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How ASC 740 Applies to Interim Reporting

May 27, 2022

ASC 740-270, Interim Reporting, is concerned with the manner in which tax expense is allocated amongst the quarters.

When preparing quarterly financial statements, companies don’t have full-year earnings information available, and can’t calculate all deferred and temporary items the same way they would for an annual income tax return. It’s not simply a matter of taking quarterly income and performing an income tax calculation on that information. Instead, FASB prescribes a methodology for estimating full-year income tax expense based on forecasts and using that as a foundation for recording income tax expense in the interim periods.

See how Bloomberg Tax Provision untangles ASC 740’s complexity.

What is the annual effective tax rate?

Generally, ASC 740-270 requires a company to calculate the income tax associated with ordinary income using an estimated annual effective tax rate (AETR). At the end of each interim period, the company applies the AETR to year-to-date (YTD) ordinary income (or loss) to arrive at the YTD income tax expense.

The AETR is the company’s best estimate of the effective rate expected for the full year. The estimated AETR should include any changes in a valuation allowance that arise from deferred tax items.

Typically, a company bases its estimated AETR on a variety of data sources, including forecasts, prior year information, and YTD results.

AETR Versus the Reported Income Tax Rate

Although companies estimate an AETR for each interim period, it is distinct from the reported income tax rate in the interim period. The AETR is applied to YTD pretax income to derive the interim reported income tax rate.

Even in the absence of discrete items (items excluded from the AETR), changes to the AETR between interim periods will have an exaggerated impact on the reported income tax rate since the subsequent period must include any “catch up” amount to arrive at the appropriate YTD AETR.

calculate interim reported income tax rate

Inability to Estimate an AETR

A company that cannot reliably estimate some or all of its AETR will record its income tax provision for those items in the period in which the items that cannot be reliably estimated occur.

Under these circumstances, the company calculates its interim provision for those items or jurisdictions based on actual results consistent with how it would calculate them at year-end.

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What is excluded from the annual effective tax rate?

Certain items are excluded from the AETR. These are known as discrete items and are instead recorded in the interim period in which they occur. Typically, discrete items do not relate directly to the ordinary income expected to be reported in the fiscal year.

Some common discrete items include:

  • Provision to return true-ups
  • Interest expense associated with uncertain tax benefits
  • Excess benefits/shortfalls from share-based compensation
  • Impacts of income tax rate and law changes accounted for in the period in which the law is enacted
  • Taxes related to significant unusual or extraordinary items that will be separately reported or reported net of their related tax effect
  • Changes in judgment about beginning-of-the-year valuation allowances
  • Changes in the recognition test or measurement test of an uncertain tax position

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Watch on demand: Interim Reporting Webinar

Learn about the basic concepts of accounting for income taxes under ASC 740 on an interim basis including how to handle the annual effective tax rate, discrete items, losses, and multiple jurisdictions.

How do losses affect the annual effective tax rate?

The estimated AETR may include only the amount of benefit from a loss that is expected to be realized and recognized at the end of the fiscal year (i.e., the amount that will not require a valuation allowance).

If the company incurs YTD ordinary losses, the amount of benefit recognized cannot exceed the benefit estimated in the AETR.

AETR benefit in YTD loss

Multiple Jurisdictions

Generally, a company that operates in multiple jurisdictions should apply a consolidated AETR to its YTD consolidated ordinary income to calculate the tax provision for an interim period.

However, if the company reports a loss for which it does not expect to recognize a tax benefit or anticipates a fiscal year loss in a jurisdiction, it must exclude the loss from that jurisdiction from both the consolidated AETR calculation and the YTD ordinary income to which a consolidated AETR is applied.

For each jurisdiction that a company reports a loss for which it does not expect to recognize a tax benefit for or anticipates a fiscal year loss, a separate AETR is calculated and applied to the YTD ordinary income of that jurisdiction.

zero AETR benefit in YTD loss

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Learn more: How to calculate the ASC 740 tax provision

Learn the fundamentals of ASC 740, how to calculate the tax provision, and what tool can make the process easier.

Examples of tax provision interim reporting

The following videos provide examples for accounting for income taxes under ASC 740 on an interim basis.

Example 1: Interim-Loss

This ASC 740 example includes an interim period where the year-to-date loss exceeds the forecasted full-year loss. [2:13]

Example 2: Interim-Separate AETR for Loss Jurisdictions

This ASC 740 example includes a separate jurisdiction with a year-to-date loss and a full valuation allowance resulting in that jurisdiction being excluded from the consolidated AETR. [2:45]

Example 3: Interim-Valuation Allowance Recognized

This ASC 740 example includes an interim period where a valuation allowance is recognized against a foreign subsidiary’s net deferred tax assets. The portion of the valuation allowance relating to current year activity is recorded in the AETR. In contrast, the remaining amount, which results from past activity and future forecasts, is recorded as a discrete item. [2:55]

Example 4: Interim-Valuation Allowance Removed

This ASC 740 example includes an interim period where a valuation allowance is removed due to improved profitability at a foreign subsidiary. The portion of the valuation allowance relating to current year activity is recorded in the AETR, whereas the remaining amount, which is the result of past activity and future forecasts, is recorded as a discrete item. [2:05]

Example 5: Interim-U.S. True-Up

This ASC 740 example calculates a tax return true-up and incorporates it into the subsequent year provision in an interim period. [12:46]

Example 6: Interim-UTBs

This video covers the thorough process that should be applied to UTBs on an interim basis. [1:01]

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Learn more: How ASC 740 Applies to Controlled Foreign Corporations

ASC 740 governs how companies, including U.S. parents of controlled foreign corporations, recognize the effects of income taxes on their financial statements under U.S. GAAP.

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