Chapter 7 — Interim Reporting

7.4.2 Intraperiod Tax Allocation When There Is a Loss From Continuing Operations and Income in Discontinued Operations

7.5.1 Inability to Make a Reliable Estimate of the AETR

7.5.3 Balance Sheet Effects of the Interim Provision for Income Taxes

7.1 Overview

ASC 740-270

05-1 This Subtopic addresses the accounting and disclosure for income taxes in interim periods. The accounting requirements established in this Subtopic build upon the general requirements for accounting for income taxes established in Subtopic 740-10 as well as the intraperiod tax allocation process established in Subtopic 740-20.

05-2 Subtopic 740-10 addresses the computation of total tax expense for an entity. Subtopic 740-20 addresses the process of allocating total income tax expense (or benefit) for a period to different components of comprehensive income and shareholders’ equity.

05-3 Because an interim period is a subset of a longer period, typically a year, incremental requirements for recognition and measurement are established by this Subtopic.

05-4 This Subtopic describes:

The general computation of interim period income taxes (see paragraphs 740-270-30-1 through 30-9)
The application of the general computation to specific situations (see paragraphs 740-270-30-22 through 30-28)
The interim period income taxes requirements applicable to significant unusual or infrequently occurring items and discontinued operations (see Section 740-270-45)
Special computations applicable to operations taxable in multiple jurisdictions (see paragraph 740-270-30-36)
Guidelines for reflecting the effects of new tax legislation in interim period income tax provisions (see paragraphs 740-270-25-5 through 25-6)
Disclosure requirements (see paragraph 740-270-50-1).

This Subtopic also provides Examples and illustrations in Section 740-270-55.

Overall Guidance

15-1 This Subtopic follows the same Scope and Scope Exceptions as outlined in the Overall Subtopic, see Subtopic 740-10-15.

General Recognition Approach

25-1 This guidance addresses the issue of how and when income tax expense (or benefit) is recognized in interim periods and distinguishes between elements that are recognized through the use of an estimated annual effective tax rate applied to measures of year-to-date operating results, referred to as ordinary income (or loss), and specific events that are discretely recognized as they occur.

25-2 The tax (or benefit) related to ordinary income (or loss) shall be computed at an estimated annual effective tax rate and the tax (or benefit) related to all other items shall be individually computed and recognized when the items occur.

25-3 If an entity is unable to estimate a part of its ordinary income (or loss) or the related tax (or benefit) but is otherwise able to make a reliable estimate, the tax (or benefit) applicable to the item that cannot be estimated shall be reported in the interim period in which the item is reported.

25-4 The tax benefit of an operating loss carryforward from prior years shall be included in the effective tax rate computation if the tax benefit is expected to be realized as a result of ordinary income in the current year. Otherwise, the tax benefit shall be recognized in the manner described in paragraph 740-270-45-4 in each interim period to the extent that income in the period and for the year to date is available to offset the operating loss carryforward or, in the case of a change in judgment about realizability of the related deferred tax asset in future years, the effect shall be recognized in the interim period in which the change occurs.

25-5 The effects of new tax legislation shall not be recognized prior to enactment. The tax effect of a change in tax laws or rates on taxes currently payable or refundable for the current year shall be reflected in the computation of the annual effective tax rate beginning in the first interim period that includes the enactment date of the new legislation. The effect of a change in tax laws or rates on a deferred tax liability or asset shall not be apportioned among interim periods through an adjustment of the annual effective tax rate.

25-6 The tax effect of a change in tax laws or rates on taxes payable or refundable for a prior year shall be recognized as of the enactment date of the change as tax expense (benefit) for the current year. See Example 6 (paragraph 740-270-55-44) for illustrations of accounting for changes caused by new tax legislation.

25-7 The effect of a change in the beginning-of-the-year balance of a valuation allowance as a result of a change in judgment about the realizability of the related deferred tax asset in future years shall not be apportioned among interim periods through an adjustment of the effective tax rate but shall be recognized in the interim period in which the change occurs.

Recognition of the Tax Benefit of a Loss in Interim Periods

25-8 This guidance establishes requirements for considering whether the amount of income tax benefit recognized in an interim period shall be limited due to interim period losses.

