Help is On the Way: Revised GAAP Accounting for the Effect of Tax Reform
The Financial Accounting Standards Board (FASB) met on January 10, 2018 to discuss financial reporting issues raised by the Tax Cuts and Jobs Act (the “Act”). Currently, GAAP requires the effects of changes in tax laws or rates on deferred tax balances to be recorded through income tax expense and included in income from continuing operations for the period in which the law was enacted – even if the deferred balances relate to items in accumulated other comprehensive income (AOCI).
Stakeholders, particularly those with material unrealized losses on available-for-sale securities such as insurance entities, provided unsolicited comments to FASB expressing concerns with the current accounting model. Stakeholders requested that the Board consider allowing backward tracing, which would allow entities to recognize the effects of the changes in deferred tax amounts in the same line items in which the amounts were originally recognized in prior years. Currently, backward tracing is not allowed under GAAP.
At the meeting, the Board voted to add a narrow-scope project allowing a one-time reclassification of the tax effects stranded in AOCI. The proposal would require the tax effects stranded in AOCI as a result of the reduction in corporate tax rate be reclassified to retained earnings. FASB instructed the FASB staff to draft an exposure draft which will also solicit feedback on whether to pursue a separate research project on the broader issue of backward tracing. If approved, the reclassification adjustment would be the difference between the current 35% and the new 21% tax rates resulting from the Act. The proposal is limited to the impact of the Act and would not apply to the impact of prior or future changes in federal or state and local tax laws.
Within the next two weeks, FASB will be issuing an Exposure Draft that will include a narrow-scope change, which would require the one-time reclassification noted above. Stakeholders will have 15 days to comment on this proposal. Afterward, FASB will consider the comments and vote on whether to proceed with issuing an Accounting Standards Update (ASU).
An effective date for the forthcoming ASU has not yet been decided, but the Board indicated that early adoption would be permitted.
Upon issuance, the guidance would apply to each period in which the effect of the Act (or portion thereof) is recorded, which may be retrospectively adjusted to the December 2017 enactment date. In addition, the following disclosures will be required:
- The nature of and reason for the change
- A description of the prior period information that has been retrospectively adjusted
- The effect of the change on affected financial statement line items
How to Account for This Update
As companies consider the impact of this proposal on their December 31, 2017 financial statements, they need to be mindful of the timing of any ASU issuance. Companies cannot early adopt the ASU until it is issued by FASB. While FASB has fast-tracked this project, the Board needs to follow the normal ASU issuance protocol including issuance of the exposure draft, a 15-day comment period and issuance of an ASU. That process will likely push the issuance date of any ASU to February or March of 2018.
Companies issuing their 2017 financial statements prior to the issuance of the ASU will need to recognize the changes in the deferred tax balances through income from continuing operations in 2017 (the period in which the law was enacted).
Companies issuing their 2017 financial statements after issuance of the ASU will have the option to early adopt the ASU. If early adopted, companies would recognize a one-time reclassification from accumulated other comprehensive income to retained earnings.
Fiscal year-end companies, with fiscal year-end prior to the December 2017 Tax Cuts and Jobs Act enactment date should disclose the change in rate as a subsequent event in accordance with ASC 855-10-50-2. Such disclosures should include a description of the nature of the event and an estimate of the financial effect of the event on the financial statements.