As mentioned in previous announcements we have made regarding tax reform, The Tax Cuts and Jobs Act (the “Act”) represents one of the most significant overhauls to the United States federal tax code since 1986 and could have a significant impact on a company’s domestic and international tax consequences. The magnitude of the changes may give rise to certain operational challenges and constraints for entities when complying with the requirements under ASC Topic 740 upon issuance of an entity’s financial statements for the 2017 reporting period.
The U.S. Securities and Exchange Commission (the “SEC”) recently announced publication of staff guidance for publicly traded companies, audit firms, and others interested parties to help ensure timely public disclosures of the accounting impacts of the Act. The staff is issuing guidance in Staff Accounting Bulletin (“SAB”) 118 to address certain fact patterns where the accounting for changes in tax laws or tax rates under ASC Topic 740 is incomplete upon issuance of an entity’s financial statements for the reporting period in which the Act is enacted. Under the staff guidance in SAB 118, in the financial reporting period the Act is enacted, the income tax effects of the Act (i.e., only for those tax effects in which the accounting under ASC 740 is incomplete) would be reported as a provisional amount based on a reasonable estimate (to the extent a reasonable estimate can be determined), which would be subject to adjustment during a “measurement period” until the accounting under ASC 740 is complete. The measurement period would be limited under the staff’s guidance.
Income Tax Accounting Implications of the Tax Cuts and Jobs Act
The Act changes existing United States tax law and includes numerous provisions that will affect businesses. The Act, for instance, introduces changes that impact U.S. corporate tax rates, business-related exclusions, and deductions and credits. The Act will also have international tax consequences for many companies that operate internationally.
ASC Topic 740 provides accounting and disclosure guidance on accounting for income taxes under generally accepted accounting principles (“U.S. GAAP”). This guidance addresses the recognition of taxes payable or refundable for the current year and the recognition of deferred tax liabilities and deferred tax assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. ASC Topic 740 also addresses the accounting for income taxes upon a change in tax laws or tax rates. The income tax accounting effect of a change in tax laws or tax rates includes, for example, adjusting (or re-measuring) deferred tax liabilities and deferred tax assets, as well as evaluating whether a valuation allowance is needed for deferred tax assets.
Companies will potentially encounter a situation in which the accounting for certain income tax effects of the Act will be incomplete by the time financial statements are issued. Questions have arisen regarding different approaches to the application of the accounting and disclosure guidance in ASC Topic 740 to such a situation.
Use of Reasonable Estimates
If the accounting for certain income tax effects of the Act is not completed by the time the company’s financial statements are to be issued, the SEC staff would not object, according to SAB 118, to the company including in its financial statements a reasonable estimate of the effects that it had carefully determined. The reasonable estimate would be reported as a provisional amount in the company’s financial statements during a “measurement period”.
The Measurement Period
The measurement period begins in the reporting period that includes the Act’s enactment date and ends when an entity has obtained the accounting requirements under ASC Topic 740. During the measurement period, the SEC expects companies to act in good faith.
Changes in subsequent reporting periods
During the measurement period, an entity may need to reflect adjustments to its provisional amounts upon obtaining, preparing, or analyzing additional information about facts and circumstances that existed as of the enactment date that, if known, would have affected the income tax effects initially reported as provisional amounts. Further, an entity may also need to report additional tax effects during the measurement period, based on obtaining, preparing, or analyzing additional information about facts and circumstances that existed as of the enactment date that was not initially reported as provisional amounts. Any income tax effects of events unrelated to the Act should not be reported as measurement period adjustments.
Prior to the reporting period in which the Act was enacted, Company X did not recognize a deferred tax liability related to unremitted foreign earnings because it overcame the presumption of the repatriation of foreign earnings. Upon enactment, the Act imposes a tax on certain foreign earnings and profits at various tax rates. Based on Company X’s facts and circumstances, it was not able to determine a reasonable estimate of the tax liability for this item for the reporting period in which the Act was enacted by the time that it issues its financial statements for that reporting period; that is, Company X did not have the necessary information available, prepared, or analyzed to develop a reasonable estimate of the tax liability for this item (or evaluate how the Act will impact Company X’s existing accounting position to indefinitely reinvest unremitted foreign earnings). As a result, Company X would not include a provisional amount for this item in its financial statements that include the reporting period in which the Act was enacted, but would do so in its financial statements issued for subsequent reporting periods that fall within the measurement period, beginning with the first reporting period falling within the measurement period by which the necessary information became available, prepared, or analyzed in order to develop the reasonable estimate, and ending with the first reporting period within the measurement period in which Company X was able to obtain, prepare, and analyze the necessary information to complete the accounting under ASC Topic 740.
Assume a similar fact pattern as Example 1; however, Company Y was able to determine a reasonable estimate of the income tax effects of the Act on its unremitted foreign earnings for the reporting period in which the Act was enacted. Company Y, therefore, reported a provisional amount for the income tax effects related to its unremitted foreign earnings in its financial statements that included the reporting period the Act was enacted. In a subsequent reporting period within the measurement period, Company Y was able to obtain, prepare and analyze the necessary information to complete the accounting under ASC Topic 740, which resulted in an adjustment to Company Y’s initial provisional amount to recognize its tax liability.
Example 2 – Company Z has deferred tax assets (assume Company Z was able to comply with ASC Topic 740 and re-measure its deferred tax assets based on the Act’s new tax rates) for which a valuation allowance may need to be recognized (or released) based on application of certain provisions in the Act. If Company Z determines that a reasonable estimate cannot be made for the reporting period the Act was enacted, no amount for the recognition (or release) of a valuation allowance would be reported. In the next reporting period (following the reporting period in which the Act was enacted), Company Z was able to obtain, prepare and analyze the necessary information in order to determine that no valuation allowance needed to be recognized (or released) in order to complete the accounting under ASC Topic 740.
For more information or resources to assist with accounting for income taxes under ASC Topic 740, please contact your Caroprese tax professional.
 Source: SAB 118