Whitepaper- Controlling the “Out-of-Control” Tax Provision Or How to Make Your Auditors Love You & Your Tax Provision!

The PCAOB is using the type of logic that made you feel clever in 4th grade when you finally grasped that a square is a rectangle but a rectangle is not necessarily a square.

The general premise of the PCAOB is this; Restatements will most likely arise when there are material weaknesses in the internal controls environment. But the existence of a material weakness won’t necessarily lead to a restatement.  In other words, you might still get things right in spite of poor internal controls.

If this logic holds true, there should be more general control issues (e.g., significant deficiencies) than material weaknesses and similarly more material weaknesses than financial restatements.  In 2015 this did not hold true. Here is a troubling pattern:

Tax-Related Control Issues Reported in 2015
  Number of

reported tax control events

Tax issues as a percentage of all control events  
General Control Issues 85 6% 6% of all general control issues reported in public filings relate to tax internal control challenges.
Material Weaknesses 176 9% 9% of general control weakness that turn into a formal Material Weakness relate to tax
Financial Restatements 154 15% 15% of all financial reporting restatements relate to tax control issues

*Raw data provided by Audit Analytics

What does this mean? It means that too many tax professionals struggle identifying and addressing internal control issues before they escalate into financial restatements. There should be a much greater spread between the number of reported Material Weaknesses and the Financial Restatements. In most cases only 50% of Material Weaknesses turn into Financial Restatements. For Tax, in 2015, it’s above 80%. Tax executives continue to ignore the warning signs related to control issues at a higher rate than any other group in finance accounting.  This leads to an abnormal proportion of tax control issues escalating to the point of causing financial restatements.

“If you ask ten different tax department teams, ‘How do you feel about the provision process?’ you might get ten different answers but the themes will be similar”, says veteran tax technologist, Stephen Francis.

The themes of why the tax provision is so difficult center on:

·         Tight close cycle ·  Onerous reconciliations ·  Poor legal entity data
·  Lag of global tax filings ·  Books not setup for tax ·  Rework of financial data


Mr. Francis continues, “It’s as if the whole process has a severe case of ‘man flu’! In the 30 plus years I have been involved in the high-flying life of tax accounting, not much has changed. At the end of the day tax teams will argue their processes are effective even if not efficient. The problem is the overwhelming focus is on the effective tax rate rather than the balance sheet. And internal controls are typically far down the list of priorities.” This is true even though many tax executives will readily admit that a control issue is one of the easiest ways to lose their job.

During interviews with VPs of Tax and their auditors, three key factors emerged that begin to explain why tax departments don’t respond better when control issues arise. Tax executives struggle to fully understand and appreciate the:

  • Economics of Controls
  • Framework of Controls
  • Solutions for Controls

Economics of Controls

The economic impact of control issues in general is widely under-appreciated. This is probably more prevalent for tax-related control issues. More than 10 years ago Glass, Lewis & Co. published an analysis of the market reaction to announcements by publically-traded companies about Material Controls Weaknesses. The analysis showed that 60 days after the announcement, the company lost over 4% of its market cap. If the company’s market cap were $1 billion, the shareholder value loss would be $40 million. This relationship between Control Weaknesses and market cap has  held steady since these original findings were published. Additionally, during that same time period Deloitte focused on the market results for tax control issues and found that the markets treat tax even more harshly with a drop of nearly 6% or $60 million market cap loss for a $1billion company.

Regardless of the exact amounts, senior tax leaders often deny that tax control issues can erode shareholder confidence and negatively affect their company’s valuation. The “C Suite” often ignores the challenges of tax for the same reasons. one CFO said, “investors don’t really care about the anything ‘below the line’; they just don’t understand it”. The research shows just how wrong she is.

This misconception leads to another challenge. Finance and accounting leadership, as well as tax professionals are struggling to understand what an adequate control environment for tax looks like. According to Stephen Francis, “The most critical issue is the control environment and educating the C Suite on the issues and the need for talent.”

Framework of Tax Controls

Years ago when internal controls came crashing to the forefront of the finance and accounting world, tax professionals had one primary question in mind: “What’s a control?” Well, it may not have been as bad as that, but there was a severe lack of understanding about internal controls, COSO, and all things relating to an adequate control framework.

