eConnect Pays Up or Not?

eConnect, an online retailer, fulfills its online orders by shipping its products directly to customers in all 50 states. eConnect does not have a brick-and-mortar store presence in any state, but does operate distribution centers in various states across the country, including State X. Consistent with its practice in all 50 states, eConnect does not collect or remit sales tax to State X.

In court rulings in 2005, State X had taken the position that operating a distribution center within a state constitutes nexus and thus would subject that company to collect and remit sales tax on all sales within that state.

As of December 31, 2011, eConnect has operated its distribution center in State X for five years and has never collected or remitted sales tax to State X. The company considers the risk of detection to not be probable, hence no contingency needs to be recognized. However, eConnect has estimated the total amount of sales tax payable to the state for the past five years to be $50 million plus $6 million in interest and $4 million in penalties.

On March 15, 2012, Mr. Needmoney, the governor of State X, established a tax amnesty program. The program provides that any unregistered taxpayer who voluntarily registers to collect sales tax on a prospective basis will be forgiven (1) 50 percent of all unpaid sales tax and (2) all interest and penalties on unpaid taxes. On the same date of this announcement, eConnect management decides to take advantage of this program.

On June 15, 2012, eConnect completes the necessary paperwork and other actions to participate in the program and pays State X $25 million to settle its obligation through December 31, 2011.

Instructions/requirements/grading policies:

1. As of December 31, 2011, what amount, if any, of sales taxes due should be recognized in eConnects financial statements? (2.5 points)

   1. Please provide a direct answer to the question (i.e., there is $xxx of sales taxes should be recognized as of Dec 31, 2011, or there isnt any taxes due need to be recognized as of Dec 31, 2011). 1 point.

   2. Please explain the reasons behind your conclusion and provide supports to your conclusion by using references from the FASB pronouncements listed above. You need to provide at least 3 references. Please note that references from the FASB includes basically two parts: 1) direct quotation of the original wordings from FASB pronouncement, and 2) your argument/explanation why and how the quotation supports your opinion, in another word, how it is relevant to this case.

1.5 points in total for this part, of which 0.5 point for references, 1 point for the logics presented in your argument. Please note that if you provide wrong answer to the first question, you lose the entire 2.5 points of this question.

1. Should eConnect restate financial statements prior to 2011 and why? (2.5 points)

   1. Direct answer to the question (i.e., yes or no). 1points.

   2. Explain how you come to your conclusion. You may not need the pronouncements listed above, however, you need to point out other appropriate FASB rulings regarding financial statement restatements. Total 1.5 point. (Note that if your conclusion is wrong then you lose the whole 2.5 points for this question.)

2. As of March 31, 2012, what effect (adjustments), if any, does eConnects decision to participate in the tax amnesty program have on the amount recognized? (2.5 points.)

   1. Direct answer to whether there should be any effect, and/or adjustments, and if yes, what kind of effect. 1 point.

   2. Your argument/reasoning of your opinion stated above. 1 point.

   3. At least one reference from the listed pronouncements to support your opinion. 0.5 points.

3. What amounts, if any, should be recognized in the financial statements associate with the $25 million payment on June 15, 2012? (2.5 points)

   1. Please provide the correct amount you believe that is subject to recognition. 1 point.

   2. Please provide journal entry for this recognition. 1 point.

   3. Please briefly explain how you come to this amount and the adjusting entry. 0.5 points.

   4. You are not required to quote from FASB pronouncements.