Current financial reporting, governance, and risk management topics
On Jan. 18, 2018, the federal banking agencies, including the Board of Governors of the Federal Reserve System (Fed), the Federal Deposit Insurance Corp. (FDIC), and the Office of the Comptroller of the Currency (OCC), issued guidance, "Interagency Statement on Accounting and Reporting Implications of the New Tax Law." The guidance covers certain accounting implications of H.R. 1, known as the Tax Cuts and Jobs Act, signed into law on Dec. 22, 2017.
These are some key points of the guidance:
- U.S. generally accepted accounting principles (GAAP) require recognition of the effect of changes in tax laws or rates in income tax expense in the period in which the legislation is enacted, which is the quarter ended Dec. 31, 2017.
- For Dec. 31, 2017, call reports, deferred tax assets (DTAs) and deferred tax liabilities (DTLs) should be remeasured at the enacted tax rates expected to apply when these assets and liabilities are expected to be realized or settled.
- As described later, on Jan. 18, 2018, the Financial Accounting Standards Board (FASB) issued a proposed Accounting Standards Update (ASU), "Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects From Accumulated Other Comprehensive Income," to require reclassification from accumulated other comprehensive income (AOCI) to retained earnings of the stranded tax effects created when DTAs and DTLs previously established through other comprehensive income are remeasured through the income statement. Early adoption of the ASU would be permitted for any financial statements not yet issued or made available for issuance. Recognizing the fourth-quarter call report is due Jan. 30, 2018, prior to issuance of the final ASU, the agencies permit institutions to apply the proposed reclassification guidance for Dec. 31, 2017, call reports, if they plan to early adopt the ASU.
- The potential for net operating loss (NOL) carryback may be considered when determining the amount of temporary difference DTAs, if any, subject to the deduction thresholds in the regulatory capital rules for purposes of calculating and reporting regulatory capital as of Dec. 31, 2017 (and, for a fiscal year institution, through the end of its last tax year beginning on or before that date).
- For tax years beginning on or after Jan. 1, 2018, the new tax law generally removes the ability to use NOL carrybacks to recover taxes paid in prior tax years. As a result, the realization of all temporary difference DTAs will be dependent on future taxable income, and they will be subject to the deduction thresholds for regulatory capital purposes in such tax years.
- Institutions should make a good faith effort to reasonably estimate the effects of the new tax law when preparing Dec. 31, 2017, and subsequent regulatory reports. Given its magnitude, evaluating tax law changes and accompanying financial reporting impacts could take time. As described later, the SEC provided guidance to registrants on how to address the unknown effects, and the FASB has clarified the SEC guidance is also available to private companies and not-for-profit entities. The agencies permit using this guidance for regulatory reporting.
On Jan. 3, 2018, the federal banking agencies announced they are finalizing revisions to the call report as part of their burden-reducing initiative. Changes include removing or consolidating some existing items as well as increasing certain reporting thresholds and will take effect for the June 30, 2018, report date.
Several call report schedules will be revised to address accounting changes for equity securities and other equity investments (as a result of ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities”) that take affect for institutions that qualify as public business entities in the first quarter of 2018. These revisions will be effective for March 31, 2018, call reports.
In addition, regulators decided not to proceed with the revisions to the regulatory reporting instructions on determining past-due status that were included in the June 2017 proposed changes.
In response to recent hurricanes, wildfires, and other disasters, the Fed, the FDIC, the OCC, and the National Credit Union Administration jointly issued on Dec. 15, 2017, guidance on how examiners will approach financial institutions affected by major natural disasters. According to the guidance, examiners evaluating composite ratings for institutions should review management’s overall response and recovery planning. The guidance also provides that the regulatory agencies will work with institutions affected by major disasters to determine needs, reschedule exams, and extend deadlines as needed.
“The examiner’s assessment may result in assigning a lower component or composite rating for some affected institutions,” the regulators said. “However, in considering the supervisory response for institutions accorded a lower rating, examiners should give appropriate recognition to the extent to which weaknesses are caused by external problems related to the major disaster and its aftermath.” According to the guidance, actions normally taken for lower-rated banks “may not be necessary,” provided the bank has planned appropriately and is on track for recovery.
The guidance provides instructions for examiners on how to assess component CAMELS or ROCA ratings, focusing on losses associated with a disaster, identification of credits affected, prudent planning by management, disaster-related effects on earnings, and fluctuations in liquidity associated with customer cash flow needs.
On Dec. 15, 2017, FinCen published a periodic update to its frequently asked questions providing guidance to financial institutions for efforts with Bank Secrecy Act (BSA) compliance. Revisions include currency transaction reporting (CTR) issues related to government officials conducting large currency transactions and criteria for determining whether a state-licensed check-cashing business is eligible for exemption from CTR requirements under the BSA.
President Donald Trump signed into law H.R. 1, which could have significant income tax accounting implications for companies. Under U.S. GAAP, companies are required to account for the effects of this change in the period of enactment, and they should execute their implementation plans immediately so they are prepared to record and disclose the financial reporting effects. The date of enactment was Dec. 22, 2017.
A number of GAAP implementation questions have arisen because of the new law. Please see “From the Federal Financial Institution Regulators,” “From the FASB,” and “From the SEC” for further guidance.
At its meeting on Jan. 10, 2018, the FASB discussed the financial reporting effects of H.R. 1. The issues of highest interest to banks include:
- Reclassification of disproportionate tax effects. The FASB decided the effects, limited only to the rate change differential in H.R. 1, on deferred tax assets and liabilities related to items presented in AOCI will be reclassified from AOCI to retained earnings. This means most banks will be able to count these amounts as part of regulatory capital.
On Jan. 18, 2018, the FASB issued a proposed ASU, “Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects From Accumulated Other Comprehensive Income.” Comments are due Feb. 2, 2018. Early adoption would be permitted for periods for which financial statements have not yet been issued or have not yet been made available for issuance. The FASB expects to issue a final ASU in February.
As already noted, the federal banking agencies issued guidance, on Jan. 18, 2018, that permits banks to record this reclassification in the fourth-quarter call reports, which are due Jan. 30, 2018.
- Application of SEC Staff Accounting Bulletin (SAB) 118 by private entities. The FASB staff does not object to private companies applying SAB 118. “FASB Staff Q&A on Whether Private Companies and Not-for-Profit Entities Can Apply SAB 118,” was issued on Jan. 12, 2018.
As already noted, the federal banking agencies encourage banks to review SAB 118 and FASB Staff Q&A. They also provide guidance on how to disclose significant provisional amounts, information limitations, and measurement period adjustments for call reporting.
- Measurement of alternative minimum tax (AMT) credit carryforwards. The FASB staff view is these amounts should not be discounted, and the board concurred. The FASB staff view is memorialized in a draft, “FASB Staff Q&A on Whether to Discount Alternative Minimum Tax Credits That Become Refundable,” which was discussed at the Jan. 18, 2018, Emerging Issues Task Force (EITF) meeting. The FASB staff received minor wording changes and plans to post a final FASB Staff Q&A to the implementation portal within days.
The tax act made substantial changes to the corporate AMT. The corresponding changes in financial reporting for AMT credits could provide an immediate regulatory capital boost to affected banks. However, any banks whose AMT credits are subject to limitation under Internal Revenue Code Section 382 (due to ownership changes of “loss corporations”) should take care before changing their balance sheet reporting of these credits. See the Crowe article “Changes to Corporate Alternative Minimum Tax Raise Issues and Opportunities for Banks” for more information.
For banks with international activities, the board also agreed with the following preliminary staff views, all discussed at the Jan. 18, 2018, EITF meeting:
- Entities subject to the base erosion anti-abuse tax (BEAT) in future years should record it as a period cost. They should continue to record deferred tax assets and liabilities at the regular statutory rate, even if they expect to be subject to BEAT indefinitely. The FASB staff view is memorialized in a draft, "FASB Staff Q&A on the Accounting for the Base Erosion Anti-Abuse Tax."
