The FASB agreed to finalize a proposal it released in January that aims to alleviate concerns from banks and insurance companies about the accounting implications of the Tax Cuts and Jobs Act. The final update to U.S. GAAP will be optional for companies to apply, the board agreed.
The FASB on February 7, 2018, fast-tracked an amendment to U.S. GAAP to offset the decrease in regulatory capital that banks and insurance companies said was an unanticipated consequence from the Tax Cuts and Jobs Act (TCJA).
The board approved the bulk of the changes in the January 18 Proposed Accounting Standards Update(ASU) No. 2018-210, Income Statement — Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects Ffrom Accumulated Other Comprehensive Income, although instead of requiring a change, a 6-1 majority of the board agreed to make it optional.
The forthcoming update to U.S. GAAP attempts to address concerns about a provision in ASC 740, Income Taxes , in which businesses must adjust the value of deferred tax assets and liabilities upon enactment of a new tax law. The TCJA, signed into law by President Donald Trump on December 22, lowers the corporate tax rate from 35 percent to 21 percent, which means that deferred tax credits will be worth less. At the same, deferred tax liabilities also will decrease.
The effects of the change in the tax rate must be presented in current 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 recorded in other comprehensive income (OCI), told the FASB that without a change to the presentation guidance, the requirement to record the effect of a reduction in deferred tax credits, for example, could reduce their earnings and, ultimately, their regulatory capital. Bank regulatory capital typically excludes items recorded in other comprehensive income.
In addition, because U.S. GAAP does not permit the adjustment of tax amounts included in OCI for changes in tax rates, those impacts become “stranded” in OCI, they said.
The FASB’s amendment will give businesses the option of reclassifying the so-called “stranded effects” of the tax law to retained earnings from OCI. The amount of the reclassification will be calculated as the difference between the amount initially charged to OCI and the amount that would have been charged using the newly enacted tax rate.
“It makes the accumulated OCI balance right now,” said American Bankers Association (ABA) Vice President Mike Gullette, who supports the FASB’s move. “It makes it what everybody thought it would be and should be. The numbers are reflective of the current tax rate. Where before, if you hadn’t done this change, it would still have been a 35 percent tax effect within OCI. It’s a mess.”
But while banks and insurance companies said the plan should be mandatory, many other groups, including large audit firms, said nonfinancial companies should not be forced to make the change. KPMG LLP told the FASB in a comment letter that the costs for some organizations to isolate and reclassify only the amounts resulting from the newly enacted federal corporate income tax rate could outweigh the financial benefits.
A majority of the FASB agreed.
“I suspect that a lot of the noncommenters — we heard from a lot of financial institutions — in commercial industrial America hasn’t even thought about this issue because the trade journals weren’t telling them to comment to us,” FASB Vice Chairman James Kroeker said. “They’re going to wake up and say, ‘I have to calculate this for what reason?’ They’ll wake up and say this provides no benefit.”
FASB member Christine Botosan cast the lone vote against making the plan optional.
“I’ve got some concerns with allowing an option because there’s a potential for it to be applied in a way that is not unbiased,” Botosan said. “If you have losses sitting in OCI and you’re concerned about, or want to report the highest earnings possible, you’re going to have an incentive not to do that reclassification because, ultimately, when that loss gets recycled out of OCI and into income, it’s going to be net of a larger amount of tax, which is going to understate the amount of tax relative to reality.”
The FASB is expected to publish the final update to U.S. GAAP in short order. Its research staff told the board that a ballot draft would be in board members’ hands as early as February 9.
While the FASB got largely positive marks from groups in favor of the proposal, one prominent investor group decried it in a February 2 comment letter. The CFA Institute said that booking the tax change effect to retained earnings instead of in the income statement will mask the change in the value of the deferred tax asset or liability on the value of the company. Investors do not pay as much attention to the statement of stockholders’ equity accounts than they do the income statement, the institute wrote. (See Securities Analysts Raise Concerns About Plan to Limit Effect of New Tax Law in the February 7, 2018, edition of Accounting & Compliance Alert.)
Tony Sondhi, a member of the FASB’s Emerging Issues Task Force (EITF) and a coauthor of the letter, said he remained concerned about the FASB’s path on the issue. In addition, the Codification of U.S. GAAP does not define “stranded tax effect,” which can create even further confusion for investors and analysts.
“The question is, how does one develop guidance for something that one does not define?” Sondhi said.
He also questioned why the FASB moved so quickly on this project when tax rate changes happen frequently as laws change.
“This haste that appears to be present in here, I just would like to understand better why it was so essential to do it so quickly,” he said.