OUTLOOK: Five Areas Where New Tax Law Affects Accounting

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By Denise Lugo and Steven Marcy

Companies need to prepare for the financial reporting effects of the new tax law by establishing a good accounting plan to find answers to questions as they arise, accountants and analysts told Bloomberg Tax.

Here are five developing areas that warrant close monitoring:

1. Repatriation Tax

Multinational companies, now subject to a one-time repatriation tax—also called a transition tax—on post-1986 accumulated foreign earnings under the 2017 tax law ( Pub. L. No. 115-97), might find calculating the liability they expect to pay complex, accountants said. That complexity comes from having to determine the amount of the liability at two different tax rates: a 15.5 percent rate for cash or cash equivalents and an 8 percent rate for illiquid assets.

In determining the cash amount, cash is measured at three different dates. Companies wouldn’t discount the liability recorded, even though it may be paid over an eight-year period on an interest-free basis.

The repatriation tax on foreign earnings will be especially important to companies in the technology, health care, and pharmaceutical sectors, and other large multinationals with significant offshore cash balances and international operations, said Rick Lane, senior vice president at Moody’s Investors Service Inc. in New York. “Of course they will be repatriating significant amounts of their offshore money,” he said.

2. Remeasuring Deferred Tax Items

Because of the reduction of the corporate tax rate to 21 percent from 35 percent, companies must remeasure their deferred tax assets and liabilities at the new rate.

Calendar-year companies will remeasure their deferred tax items to 21 percent in their fourth quarter of 2017. Fiscal-year companies have a blended tax rate in their year of enactment. For example, a June 30 fiscal year-end company has a blended tax rate that goes back to its fiscal year beginning July 1, 2017, and ending June 30, 2018. Therefore, a company may have to schedule the reversal of its temporary differences for two years to remeasure its deferred tax items.

Depending on whether a company is in an overall deferred tax asset position or a deferred tax liability position, the effect of adjusting its deferred tax items to the new statutory rate will result in either a tax expense or a tax benefit, recorded in its income tax expense in the period of enactment.

“One item of caution I have for companies,” Joan Schumaker, a partner at Ernst & Young LLP in New York, said, “is that even though the Dec. 22 enactment date may be very close to their year-end date, they need to make sure that they’re determining their temporary differences as of the enactment date, rather than just using the balances at their year-end date and remeasuring those year-end balances to the new tax rate in continuing operations.”

The adjustment companies make for the rate change could create amounts that are stranded in accumulated other comprehensive income. Companies will be allowed a one-time reclassification to retained earnings of those stranded amounts, the U.S. Financial Accounting Standards Board said Jan. 10.

3. Putting SAB 118 Into Practice

The Securities and Exchange Commission issued Staff Accounting Bulletin 118 on Dec. 22 to provide greater clarity to investors and preparers about the financial reporting impacts of the new tax law. It has succeeded, in part, analysts and investors said.

The guidance allows financial report preparers to provide estimates of the tax law’s effects and adjust them quarterly until they can complete the full accounting of the effects. The full accounting must be completed by Dec. 22, 2018, the SEC said.

But SAB 118 also has “driven some confusion” for investors as companies determine and book shifting provisional estimates over the next year of deferred tax assets and deferred tax liabilities, Todd Castagno, an equity analyst at Morgan Stanley & Co. in New York, said Jan. 11.

“Investors should note they may not receive full tax reform information perhaps expected in the next earnings release or 10-K/Q filing,” Castagno and other Morgan Stanley analysts wrote in a Jan. 2 client note. “The mix of evolving tax and accounting requirements will likely create volatility in key financial statement line items and metrics as certain effects will be booked before others and provisional amounts will require adjustment.”

Global law firm White & Case LLP advised companies in a Jan. 11 note to “carefully consider the impact that future tax rates and any impairments could have on contractual provisions, such as debt maintenance covenants and executive compensation targets, and update disclosure as necessary.”

4. What to Disclose

SAB 118 also provides guidelines for what companies need to disclose for calendar year-end statements ending Dec. 31, or fiscal-year filers with the period that includes Dec. 22, the date the tax legislation was signed. If a company has a September year-end, it would file its disclosures in the first quarter ended Dec. 31, 2017.

“When reviewing disclosure costs and redundancies, SEC 118 is an exception. It’s designed for short-term application in a transition time,” said Rick Day, a partner and national director of accounting at RSM US LLP in Davenport, Iowa. “In essence, it affords companies a one-time extension to ensure time for accurate financial impact assessment, meaning it won’t be repeated and therefore isn’t overly burdensome for companies to apply.”

Filers would have to include a paragraph in their tax footnote that explains the impact of the tax law changes on their rates. The disclosures should provide clarity as to where a company is in its analysis.

“Even if companies have a fairly precise estimate, many may choose to apply the estimate disclosure for added cover in case unexpected impacts arise as they file their tax returns and refine the numbers,” said Al Cappelloni, a partner at RSM in Boston. “You see that now in the business combination area, which provides a similar measurement time period window.”

Other disclosures should provide accounting estimates on the effects of the tax rule, why the estimate is being made, or if the number is too complex to be estimated.

5. Reporting Burden

The whole idea behind SAB 118 was to reduce the reporting burden. Several analysts and accounting firms in notes to clients called it the SEC staff’s “Christmas present” to the profession.

But it can have effects that will ripple throughout the financial statement, including additional information in the management discussion and analysis (MD&A) section, an area where many companies might not have focused.

Jeffrey Hochman of Willkie Farr and Gallagher LLP, a New York-based law firm whose clients include financial services companies, said in a Dec. 29 report that in preparing MD&As, “companies must evaluate and discuss the impact of the Tax Cuts Act, to the extent material, with respect to the just completed fiscal year as well as its impact on future periods as a ‘known trend.’”

The MD&A and other reporting burdens will “vary widely by company,” Hochman said Jan. 12. He said there is “clearly a requirement to not only disclose and analyze historical results,” but also to disclose in MD&A “known trends and to make them reflective of future results.”

A company that might have a future tax liability should describe it in the MD&A qualitatively, if not quantitatively, Hochman said.

Still, SAB 118 has made financial reporting under the law easier. It “is another instance of the SEC staff coming out with helpful guidance in light of new developments and providing flexibility, and making disclosures good as well as flexible,” Hochman said.

To contact the reporters on this story: Denise Lugo in New York at dlugo@bloombergtax.com; Steven Marcy in Washington at smarcy@bloombergtax.com

To contact the editor responsible for this story: S. Ali Sartipzadeh at asartipzadeh@bloombergtax.com

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