Deferred Income Tax Implementation

9.27.18
C-Corporation balance sheets are changing!

Balance sheets of C-Corporations may look a little different beginning with their December 2018 financial statements and it could have some serious side effects for companies with significant timing differences between book reporting and tax reporting.  Generally accepted accounting principles (GAAP) have historically required an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified statement of financial position.  Deferred tax assets and liabilities are recognized in balance sheets of tax paying entities as a result of temporary timing differences between GAAP financial reporting and tax treatment for various income and expense items. In November 2015, the Financial Accounting Standards Board (FASB) issued ASU No. 2015-17 Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes, which will require that all deferred income tax assets and liabilities be classified only as long-term within balance sheets of C-Corporations.

 

Why is the change necessary and when does your company have to comply?

The issuance of ASU No. 2015-17 by the Financial Accounting Standards Board (FASB) was in direct response to many stakeholders’ concerns that presenting deferred income tax assets and liabilities within current classifications of balance sheets did not necessarily align with the time period in which the recognized deferred tax amounts are expected to be recovered or settled.  There could be significant costs incurred to separate the current and noncurrent portions of deferred taxes with very little benefit to the users of the financial statements. The FASB has eliminated the separation requirement as part of its Simplification Initiative to reduce complexity in accounting standards and to more closely align with International Financial Reporting Standards (IFRS). The standard is effective for non-public entities for annual financial reporting periods beginning after December 15, 2017, meaning all entities with a calendar year-end will be required to implement this change effective for their 2018 financial statements.

 

What impact will this have on your company?

Depending on the make-up of your business’s current assets and liabilities, the change could have either a positive or negative impact on your company’s perceived financial standing without changing the economic fundamentals of the company in any way.  Certain financial metrics are based on current assets and liabilities in a balance sheet, such as current ratio (current assets divided by current liabilities) and working capital (current assets minus current liabilities). These metrics are utilized by banks and other users of financial information to make determinations about a company’s financial well-being. Companies with balance sheets that contained a greater balance of current deferred tax assets than current deferred tax liabilities using the old standard will see the current ratio and working capital figures decline upon reclassification to noncurrent in accordance with the newly-effective standard.  Conversely, those balance sheets with a greater balance of current deferred tax liabilities than current deferred tax assets under current standards will see these financial metrics improve upon implementation of ASU No. 2015-17.

 

What should you do now?

There are several actions that you can take now to address the impact that the implementation of this newly effective standard could have on your company’s financial statements.

  • Review your company’s balance sheet and the current status of deferred tax assets and liabilities.
  • Understand any financial covenants imposed on your Company by banks or other financial institutions.
  • Using your most recently available financial statements, calculate the impact that ASU No. 2015-17 would have if implemented immediately.
  • Contact your bank or financial institution to make them aware of the change and to inform them of the impact that this will likely have on your Company’s compliance with covenants. This will give them time to assess whether or not a change may be needed.

 

The effective date for this standard is coming in a few short months.  It is important that you act now in order to prepare for any negative impacts on your Company’s perceived financial standing.  Contact Benjamin Sumner, CPA, with any questions regarding ASU No. 2015-17 Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes.