SEC gives relief from tax reform year-end reporting crisis

Swift guidance from the Securities and Exchange Commission on how to book the effects of tax reform in year-end financials offers companies some welcome relief, but it’s not a free pass on the mountain of work that must be done, nor does it put to rest all accounting questions.

Almost immediately after President Trump signed into law the Tax Cuts and Jobs Act, making sweeping changes to the U.S. tax code only days before the end of 2017, the SEC issued Staff Accounting Bulletin No. 118 to give companies some guidance on how to handle their financial reporting obligations.

Accounting Standards Codification Topic 740 require companies to report the effects of legislation in their financial statements in the period in which the legislation is enacted. For public companies that must file financial statements with the SEC, that would mean digesting the numerous provisions of the Tax Cuts and Jobs Act and altering each line item in financial statements that will be affected in their year-end reporting.

With the legislation signed into law on Dec. 22, that’s only eight days before the end of the reporting period. The SEC had signaled even before Congress ironed out the details that it recognized the enormity of such a job — especially considering the scope of the new law in dramatically lowering the corporate tax rate, significantly altering the approach to taxation of earnings outside the United States, and revising provisions around numerous longstanding deductions, exemptions, and credits.

To come up with a practical approach for how companies could accomplish so much shift in reporting in such a short window of time, the SEC staff took a page from the playbook of the Financial Accounting Standards Board. In 2004, FASB issued a staff position giving companies some breathing room on reporting the effects of a one-time tax deduction that companies could take on the repatriation of foreign earnings under the American Jobs Creation Act.

“This will be facts and circumstances with each individual registrant in terms of what you can complete, what you can reasonably estimate, and what you can’t estimate at all.”
Matt Himmelman, Tax Partner, Deloitte & Touche

The SEC analogized to that guidance — along with existing accounting rules on business combinations, where sometimes the timing of transactions can clash with filing deadlines — in providing a one-year “measurement period” approach companies can follow to reflect the effects of the new tax law in financial statements.

SAB 118 gives companies three possible avenues for each of the various financial statement provisions that might need to change. First, it tells companies to the extent they can quantify and reflect the tax law, they should do so. Second, where they can’t access the necessary data, perform the appropriate analysis, or complete the required calculations by their relevant filing deadlines, they should arrive at reasonable estimates that can be booked as provisional amounts in financial statements.

And if even reasonable estimates are not possible, SAB 118 says, companies should rely on historic numbers. Where companies decide to rely on estimates or historic figures, they’ll be expected to provide plenty of disclosure to explain.

“The marching order is companies should still be charging forward, understanding what this means for them, and making computations require to account for the new law in the period of enactment,” says Ashby Corum, tax partner at KPMG.

In addition to SAB 118, the SEC also updated its Compliance and Disclosure Interpretations to signal that it does not regard any of the adjustments companies will need to make as a result of the new tax law or to comply with SAB 118 as “impairments” that would trigger Form 8-K disclosures regarding impairments of material assets. “There was some concern of whether remeasurement of deferred tax assets or the use of valuation allowances might fall under the 8-K filing requirements, so this just clarifies those don’t come into play,” says Corum.

Matt Himmelman, a tax partner at Deloitte & Touche, says companies should think about what they can accomplish in the context of the three action buckets that the SEC describes in SAB 118 — what can be calculated in time to report, what can be estimated, and what should be left under historic accounting for now.

“Some had hoped for maybe a blanket deferral, maybe another quarter or six months, but that’s not what SAB 118 is,” says Himmelman. “Companies have to work as expeditiously as possible and try to get through those three buckets.”

Perhaps the most straightforward change to make to financial statements is the remeasurement of deferred tax assets and deferred tax liabilities at the new corporate tax rate, which falls from 35 percent to 21 percent. “That’s something that can probably be completed in the period of enactment,” says Himmelman. “If you can do that, you’re supposed to record it in that period.”

