With the Tax Cuts and Jobs Act signed into law, the Securities and Exchange Commission has issued guidance explaining its expectations with respect to the related financial reporting requirements.
The Tax Cuts and Jobs Act makes numerous, significant changes to corporate taxation provisions, including a big rate reduction and a paradigm shift in taxation of foreign earnings, which creates a huge change in corporate balance sheets. Under Accounting Standards Codification Topic 740 in U.S. GAAP, companies are required to reflect such changes in tax law in the financial statement period in which the law was enacted.
The SEC issued Staff Accounting Bulletin No. 118 to signal it recognizes the short time from the law’s Dec. 22 enactment to the Dec. 30 end of reporting periods for most public companies creates an enormous reporting burden. SAB 118 tells companies that the SEC will accept reasonable estimates for up to a year, combined with plenty of disclosure, to explain the implications of the new law to investors.
The SEC also issued a new question and answer in its Compliance and Disclosure Interpretations to answer questions about whether companies should regard the re-measurement of deferred tax assets under the new tax law as a material impairment that would trigger a Form 8-K disclosure. As long as companies follow the guidance in SAB 118, the SEC staff says, then the re-measurement of DTAs will not necessitate a Form 8-K event.
SAB 118 explains a “measurement period” approach to reflecting the effects of the Tax Cuts and Jobs Act in financial statements as companies are able to assemble the necessary data and perform the necessary calculations to shift to the new law. Under this approach, the SEC expects companies to report what they can under ASC 740, estimate what they can’t report in full numeric detail, and leave the rest under historic accounting, using disclosure to bridge gaps.
The guidance tells companies to report “provisional” amounts “for those specific income tax effects of the Act for which the accounting under ASC Topic 740 will be incomplete but a reasonable estimate can be determined.” And where provisional amounts cannot be established by period-end reporting deadlines, companies should “continue to apply ASC Topic 740 based on the provisions of the tax laws that were in effect immediately prior to the Act being enacted.”
Where companies rely on provisional amounts or even historic accounting, the SEC expects updates in subsequent reporting periods. The “measurement period” approach will be in effect for one year, the SEC staff indicates.
“The measurement period begins in the reporting period that includes the Act’s enactment date and ends when an entity has obtained, prepared, and analyzed the information that was needed in order to complete the accounting requirements under ASC Topic 740,” SAB 118 says. “During the measurement period, the staff expects that entities will be acting in good faith to complete the accounting under ASC Topic 740. The staff believes that in no circumstances should the measurement period extend beyond one year from the enactment date.”
To supplement this “measurement period” accounting approach, SAB 118 lists a series of disclosures companies will be expected to provide to assure investors understand the transition that is occurring. Those include:
qualitative disclosures of the income tax effects of the law 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 law 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 law has been completed.
In a prepared statement, Bill Hinman, director of the SEC's Division of Corporation Finance, said: "This guidance recognizes that investors demand and deserve high-quality information, while also recognizing that entities may face challenges in accounting for one of the most comprehensive changes to the U.S. federal tax code since 1986."