25-9 The tax effects of losses that arise in the early portion of a fiscal year shall be recognized only when the tax benefits are expected to be either:

Realized during the year
Recognizable as a deferred tax asset at the end of the year in accordance with the provisions of Subtopic 740-10.

25-10 An established seasonal pattern of loss in early interim periods offset by income in later interim periods shall constitute evidence that realization is more likely than not, unless other evidence indicates the established seasonal pattern will not prevail.

25-11 The tax effects of losses incurred in early interim periods may be recognized in a later interim period of a fiscal year if their realization, although initially uncertain, later becomes more likely than not. When the tax effects of losses that arise in the early portions of a fiscal year are not recognized in that interim period, no tax provision shall be made for income that arises in later interim periods until the tax effects of the previous interim losses are utilized.

25-12 If an entity has a significant unusual or infrequently occurring loss or a loss from discontinued operations, the tax benefit of that loss shall be recognized in an interim period when the tax benefit of the loss is expected to be either:

Realized during the year
Recognizable as a deferred tax asset at the end of the year in accordance with the provisions of Subtopic 740-10.

Realization would appear to be more likely than not if future taxable income from (ordinary) income during the current year is expected based on an established seasonal pattern of loss in early interim periods offset by income in later interim periods. The guidance in this paragraph also applies to a tax benefit resulting from an employee share-based payment award within the scope of Topic 718 on stock compensation when the deduction for the award for tax purposes is greater than the cumulative cost of the award recognized for financial reporting purposes.

25-13 See Example 3, Cases A and B (paragraphs 740-270-55-26 through 55-28) for example computations involving unusual or infrequently occurring losses.

25-14 If recognition of a deferred tax asset at the end of the fiscal year for all or a portion of the tax benefit of the loss depends on taxable income from the reversal of existing taxable temporary differences, see paragraphs 740-270-30-32 through 30-33 for guidance. If all or a part of the tax benefit is not realized and future realization is not more likely than not in the interim period of occurrence but becomes more likely than not in a subsequent interim period of the same fiscal year, the previously unrecognized tax benefit shall be reported that subsequent interim period in the same manner that it would have been reported if realization had been more likely than not in the interim period of occurrence, that is, as a tax benefit relating to continuing operations or discontinued operations. See Subtopic 740-20 for the requirements to allocate total income tax expense (or benefit).

General Methodology and Use of Estimated Annual Effective Tax Rate

30-1 This guidance establishes the methodology, including the use of an estimated annual effective tax rate, to determine income tax expense (or benefit) in interim financial information.

30-2 In reporting interim financial information, income tax provisions shall be determined under the general requirements for accounting for income taxes set forth in Subtopic 740-10.

30-3 Income tax expense (or benefit) for an interim period is based on income taxes computed for ordinary income or loss and income taxes computed for items or events that are not part of ordinary income or loss.

30-4 Paragraph 740-270-25-2 requires that the tax (or benefit) related to ordinary income (or loss) be computed at an estimated annual effective tax rate and the tax (or benefit) related to all other items be individually computed and recognized when the items occur (for example, the tax effects resulting from an employee share-based payment award within the scope of Topic 718 when the deduction for the award for tax purposes does not equal the cumulative compensation costs of the award recognized for financial reporting purposes).

30-5 The estimated annual effective tax rate, described in paragraphs 740-270-30-6 through 30-8, shall be applied to the year-to-date ordinary income (or loss) at the end of each interim period to compute the year-to-date tax (or benefit) applicable to ordinary income (or loss).

30-6 At the end of each interim period the entity shall make its best estimate of the effective tax rate expected to be applicable for the full fiscal year. In some cases, the estimated annual effective tax rate will be the statutory rate modified as may be appropriate in particular circumstances. In other cases, the rate will be the entity’s estimate of the tax (or benefit) that will be provided for the fiscal year, stated as a percentage of its estimated ordinary income (or loss) for the fiscal year (see paragraphs 740-270-30-30 through 30-34 if an ordinary loss is anticipated for the fiscal year).

