The Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) 2019-12, Simplifying the Accounting for Income Taxes on Dec. 18, 2019. The ASU includes several provisions aimed at reducing complexity for financial statement preparers and increasing consistency and clarity for financial statement readers.
The new guidance is effective for public business entities with fiscal years, and the related interim periods, beginning after Dec. 15, 2020. For other entities, the ASU is effective for fiscal years beginning after Dec. 15, 2021, and interim periods within fiscal years beginning after Dec. 15, 2022. The guidance in the ASU may be adopted prior to the effective dates; however, companies must adopt all of the changes identified in ASU 2019-12 at the same time. The changes made by ASU 2019-12 are summarized as follows:
Intraperiod tax allocation
The ASU removes the exception to the incremental approach for intraperiod allocation of tax expense when a company has a loss from continuing operations and income from other items that are not included in continuing operations, such as income from discontinued operations, or income recorded in Other Comprehensive Income. The general rule under ASC 740-20-45-7 is that the tax effect of pretax income or loss from continuing operations should be determined by a computation that does not consider the tax effects of items that are not included in continuing operations (the so-called incremental approach). Previously, companies could consider the impact on a loss from continuing operations of items in discontinued operations or other comprehensive income. However, under the amended guidance, companies should not consider the effect of items outside of continuing operations in calculating the tax effect on continuing operations.
For example, a company with a loss in continuing operations but a gain from the increase in value of available-for-sale securities should no longer consider the effect of the gain in other comprehensive income when calculating income tax expense for continuing operations. Prior to the amendment, a loss company in a full valuation allowance, that would have otherwise recorded no tax benefit in this situation, would have recorded a tax benefit in continuing operations, offset by a tax expense in other comprehensive income. Under the amendment, a company with a loss in continuing operations that would not result in a tax benefit, due to a full valuation allowance, and a gain on discontinued operations would not consider the gain in determining the amount of benefit to recognize for the loss in continuing operations.
The exception to the incremental approach was removed for a number of reasons. Included among those reasons were that some preparers and auditors had difficulty applying the exception, that the exception to the incremental approach creates counterintuitive outcomes because it results in a benefit being allocated to continuing operations with an offsetting expense in another component of income. In addition, users of financial statements and preparers indicated the exception is difficult to apply, is often overlooked, and does not provide any perceived benefit.
The ASU includes two changes to interim accounting. The first amendment removes the exception to the general method for interim period calculations when the year-to-date loss exceeds the anticipated annual loss. Previously, the guidance limited the amount of benefit recorded in interim periods by determining a dollar amount limitation based on statutory rates for companies with a year-to-date ordinary loss and anticipated full-year ordinary loss. The benefit was limited to the benefit that could be realized by applying the statutory tax rate to the year-to-date loss, or the amount of benefit that could be recognized as a deferred tax asset. See the following example from ASC 740-270-55-16, where the stricken text shows the changes from ASU 2019-12:
The entity has ordinary income and losses in interim periods for the year to date. The full tax benefit of the anticipated ordinary loss and the anticipated tax credits will be realized by carryback. The full tax benefit of the maximum year-to-date ordinary loss can also be realized by carryback.