ASC 740-10-25-10:

The taxing authority has completed its examination procedures including all appeals and administrative reviews that the taxing authority is required and expected to perform for the tax position.
The entity does not intend to appeal or litigate any aspect of the tax position included in the completed examination.
It is remote that the taxing authority would examine or reexamine any aspect of the tax position. In making this assessment management shall consider the taxing authority’s policy on reopening closed examinations and the specific facts and circumstances of the tax position. Management shall presume the relevant taxing authority has full knowledge of all relevant information in making the assessment on whether the taxing authority would reopen a previously closed examination.

If the tax authority has specifically examined a tax position during the examination process, an entity should consider this information in assessing the likelihood that the tax authority would reexamine the tax position included in the completed examination. Effective settlement of a position subject to an examination does not result in effective settlement of similar or identical tax positions in periods that have not been examined.

Accordingly, an entity must first determine whether the tax authority has completed its examination procedures, including all appeals and administrative reviews that are required and are expected to be performed for the tax position. For U.S. federal income tax positions, we believe that the condition that all administrative reviews be complete includes reviews by the Joint Committee on Taxation for cases that are subject to the committee’s approval. A completed tax examination may be related only to specific tax positions or to an entire tax year. While it is common for all tax positions for a particular tax year to be effectively settled at the same time, there may be circumstances in which individual tax positions are effectively settled at different times.

The entity must then determine whether it intends to appeal or litigate any aspect of the tax position associated with the completed examination. If the entity does not intend to appeal or litigate, it must determine whether the tax authority’s subsequent examination or reexamination of any aspect of the tax position is remote.

In determining whether to reopen a closed examination, tax authorities follow policies that vary depending on the type of examination and the agreement entered into between the taxpayer and the tax authority. For example, a tax authority may be permitted to reexamine a previously examined tax position (or all tax positions that were part of a closed examination) only if specific conditions exist, such as fraud or misrepresentation of material fact. An entity must base the likelihood that the tax authority would examine or reexamine a tax position on individual facts and circumstances, assuming that the tax authority has all relevant information available to it. The entity may need to use significant judgment to evaluate whether individual tax positions included in the completed examination meet the conditions of a tax authority’s policy not to examine or reexamine a tax position. If the likelihood is considered remote and the other conditions are met, the tax position is effectively settled and the entity recognizes the full benefit associated with that tax position.

Given the complexities in the determination of whether a tax position has been effectively settled, consultation with income tax accounting advisers is encouraged.

A tax position that is determined to be effectively settled must be reevaluated if (1) an entity becomes aware that the tax authority may examine or reexamine that position or (2) the entity changes its intent to litigate or appeal the tax position. In addition, an entity may obtain information in an examination that leads it to change its evaluation of the technical merits.

ASC 740-10-25-12 acknowledges that “[a]n entity may obtain information during the examination process that enables that entity to change its assessment of the technical merits of a tax position or of similar tax positions taken in other periods.” However, an entity’s conclusion that a position is “effectively settled,” as described in ASC 740-10-25-8, is not a basis for changing its assessment of the technical merits of that or a similar tax position.

See Section 7.3.3 for a discussion related to the interim accounting for subsequent change in recognition and measurement.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.