Small Business Forum FASB Simplification Initiative Related to Income Taxes

EDITOR Barbara A. Wech, Ph.D. Department of Management, Information Systems, and Quantitative Methods University of Alabama at Birmingham COLLAT School of Business 710 13th St. South Department of Management, Information Systems, & Quantitative Methods Birmingham, Alabama 35233 bawech@uab.edu

In recent years the Financial Accounting Standards Board (FASB) launched the Simplification Initiative to reduce unnecessary complexity in the various areas of accounting. The Simplification Initiative has resulted in several narrow scope changes to the accounting guidance while maintaining the decision usefulness of the financial information. The FASB has issued the following Accounting Standards Updates (ASU) in an effort to simplify the guidance in Accounting Standards Codification (ASC) Topic 740, entitled Income Taxes: • ASU 2019-12, entitled Simplifying the

Accounting for Income Taxes. • ASU 2016-16, entitled Intra-Entity transfers of Assets Other Than Inventory. • ASU 2015-17, entitled Balance Sheet

Classification of Deferred Taxes.

This guidance reflects changes to the accounting standards that are a direct result of the Simplification Initiative. In general, the objective of the FASB with this new guidance is to reduce the cost and complexity associated with the accounting requirements related to income taxes while maintaining the decision usefulness of the financial information.

GUEST WRITERS Dr. Steve Grice, CPA Sorrell College of Business School of Accountancy Botts Professor of Accounting 334-670-3136 sgrice@troy.edu

Dena Mitchell, CPA Sorrell College of Business School of Accountancy Assistant Professor of Accounting Eliminated Troy University Exceptions dsmitchell@troy.edu

to the Provisions of ASC Topic 740 (ASU 2019-12)

The FASB issued ASU 2019-12 to reduce the complexity of the accounting guidance by eliminating the following exceptions to the provisions of ASC Topic 740.

Incremental approach for intraperiod tax

allocation. ASC 740-20-45-7 indicates that the tax effect of pretax income or loss from continuing operations should be determined by a computation that does not consider the tax effects of items that are not included in continuing operations. For example, assume that a reporting entity has a $1,000 ordinary loss from continuing operations and an $1,800 gain from discontinued operations that is a capital gain for tax purposes. Also, assume the reported entity determined that a

deferred tax asset (with no allowance) would have been recognized for the loss if the capital gain did not exist. Assuming the tax rates are 21% on ordinary income and 21% on capital gains, the income tax expense is allocated between continuing operations and discontinued operations as follows:

$168 – Total Tax Expense ($1,800 capital gain less $1,000 ordinary loss = $800 x 21%) (210) – Tax benefit allocated to the loss from operations ($1,000 ordinary loss x 21%) $378 – Increment tax expense allocated to gain on discontinued operations

Prior to ASU 2019-12, the exception to this incremental approach was that all items (e.g., discontinued operations) be considered in determining the amount of tax benefit that is allocated to continuing operations. Using the pre-2019-12 guidance, the tax benefit allocated to the loss from operations would assume that the $1,000 ordinary loss was used to offset a portion of the $1,800 capital gain that otherwise would have been taxed at 21%. Thus, $210 ($1,000 x 21%) of the tax benefit would have been allocated to continuing operations.

Transition from equity method investment to foreign subsidiary (or vice-versa).

Paragraphs ASC 740-30-25-15 and 74030-25-16 contained two exceptions to the general principles in ASC Topic 740 related to the recognition of a deferred tax liability when there is a transition from an equity method investment to a foreign subsidiary (or vice-versa). Specifically, paragraph 740-3025-15 indicated that the parent company of a foreign subsidiary that changes to an equity method investment should not recognize deferred taxes on the undistributed earnings that existed prior to the change in status until those earnings are remitted. When an equity method investment becomes a foreign subsidiary, paragraph 740-30-2516 indicated that the deferred tax liability for the outside basis previously recognized could not be derecognized until dividends received exceeded earnings from the foreign subsidiary after the date of transition. ASU 2019-12 eliminated these two exceptions to the general principles in ASC Topic 740. The FASB believes that these changes will mitigate the complexity associated with having to separately track the “frozen” outside basis differences and any basis differences arising subsequent to the change in status from an equity method investment to a foreign subsidiary (or vice-versa).

