The Financial Accounting Standards Board (FASB or Board) decided that companies would defer only the income tax effects of intercompany inventory transactions under an exception to the guidance on income taxes that currently applies to intercompany sales and transfers of all assets. The Board then directed the staff to draft a final standard to make the change.

The FASB had previously proposed¹ eliminating the exception entirely and requiring companies to immediately recognize income tax expense (or benefit) on all intercompany transactions in their income statements. Under the Board's latest decision, companies would no longer defer the income tax effects of intercompany sales and transfers of assets other than inventory (e.g., intangible assets).

Key considerations

Under an exception to the guidance on income tax accounting, companies currently are prohibited from recognizing in the income statement the income tax effects of sales or transfers of assets among members of a consolidated group. Under that exception, income tax expense associated with intra-entity profits in an intercompany sale or transfer of assets is eliminated from earnings. Instead, that cost is deferred and recorded on the balance sheet (e.g., as a prepaid asset) until the assets leave the consolidated group.² Similarly, the entity is prohibited from recognizing deferred tax assets for the increases in the tax bases due to the intercompany sale or transfer.

The Board had previously proposed eliminating the exception entirely. Several comment letter writers at the time observed that the exception was intended to address the accounting for intercompany inventory transactions. They also observed that the cost and complexity the Board was attempting to alleviate with the proposal actually results from applying the exception to other intercompany transactions such as those involving intangible assets. Some respondents asked the Board to consider whether the exception should be maintained for inventory transactions.

Based on research performed by the staff, the Board decided to limit the scope of the exception to intercompany inventory transactions and require companies to recognize the income tax effects of intercompany sales or transfers of other assets in the income statement as income tax expense (or benefit) in the period the sale or transfer occurs. The Board also decided that companies would evaluate whether the tax effects of intercompany sales or transfers of non-inventory assets should be included in their estimates of annual effective tax rates by using today's interim guidance on income tax accounting.

Effective date and transition

The Board decided that the new guidance would be effective for public business entities (PBEs) for annual periods beginning after December 15, 2017 (i.e., 2018 for a calendar-year entity), and interim periods within those annual periods. For all other entities, the guidance would be effective for annual periods beginning after December 15, 2018 (i.e., 2019 for a calendar-year entity), and interim periods the following year. Early adoption would be permitted for all entities as of the beginning of an annual period that starts after the FASB issues the final standard (i.e., early adoption would only be permitted in the first quarter of an entity's annual period that starts after the FASB issues the final standard).

The guidance would require modified retrospective transition with a cumulative catch-up adjustment to opening retained earnings in the period of adoption (i.e., 2018 for calendar-year PBEs). In the period of adoption, companies would write off any income tax effects that had been deferred from past intercompany transactions involving non-inventory assets to opening retained earnings. In addition, companies would record deferred tax assets with an offset to opening retained earnings for amounts that they haven't recognized under today's guidance but would recognize under the new guidance.

Companies would be required to disclose in the year of adoption the nature of and reason for the change in accounting principle and certain quantitative information about the effects of the change in accounting principle.

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ENDNOTES

¹ Proposed Accounting Standards Update, Intra-Entity Asset Transfers.

² Accounting Standards Codification (ASC) 740-10-25-3(e) and ASC 810-10-45-8.