Authored by Anna Kooi and Mary Miske
To aid depository and lending institutions in understanding the implementation of certain affects from tax reform, regulatory bodies have begun to release guidance and clarifications. The Financial Accounting Standards Board (FASB) released a proposed Accounting Standards Update (ASU) related to reclassification of other comprehensive income (OCI) and the Securities and Exchange Commission (SEC) released Staff Accounting Bulletin (SAB) 118 related to accounting and disclosures.
FASB Exposure Draft: Regarding stranded tax effects within other comprehensive income (OCI)
On Jan. 18, 2018, the FASB released an exposure draft, Proposed Accounting Standards Update, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, related to the reclassification of certain tax effects from accumulated other comprehensive income (AOCI). The exposure draft, in response to unsolicited comment letters from the banking industry, provides guidance on a financial reporting issue arising from the adoption of tax reform. The FASB issued the proposed ASU to solicit public comment on changes to Topic 220 of the FASB Accounting Standards Codification.
On Dec. 22, 2017, the Tax Cuts and Jobs Act (TCJA or the Act) reduced the corporate federal income tax rate to 21 percent. Currently, generally accepted accounting principles (GAAP) requires deferred tax assets and liabilities to be adjusted for the effect of a change in tax laws or rates in the reporting period that includes the enactment date. The tax effect of the rate change is included in income from continuing operations even when the deferred taxes were originally recorded in OCI. Thus, AOCI includes the deferred taxes recorded at the historical tax rate and does not reflect the adjustments made to the deferred tax assets or liabilities for the newly enacted tax rate of 21 percent. The exposure draft refers to this difference as stranded tax effects.
The proposed ASU requires a reclassification from accumulated other comprehensive income to retained earnings to eliminate the stranded tax effects from the adoption of the newly enacted federal corporate tax rates as a result of TCJA. The amount of the reclassification is calculated as the difference between the amount initially charged to other comprehensive income at the time of the previously enacted tax rate that remains in AOCI and the amount that would have been charged using the newly enacted tax rate, excluding any valuation allowance previously charged to income. It is important to note that the proposed ASU only applies to the stranded tax effects resulting from the enactment of the TCJA and it does not address the current prohibition in GAAP on backwards tracing which resulted in prior stranded tax effects.
The proposed ASU would be effective for fiscal years beginning after Dec. 15, 2018 and interim periods within those fiscal years, with early adoption permitted. Comments on the proposed ASU are due Feb. 2, 2018.
SEC Staff Accounting Bulletin (SAB) 118: Accounting and disclosures for impact of tax reform
Significant concerns were raised by companies regarding the enactment date of the TCJA and the limited timeframe available to accurately determine the impact of the tax changes within their annual and quarterly reports filed with the SEC. To help companies address the challenges arising out of the magnitude of the changes in the TCJA, the staff from the Office of the Chief Accountant and Corp Fin released SAB 118 on Dec. 22, 2017 to provide guidance on accounting and disclosures for the impact of TCJA.
Under SAB 118, for those tax effects that are incomplete (i.e., the company did not have adequate time to prepare or analyze the tax effects in reasonable detail), the company would report a provisional amount based upon a reasonable estimate. The provisional amount would be subject to adjustment during the measurement period, not to exceed one year. The provisional amount, estimate, should be recorded in the first reporting period in which one is determined. The staff believes it would be inappropriate to exclude a reasonable estimate if one is determined.
If the company does not have the information available, prepared or analyzed that is necessary to make a reasonable estimate, the staff does not expect the company to include a provisional amount, and, in that case, the company “should continue to apply ASC Topic 740 (e.g., when recognizing and measuring current and deferred taxes) based on the provisions of the tax laws that were in effect immediately prior to the Act being enacted. That is, the staff does not believe an entity should adjust its current or deferred taxes for those tax effects of the Act until a reasonable estimate can be determined.”
SAB 118 also describes the supplemental disclosures that should be included in the financial statements where the accounting under ASC Topic 740 is incomplete, such as the reasons why the accounting is incomplete and the additional information needed. More specifically, the supplemental disclosures should describe the following:
- Qualitative disclosures of the income tax effects of the TCJA for which the accounting is incomplete;
- Disclosures of items reported as provisional amounts;
- Disclosures of existing current or deferred tax amounts for which the income tax effects of the TCJA have not been completed;
- The reason why the initial accounting is incomplete;
- The additional information that is needed to be obtained, prepared or analyzed in order to complete the accounting requirements under ASC Topic 740;
- The nature and amount of any measurement period adjustments recognized during the reporting period;
- The effect of measurement period adjustments on the effective tax rate; and
- When the accounting for the income tax effects of the TCJA has been completed.
SAB 118 only applies to the accounting and disclosures of the TCJA.
Private company application
Can private companies apply SAB 118? Earlier this month, the FASB released a Q&A confirming SAB 118 may be used by private companies. The Q&A explains that based upon the longstanding practice of private companies electing to apply SABs, the FASB staff would not object to private companies and not-for-profit entities applying SAB 118. If a private company or not-for-profit entity applies SAB 118, they would be in compliance with GAAP.
However, if a private company applies SAB 118, it should apply all relevant aspects of the SAB in its entirety including disclosures. The FASB staff also believes a private company applying SAB 118 should disclose its accounting policy of applying SAB 118.
Continued guidance likely
As issues and questions arise, additional guidance from regulatory bodies is highly likely. We recommend you consult with your Baker Tilly advisors to understand all of the implications for your organization.
For more information on the accounting implications of tax reform on 2017 financial reporting and beyond, or to learn how Baker Tilly professionals can help, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.