30-7 The tax effect of a valuation allowance expected to be necessary for a deferred tax asset at the end of the year for originating deductible temporary differences and carryforwards during the year shall be included in the effective tax rate.

30-8 The estimated effective tax rate also shall reflect anticipated investment tax credits, foreign tax rates, percentage depletion, capital gains rates, and other available tax planning alternatives. However, in arriving at this estimated effective tax rate, no effect shall be included for the tax related to an employee share-based payment award within the scope of Topic 718 when the deduction for the award for tax purposes does not equal the cumulative compensation costs of the award recognized for financial reporting purposes, significant unusual or infrequently occurring items that will be reported separately, or for items that will be reported net of their related tax effect in reports for the interim period or for the fiscal year. The rate so determined shall be used in providing for income taxes on a current year-to-date basis.

30-9 Examples 1 through 2 (see paragraphs 740-270-55-2 through 55-23) contain illustrations of the computation of estimated annual effective tax rates beginning in paragraphs 740-270-55-3; 740-270-55-12; and 740-270-55-19 through 55-20.

Related Implementation Guidance and Illustrations

Example 1: Accounting for Income Taxes Applicable to Ordinary Income (or Loss) at an Interim Date if Ordinary Income Is Anticipated for the Fiscal Year [ASC 740-270-55-2].
Example 2: Accounting for Income Taxes Applicable to Ordinary Income (or Loss) at an Interim Date if an Ordinary Loss Is Anticipated for the Fiscal Year [ASC 740-270-55-11].
Example 3: Accounting for Income Taxes Applicable to Unusual or Infrequently Occurring Items [ASC 740-270-55-24].
Example 4: Accounting for Income Taxes Applicable to Income (or Loss) From Discontinued Operations at an Interim Date [ASC 740-270-55-29].

The core principle of ASC 740-270 is that the interim period is integral to the entire financial reporting year. Thus, this chapter describes the general process for allocating an entity’s annual tax provision to its interim financial statements. A major part of that process is estimating the entity’s AETR, which is determined and updated in each interim reporting period.

An entity faces various challenges when estimating its AETR. For example, when estimating this rate, an entity must also estimate its income by jurisdiction, impact of operating losses, changes to valuation allowances, and use of tax credits. These estimates are further complicated when a change in tax law or income tax rates occurs within a particular interim period. An entity must also consider taxable transactions outside of ordinary income when calculating discrete tax consequences (or benefits) and recognize them in the interim period in which they occur and in the appropriate components of the financial statements. This chapter discusses considerations and complexities when an entity is accounting for income taxes in interim periods.

7.1.1 The Basic Interim Provision Model

ASC 740-270-25-2 requires entities to compute tax (or benefit) related to ordinary income (or loss) by using an estimated AETR for each interim period. To calculate its estimated AETR, an entity must estimate its ordinary income and the related tax expense or benefit for the full fiscal year. The formula to compute the estimated AETR is as follows:

The estimated AETR is then applied to YTD ordinary income or loss to compute the YTD tax (or benefit) applicable to ordinary income or loss as follows:

The interim tax expense (or benefit) is the difference between current YTD tax (or benefit) and prior YTD tax (or benefit):

The AETR should also include anticipated ITCs (see ASC 740-270-30-14 and 30-15 for certain exclusions), FTCs, percentage depletion, capital gains rates, and other available tax-planning alternatives.

The example below illustrates a typical computation of the AETR and interim tax expense as determined under ASC 740-270.

Example 7-1

Assume the following:

The entity anticipates ordinary income of $100,000 for the full fiscal year.
All income is taxable in the United States at a 21 percent rate. The income is not taxable in any other jurisdiction.
Estimated tax credits for the fiscal year total $4,000.
No events that do not have tax consequences are anticipated.
No changes in estimated ordinary income, tax rates, or tax credits occur during the year.

Computation of the estimated AETR is as follows:

Assuming that ordinary income before tax is $20,000 in each of the first three quarters and $40,000 in the fourth quarter, the entity computes quarterly taxes as follows:

7.2 Items Accounted for Separately From the AETR

ASC 740-270

Exclusion of Items From Estimated Annual Effective Tax Rate

30-10 This guidance identifies items that are always excluded from the determination of the estimated annual effective tax rate. This guidance also specifies the alternatives for including or excluding certain investment tax credits in the estimated annual effective tax rate.

