ASU 2018-02 Addressing Stranded Tax Effects Resulting from U.S. Tax Reform

On February 14, 2018, the FASB issued Accounting Standards Update (ASU) 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments in this ASU address a narrow-scope financial reporting issue related to the tax effects that may become “stranded” in accumulated other comprehensive income (AOCI) as a result of the Tax Cuts and Jobs Act (TCJA). The CPEA issued a report in January on the effects of the TCJA on accounting for income taxes.

FASB Accounting Standards Codification (FASB ASC) 740, Income Taxes, requires deferred tax liabilities and assets to be adjusted for the effect of a change in tax laws or rates.  Under FASB ASC 740-20-45-15, the impact of the rate reduction applied to temporary differences (including those related to other comprehensive income [OCI] or acquisition accounting still within the measurement period) is recorded in income from continuing operations. In the case of unrealized gains or losses in OCI, this could result in a disproportionate effect (dangling debits or credits, or stranded tax effects) left in AOCI as a result of the prohibition of the backwards tracing of unrealized gains and losses on available-for-sale securities, pursuant to FASB ASC 740- 20-45-3 (i.e., an entity wouldn’t consider where the previous tax effects were allocated in the financial statements).

Under the amendments in ASU 2018-02, an entity may elect to reclassify the income tax effects of the TCJA on items within AOCI to retained earnings. If an entity elects to reclassify the income tax effects of the TCJA, the amount of that reclassification should include the following:

·         The effect of the change in the U.S. federal corporate income tax rate on the gross deferred tax amounts and related valuation allowances, if any, at the date of enactment of the TCJA related to items remaining in AOCI. The effect of the change in the U.S. federal corporate income tax rate on gross valuation allowances that were originally charged to income from continuing operations should not be included.

·         Other income tax effects of the TCJA on items remaining in AOCI that an entity elects to reclassify.

If an entity does not elect to reclassify the income tax effects of the TCJA, it should provide certain disclosures, as indicated below.

Practice Note. The amendments in ASU 2018-02 only relate to the reclassification of the income tax effects of the TCJA. The underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected.

Required Disclosures

The amendments in ASU 2018-02 add the following disclosure requirements:

• An entity should disclose a description of the accounting policy for releasing income tax effects from AOCI
• An entity that elects to reclassify the income tax effects of the TCJA should disclose, in the period of adoption, both of the following:
• A statement that an election was made to reclassify the income tax effects of the TCJA from AOCI to retained earnings
• A description of other income tax effects related to the application of the TCJA that are reclassified from AOCI to retained earnings, if any
• An entity that does not elect to reclassify the income tax effects of the TCJA should disclose, in the period of adoption, a statement that an election was not made to reclassify the income tax effects of the TCJA from AOCI to retained earnings.

Effective Date

The amendments in ASU 2018-02 are effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period, (1) for public business entities for reporting periods for which financial statements have not yet been issued and (2) for all other entities for reporting periods for which financial statements have not yet been made available for issuance.

The amendments in ASU 2018-02 should be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the TCJA is recognized.

The CPEA will issue a second report on the accounting effects of the TCJA in March, to cover developments since our January report.