Interim-period income tax model. Prior to ASU 2019-12, the guidance in ASC 740270, entitled Interim Reporting, provided an exception to the general interim-period income tax model for calculating income taxes in an interim period when a year-todate loss exceeds the anticipated loss for the year. Specifically, paragraph 740-270-30-28 limited the income tax benefit recognized in the interim period in cases when the year-to-date loss exceeded the anticipated loss for the year. ASU 2019-12 removes this exception, thus, entities will recognize the entire benefit that is determined using the interim-period income tax model without limitation. The illustrative case found in paragraph 740-270-55-16 of the Implementation Guidance and Illustrations was modified to reflect this change. Practitioners may find it helpful review this illustrative case when implementing this new guidance.

ASU 2019-12 also simplified the accounting for income taxes with the following requirements.

Franchise tax recognition. Under ASU 201912, entities are now required to recognize a franchise (or similar) tax partially based on income as an income-based tax and account

for any incremental amount incurred as a non-income-based tax. This requirement would apply if, for example, an entity is required to pay the greater of an incomebased tax or a capital-based tax. In addition, the provision simplifies deferred tax asset and liability calculations with the specification that the statutory income tax rate should be used but that temporary difference reversals need not be considered with regards to a valuation allowance when a tax base is other than the entity’s income. Consider the following example.

A state’s franchise tax on corporations is set at the greater of 0.30 percent of the corporation’s net taxable capital or 5 percent of the corporation’s net taxable earned surplus (defined by the state’s tax statute as federal taxable income). The amount of franchise tax equal to the tax on the corporation’s net taxable earned surplus is an income tax. Assuming the corporation’s net taxable capital is $2,000,000 and net taxable earned surplus is $110,000, the amount reported as franchise” tax on the corporation is $500 while state income tax is reported as $5,500.

The franchise tax is the greater of: Net Taxable Capital $2,000,000 Rate 0.30% $2,000,000 x 3% $6,000 or Net Taxable Earned Surplus (federal taxable income) $110,000 Rate 5% $110,000 x 5% $5,500

Per the state’s rules, the franchise tax is $6,000. Under ASU 2019-12, this tax would be reported as $5,500 of income tax and $500 of non-income-based tax (or franchise tax). Computed franchise tax exceeding the amount of tax on the corporation’s net taxable earned surplus ($500 in this example) should not be presented as a component of income tax expense. Consider instead, using the same state’s rules:

The franchise tax is the greater of: Net Taxable Capital $1,500,000 Rate 0.30% $2,000,000 x 3% $4,500 or Net Taxable Earned Surplus (federal taxable income) $110,000 Rate 5% $110,000 x 5% $5,500

Per the state’s rules, the franchise tax is $5,500. Under ASU 2019-12, state income tax is reported as $5,500 while no franchise tax is reported.

Under this subtopic, deferred tax assets and liabilities are required to be recognized for temporary differences existing as of the date of the statement of financial position using the tax rate to be applied to the corporation’s net taxable earned surplus (5 percent in the preceding example).

Goodwill step up in tax basis. ASU 201912 provides the following clarification for the recognition of a deferred tax asset resulting from a step up in tax basis of goodwill when the goodwill originates from either the prior business combination producing the goodwill, or a step up in basis related to a separate transaction.

When the step up in tax basis results from the business combination from which the goodwill originated, a deferred tax asset will only be recognized for the amount of additional goodwill exceeding the remaining balance of book goodwill.

However, if the step up in tax basis of goodwill is deemed to result from a separate transaction from the business combination originally producing the goodwill, a deferred tax asset will be reported for the amount of the newly created tax goodwill. (In this situation, there will not be a book basis for the goodwill.) Situations resulting in a step up in tax basis of goodwill that may be considered as separate

transactions from the business combination originally resulting in the goodwill can include:

A. a significant lapse in time occurs between the transactions, B. the transaction resulting in the step up in tax basis requires more than a simple tax election, C. the entity achieves the step up in tax basis by incurring a tax cost cash outlay or by sacrificing existing tax attributes, D. the business combination did not include the transaction resulting in the step up in tax basis, E. a valuation of the business or goodwill occurs after the date of the business combination results in the step up in basis, or F. the step up in basis of the goodwill does not directly result from the settlement of liabilities recorded as a result of the original business combination.