- Entities required to include in taxable income their global intangible low-taxed income (GILTI) should be allowed to make a policy choice of whether to recognize deferred taxes for basis differences expected to reverse as GILTI in future years. The FASB staff view is memorialized in a draft, “FASB Staff Q&A on the Accounting for Global Intangible Low-Taxed Income.”
- The tax liability recorded for the one-time deemed repatriation of foreign earnings and profits, which can optionally be paid over eight years, should not be discounted. The FASB staff view is memorialized in a draft, “FASB Staff Q&A on Whether to Discount the Tax Liability on the Deemed Repatriation.”
During the EITF meeting, the FASB staff noted it received minor wording changes and plans to post final FASB Staff Q&As to the implementation portal within days.
On Jan. 5, 2018, the FASB issued a proposed ASU, “Leases (Topic 842): Targeted Improvements,” to simplify implementation of the leases standard by providing the following:
- An optional transition method would allow an entity to apply the transition provisions at its adoption date rather than at the earliest comparative period presented in its financial statements. Under this transition method, an entity would initially apply the requirements to all leases that exist at the adoption date, with the cumulative effect recognized as an adjustment to retained earnings as of the adoption date. The FASB is proposing this additional transition method in response to preparers experiencing unanticipated costs and complexities associated with the modified retrospective transition method, particularly the comparative period reporting requirements.
- For lessors, a practical expedient would allow them to not separate nonlease components from the related lease components if certain criteria are met (that is, the pattern of recognition must be the same and it must be an operating lease). Examples of nonlease components include equipment maintenance services, common area maintenance services in real estate, or other goods or services provided to the lessee apart from the right to use the underlying asset. The FASB is proposing this option in response to stakeholder observations that, except for presentation and disclosure, the timing and pattern of revenue recognition would be the same regardless of whether the nonlease components are separated from the lease component. It would be elected by class of underlying assets, and would require certain disclosures.
Comments are due Feb. 5, 2018.
At its Dec. 13, 2017, board meeting, the FASB discussed both general implementation activities for the current expected credit loss (CECL) model as well as the following issues:
- Troubled debt restructurings (TDRs): For entities that elect to use a prepayment-adjusted effective interest rate (EIR) in a discounted cash flow (DCF) approach, the board decided to provide transition relief. Rather than calculate the prepayment-adjusted EIR for each TDR as of the date preceding the asset restructure, entities may calculate the prepayment-adjusted EIR based on the original contractual terms of the loan and prepayment assumptions as of the date of adoption.
- Variable-rate financial assets: The board decided to allow entities that are estimating credit losses on variable-rate financial assets using a DCF method to determine the EIR and expected cash flows (including expected prepayments and defaults) using their own expectations (projections) of future interest rate environments, provided those expectations are reasonable and supportable. However, the use of projections will not be required.
- Subsequent events: An entity should not recognize in the financial statements the effects of any events that occur after the balance sheet date but before financial statements are issued or are available to be issued. However, subsequent events should be reflected in the estimate of credit losses if an entity determines an error correction is necessary.
With H.R. 1 signed into law by the president on Dec. 22, 2017, the SEC’s Office of the Chief Accountant (OCA) and Division of Corporation Finance (Corp Fin) staff issued interpretive guidance for public companies, auditors, and other stakeholders to consider as they contemplate disclosures for investors related to the accounting impacts of the tax reform law.
The SEC staff acknowledges that – given magnitude of H.R. 1 and the accompanying conference report – evaluating tax changes and accompanying financial reporting impacts will take time for some entities. To that end, the staff guidance addresses the various levels of uncertainty in measuring the impact and how an issuer should evaluate those situations; it also provides a period of time, not to extend beyond one year, to refine provisional amounts.
The interpretive guidance includes a new SAB and a new Compliance and Disclosure Interpretation (C&DI).
SAB 118 (codified in SAB Topic 5.EE) provides the following measurement model and disclosure considerations.
In scenarios where an entity’s measurement of accounting for changes in tax laws is:
- Complete (in whole or in part): The effects should be recorded in the reporting period.
