The Financial Accounting Standards Board has decided it will fast-track a change to accounting rules to reclassify the income tax effects of recent tax reform legislation as advocated by the financial services sector.
While the American Bankers Association is encouraged by FASB’s willingness to move forward, the timing will still be tricky for companies, given how soon reporting needs to occur and how long it takes for rules to change, even under a compressed time line.
FASB not only opened a project but also tentatively decided at its most recent open meeting that it will allow entities to reclassify certain tax effects of the Tax Cuts and Jobs Act from “accumulated other comprehensive income” to retained earnings rather than net income as currently required. Accounting Standards Codification Topic 740 requires companies to remeasure any deferred tax assets or liabilities at the newly reduced corporate tax rate of 21 percent and report the effect through earnings.
The FASB instructed its staff to draft the Accounting Standards Update so the board can approve and issue it for a 15-day public comment period, which is unusually brief under the board’s normal operating procedures. The board’s time line would suggest it intends for the rule change to be effective in time for first-quarter 2018 reporting.
The ABA and others had appealed to the board for the change to accounting standards, concerned about the mismatch that would occur if entities must move items out of AOCI, which resides in equity on the balance sheet, into the income statement. For financial services entities in particular, the mismatch is a problem because it has implications for capital requirements under other banking regulatory rules.
The numbers could be big, confusing to investors, and cumbersome to track and reconcile, especially on deferred taxes associated with unrealized capital gains and losses related to portfolios of available-for-sale debt securities, the ABA said. A recent analysis by Audit Analytics finds the earliest reports of 36 companies suggest an earnings swing of $50 billion under current requirements from those entities alone. Citigroup reported the largest effect, indicating it will take a $20 billion hit to earnings following current rules.
The board decided with the reclassification provision, it will also require entities to provide some disclosures, such as the nature and reason for the change in accounting principle, a description of the prior-period information that has been retrospectively adjusted, and the effect of the reclassification on relevant financial statement line items.
Mike Gullette, vice president in accounting and financial management at the ABA, said he’s encouraged with the board’s general direction, but still concerned about timing. FASB’s due process for rulemaking requires the issuance of an exposure draft for a period of public comment and deliberation of those comments before any final standard can be issued.
“Based on the FASB’s time frame, it appears that banks will be filing bank call reports the day before a standard will be issued,” Gullette says. That puts banks in a pinch to decide if they will assume the rules will change and prepare accordingly or proceed as current rules require. He’s hopeful banking regulators might consider allowing banks to report on an “as expected” accounting basis.
The FASB also indicated it will do some research on another appeal from the financial services sector to permit “backward tracing” of deferred tax items originally charged or credited directly to equity, as allowed in International Financial Reporting Standards. That would help address further mismatches called out by the financial services sector in areas such as foreign currency translation adjustments, certain pension adjustments, gains and losses on cash flow hedges, other-than-temporary impairments in held-to-maturity securities, and the credit risk portion of a entity’s own debt when reported at fair value.
The board also discussed but not make decisions on five other implementation issues associated with the Tax Cuts and Jobs Act. They include the use of the Securities and Exchange Commission’s Staff Accounting Bulletin No. 118 by private entities, whether to discount the tax liability on the deemed repatriation of foreign earnings, whether to discount alternative minimum tax credits that become refundable, how to account for the base erosion anti-abuse tax, and how to account for global intangible low-taxed income.
The board indicated its staff will prepare a question-and-answer document on each of those issues and post it to the FASB website “at a future date.”