Knocking on House Doors: What the Blueprint for Tax Reform Means for Financial Reporting

In a sense financial reporting and taxes are analogous to a sprinter and a marathon runner─Usain Bolt and Haile Gebrselassie, opposing branches of a single tree. Regulations on financial reporting exist to standardize the earnings reporting process, consciously acknowledging that companies possess a deep corporate desire for continuous and consistent financial growth. Tax regulation, housed on IRS pillars, however, is designed to battle a much different dilemma. Corporations, both domestic and abroad, spend heavily in an effort aimed at tax avoidance. The difference in intent is startling, and in the wake of the house tax reform proposal, financial reporting standards and tax regulation seem further apart than ever.

Unintended Consequences

The tax reform proposal released on June 24, 2016 by the House Ways and Means Committee, “A Better Way Forward on Tax Reform” was designed to promote national growth across commercial and individual spectra. The details of the proposal and its potential tax impacts have been discussed ad nauseum, but the effects of the blueprint could extend far beyond the tax realm:

  • Economists have hypothesized that the “border-adjustment tax,” which exempts exports from taxation and no longer permits a company to deduct imported inputs, will push the U.S. dollar index significantly higher. A strong dollar would result in more travel by US residents, as they take advantage of weaker currencies abroad, but the focus here is on the translation risk of financial reporting.  Multi-national companies that sell services in foreign currencies risk lower revenue numbers when converted to U.S. dollars (in perfect economic theory the price of the services and products should adjust in the long-run to negate the currency adjustment). 
  • Non-GAAP Measures might experience the largest transition, as the reform could possibly mean the extinction of such evaluators as the infamous “EBITDA,” earnings before interest, taxes, depreciation, and amortization, which commonly graces corporate press releases and management discussion and analysis. 
  • The complete elimination of tax depreciation for both real and personal property will greatly elevate the adjustment necessary to reconcile taxable income with net income reported on the financial statements. Billions of dollars of undepreciated asset basis on the corporate statements of financial position will no longer appear on corporate tax returns. 
  • The removal of the interest expense deduction could have far-reaching effects on financial reporting, possibly triggering a radical shift in the makeup of debt to equity financing. This could force companies to opt for Initial Public Offerings (IPO’s) and private equity rounds instead of commercial bank funding. Traditional metrics for evaluating the financial health of organizations, such as liquidity and solvency ratios, may lose their potency altogether.

Reform on Our Doorsteps

Treasury Secretary Steven Mnuchin, in an interview with CNBC’s Becky Quick on February 22nd, 2017, stated "we want to get this done by the August recess" when asked about a target date for tax reform. It is welcomed news for many analysts who believe that U.S. corporate tax reform is long overdue, and that it will assist U.S. companies to compete on an equal playing field with their foreign competitors. However, like nearly all legislation, the aggregate effects often swim in murkier waters.

By: Todd Cheney, CPA, Accounting Policy and Practice Editor

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