It should be noted that any of the above examples which take place during the same measurement period as the business combination could be considered as separate transactions.

Enacted change in tax laws in interim periods. Prior to ASU 2019-12 there were conflicting opinions regarding the reporting of the effect of an enacted change in tax laws or rates. The differences arose from the timing of the enactment date of the change and the calculation of the annual effective tax rate computation. ASU 2019-12 clarifies that the effects of tax rate or law changes should be reflected in the reporting for the interim period including the enactment date. For example, the corporate tax rate changed in late 2017 (12/22/2017) to a flat rate of 21%, effective for taxable years beginning after December 31, 2017. According to the FASB’s clarifying guidance in ASU 2019-12, entities would measure their deferred tax assets and liabilities and current payables in the interim period which included the enactment date. For a calendar year entity then, deferred tax assets and liabilities, and current payables would be recalculated using the 21% tax rate for the fourth quarter of 2017 instead of waiting to recalculate starting in January of 2018.

These amendments also specify that there is no requirement to allocate the consolidated amount of tax expense (current and deferred provisions) to a legal entity that is not subject to tax in its separate financial statements. The amendments specify that an entity may elect to do so on an entity-by-entity basis when the entity is both a.) not subject to tax and b.) disregarded by the taxing authority, such as a single owner LLC.

Effective Date

This guidance in ASU 2019-12 is effective for nonpublic entities for fiscal years beginning after December 15, 2021 and interim periods within fiscal years beginning after December 15, 2022. The guidance is effective for public entities for fiscal years beginning after December 15, 2020 and interim periods within those years. Early adoption of this guidance is acceptable.

Income Tax Consequences of Intra-Entity Asset Transfers (ASU 2016-16)

The FASB issued ASU 2016-16 to simplify the provisions ASC Topic 740 related to intraentity asset transfers. ASC Topic 740 identifies certain basic requirements for accounting for income taxes as of the date of an entity’s financial statements. Specifically, an entity should (1) recognize a tax liability (or asset) for the estimated taxes payable (or refundable) on the tax returns for current and prior years and (2) recognize a deferred tax asset or liability for the estimated future tax effects related to temporary difference and carryforwards. However, paragraph 740-10-25-3e. in the preASU 2016-16 guidance prohibited entities from applying these basic requirements (i.e., not allowed to recognize current and deferred income taxes) for intra-entity asset transfers until the asset had been sold to a third-party.

The ASU 2016-16 amendments eliminated this recognition prohibition for intra-entity asset transfers other than inventory. Thus, the

reporting entity should recognize the current and deferred income taxes when those asset transfers occur. For example, the entity should recognize the income tax consequences of an intra-entity transfer of equipment. Importantly, the amendments did not change the recognition exception as it relates to intraentity inventory transfers.

Thus, the reporting entity should not recognized the current and deferred income taxes related to such inventory transfers until the inventory has been sold to a third-party. The amended exception provision in paragraph 740-10-25-3e. indicates that the reporting entity should not recognize a deferred tax asset for the difference between the tax basis of inventory in the buyer’s tax jurisdiction and the carrying value as reported in the consolidated financial statements as a result of an intra-entity inventory transfer between taxpaying components in the same consolidated group. As in the pre-ASU 2016-16 guidance, entities should account for income taxes paid on intra-entity profits on inventory within the consolidated group by following ASC Topic 810, entitled Consolidation. The provisions of ASB 2016-16 became effective for nonpublic entities beginning with December 31, 2019 calendar year end financial statements.

