United States

FASB addresses AOCI reclassification related to tax reform

FINANCIAL REPORTING INSIGHTS  | 

The Financial Accounting Standards Board (FASB) met on February 7, 2018 to discuss comment letters received related to the proposed Accounting Standards Update (ASU), Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The FASB decided to move forward with a final ASU that will allow entities to make a one-time reclassification from accumulated other comprehensive income (AOCI) to retained earnings for the effects of remeasuring deferred tax liabilities and assets originally recorded in other comprehensive income (OCI) as a result of the change in the federal tax rate by the Tax Cut and Jobs Act (TCJA).

To illustrate why the FASB decided to change its guidance, consider a situation in which an entity has a calendar year end and was in the 35 percent tax bracket prior to the TCJA and is in the 21 percent tax bracket after the TCJA. During 2016, the entity recognized a deferred tax asset of $35 related to an item that was recorded as a debit to OCI of $100. In 2017, the gross amount remained in AOCI, and as a result of the TCJA, the entity reduces the deferred tax asset and recognizes tax expense from continuing operations of $14 (which is the difference between the deferred tax asset before the TCJA of $35 and the deferred tax asset after the TCJA of $21). If the FASB did not change its guidance, the net amount in AOCI related to this item would remain at $65, even though it would be expected to reverse in the future at a net amount of $79 ($100 less the related tax effects at 21 percent), which creates a stranded debit of $14 in AOCI. The FASB’s decision to change its guidance will allow the entity to reclassify $14 between retained earnings and AOCI and eliminate that stranded debit in AOCI.

Several comment letters expressed concern that in certain situations the complexities of calculating the amount that should be reclassified may offset the potential benefit, and therefore, constituents requested the reclassification be optional instead of required. The FASB agreed and modified the proposal to allow for implementation to be optional until they complete a more comprehensive project on backwards tracing. If an entity does not elect to make the reclassification, it would be required to disclose that fact, as well as its accounting policy for reversing stranded tax impacts in AOCI. 

The effective date for all entities that elect to make the reclassification is for fiscal years beginning after December 15, 2018, including interim periods within those years. Early adoption will be permitted in financial statements for fiscal years or interim periods that have not been issued or made available for issuance. While the FASB voted to move forward with the final ASU, the changes to its guidance will not be part of U.S. generally accepted accounting principles until the final ASU has been issued. Therefore, entities that file or issue financial statements prior to the release of the final ASU will not be allowed to make the reclassification until the subsequent period when the final ASU is issued. Upon adoption, an entity can elect to apply the guidance either: (a) at the beginning of the period of adoption or (b) retroactively to the TCJA enactment date. Certain transition disclosures will be required.