Tax Law Rekindles Debate Over Prohibited Accounting Rule

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By Denise Lugo

A banned and complex rule that would require companies to consider a transaction’s prior history in accounting for its tax effects is being reconsidered by U.S. accounting rulemakers in response to federal corporate tax rate changes.

Banking and insurance groups have told the Financial Accounting Standards Board that the long-prohibited practice, called “backwards tracing,” could serve as a tool to help align financial reporting with the new tax law ( Pub. L. No. 115-97).

The accounting method requires the effects of a change in a deferred tax credit or charge to be included in the same line item in which the deferred taxes were originally recorded. The practice is allowed under International Accounting Standards Board rules.

“One of the reasons the board at the time didn’t require it was because of the complexity of requiring entities to go figure out what generated the initial entry,” FASB Vice Chairman James Kroeker said during a May 10 discussion of the board’s Small Business Advisory Committee. “Historically people said requiring backwards tracing could be hard—I don’t know if systems have changed that or not.”

Complexity Outweighs Benefits?

FASB’s income-tax accounting rules, however, prohibit “backwards tracing” because the board determined that getting the needed historical information to comply with that rule could prove challenging for companies and burden them with substantial costs.

FASB—over two decades ago—also questioned whether the resulting information would really provide any benefit to analysts and investors. The board concluded that the costs of applying the “backwards tracing” requirements outweighed the benefits. The topic, however, has been debated by accountants for many years.

“What transpired was you have these things that occurred years and years ago, and for simplicity, FASB said book the changes in income from continuing operations so you wouldn’t have to go back and figure out where they came from,” Peter Vinci, a consultant at Resources Global Professionals in Charlotte, N.C., told Bloomberg Tax.

Generally, the impact of tax changes have been minor. “So why go through all this pain,” Vinci said. “On the flip side IASB permits it.”

Resurfaces With Tax Rate Change

The topic resurfaced with the enactment of the new tax law in December, which reduced the corporate tax rate from 35 percent to 21 percent.

Accounting rules require that when a tax law or rate changes, companies have to adjust deferred tax assets (DTAs) and deferred tax liabilities (DTLs). Companies, however, said this requirement resulted in an accounting mismatch when they remeasured some balance sheet items to conform to the lower tax rate.

FASB issued earlier this year narrow rules to enable companies to reclassify certain tax effects from accumulated other comprehensive income, an equity item on the balance sheet, to retained earnings.

Banking and insurance groups told the board, however, that although those changes would address the balance sheet mismatch, FASB needed to go further. They suggested allowing companies the option to use backwards tracing. The topic is currently on FASB’s research agenda.

According to FASB documents, backwards tracing requires to reexamine events of prior years in conjunction with:

  •  temporary differences, such as the the difference between pretax book income and taxable income that will eventually reverse or eliminate itself;
  •  incremental tax rates that are used for intraperiod allocation, which may be different from statutory tax rates; and
  •  operating loss and tax credits that are carried back to prior periods, or forward to future periods.

To contact the reporter on this story: Denise Lugo in Norwalk, Conn. at dlugo@bloombergtax.com

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

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