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On the Horizon: accounting for income taxes in interim periods

RFP
Contents Current reporting issue
     Interim reporting: accounting for income taxes in interim periods

FASB updates U.S. GAAP Taxonomy for recent ASUs SEC
     Staff confirms expanded non-public review of certain draft registration statements for BDCs
     SEC accepts 2018 GAAP Financial Reporting Taxonomy

AICPA
     PEEC proposes revisions to information systems services to attest clients
     Technical Q&As on benefit plans issued
     Technical Q&A on partnership tax accounting released

GASB issues Q1 2018 newsletter

IASB issues update on March meetings
     March 2018 IFRIC update issued



Current reporting issue Interim reporting: accounting for income taxes in interim periods Most public business entities that report based on a calendar year have already completed the accounting for income taxes in their most recent annual financial statements and, in doing so, have recognized certain tax effects of the Tax Cuts and Jobs Act of 2017 (the Act) during their fourth quarter. These entities have also considered FASB and SEC staff views on certain accounting and financial reporting issues related to the Act, along with a FASB amendment to existing guidance that provides an option to reclassify stranded tax effects resulting from the Act from accumulated other comprehensive income to retained earnings (see NDS 2018-03, “Accounting and financial reporting implications of the Tax Cuts and Jobs Act of 2017”).

These public business entities will soon be preparing interim financial statements for their first quarter ending March 31, 2018 and will need to apply the guidance on accounting and disclosure requirements for income taxes in interim periods under ASC 740-270, Income Taxes – Interim Reporting. This guidance does not change as a result of the Act, but entities will need to consider the tax effects of the Act when applying ASC 740-270 for interim financial statements in 2018. Because the reduction to the corporate tax rate is effective in tax years beginning after December 31, 2017, entities should consider the new 21 percent federal income tax rate when calculating the income tax provision (or benefit) beginning with the first quarter in 2018. In addition, several provisions under the Act are effective for calendar-year taxpayers beginning January 1, 2018, which should also be considered when determining the estimated annual effective tax rate for the full year, including

  • Tax expense associated with the Global Low-Taxed Intangible Income (GILTI) provisions
  • Tax expense associated with the Base Erosion and Anti-Abuse Tax (BEAT)
  • The expiration of certain credits and incentives
  • The repeal of the manufacturing activities deduction (domestic production activities deduction, or DPAD)
  • Additional limitations on deductible meals and entertainment expenses
  • Additional limitations on deductible compensation

Entities will need to consider each applicable provision of the Act to determine how it may impact the overall estimated effective tax rate. The guidance in Staff Accounting Bulletin (SAB) 118 does not apply to accounting that arises in periods following the period containing the Act’s enactment date. While additional implementation guidance on certain provisions of the Act is still anticipated, the estimated annual effective tax rate should represent the entity’s best estimate of the total tax provision in relation to the best estimate of worldwide pretax ordinary income. When additional implementation guidance is available, the estimated annual effective tax rate should be updated to reflect the new information.

The major provisions of ASC 740-270 that affect interim reporting of income taxes are summarized below.

Under ASC 740-270, entities calculate the income tax provision for an interim period by distinguishing between elements recognized in the income tax provision through (1) applying an estimated annual effective tax rate (ETR) to a measure of year-to-date operating results referred to as “ordinary income (or loss),” and (2) discretely recognizing specific events (referred to as “discrete items”) as they occur.

Entities must often make significant estimates and exercise judgment when determining the income tax provision (or benefit) for an interim period, including whether an element applies to either ordinary income or loss, which should be recognized in the estimated annual ETR, or a discrete item, which should be recognized in the period in which it occurs. Entities are required to make estimates of both operating results for the fiscal year and the total income tax provision or benefit, including current and deferred taxes for each jurisdiction where the entity is subject to tax. One common area of estimate involving management judgment includes determining whether a valuation allowance might be necessary for a deferred tax asset at the end of the year related to originating deductible temporary differences and carryforwards during the year, or whether compensation cost recognized for a share-based payment award is expected to result in a tax deduction. Entities should revise the ETR, as necessary, as of the end of each successive interim period during its fiscal year based on changes to any of these estimates and judgments.

The ETR expected to apply for the full fiscal year is applied to year-to-date ordinary income (or loss) at the end of each interim period to compute the year-to-date income tax (or benefit) applicable to ordinary income or loss. Income tax expense (or benefit) related to each discrete item is individually determined and recognized in the interim period when the discrete item occurs. As a result, the income tax provision (or benefit) for an interim period might include elements that apply to ordinary income or loss, as well as elements related to discrete items. Discrete items include significant items that are unusual or that occur infrequently. Determining which items are unusual or infrequent often requires a significant degree of judgment. The guidance in ASC 220-20-60-1, Income Statement – Reporting Comprehensive Income: Unusual or Infrequently Occurring Items, states that “unusual” events are those that are highly abnormal and clearly unrelated (or only incidentally related) to the ordinary and typical activities of the entity, while “infrequent” events are those that would not reasonably be expected to recur in the foreseeable future.