Items Always Excluded From Estimated Annual Effective Tax Rate

30-11 The effects of changes in judgment about beginning-of-year valuation allowances and effects of changes in tax laws or rates on deferred tax assets or liabilities and taxes payable or refundable for prior years (in the case of a retroactive change) shall be excluded from the estimated annual effective tax rate calculation.

30-12 Taxes related to an employee share-based payment award within the scope of Topic 718 when the deduction for the award for tax purposes does not equal the cumulative compensation costs of the award recognized for financial reporting purposes, significant unusual or infrequently occurring items that will be reported separately or items that will be reported net of their related tax effect shall be excluded from the estimated annual effective tax rate calculation.

30-13 As these items are excluded from the estimated annual effective tax rate, Section 740-270-25 requires that the related tax effect be recognized in the interim period in which they occur. See Example 3 (paragraph 740-270-55-24) for illustrations of accounting for these items in the interim period which they occur.

Certain Tax Credits

30-14 Certain investment tax credits may be excluded from the estimated annual effective tax rate. If an entity includes allowable investment tax credits as part of its provision for income taxes over the productive life of acquired property and not entirely in the year the property is placed in service, amortization of deferred investment tax credits need not be taken into account in estimating the annual effective tax rate; however, if the investment tax credits are taken into account in the estimated annual effective tax rate, the amount taken into account shall be the amount of amortization that is anticipated to be included in income in the current year (see paragraphs 740-10-25-46 and 740-10-45-28).

30-15 Further, paragraphs 842-50-30-1 and 842-50-35-3 through 35-4 require that investment tax credits related to leases that are accounted for as leveraged leases shall be deferred and accounted for as return on the net investment in the leveraged leases in the years in which the net investment is positive and explains that the use of the term years is not intended to preclude application of the accounting described to shorter periods. If an entity accounts for investment tax credits related to leveraged leases in accordance with those paragraphs for interim periods, those investment tax credits shall not be taken into account in estimating the annual effective tax rate.

Ability to Make Estimates

30-16 This guidance addresses the consequences of an entity’s inability to reliably estimate some or all of the information which is ordinarily required to determine the annual effective tax rate in interim financial information.

30-17 Paragraph 740-270-25-3 requires that if an entity is unable to estimate a part of its ordinary income (or loss) or the related tax (or benefit) but is otherwise able to make a reliable estimate, the tax (or benefit) applicable to the item that cannot be estimated be reported in the interim period in which the item is reported.

30-18 Estimates of the annual effective tax rate at the end of interim periods are, of necessity, based on evaluations of possible future events and transactions and may be subject to subsequent refinement or revision. If a reliable estimate cannot be made, the actual effective tax rate for the year to date may be the best estimate of the annual effective tax rate.

30-19 The effect of translating foreign currency financial statements may make it difficult to estimate an annual effective foreign currency tax rate in dollars. For example, in some cases depreciation is translated at historical exchange rates, whereas many transactions included in income are translated at current period average exchange rates. If depreciation is large in relation to earnings, a change in the estimated ordinary income that does not change the effective foreign currency tax rate can change the effective tax rate in the dollar financial statements. This result can occur with no change in exchange rates during the current year if there have been exchange rate changes in past years. If the entity is unable to estimate its annual effective tax rate in dollars or is otherwise unable to make a reliable estimate of its ordinary income (or loss) or of the related tax (or benefit) for the fiscal year in a jurisdiction, the tax (or benefit) applicable to ordinary income (or loss) in that jurisdiction shall be recognized in the interim period in which the ordinary income (or loss) is reported.

Effect of Operating Losses

30-20 This guidance addresses changes to the general methodology to determine income tax expense (or benefit) in interim financial information as set forth in paragraph 740-270-30-5 when an entity has experienced or expects to experience operating losses.