Today there is a great deal more understanding and yet tax professionals continue to struggle with addressing controls issues as they arise. The Committee of Sponsoring Organizations of the Treadway Commission (COSO) publishes the “Internal Control – Integrated Framework”. An understanding of the integrated control framework can help tax executives identify the real control risks and address them before a public filing disclosure is required. As shown in the “COSO Cube”, the primary components of internal controls, including for the Tax Department, of an adequate internal controls framework are:

Control Environment – Tone at the top, adequate infrastructure, and enforcement of accountability

Risk Assessment – Analyze risk inherent in the business and the function as well as significant changes as they occur

Control Activities – Develop control activities and deploy them through policies and procedures

Information & Communication – Communicate relevant information internally and externally

Monitoring Activities – Conducts ongoing evaluations and communicates findings

Addressing these five components has been challenging for tax in the past primarily because of the fragmented and dispersed nature of the tax impact on the financial statements. Some taxes are recorded in operating expenses, other are recorded following net income in the income tax provision. Establishing an environment of controls and assessing the most significant risks can be a little like playing “whack-a-mole” because taxes pop up all over the financial statements. Nevertheless, most tax professionals and their auditors will agree that the application of ASC 740 in calculating the provision for income taxes is one of the more challenging areas. Further, even when the provision risk is properly assessed, control activities are deployed and information is communicated, monitoring these controls is still proving to be difficult.

One “Big 4” tax partner we spoke with indicated that in the latest round of PCAOB reviews (the audit of the auditors), a recurring theme arose around monitoring activities, specifically with respect to insufficient “evidence of review”.  This anecdotal experience is supported by the very public statement made in 2014 by the chief auditor of the Public Company Accounting Oversight Board, Martin Bauman when he said “When we look at an audit, the rate of failure has been in a range of around 35 to 40%,”. And why is the failure rate so high? The watchdog said it found that auditors did not have sufficient evidence to support their opinions. And of course audit professionals have reacted. They are spending more time testing, more time documenting and more time forcing company management to document the evidence that they did their job, evidence the PCAOB demands.

From establishing a strong control environment to properly documenting the back and forth of the monitoring activities, the audit community and  the PCAOB are serious about controls and tax professionals seem to be slow in receiving the message. Or just maybe there is a lack of practical information and solutions to support tax processes and the related controls?

Solutions for (Tax) Controls

“I don’t know if there is a solution…”, states Stephen Francis, noted tax technologist. “Sure there are tools, some which come with hefty price tags and eye-watering implementation costs. It is hard to take an off-the-shelf system and have it give you a last-mile solution.”

It’s been more than a decade since the topic of internals controls has borne down on the finance and accounting industry. And tax is still challenged with the controls process. Here are some specific, tactical ideas for tax which are organized by the COSO Framework:

  • Control Environment – Tax leadership needs to establish a culture by setting priorities and allocating resources at the approach level. Here are some suggestions.
    • Targeted Training – “Teach a person to fish…” Many tax executives hire outsiders to come in and do a “good check” on the provision before the auditors arrive. This is not a bad approach, but pay them for the extra few hours to do a deep dive review of findings with the tax team. Bring lunch in and make it a full training on the topics more relevant to your provision.
    • Infrastructure – Invest in the tools that not only support getting calculations right but also support an adequate control environment. ASC 740 technology solutions need to hold and protect data, provide functionality for adequate workpaper referencing and provide preparers and auditors a common platform for making review notes, asking questions and tracking the responses.

Much has been written and discussed about tax technology over the years. There has been a great deal of “spreadsheet bashing”. We find that the off-the-shelf software offerings are broken into separate modules that are not well integrated. The net result is that tax provision software can actually cause additional control-related concerns rather than address them.

Finally, most vendors do not have a clear understanding of internal controls and, as a result, do not provide feature functionality to support the control process. Be careful in evaluating your software selections. Once you know what you need for your business environment, you can determine if the offering has what you need.

  • Risk Assessment & Control Activities – These two components are so connected, they should be addressed together. But the way to assess risk from a tax perspective may be different than you expect.
    • Source Data – The first risk for most tax processes and certainly for the income tax provision process is the quality and timing of the enterprise data needed to complete the calculations. Start your assessment of the tax risk by analyzing the flow of information from accounting and operations into the tax function. Grade the data by the manual processes tax professional are forced to complete to simply prepare the data for use in an actual tax process. Apply control activities on both sides of the information exchange that create accountability for the accounting function providing the data as well as the tax function in its data management practices. One such control could be a requirement for accounting management to sign off on book numbers after tax has manipulated them to be “tax-ready”. Although this will undoubtedly slow the process, it will have the added benefit of pulling the accounting professionals into the hell they sometimes create for tax.

How often have the words been uttered by corporate controllers, “We are wrapped up with the audit… except for Tax”. Though it is a true statement, the underlying tone often implies some level of frustration with the way the tax function completes its work.  Where in reality, the tax function cannot complete its work ahead of the rest of the financial close process. It is akin to being upset that the Monday night football isn’t in the afternoon or that the caboose never beats the engine. To calculate the tax accounts properly you need final pretax income. So yes, tax is always last. Always. The better statement might be “Tax is waiting for pretax income and will complete the provision quickly depending on the quality of the information we provide them.”

