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Welcome back. To conclude our discussion of uncertain tax positions,

let's do an example that shows how uncertain tax positions are recognized and settled.

So, we're going to use research and development tax credits.

In this notice, these are not deductions,

these are credits, to illustrate initial recognition,

subsequent recognition, accrual of interest,

and then final resolution of an uncertain tax position.

So, Cybercryme system takes an aggressive stance in

claiming 75,000 in R&D credits for software development.

The entire credit is considered a single unit of account.

External tax consultants estimate there is a one in four chance that

the claims could be accepted by the tax authorities upon examination.

So, it's not more likely than not.

Because recognition is not more likely than not,

zero tax benefit is recognized.

So I'm showing current taxes payable is reduced because I've taken

the credits but I'm also recognizing a tax liability in

anticipation of the tax authority not accepting them on examination.

Notice that this is a liability.

This is a 100 percent liability here.

It is not a deferred tax liability.

This is a liability for an expected payment

to the tax authority if it's not accepted upon examination.

So, in year two, Cybercryme will need to accrue interest

on the liability and the IRS rate currently is three percent.

So they will recognize an accrued liability,

accrued interest of $2,250

anticipating that they will have to pay back the amount in accrued interest.

Well, in year three,

Cybercryme determines the IRS will examine

anti-fraud software separately and then look into some of this anti-fraud.

So, now, they're going to break this into two units of account.

One of 55,000 which is still uncertain,

and one of 20,000 which is now more likely than not of acceptance.

And the largest amount that they determine is more likely than

not of being accepted is $15,000.

So, now, what happens?

So, what's the impact of the financial statements of that change in

judgment that we have from the change in unit of account?

Well, first, I'm going to reduce my tax liability for the amount that's more likely than

not of being recognized and I'm going to recognize a tax benefit.

So, I'll debit my tax liability for 15,000

and I'll credit the tax benefit for the same amount.

Also, remember I accrued interest on that amount.

I'm going to reverse that accrued interest.

Suppose three percent was accrued on that.

I'm going to reverse that because now I no longer need to accrue

interest on the amount that's more likely than not of being accepted.

And this is the largest amount that's more likely than not,

I'm reversing the interest.

So, overall, I have a tax benefit of 15,000 and I'll reverse

the interest expense of $450. So, let's move forward.

At the end of year three, the IRS does conclude

its examination and they reject 20,000 of the claim credit overall.

So, Cybercryme will recognize additional benefit of

40,000 and reverse the accrued interest of $2,436 on that.

So remember, they had previously recognized 15,000 out of 75,000.

So the IRS has rejected 20,000,

that means they've accepted 55000 out of 75,000.

And we'll pay the IRS $20,000 for the amount they

rejected plus $1,218 of accrued interest and we will

derecognize the previous liability of

$60,000 in accrued interest on that amount of $3,654.

So here's my journal entry. I'm going to have

a gain from accrued interest on the uncertain tax position that was ultimately accepted.

I'm going to have a tax benefit of 40,000 from

the amount that was not more likely than not previously but was accepted.

I'll show a payable for the amount that I have to pay

back to the IRS including accrued interest.

And then, of course, I've accrued interest for the period that I had

previously accrued just so you can see how these numbers are tied together.

So these can add up to big numbers.

Here's a disclosure from a company that has more than $3 billion in

unrecognized tax positions and you can see

the roll forward that they've prepared for 2016,

for example, starts with

almost three and a half billion dollar balance at the beginning of the year.

They add $196 million.

They have prior year additions.

These are changes in judgments that causes them to

add two amounts from prior years of 75 million.

They have prior year reductions where they have a change in judgment that

they've reduced their unrecognized positions by 90 million.

They have settlements with the IRS or other

taxing authorities that have reduced the amount of uncertainty by

92 million and the statute of limitations expired to the tune

for another 43 million leading to an ending balance which is almost the same,

if you notice, of 3,494.

So, again, the numbers are big.

You can see right here the effect of prior year additions which mean that amounts that we

previously thought were more likely than not

are now no longer concerned to be more likely than not.

Prior year reductions, amounts that we didn't consider in

previous years to be more likely than not but we now consider to be more likely than not.

And then, settlements and statute of limitations and there's the remaining balance.

So, here's an example two of the disclosure of interest accrued and payable.

So expenses for interest and penalties associated with

uncertain tax positions amounted to 134 million in 2016,

102 million in 2015,

and 9 million in 2014.

These amounts reflect the beneficial impacts of various tax settlements.

Liabilities were 886 million and 766 million as of December 31,

2016 and 2015, respectively.

So, you can see that you can get a lot of movement in here from either

recognizing interest or reversing interest and penalties. The numbers are big.

Any time you're dealing with income taxes,

it tends to be some of the biggest numbers on the financial statements.

So overall, it's a very important topic.

So, that concludes our discussion of uncertain tax positions.

Again, it's a highly complex topic that involves the use of a lot of experts from

both the tax side and

the accounting side and hopefully

now you have a better idea of how that works. Thank you.