The FASB updated U.S. GAAP to alleviate concerns from banks and insurance companies about the accounting implications of the Tax Cuts and Jobs Act. The final amendment is optional for companies to apply.
The FASB on February 14, 2018, published an update to U.S. GAAP to ease the financial reporting requirements of the Tax Cuts and Jobs Act (TCJA) for banks and insurance companies.
Accounting Standards Update (ASU) No. 2018-02, Income Statement — Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, gives businesses the option of reclassifying to retained earnings the so-called “stranded tax effects” left in accumulated other comprehensive income (AOCI) because of the reduction to the corporate income tax rate.
The TCJA, signed into law on December 22, is considered the biggest tax change in three decades, reducing the corporate income tax rate to 21 percent from 35 percent. ASC 740, Income Taxes , requires businesses to adjust the value of deferred tax assets and liabilities upon a change in tax law. Changes related to the tax rate change must be presented in earnings, even when the corresponding deferred taxes relate to items initially recognized in accumulated other comprehensive income (AOCI), such as pension adjustments, gains or losses on cash flow hedges, foreign currency translation adjustments, and unrealized gains or losses on available-for-sale securities.
Banks and insurance companies, which hold significant available-for-sale securities in other comprehensive income, raised concerns about following this aspect of the accounting guidance ASC 740, and said that as they record the reduction to their deferred tax credits, for example, reported earnings and regulatory capital could both be reduced. Bank regulatory capital typically excludes items recorded in other comprehensive income.
The banks and insurers said the reduction in reported earnings and capital would not be an accurate reflection of a weakening in their financial condition.
In addition, because U.S. GAAP does not permit the adjustment of tax amounts in OCI for changes in tax rates, the effects become stranded in OCI, they said.
Banks and insurers wanted the FASB to issue an amendment permitting “backwards tracing,” which would make it difficult for the board to offer the accounting relief the banks and insurers sought.
Instead, the standard-setter took a more focused approach and dealt solely with the stranded tax effects.
“Consequently, the amendments eliminate the stranded tax effects resulting from the Tax Cuts and Jobs Act and will improve the usefulness of information reported to financial statement users,” the board wrote. “However, because the amendments only relate to the reclassification of the income tax effects of the Tax Cuts and Jobs Act, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected.”
Banks and insurers applauded the FASB’s proposal when the board released it in January via Proposed Accounting Standards Update(ASU) No. 2018-210 Income Statement — Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, saying the plan would give a more accurate description of the components of equity.
U.S. GAAP does not define the term stranded tax asset. These stranded assets arise, however, for example, when a business originally records the tax effect of an unrealized gain or loss on a security in OCI at the old tax rate of 35 percent. Under the new tax law, the tax effect is recorded at 21 percent, through continuing operations.
“So that 14 percent difference is stranded; that’s where they got the phrase,” Crowe Horwath LLP partner Sheryl VanderBaan said.
Banks wanted the FASB to clear up U.S. GAAP’s presentation requirements so the tax effects in AOCI are closer to what the deferred tax amount really is, VanderBaan said.
If businesses avail of the reclassification, they must disclose a description of the accounting policy for releasing income tax effects from accumulated other comprehensive income, whether they elect to reclassify the stranded income tax effects from the TCJA, and information about the other income tax effects that are reclassified.
The amendments are effective for all organizations for fiscal years beginning after December 15 and interim periods within those fiscal years. Early adoption is allowed. The FASB also said businesses and organizations should apply the amendments either in the period of adoption or retrospectively to each period in which the effect of the change in the tax rate is recognized.
The update largely confirms the bulk of the proposal the FASB floated on January 18, but instead of requiring the reclassification, the FASB agreed to make it optional.
“The amendments will result in improved financial reporting,” the FASB wrote in the basis for conclusions of ASU No. 2018-210. “That is, after the reclassification is made for the stranded tax effects from accumulated other comprehensive income to retained earnings, the federal tax effects of items in accumulated other comprehensive income will reflect the newly enacted federal corporate income tax rate, resulting in components of equity that are more accurately stated.”