Yesterday, the staffs of the Office of Chief Accountant and Corp Fin issued guidance regarding disclosure of the accounting impact of the Tax Cuts and Jobs Act, just signed into law on December 22. As discussed in this PubCo post, companies have been fretting about the timing of the new Act and whether they will be able to accurately determine the impact of the tax changes on their financial statements in time to file their annual and quarterly reports with the SEC. That is largely because, under U.S. accounting rules, companies must generally reflect the impact of these tax changes in the quarter they are signed into law, even if they go into effect at a future date. The staff has been talking with companies about their concerns and has responded with this guidance, which, Corp Fin Director Bill Hinman observes, “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.” According to the related SEC Statement, the “staff guidance, which reflects the approach taken in prior situations where legislative changes could significantly affect financial reporting, provides a ‘measurement period’ for issuers to evaluate the impacts of the [Act] on the their financial statements. Importantly, the guidance also sets forth staff expectations for disclosure to investors during the measurement period.” Merry Christmas finance departments and auditors!

To help companies address the challenges arising out of the magnitude of the changes in the Act, the staff of OCA has issued SAB 118 and the staff of Corp Fin has issued CDI 110.02.

Staff Accounting Bulletin 118

ASC Topic 740 provides accounting and disclosure guidance on accounting for income taxes under GAAP, including “guidance addressing changes in tax laws or tax rates to be recognized in the financial reporting period that includes the enactment date, which is the date the Act is signed into law.” SAB 118 acknowledges that the “guidance in ASC Topic 740 does not, however, address certain circumstances that may arise for registrants in accounting for the income tax effects of the Act. The staff understands from outreach that registrants 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 for the reporting period that includes the enactment date of December 22, 2017. The SAB address certain fact patterns where the accounting for changes resulting from the Act will be incomplete when the company issues its financial statements for that reporting period.”

Incomplete tax effects. Under SAB 118, in the reporting period in which the Act was enacted, for those “income tax effects” of the Act that are incomplete (i.e., the company did not have the necessary information available, prepared or analyzed—including computations—in reasonable detail to complete the accounting under ASC Topic 740), the company would report “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 is discussed below, but in no circumstances would extend beyond one year from the date of enactment.

In the example provided in the SAB, some of the income tax effects of the Act have been completed by the time the company issues its financial statements, but some have not. The SAB provides that, only with respect to the tax effects that are incomplete, to the extent the company can make a “reasonable estimate” for those effects, the staff would not object if the company uses the reasonable estimate in its financial statements. In fact, the staff believes it would be inappropriate to exclude the reasonable estimate if one has been determined. The estimate should be included in the financials in the first reporting period in which it is determined. The reasonable estimate would be reported as a “provisional amount” during a “measurement period.” Examples of provisional amounts would include “reasonable estimates that give rise to new current or deferred taxes based on certain provisions within the Act, as well as adjustments to existing current or deferred taxes that existed prior to the Act’s enactment date.”

If the company does not have the information available, prepared or analyzed that is necessary to make a reasonable estimate, the staff does not expect the company to include a provisional amount, and, in that case, the company “should continue to apply ASC Topic 740 (e.g., when recognizing and measuring current and deferred taxes) based on the provisions of the tax laws that were in effect immediately prior to the Act being enacted. That is, the staff does not believe an entity should adjust its current or deferred taxes for those tax effects of the Act until a reasonable estimate can be determined.”

Below is a summary of this advice from the guidance:

“Company A must first reflect the income tax effects of the Act in which the accounting under ASC Topic 740 is complete. These completed amounts would not be provisional amounts. Company A would then also 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. For any specific income tax effects of the Act for which a reasonable estimate cannot be determined, Company A would not report provisional amounts and would 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. For those income tax effects for which Company A was not able to determine a reasonable estimate (such that no related provisional amount was reported for the reporting period in which the Act was enacted), Company A would report provisional amounts in the first reporting period in which a reasonable estimate can be determined.”

Measurement period. The measurement period begins in the reporting period that includes the date of enactment of the Act 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. 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.” The company may need to reflect adjustments during the measurement period or to report additional tax effects if it obtains, prepares or analyzes additional information about facts and circumstances that existed as of the enactment date. Any income tax effects of events unrelated to the Act should not be reported as measurement period adjustments. Any provisional amounts or adjustments to provisional amounts included during the measurement period “should be included in income from continuing operations as an adjustment to tax expense or benefit in the reporting period the amounts are determined.” The guidance includes some examples that apply the guidance in connection with unremitted foreign earnings and deferred tax assets.

Disclosures. The guidance also describes the supplemental disclosures that should be included in the financial statements where the accounting under ASC Topic 740 is incomplete, such as the reasons why the accounting is incomplete and the additional information needed. More specifically, the supplemental disclosures should describe the following:

  1. “Qualitative disclosures of the income tax effects of the Act for which the accounting is incomplete;
  2. Disclosures of items reported as provisional amounts;
  3. Disclosures of existing current or deferred tax amounts for which the income tax effects of the Act have not been completed;
  4. The reason why the initial accounting is incomplete;
  5. The additional information that is needed to be obtained, prepared, or analyzed in order to complete the accounting requirements under ASC Topic 740;
  6. The nature and amount of any measurement period adjustments recognized during the reporting period;
  7. The effect of measurement period adjustments on the effective tax rate; and
  8. When the accounting for the income tax effects of the Act has been completed.”

The staff guidance in SAB 118 applies only to the Act. The staff encourages companies to consult with staff members for interpretative assistance.

Compliance and Disclosure Interpretation 110.02

This new CDI is intended to clarify how companies relying on SAB 118 should comply with their obligations under Item 2.06 of Form 8-K with respect to disclosure of material impairments of assets. Under the CDI, the re-measurement of a deferred tax asset to incorporate the effects of the Act is not an impairment under ASC Topic 740 and, therefore, does not trigger an obligation to file under Item 2.06 of Form 8-K; however, “the enactment of new tax rates or tax laws could have implications for a registrant’s financial statements, including whether it is more likely than not that the [deferred tax asset] will be realized.” [Emphasis added.] A company that uses the “measurement-period” approach of SAB 118 that concludes “that an impairment has occurred due to changes resulting from the enactment of the Act may rely on the Instruction to Item 2.06 and disclose the impairment, or a provisional amount with respect to that possible impairment, in its next periodic report.” The relevant instruction provides that “[n]o filing is required under this Item 2.06 if the conclusion [regarding the material charge for the impairment] is made in connection with the preparation, review or audit of financial statements required to be included in the next periodic report due to be filed under the Exchange Act, the periodic report is filed on a timely basis and such conclusion is disclosed in the report.”