Too Taxing

The flood of material weaknesses related to tax reflects a lack of expertise — and the evolution of an art into a science.

Applying specific rules takes time. Dynegy Inc., which received an adverse 404 opinion on its 2004 report due to a material weakness in tax accounting, knows the problem all too well. When the company began a deep analysis of its tax provisions in accordance with Sarbox requirements, CFO and executive vice president Nick J. Caruso and his staff realized that tax positions taken in earlier years were not adequately tracked. They discovered that the company had set aside too much in deferred taxes. “That’s good information,” he says, “but we then had to find out what caused [the discrepancy], and, thanks to Sarbanes, in which quarter.”

As a result of the exercise, errors were identified and restated for pre-1999, 2001, 2002, and 2003, while adjustments were made to 2004 year-end figures. The good news: the company received a clean financial-audit opinion. The bad news: remediation of its tax-accounting systems and procedures had not been completed as of December 31, 2004, hence the adverse 404 opinion.

“I’m confident that we now have excellent controls in place,” says Caruso. Dynegy has installed a new tax-software package — CorpTax ETS from Deloitte & Touche Technologies — to help it comply with Sarbox regulations and controls, and Caruso has added staff to the tax department to keep up with the “people-driven” nature of the new environment, which requires the company to keep a “complete set of tax books that allows us to keep up with depreciation from various acquisitions,” says Caruso.

Shortage of Experts

Like Caruso, many CFOs are trying to beef up their tax departments in response to the increased scrutiny. Of the companies criticized for tax-accounting weakness, more than half blamed personnel deficiencies — lack of training, insufficient resources, and so forth. “I’m surprised [personnel issues] weren’t listed in all of them,” says Cheffers.

Part of the problem, says Hauser of Jefferson Wells, is that firms can no longer rely on their external auditors to provide guidance for complex tax computations or footnote disclosures. Now that the Public Company Accounting Oversight Board views such assistance as consulting, auditors can offer only limited tax advice to their audit clients, and many public companies now get their tax advice elsewhere. In a 2004 TEI study, 40 percent of companies surveyed said they had decreased use of their external audit firms for tax services since Sarbox was issued; another 11 percent completely refuse to use their audit firms for tax questions.

But hiring new tax accountants is not easy. Caruso, for example, says he was lucky to find five qualified tax people in Houston to add to his tax department. Kathleen Jennings, president and CEO of ET Search Inc., says, “I’ve never seen the pool so small.” Tax professionals are leaving the profession, she says, because they know that “one mistake means somebody gets scapegoated.” Eastman Kodak, for example, hired a new tax director in the wake of its adverse opinion, but wouldn’t comment on the status of its previous tax director, citing a policy of not commenting on personnel matters.

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