Under ASC 740-270-30-36, entities subject to income taxes in multiple jurisdictions should apply one overall ETR instead of separate ETRs for each jurisdiction when calculating the interim-period income tax or benefit related to consolidated ordinary income (or loss) for the year-to-date interim period, except in certain circumstances. The income tax provision or benefit for each interim period is the difference between the year-to-date amount for the current period and the year-to-date amount for the prior period.

Entities should consider the enacted income tax rates in each jurisdiction, as well as the anticipated effects of a naked credit associated with deferred tax liabilities that may not be used as a source of income, to support the realization of deferred tax assets. Other common examples of items considered in calculating the estimated annual effective tax rate include certain anticipated investment tax credits, special deductions such as percentage depletion, the effects of capital gains or other preferential tax rates, and tax-planning alternatives. However, entities should not consider the income tax related to the following elements when determining the estimated ETR, since these items are examples of discrete events that are accounted for in the period when they arise:

  • Excess tax deductions related to certain share-based payment awards
  • Interest and penalties recognized on uncertain tax positions
  • Changes in tax law or tax status
  • Significant unusual or infrequently occurring items that are reported separately
  • Items that are reported net of tax, such as discontinued operations or the cumulative effect of a change in accounting principle
  • Effects of measurement-period adjustments associated with either provisional amounts or amounts that cannot be reasonably estimated related to the initial impact of the Act

See the March 22 On the Horizon for a discussion of how an entity should remeasure its existing deferred tax liabilities and assets on the enactment date when it has consistently not asserted that foreign accumulated earnings are indefinitely reinvested. An entity might change its indefinite reinvestment assertion for investments in foreign subsidiaries and joint ventures (often referred to as an “APB 23 assertion”) during any interim period in the fiscal year as facts and circumstances change. The income tax effects of a change in an APB 23 assertion should be accounted for in the interim period when the change occurs and recognized as a discrete item in that period. However, if an entity has historically not made an APB 23 assertion and continues to recognize a deferred tax liability associated with investments in foreign subsidiaries and joint ventures, the income tax effects of the foreign subsidiary or joint venture’s estimated unremitted earnings for the current fiscal year should be considered when determining the ETR for an interim period, including any effects of the Act that will impact the eventual tax effects of such earnings.

Additionally, entities should consider the tax effect of any valuation allowance that might be necessary at the end of the year for a deferred tax asset related to originating deductible temporary differences and carryforwards during the year when calculating the ETR in an interim period. However, if a change in valuation allowance during an interim period results from a change in circumstances that causes a change in judgment about the realizability of the beginning-of-year deferred tax asset, the income tax effect of the change in valuation allowance is accounted for as a discrete item in that interim period.

In completing interim tax accounting and reporting, entities should pay particular attention to the exceptions to the general rules in this area. One exception is the limitation on recognizing a tax benefit for year-to-date losses in certain circumstances, such as when the entity’s year-to-date loss exceeds the expected annual loss. Another exception is the use of a year-to-date ETR model for components of income or for jurisdictions in which a reliable estimate cannot be made. Additionally, there is an exception for loss jurisdictions if no tax benefit can be realized. The interim accounting guidance is inherently complex due to the exceptions to the general rules and how interim accounting and reporting guidance interacts with other topics, such as the allocation of tax expense to the various components of comprehensive income, also known as “intraperiod allocation of tax expense.”



FASB updates U.S. GAAP Taxonomy for recent ASUs The FASB staff issued improvements and implementation guidance to the U.S. GAAP Taxonomy related to reporting requirements included in the following ASUs:
  • ASU 2018-03, Technical Corrections and Improvements to Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities
  • ASU 2018-04, Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 117 and SEC Release No. 33-9273
  • ASU 2018-05, Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118



SEC Staff confirms expanded non-public review of certain draft registration statements for BDCs The statements in the Accounting and Disclosure Information (ADI) described below represent the views of the Division of Investment Management. The ADI is not a rule, regulation, or statement of the SEC, nor has the Commission approved or disapproved its content.

The SEC’s Division of Investment Management (IM) recently issued Accounting and Disclosure Information (ADI) 2018-01, “Expanded Use of Draft Registration Statement Review Procedures for Business Development Companies,” to confirm that it will accept draft registration statements submitted by business development companies (BDCs) for non-public review relating to:
  • Initial registrations under Section 12(b) of the Exchange Act
  • Securities Act offerings within one year of an initial offering or of an initial registration under Exchange Act Section 12(b)

IM issued the ADI following an inquiry related to the application of the Division of Corporation Finance’s 2017 announcement on its expanded non-public review process for certain draft registration statements. Refer to On the Horizon dated July 13, 2017 and August 24, 2017 for further discussion on the Division of Corporation Finance’s announcements on the expanded non-public review process.

