In the accounting practice, the recognition of a deferred tax asset or liability takes into account the forecasted future effects of the tax associated with the short period differences. Under the current accounting principles, there is the differentiation of the deferred tax assets and liabilities into current and non-current amounts in the classified statement of financial position. The difference is based on how the particular assets or liabilities are classified for purposes of financial reporting. For those assets and liabilities for which there is no close association, the deferred tax is based on the anticipated date of reversal of the short period difference.
Reasons for Proposed Amendments
The basis of classifying deferred tax under the current accounting principles does not avail useful information to the users of such information (“Two Proposed Accounting Standards Updates”). The main reason for this is that the differentiation of deferred tax to either current or non-current amounts does not reveal when the short period differences are reversed to become taxable items. As such, the current accounting principles create room for complexities and needless costs attributable to such classification.
Following this justification, the Board has proposed some updates to revise the current accounting principles as part of a global initiative to bring down the levels of complexity as identified. The primary objective of the proposed updates simplification initiative is to detect, assess, and improve on the GAAP standards ((“Two Proposed Accounting Standards Updates”). Agreeably, this will help to bring down the levels of complexity and unnecessary costs, and at the same time enhance the significance of the financial information availed to the users of the financial statements.
Old vs. Proposed New GAAP
The current accounting principles prevent the recognition of current and deferred income tax for asset transfer transactions among intra-entities until the finalization of the transaction and the selling of the assets to the external parties. As part of the updates to the current GAAP standards, the Board suggests the elimination of this exemption. Accordingly, the proposal necessitates that whenever there are transfer transactions among intra-entities, the current and deferred tax consequences are recognized immediately. The suggested GAAP updates are well in line with the International Financial Reporting Standards as pertains to the recognition of income tax for transfer transactions between intra-entities (“Balance Sheet Classification”). In the IFRS, Income Taxes necessitates that the recognition of current and deferred income tax is recognized immediately after a transfer involving intra-entity assets.
There is still some comparison between the old and the proposed new accounting guidelines on deferred taxes. Of significance is the fact that the proposed guidelines do not interfere with the requirement permitting the offsetting of deferred tax liabilities within a jurisdiction. The implication is that it is unlawful for entities to offset deferred tax liabilities against deferred tax assets between jurisdictions. Another similarity is that for both the current and the proposed new standards, the primary objective of reporting income tax is to account for both payable and refundable taxes and deferred tax (Thornton). The total expenses in taxes are as a result of the addition of deferred and current taxes. In addition, deferred tax in both standards can be identified on a broader perspective using the asset and liability approach although the implementation of the approaches is different.
Impact on Financial Statements and Affected Parties
In simplified terms, the proposed amendments in the GAAP necessitate that in the classified statement of financial position, the deferred tax for assets and liabilities should be grouped as non-current amounts. This eliminates the need to differentiate the deferred tax for assets and liabilities in the classified statement of financial position into current and non-current amounts. However, these proposed updates will not affect those entities that do not prepare classified statements of financial position.
According to an article by KPMG, the requirement to recognize deferred tax consequences for intra-entity transfer transactions is likely to result in increased volatility in earnings more so for entities whose transfer transactions involve intangible assets (“FASB Proposes Changes”). If the proposed new guidelines are implemented, most entities will experience a decrease in current deferred liabilities and assets resulting in a decline in the working capital. According to an article in PWC about an in-depth look at the current financial reporting issues, a company with restructuring charges currently classified as current will now report the related deferred tax asset as non-current (“FASB Simplifies Balance Sheet Classification”). In addition, entities with net operating losses will now classify deferred tax assets under noncurrent cash items. PWC advises that entities must be attentive in evaluating the effect of the new guidelines on the financial ratios.
Despite the proposal to alter the representation of deferred tax charges on the balance sheet, entities still have to provide single amounts for every tax paying component. An article by Earnest and Young reveals that this will have a significant impact on the reported tax rates (“FASB Proposes Simplifying Income Tax Accounting”). In another article by EFRAG, initial assessments indicated that the proposed new guidelines would not have a significant effect on the costs of users. EFRAG’s original evaluations indicated that users would more likely benefit from the new guidelines since the information availed is less subjective and enhances comparison between different entities ("Introduction, Background and Conclusions"). However, if the information provided is not relevant to the users, they are less likely to benefit from the amendments.
ASCFACB. "Balance Sheet Classification of Deferred Taxes." FASB Accounting Standards Update 17, 2015. Web. 6 Apr. 2016.
Ernst & Young. "FASB Proposes Simplifying Income Tax Accounting." To the Point: FASB Proposed Guidance 7, 2015. Web. 6 Apr. 2016.
European Commission. "Introduction, Background and Conclusions." Endorsement of Deferred Tax: Recovery of Underlying Assets - Amendments to IAS 12 Income Taxes, 2015. Web. 11 Apr. 2016.
FASB. "Two Proposed Accounting Standards Updates." FAS Exposure Draft, 2015. Web. 6 Apr. 2016.
KPMG. "FASB Proposes Changes to Accounting for Income Taxes on Intercompany Transfers and Deferred Tax Classification." Defining Issues 15.3, 2015. Web. 6 Apr. 2016.
PWC. "FASB Simplifies Balance Sheet Classification of Deferred Taxes." In Brief: The Latest News in Financial Reporting 37, 2015. Web. 6 Apr. 2016.
Thornton, Grant. "Comparison of IFRS with Us Gaap." An Instinct for Growth, 2015. Web.