30-21 An entity may have experienced year-to-date ordinary income (or loss) at the end of any interim period. These year-to-date actual results of either ordinary income (or loss) may differ from the results expected by the entity for either ordinary income (or loss) for the full fiscal year. This guidance identifies the required methodology for recording interim period income taxes for each of the four possible relationships of year-to-date ordinary income (or loss) and expected full fiscal year ordinary income (or loss).See Examples 1 through 2 (paragraphs 740-270-55-2 through 55-23 ) for example computations in these different situations. This guidance also establishes income tax benefit limitations when ordinary losses exist.

Year-to-Date Ordinary Income; Anticipated Ordinary Income for the Year

30-22 If an entity has ordinary income for the year to date at the end of an interim period and anticipates ordinary income for the fiscal year, the interim period tax shall be computed in accordance with paragraph 740-270-30-5.

30-23 See Example 1, Cases A and B1 (paragraphs 740-270-55-4 through 55-6) for illustrations of the application of these requirements.

Year-to-Date Ordinary Loss; Anticipated Ordinary Income for the Year

30-24 If an entity has an ordinary loss for the year to date at the end of an interim period and anticipates ordinary income for the fiscal year, the interim period tax benefit shall be computed in accordance with paragraph 740-270-30-5, except that the year-to-date tax benefit recognized shall be limited to the amount determined in accordance with paragraphs 740-270-30-30 through 30-33.

30-25 See Example 1, Cases B2 and B3 (paragraphs 740-270-55-7 through 55-8) for illustrations of the application of these requirements.

Year-to-Date Ordinary Income; Anticipated Ordinary Loss for the Year

30-26 If an entity has ordinary income for the year to date at the end of an interim period and anticipates an ordinary loss for the fiscal year, the interim period tax shall be computed in accordance with paragraph 740-270-30-5. The estimated tax benefit for the fiscal year, used to determine the estimated annual effective tax rate described in paragraphs 740-270-30-6 through 30-8, shall not exceed the tax benefit determined in accordance with paragraphs 740-270-30-30 through 30-33.

30-27 See Example 2, Cases A2 and C2 (paragraphs 740-270-55-16 and 740-270-55-20) for illustrations of the application of these requirements.

Year-to-Date Ordinary Loss; Anticipated Ordinary Loss for the Year

30-28 If an entity has an ordinary loss for the year to date at the end of an interim period and anticipates an ordinary loss for the fiscal year, the interim period tax benefit shall be computed in accordance with paragraph 740-270-30-5. The estimated tax benefit for the fiscal year, used to determine the estimated annual effective tax rate described in paragraphs 740-270-30-6 through 30-8, shall not exceed the tax benefit determined in accordance with paragraphs 740-270-30-30 through 30-33.

30-29 See Example 2, Cases A1, B, and C1 (paragraphs 740-270-55-15, 740-270-55-17, and 740-270-55-19) for illustrations of the application of these requirements.

Determining Income Tax Benefit Limitations

30-30 Paragraph 740-270-25-9 provides that a tax benefit shall be recognized for a loss that arises early in a fiscal year if the tax benefits are expected to be either of the following:

Realized during the year
Recognizable as a deferred tax asset at the end of the year in accordance with the requirements established in Subtopic 740-10. Paragraph 740-10-30-5(e) requires that a valuation allowance be recognized if it is more likely than not that the tax benefit of some portion or all of a deferred tax asset will not be realized.

30-31 The limitations described in the preceding paragraph shall be applied in determining the estimated tax benefit of an ordinary loss for the fiscal year, used to determine the estimated annual effective tax rate and the year-to-date tax benefit of a loss.

30-32 The reversal of existing taxable temporary differences may be a source of evidence in determining whether a tax benefit requires limitation. A deferred tax liability related to existing taxable temporary differences is a source of evidence for recognition of a tax benefit when all of the following conditions exist:

An entity anticipates an ordinary loss for the fiscal year or has a year-to-date ordinary loss in excess of the anticipated ordinary loss for the fiscal year.
The tax benefit of that loss is not expected to be realized during the year.
Recognition of a deferred tax asset for that loss at the end of the fiscal year is expected to depend on taxable income from the reversal of existing taxable temporary differences (that is, a higher deferred tax asset valuation allowance would be necessary absent the existing taxable temporary differences).

