1.2 Background of ASC 740
A basic principle of the taxation of income in many jurisdictions,
including the U.S. federal jurisdiction, is that an entity is taxed only on its
net earnings (i.e., it is taxed on total revenue after allowable
expenses incurred to generate the revenue have been deducted to arrive at a net
amount of taxable income). Generally, an entity applies a rate or series of rates to
taxable income to determine a preliminary amount of income tax owed for the period.
In many jurisdictions, the entity then reduces that preliminary amount by available
income tax credits, if any, to determine the ultimate amount of tax owed in a
particular period.
If there were no differences between the way an entity determined
its income before tax under U.S. GAAP and its taxable income, and there were no tax
credits or tax loss carryforwards available, a profitable entity could simply
multiply its U.S. GAAP income before tax by the statutory tax rate(s) applicable to
the jurisdiction(s) in which the income was earned and record an income tax payable
and corresponding expense each period. While there are many similarities between the
treatment of items of income and loss under U.S. GAAP and for income tax reporting
purposes, there are still many differences. Accordingly, ASC 740 provides a
framework for the accounting for income taxes that takes into account these
differences. Under this framework, the amount of income tax expense an entity is
required to record in each period does not simply equal the amount of income tax
payable in each period. Rather, ASC 740 requires an entity to record income tax
expense in each period as if there were no differences between (1) the timing of
the recognition of events in income before tax for U.S. GAAP purposes and
(2) the timing of the recognition of those events in taxable income. ASC 740
also requires an entity to reduce income tax expense otherwise determined each
period (or record an overall income tax benefit) for the expected benefit of net
operating losses (NOLs) and tax credits that, in many taxing jurisdictions, may be
carried forward or back to reduce taxable income in a future period or get a refund
of taxes paid in a prior period.