Clock Ticking on Applying Income Reclassification Standard

Calendar year-end companies have one more freshly approved accounting standard to apply for their first quarter 2013 financial statements.

The Financial Accounting Standards Board approved a new method last month to explain to investors where companies have reclassified amounts out of “other comprehensive income,” traditionally seen as a component in equity, into net income.

The good news is that the method is regarded by most accounting experts to be fairly straightforward and simple to apply compare with a method adopted earlier and then abandoned by FASB. The bad news is that time is short to gather the details and comply with the requirement. It applies to the first interim period after Dec. 15, 2012. For calendar-year companies, that means including the new presentation for the first quarter, which closes March 31.

“It's not often we see guidance come out that is effective so quickly,” says Stuart Moss, a partner in the accounting standards and communication group at Deloitte & Touche. “It's effective, basically, immediately. Especially during the busy year-end reporting season, that is somewhat unusual.” But the guidance certainly should come as no surprise to companies. They have known since FASB issued Accounting Standards Update 2011-05 in 2011 that FASB wanted them to change the way they present other comprehensive income, giving greater prominence to how they reclassify or “recycle” amounts out of OCI to net income.

Comprehensive income is not fully defined in accounting standards, but it has become a melting pot for recognizing gains that have not been fully realized, such as equity gains on investments that are still held or gains in pension assets that are not yet paid to beneficiaries. The objective of the standard, finalized in June 2011, was to streamline the presentation of comprehensive income in financial statements, reducing the number of options for how it could be presented and making U.S. standards more consistent with international standards.

The 2011 standard was not particularly controversial, but companies ran into some difficulties in implementing it, says John Hepp, a partner with Grant Thornton, when they began trying to plot items of OCI to the various income statement line items as required by the standard.

Pension expense, for example, is disclosed in a footnote as a single number, but it can be spread across several line items in the income statement. Pension costs associated with production workers would be an operating expense, for example, but pensions associated with sales staff is a selling expense. “The numbers would get split up across multiple line items, and some might even end up on the balance sheet in inventory,” he says. “It would be very difficult to reverse engineer where these numbers would go. Historically, we just haven't focused on reclassification adjustments or recycling entries.”

FASB deferred the reclassification requirement of the 2011 standard and came up with the simplified solution issued in early February. Instead of scattering reclassifications over the income statement, FASB said companies could show parenthetically on the face of the financial statements or in the footnotes significant amounts reclassified out of OCI and the income statement line items affected.

“It's not often we see guidance come out that is effective so quickly. Especially during the busy year-end reporting season, that is somewhat unusual.”

—Stuart Moss,

Partner,

Deloitte & Touche

“It's actually much easier to apply than what was first proposed,” says Peter Bible, partner with audit firm EisnerAmper. “Now this is just another schedule to include in the body of the financial statements. The concern for operationality has gone away.” Bible expects most companies to elect to include a table in footnotes, especially since many of the items that would be included are not likely to be material in today's economic circumstances. “To see a material reclassification coming out of OCI in this economy is rare,” he says. “Gains or losses on trading securities, cash flow swaps, hedging—all of those markets are flat right now.”

All in One Place

Dan Doran, a partner at PwC, says the standard represents a compromise between the needs of financial statement readers for better understanding of OCI recycling and the burden on preparers to present it. “All of the information required by this standard was required to be in one place or another in financial statements,” he says. “So now this has the effect of putting it together in a new footnote disclosure. This was a big win for preparers.”

COMPREHENSIVE INCOME UPDATE

Below is a summary of FASB's Comprehensive Income update from McGladrey.

In June of 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. The amendments in this ASU required all nonowner changes in stockholders' equity to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Other comprehensive income includes gains and losses that are initially excluded from net income for an accounting period. Those gains and losses are later reclassified out of accumulated other comprehensive income into net income.

After the issuance of ASU 2011-05, stakeholders raised concerns that the presentation requirements of the ASU about the reclassification of items out of accumulated other comprehensive income would be costly for preparers and add unnecessary complexity to financial statements. As a result of these concerns, the FASB recently issued ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. generally accepted accounting principles (GAAP) to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is reclassified to a balance sheet account (for example, inventory or pension-related amounts) instead of directly to income or expense in the same reporting period. The amendments in ASU 2013-02 do not change the current requirements for reporting net income or other comprehensive income in financial statements.

Public companies are required to comply with the requirements of ASU 2013-02 for all reporting periods (interim and annual) beginning after December 15, 2012. The amendments are effective for reporting periods beginning after December 15, 2013 for private companies. Private companies are required to meet the reporting requirements of the amended paragraphs about the roll forward of accumulated other comprehensive income for both interim and annual reporting periods. However, private companies are only required to provide the information about the impact of reclassifications on line items of net income for annual reporting periods, not for interim reporting periods.

Source: MCGladrey.

Liza Prossnitz, a director in the national SEC Department at BDO USA, says there's still some effort required to comply with the new standard. “Anytime you have to do a new disclosure, you have to set up a system to collect the information,” she says. “The first time through, I imagine rounding it all up will be a challenge.” Companies need to scour their pension information, cumulative translation adjustments for foreign operations, deferred gains or losses on cash flow hedges, and any unrealized gains or losses on investment securities, she says. Insurance companies also need to pore over their deferred acquisition costs looking for OCI reclassifications that must be disclosed.

Companies also are working through the accounting firms with questions on the degree of detail that is likely to be expected in the first interim period compared with the first annual report, says Rick Day, national director of accounting for McGladrey. “Usually the interims are condensed financial information, so there's not as much detail,” he says. “In this case, FASB didn't provide a lot of implementation guidance that will help people decide what to do in their interim statements.”

One school of thought, says Day, is the new disclosures are not critical to measurement or recognition, so companies can comfortable forego the full granular detail required with the new pronouncement in their interim reports. The other view, he says, is because it's a brand new pronouncement companies should provide full detail at least until they reach their first annual report. “We are talking among the firms and trying to sort it out among ourselves to help clients know what they should do,” he says.

Even with that lingering issue, Scott Lehman, a partner at Crowe Horwath, says he doesn't anticipate any significant concerns with complying. “This really is just geography,” he says. “Companies do not have to calculate anything they are not already calculating. I'm not hearing concerns about getting it done.”