SEC accepts 2018 GAAP Financial Reporting Taxonomy The FASB announced that the SEC has accepted the 2018 GAAP Financial Reporting Taxonomy and the 2018 SEC Reporting Taxonomy.

The 2018 GAAP Financial Reporting Taxonomy contains updates for accounting standards and other improvements made to the official taxonomy previously used by SEC issuers.

The SEC Reporting Taxonomy, which is new for 2018, contains elements necessary to meet SEC requirements for (1) financial schedules required by the SEC, (2) condensed consolidating financial information for guarantors, and (3) disclosures about oil- and gas-producing activities. This taxonomy also includes dimensional elements that are commonly used by filers for which specific recognition and measurement guidance is lacking in U.S. GAAP.



AICPA PEEC proposes revisions to information systems services to attest clients The AICPA’s Professional Ethics and Executive Committee (PEEC) issued an exposure draft proposing revisions to the Information Systems Design, Implementation, or Integration interpretation of AICPA ET Section 1.295.145. PEEC believes certain clarifications will engender a better understanding of where significant threats to independence exist.

The proposal covers:
  • Design, development, and implementation services related to an attest client’s financial or nonfinancial information system
  • Post-implementation systems and network maintenance, support, and monitoring

Comments on the proposal are due by June 15.

Technical Q&As on benefit plans issued The AICPA issued new technical questions and answers (Q&As) for auditing benefit plans under Technical Inquiry Service (TIS) Section 6935, SSAE No. 16 Reports – Employee Benefit Plans, renamed as Multiemployer Plans. TIS Sections 6935.01 and .02 were moved from TIS Section 6933.11, “Audit Procedures When SSAE No. 16 Reports Are Not Available,” and TIS Section 6933.12, “Allocations Testing of Investment Earnings When a Type 2 SSAE No.16 Report is Available.”

The new Q&As relate to multiemployer plan payroll compliance services as follows:
  • TIS Section 6935.03, “Multiemployer Plan Payroll Compliance Services – Engagement Letter”
  • TIS Section 6935.04, “Multiemployer Plan Payroll Compliance Services – Representation Letters From Engaging Party”
  • TIS Section 6935.05, “Multiemployer Plan Payroll Compliance Services – Representations Not Obtained from Responsible Parties”
  • TIS Section 6935.05, “Multiemployer Plan Payroll Compliance Services – Use of AUP or Other Reports as Audit Evidence”

Certain other TISs were transferred from Section 6935 to Section 6933, Auditing Employee Benefit Plans.

Technical Q&A on partnership tax accounting released The AICPA has also issued TIS 7200.09, “Tax Accounting Considerations Under Partnership Audit Regime,” to address whether a partnership should account for the amounts it subsequently pays to the IRS for certain underpayments of tax, interest, and penalties as either income tax of the partnership (under ASC 740, Income Taxes) or as a transaction with, and income tax of, the partners.

The Bipartisan Budget Act of 2015 includes rules for audits of partnerships (referred to as the “IRS partnership audit regime”) that allow the IRS to collect underpayments of tax from the partnership rather than from the partners, unless the partnership elects to pass the adjustments through to its partners.

TIS 7200.09 states that because income taxes on partnership income should continue to be attributed to the partners, regardless of when these taxes were paid, the partnership should account for amounts it pays to the IRS under the IRS partnership audit regime as a distribution from the partnership to the partners.



GASB issues Q1 2018 newsletter The GASB issued the Q1 2018 edition of its GASB Outlook e-newsletter, which includes summaries of the Board’s projects and key activities.



IASB issues update on March meetings All decisions reached at IASB meetings are tentative and may be changed or modified at future meetings. Board decisions become final only after completion of a formal ballot to issue a new Standard or Interpretation or to publish an Exposure Draft.

The IASB has issued the March 2018 Update summarizing the tentative decisions reached during its March public meetings. The Board discussed the following topics:
  • Disclosure initiative: principles of disclosure
  • Dynamic risk management
  • Rate-regulated activities
  • Proposed amendments to IAS 8, Accounting Policies and Accounting Estimates
  • Improvements to IFRS 8, Operating Segments
  • Post-implementation review of IFRS 13, Fair Value Measurement
  • Management commentary

March 2018 IFRIC update issued The IASB’s IFRS Interpretations Committee (IFRIC) has issued the March 2018 Update summarizing the decisions reached by the Committee during its March 13 public meeting.

Decisions on an IFRIC Interpretation become final only after the Committee has formally voted on the Interpretation, which is then sent to the IASB for ratification.



© 2018 Grant Thornton LLP, U.S. member firm of Grant Thornton International Ltd. All rights reserved. This Grant Thornton LLP On the Horizon provides information and comments on current accounting and SEC reporting issues and developments. It is not a comprehensive analysis of the subject matter covered and is not intended to provide accounting or other advice or guidance with respect to the matters addressed in this publication. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this publication. For additional information on topics covered in this publication, contact a Grant Thornton client-service partner.