    • Tax Positions – ASC 740 requires a balance sheet approach. However, with recent changes to deferred tax asset/liability classifications and aggregation process it has become much easier to avoid certain misclassifications on the balance sheet but challenges remain. Time, effort and controls should be applied to those items that have the potential to create a material difference in the amounts reported. Obvious items will include large permanent book-to-tax differences, credits and incentives and related party transactions. Less obvious items include those things that may emerge due to business changes, geographic expansion, or acquisitions and divestitures. Part of the risk assessment and control activity should be regular updates from the business development team(s) and those closest to the strategic direction of the business.
  • Information & Communication – Tax Function communication is often only focused on communicating the controls relating to tax processes strictly internal to Tax. Because the Tax function depends so heavily on data from outside tax, proper communication of control issues in the flow of information into Tax can be very useful in addressing significant challenges.
    • Integration Partners – Begin the communication cycle with detailed explanation of the risks and control activities (as described above) relating to the information flowing into the Tax Department. Hold the providers of the source data accountable for delivering the agreed information in the agreed timing and share information with the entire stakeholder group how each party is doing in maintaining a well-controlled process.
    • Tax Function – Communicated successes and failures regularly and thoroughly to the tax team. Use implemented technology programs to identify poorly controlled activities such as manual data inputs, formula overrides, and “plug” amounts caused by inaccurate detail calculations.
    • External Stakeholders – So often we choose to shy away from the thing that concerns us the most. Internal controls and related communication often falls victim to this force of human nature. Consider how far a simple statement in the tax footnote of the 10K would go to setting a tone of controls and establishing a posture of transparency. This level of commitment to information and communication will both provide stakeholders with better information and will send a message to your team, your auditors and the “C” suite that controls are a priority.
  • Monitoring Activities – Whether justified or not, the auditors have responded to the perception that current monitoring practices are insufficient. Due to the poor results of the PCAOB reviews, external auditors/the audit firms have changed their procedures are putting additional emphasis on their clients to appease the PCAOB. Here are some suggestions:
    • Embedded Evidence of Review – Provide space within the tax provision work papers and software for answer and responses generated during the review process. Provision applications should have a robust commenting feature to allow the tax preparers, tax management and the auditors to collaborate in a single place to provide the evidence necessary to demonstrate all the hard work happening during the audit.
    • Audit Logs – Whatever tool is used to prepare the provision, there should be a detailed log, essentially keystroke by keystroke log that shows how every number was input and how every segment of the process was completed. These logs can be invaluable in monitoring the activities of the group and discovering control strengths and weaknesses.
    • SignOffs – Each material stage of the process should have oversight, review which is documented within the tool where the work is completed. The signoff itself is rather easy to demonstrate. What is more challenging is locking down the tool, especially if the tool is spreadsheets, once the signoff has occurred. Creating a true signoff and recording that activity is critical to the entire control cycle and should be monitored thoroughly.

It is time for the tax community to reverse the trend of being slow to respond to control challenges. Knowledge, tools and resources exist to better address the concerns repeatedly raised by the audit community and the oversight bodies. With real market value at stake, every tax executive should have internal controls as a high priority with the tax department. And if it is a priority, you and your team will take action and will find those tools that can enhance your control environment and make your auditors love your tax provision.





“Control Deficiencies: Finding Financial Impurities”, by shareholder-advisory firm Glass, Lewis & Co., July, 2005 and updated February, 2007

One in Three Audits Fail, PCAOB Chief Auditor Says” by Emily Chasan, The Wall Street Journal, CFO Journal, Jan 24, 2014

“The Progression of Financial Restatements: Causes and Market Reaction”, Kimberly M. Jarry, University of New Hampshire, Spring 2013

“Does SOX 404 Have Teeth? Consequences of the Failure to Report Existing Internal Control Weaknesses”, Sarah Rice, David P. Weber, Biyu Wu, published in The Accounting Review, May/June 2015

“Market uncertainty and disclosure of internal control deficiencies under the Sarbanes-Oxley Act”, Yongtae Kim, Santa Clara University, September 2009

“Material Weaknesses and Restatements: Is Tax Still In the Hot Seat ?” Deloitte, 2011. Web. 25 Mar. 2013.

“Material Weaknesses in Internal Controls a Decade after Sarbanes-Oxley” Henry Chao,  Dr. Paul Foote, published in Accounting Today, July, 2012



Stephen Day

With more than 25 years’ experience as a tax executive, in both industry and consultancy, Stephen is accomplished in leading high-performing teams to achieve results. He has the rare ability to deliver tax planning, driven by the business landscape, and to operationalize those tax strategies through creative process and organizational solutions. Simply put, he is passionate about developing and improving tax and finance operations to create value for the enterprise.

Stephen is a graduate of the BYU Marriott School of Management with a Master of Accountancy-Tax. He has completed executive development programs within both EY and Deloitte as well as at Northwestern University’s Kellogg School of Management. Stephen has also completed several tax and accounting software certification programs. While some might accuse him of actually having tax as his hobby, he can be found on the weekends riding his motorcycle in the canyons of Utah and devoting time to his family.