The transition tax companies must pay on foreign earnings held overseas under the new tax law might represent a tax effect that companies may not be able to pin down with mathematical precision in time for fourth-quarter reporting, says Himmelman. But some companies can probably get to a place where they will be able to reasonably estimate it, he says.

As companies move through each reporting period, they’ll be expected under SAB 118 to revisit estimates and finalize them as they are able, so that all tax effects are fully recognized within a year. The SEC put a time limit on the measurement period approach, saying it cannot extend past one year from the enactment date of the new law.

DISCLOSURES

Question 2: If an entity accounts for certain income tax effects of the Act under a measurement period approach, what disclosures should be provided?
Interpretive Response: The staff believes an entity should include financial statement disclosures to provide information about the material financial reporting impacts of the Act for which the accounting under ASC Topic 740 is incomplete, including:
(a) Qualitative disclosures of the income tax effects of the Act for which the accounting is incomplete;
(b) Disclosures of items reported as provisional amounts;
(c) Disclosures of existing current or deferred tax amounts for which the income tax effects of the Act have not been completed;
(d) The reason why the initial accounting is incomplete;
(e) The additional information that is needed to be obtained, prepared, or analyzed in order to complete the accounting requirements under ASC Topic 740;
(f) The nature and amount of any measurement period adjustments recognized during the reporting period;
(g) The effect of measurement period adjustments on the effective tax rate; and
(h) When the accounting for the income tax effects of the Act has been completed.
Source: SEC

“This will be facts and circumstances with each individual registrant in terms of what you can complete, what you can reasonably estimate, and what you can’t estimate at all,” says Himmelman.

Michael Williams, a tax partner at BDO USA, also is cautioning companies to see SAB 118 as a relaxation of the reporting timeline, not wholesale relief from reporting. “Companies still need to do their required analysis and quantification,” he says. “They must make a reasonable effort and act in good faith.”

Documentation will be important, says Williams, not only to support changes to financial statements to reflect the tax effects but also to support estimates, and even to support claims that something cannot be estimated. “If you can’t reasonably estimate the effect, you should still have robust documentation in place to support why you can’t make a reasonable estimate,” he says.

And as companies are working through the reporting aspects, Williams says companies need to be ever mindful of their internal controls both over the financial reporting and the new tax provisioning processes that need to be established. “This is going to be a lot of work for companies, and the reporting deadlines are coming quickly,” he says.

April Little, a tax partner at Grant Thornton, says as companies move through reporting periods until they’ve fully reflected the new tax law, they may face questions from auditors regarding prior period accounting. Anytime companies are going back and adjusting prior period financials, it’s done through a lens of whether the adjustment is a refinement based on new information or a correction.

“Eventually, you have to finalize and say pencils down, we’re done,” says Little. “To the extent there are changes from how you initially reported, you have to go back and say are we refining estimates? Or was that information that was known or knowable at an earlier date and we simply didn’t thoroughly do the calculations?” She believes auditors may challenge companies on whether they’re refining estimates in subsequent periods or determining impacts that should have been determined and reported sooner.

While SAB 118 answers the burning question at the time of enactment regarding how reporting would be handled, it still leaves unanswered other questions that the Financial Accounting Standards Board may take up separately. The American Bankers Association and others have asked FASB to consider the effects on earnings and regulatory capital of reflecting the reduced corporate rate on unrealized gains and losses currently sitting in accumulated other comprehensive income. FASB has set a meeting date to determine whether it will take up new guidance on the issue.

FASB also plans to consider whether the tax liability on the deemed repatriation of foreign earnings, which will be payable for several years into the future rather than in a lump sum, should be discounted to reflect time value of money. Book and tax rules differ on this point, leaving companies uncertain how to proceed.

FASB also will consider developing new guidance on whether the alternative minimum tax credits that become refundable should also be discounted, how companies should account for the base erosion anti-abuse tax, and the accounting for global intangible low-taxed income. The board also will consider whether to extend SAB 118 relief provisions to private companies.