- Incomplete but can be reasonably estimated: The provisional effects (or changes in the provisional effects) should be recorded in the reporting period.
- Incomplete and cannot be reasonably estimated: The entity should not record provisional amounts based on the act and should continue to record the effects based on the tax laws that were in effect immediately prior to the act being enacted. For those income tax effects for which an entity is not able to determine a reasonable estimate, the entity should record the effects in the first reporting period in which a reasonable estimate can be determined.
The provisional amount should be adjusted during the measurement period “upon obtaining, preparing, or analyzing additional information about facts and circumstances that existed as of the enactment date that, if known, would have affected the income tax effects initially reported as provisional amounts.”
Supplemental disclosures should be provided about the material financial reporting effects of the act for which the accounting is incomplete, including:
- Qualitative disclosure of the areas for which the accounting is incomplete
- Items recorded as provisional amounts
- Current or deferred tax amounts for which the income tax effects have not been completed
- Reasons for the incomplete accounting
- Additional information or analysis that still needs to occur, and other information relevant to why the registrant was not able to complete the accounting
- Nature and amount of measurement period adjustments recognized in the reporting period
- Effect of measurement period adjustments on the effective tax rate
- When the accounting for the income tax effects of the act is completed
Within the interpretation, question 110.02 related to Item 2.06 (“Material Impairments”) on Form 8-K, addresses the following:
- Remeasurement of a DTA in order to incorporate the effects of the newly enacted tax rates or other provisions of the tax reform law is not an impairment under GAAP and therefore does not trigger a Form 8-K filing requirement. The staff observes that there could be financial statement implications, including whether it is more likely than not that the DTA will be realized.
- If using the measurement period approach in SAB 118, the impairment, or a provisional amount with respect to that possible impairment, should be disclosed in the next periodic report.
On Dec. 11, 2017, SEC Chairman Jay Clayton issued a “Statement on Cryptocurrencies and Initial Coin Offerings,” to highlight the rapid growth in the cryptocurrency and initial coin offering (ICO) markets. In his statement, Clayton shared that, to date, no ICOs have been registered with the SEC, and no exchange-traded products (such as exchange-traded funds) holding cryptocurrencies or other assets related to cryptocurrencies have been approved for listing and trading by the SEC. He also emphasized securities law matters that should be considered by market professionals (such as lawyers, accountants, and consultants) when evaluating transactions in the cryptocurrency and ICO markets. Finally, he provided some sample questions for investors to consider when evaluating a cryptocurrency or ICO investment opportunity.
Subsequent to this statement, on Jan. 4, 2018, Clayton and two commissioners issued “Statement of Chairman Jay Clayton and Commissioners Kara M. Stein and Michael S. Piwowar on ‘NASAA Reminds Investors to Approach Cryptocurrencies, Initial Coin Offerings and Other Cryptocurrency-Related Investment Products With Caution’ by NASAA.” This statement commends and discusses the North American Securities Administration Association’s (NASAA) release.
On Dec. 28, 2017, the PCAOB updated its staff guidance on implementing changes to the auditor’s report, originally published on Dec. 4, 2017. These report changes are effective for audits for fiscal years ending on or after Dec. 15, 2017. The updated guidance, “Changes to the Auditor’s Report Effective for Audits of Fiscal Years Ending on or After December 15, 2017,” includes additional information on how to determine auditor tenure.
The IIA released the December 2017 issue of Tone at the Top, “Artificial Intelligence: The Future for Internal Auditing,” which defines artificial intelligence (AI) as “hardware and software that are capable of behaving like the human brain: learning, reasoning, adapting, analyzing, making decisions, and performing complex and judgment-driven tasks.” The issue notes that when AI is combined with the massive quantity of data available, it can significantly enhance productivity and take over mundane tasks. The report also speaks to understanding the risks and limits of AI.
The publication also discusses the role of company boards in dealing with the “AI/internal audit intersection,” and it provides questions that boards should ask internal auditors regarding their use of, plans for, applications of, and understanding of AI.