BKD, LLP is an IMA B2B Partner…
With record speed, the Financial Accounting Standards Board (FASB) finalized relief to reporting the effects of the Tax Cuts and Jobs Act (TCJA). The final guidance, Accounting Standards Update (ASU) 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, includes additional flexibility in adopting the standard. The reclassification of stranded tax effects in accumulated other comprehensive income (AOCI) is now an option rather than a requirement; however, disclosure is required if not elected. Entities also will have an option to adopt the standard retrospectively or in the period of adoption.
Because President Donald Trump signed the TCJA on December 22, 2017, the reporting effect must be reflected in 2017’s year-end and fourth-quarter financial statements. The accounting for changes in tax rates is complicated—sometimes the deferred tax liabilities and assets relate to items held in AOCI. This most frequently occurs in banks, insurance companies and other entities that hold available-for-sale securities or engage in hedging, as well as companies with defined benefit pension plans and those with foreign currency translation. Current generally accepted accounting principles require the effects of the change in the corporate tax rate (from 35 percent to 21 percent) on deferred tax liabilities and assets to be recognized as an adjustment to income tax expense and included in income from continuing operations even though the tax effects were initially recognized directly in OCI. This would leave stranded balances in AOCI that would not reflect the appropriate tax rates.
Scope
FASB’s exposure draft would have required all entities to restate AOCI to remove any stranded tax balances. As noted above, certain industries such as banking have large balances in AOCI. For some entities, the costs of identifying and calculating the balances in AOCI affected by the new tax law outweigh any benefit.
Under ASU 2018-02, entities are allowed, but not required, to reclassify from AOCI to retained earnings stranded tax effects resulting from the new federal corporate income tax rate. The reclass could include other stranded tax effects that relate to the TCJA but do not directly relate to the change in the federal rate, e.g., state taxes, changing from a worldwide tax system to a territorial system. Tax effects that are stranded in AOCI for other reasons, e.g., prior changes in tax law, a change in valuation allowance, may not be reclassified.
Transition & Disclosure
The exposure draft’s feedback highlighted potential additional costs to revise previously filed financial statements and certain regulatory reports under a retrospective approach. FASB had not considered this operational challenge and revised the final ASU to include an additional transition method. Entities can apply the guidance retrospectively or in the period of adoption.
An entity that elects to record the adjustment in the period of adoption would make an adjustment in the statement of shareholders’ equity as of the beginning of the reporting period. Entities would be required to disclose the nature and reason for the change and the change’s effect on affected financial statement line items.
If retrospective application is selected, an entity would make a reclassification in the period of enactment, e.g., the fourth quarter of 2017 for a calendar-year entity, and any subsequent period when changes to provisional amounts recorded under U.S. Securities and Exchange Commission Staff Accounting Bulletin 118 (see related Thoughtware® article) result in additional amounts stranded in AOCI. In the first interim and annual period of change, entities would be required to disclose the nature and reason for the change, a description of the prior period information that has been retrospectively adjusted and the change’s effect on financial statement line items.
While researching this issue, FASB noted there is current diversity in practice on releasing stranded tax effects from AOCI. For example, some entities release those effects as individual items in AOCI are sold and some entities release those effects only when the entire portfolio of similar item is liquidated. The ASU requires all entities to disclose their accounting policy for releasing stranded tax effects to the extent that it is material.
Before the ASU’s effective date, no disclosure is required before the adoption if an entity has not decided whether it will elect to reclassify its stranded tax effects.
Effective Date
The standard is effective for all entities for annual reporting periods beginning after December 15, 2018. Early adoption would be permitted for interim or annual financial statements that have not been issued or made available for issuance. Early adoption will allow some entities to align the timing of the stranded tax reclassification in their 2017 financial statements.
To view the original article, click here.