Classification of Deferred Taxes (ASU 2015-17)

The FASB issued ASU 2015-17 to simplify the provisions of ASC 740 related to the balance sheet classification of deferred taxes. The pre-ASU 2015-17 guidance required reporting entities to classify deferred tax assets and liabilities within a tax jurisdiction as current or noncurrent based on the assets or liabilities that give rise to the deferred tax amounts. For example, a deferred tax amount that is related to a difference between book and tax depreciation generally is classified as noncurrent since the depreciable asset is classified as noncurrent. When a deferred tax amount is not related to an asset or a liability (e.g., NOL carryforward), the guidance requires the deferred tax amount to be classified according to the expected reversal date. In addition, the guidance required that all current (noncurrent) deferred tax assets and liabilities be offset and presented as a single current (noncurrent) amount in the classified balance sheet.

To illustrate, assume that Adam Co. had the following deferred tax amounts at December 31, Year 1:

Deferred Tax Deferred Tax Assets Liabilities

Current $12,000 $10,000 Noncurrent $15,000` $19,000

Total $27,000 $29,000

Pursuant the pre-2015-17 guidance, Adam Co. should report a net current deferred tax asset of $2,000 ($12,000 minus $10,000) and a net noncurrent deferred tax liability of $4,000 ($19,000 minus $15,000) in its December 31, Year 1 classified balance sheet.

Simplified Guidance for Balance Sheet Classification of Deferred Taxes

ASU 2015-17 simplified the guidance related to the balance sheet classification of deferred taxes by eliminating the current classification for deferred taxes. That is, the new guidance stipulates that all deferred tax assets and liabilities (as well as any valuation allowance) within a tax jurisdiction should be classified as noncurrent in a classified balance sheet. To illustrate, assume an entity had the deferred tax amounts shown in the table above at December 31, Year 1. Pursuant the new guidance, Adam Co. should report a net noncurrent deferred tax liability of $2,000 ($29,000 minus $27,000) in its December 31, Year 1 classified balance sheet. Importantly, the new guidance does not change the requirement to offset the deferred tax assets and liabilities and report a single amount. The provisions of ASU 2015-17 became effective for nonpublic entities beginning with December 31, 2018 calendar year-end financial statements. The transition disclosures varied depending on whether the entity implemented the new guidance using a prospective or retrospective approach.

Published September 30, 2019

Accountancy has long been a stressful, highstakes profession. Ensuring that a client’s books are in order is a task that comes with great responsibility. In today’s age, that sense of stress is compounded by reams of discourse about how the rise of advanced technology will forever alter the way we do our jobs, if not replace them altogether. We have to deal with innovation happening at an ever-increasing rate, which can induce a feeling of stress akin to whiplash.

Stress isn’t all bad. Internal pressure, after all, signifies that your work matters to you, that you care about doing a good job. If you are lax and carefree at your job, you’re probably just going through the motions.

Far more common than too little stress, though, is too much of it. Stress shouldn’t be so constant or overwhelming that it leads to sleepless nights. When you find yourself in a harried mood 24/7, it’s time to make a change — and fast.

As counterintuitive as it sounds, the way you live outside the office may contribute to your stress inside it. These external stressors, while not directly related to work, compound our sense of frustration. If you’ve ever been to work without enough sleep, you know how difficult it can be to focus on the job when your body and mind are not at their best. When we treat ourselves without care and consideration, we are, in a certain sense, coming to the office without a fresh perspective every day. To avoid that fate, ask yourself how you measure up in the following four crucial wellness categories, each of which is essential for you to perform at a high level.

1. Get regular exercise

Our minds and bodies are connected. Ignoring the health of one has negative effects on the other. “Studies indicate that our mental firepower is directly linked to our physical regimen,” wrote Ron Friedman in Harvard Business Review. As such, maintaining a healthy exercise routine can help you feel more alert and energized at work.

Unfortunately, most of us simply don’t exercise enough. When I speak about this at conferences, it usually comes down to most saying they don’t have time. According to a recent National Health Statistics Report issued by the Centers for Disease Control, only “22.9% of U.S. adults ages 18–64 met the guidelines for both aerobic and musclestrengthening activities.” That means that roughly 4 out of every 5 accountants could stand to work out a little more.

It can seem like a burden to expend energy after you’re finished working, but that initial outlay of effort will reap huge benefits in no time. It can take as little as one week of working out to begin to see and feel benefits, and those will compound over time.

Exercise also can be worked right into your day. Walking has always proved to be one of the most beneficial exercises you can do. So rather than meeting with one of your coworkers in the office, ask him or her to take a walk and meet instead! Then you can get a workout while getting work done.

2. Develop good sleep habits

“The shorter your sleep, the shorter your life,” writes Matthew Walker, Ph.D., in his best-selling book Why We Sleep. “The leading causes of disease and death in developed nations — diseases that are crippling health-care systems, such as heart disease, obesity, dementia, diabetes, and cancer — all have recognized causal links to a lack of sleep.” It’s not a stretch to say that what happens when we sleep informs how we act when we’re awake.

What does good sleep look like? Adults should aim to have at least eight hours of quality sleep per night. Quality is the operative word here. Eight hours spent tossing and turning, trying to sleep, is not eight hours spent sleeping.

If you struggle to get enough sleep, try creating a regular sleep schedule, eliminating blue light in the hours before bedtime, and disconnecting from electronic devices (one of the main sources of blue light) before getting under the covers.

Accountants tell me all the time that they work right up until going to bed. I have found that it’s important to find a way to disconnect before going to sleep. One activity that has helped me is doing a sleep meditation using a guided meditation app to have a better night’s sleep. When you can’t get a good night’s sleep no matter how hard you try, you should consider consulting a doctor.

3. Embrace a healthy diet

The fuel you put into your body is just as important as your rest and exercise. If you’re familiar with the term “hangry,” you understand how much our food intake impacts our mood. But the links go beyond even that. A study from the University of Gothenburg found that hormones released during hunger adversely affect our decisionmaking skills.

It’s not just about how much we eat, but rather the nutritional profile of the foods we consume. Binging on sugar and caffeine may give you a jolt of energy, but it will leave you feeling burned out in a hurry. Instead of relying on cheap pick-me-ups to get you through the day, stay hydrated, eat well, and pack healthy snacks for when you’re getting weary. Review what food you are putting out in the office as snacks or assess your eating rituals when you are on the road visiting clients. It’s important that what we are putting into our body isn’t always processed, sugar-packed foods. Make an effort to eat

fruits, vegetables, and proteins that you know where all the ingredients came from. It will do wonders for evening out your energy throughout the day.

4. Practice mindfulness techniques

I’m a huge proponent of teaching mindfulness in the workplace. Taking time to put ourselves in the present moment and reflecting on our surroundings helps us stay centered and calm in even the most chaotic of times. We can’t always change the circumstances of our day, but we can change how we respond to them.

Simply taking 10 minutes a day to step away from the grind and practice some guided meditation can make a world of difference. Apps like Calm and Headspace allow you to practice mindfulness no matter where you are or how much (or little) time you have.

At some workplaces, I have seen mindfulness breaks built into the morning and afternoon. During these times, employees can go to a designated area to meditate, read, or listen to music, so that they can reset, reduce stress, and be present.

If you’re resistant to mindfulness practice, I urge you to put those preconceived notions aside and give it a try, or instead of meditating, listen to music, read, or get up from the desk and take a walk. You will find when you give yourself mental breaks, you will actually be more productive and probably get more done than less.

As with anything, trying something once isn’t enough to know whether you truly like something or not. Dedicate 10 minutes a day for 30 days, and then assess how you are feeling and whether you are better for the people around you as well.

Bringing it all together

While each of these practices has benefits in its own right, they really begin to work wonders when you apply them in concert. We could all stand to improve our wellness outside of the office in at least one of these areas, however; as you can see, many of these areas can be accomplished right within our workday for optimum mind and body health.

You may be surprised to learn that success in the four areas not only can improve how you feel on the inside, but it also can possibly have a positive impact on those around you as well.

You can’t just flip a switch and begin attacking all of these areas at full speed. Start piecemeal and try to improve a little bit in one or two places, beginning with those that are most in need of an upgrade. Don’t get discouraged. Building new habits takes time, but the results you’ll see both inside and outside the office will make it more than worth it.

Source: AICPA – CPA Letter Daily - CPA Insider – September 24, 2019