The requirement to consider the reversal of existing taxable temporary differences is illustrated in Example 2, Case D (see paragraph 740-270-55-21).

30-33 If the tax benefit relates to an estimated ordinary loss for the fiscal year, it shall be considered in determining the estimated annual effective tax rate described in paragraphs 740-270-30-6 through 30-8. If the tax benefit relates to a year-to-date ordinary loss, it shall be considered in computing the maximum tax benefit that shall be recognized for the year to date.

30-34 See Example 2, Cases A1 and A2; B; and C1 and C2 (paragraphs 740-270-55-15 through 55-17 and 740-270-55-19 through 55-20) for illustrations of computations involving operating losses, and Example 1, Cases B2 and B3 (see paragraphs 740-270-55-7 through 55-8) for illustrations of special year-to-date limitation computations.

Multiple Tax Jurisdictions

30-35 This guidance addresses possible changes to the general interim period income tax expense methodology when an entity is subject to tax in multiple jurisdictions.

30-36 If an entity that is subject to tax in multiple jurisdictions pays taxes based on identified income in one or more individual jurisdictions, interim period tax (or benefit) related to consolidated ordinary income (or loss) for the year to date shall be computed in accordance with the requirements of this Subtopic using one overall estimated annual effective tax rate with the following exceptions:

If in a separate jurisdiction an entity anticipates an ordinary loss for the fiscal year or has an ordinary loss for the year to date for which, in accordance with paragraphs 740-270-30-30 through 30-33, no tax benefit can be recognized, the entity shall exclude ordinary income (or loss) in that jurisdiction and the related tax (or benefit) from the overall computations of the estimated annual effective tax rate and interim period tax (or benefit). A separate estimated annual effective tax rate shall be computed for that jurisdiction and applied to ordinary income (or loss) in that jurisdiction in accordance with the methodology otherwise required by this Subtopic.
If an entity is unable to estimate an annual effective tax rate in a foreign jurisdiction in dollars or is otherwise unable to make a reliable estimate of its ordinary income (or loss) or of the related tax (or benefit) for the fiscal year in a jurisdiction, the entity shall exclude ordinary income (or loss) in that jurisdiction and the related tax (or benefit) from the overall computations of the estimated annual effective tax rate and interim period tax (or benefit). The tax (or benefit) related to ordinary income (or loss) in that jurisdiction shall be recognized in the interim period in which the ordinary income (or loss) is reported. The tax (or benefit) related to ordinary income (or loss) in a jurisdiction may not be limited to tax (or benefit) in that jurisdiction. It might also include tax (or benefit) in another jurisdiction that results from providing taxes on unremitted earnings, foreign tax credits, and so forth.

See Example 5, Cases A; B; and C (paragraphs 740-270-55-39 through 55-43) for illustrations of accounting for income taxes applicable to ordinary income if an entity is subject to tax in multiple jurisdictions.

Accounting for Income Taxes Applicable to the Cumulative Effect of a Change in Accounting Principle

30-37 Topic 250 establishes the accounting requirements related to recording the effect of a change in accounting principle. The guidance in this Subtopic addresses issues related to the measurement of the tax effect in interim periods associated with those changes.

30-38 The tax (or benefit) applicable to the cumulative effect of the change on retained earnings at the beginning of the fiscal year shall be computed the same as for the annual financial statements.

30-39 When an entity makes an accounting change in other than the first interim period of the entity’s fiscal year, paragraph 250-10-45-14, requires that financial information for the prechange interim periods of the fiscal year shall be reported by retrospectively applying the newly adopted accounting principle to those prechange interim periods. The tax (or benefit) applicable to those prechange interim periods shall be recomputed. The revised tax (or benefit) shall reflect the year-to-date amounts and annual estimates originally used for the prechange interim periods, modified only for the effect of the change in accounting principle on those year-to-date and estimated annual amounts.

Subsequent Measurement

35-1 This guidance addresses the accounting for interim period income tax expense (or benefit) in periods subsequent to an entity’s first interim period within a fiscal year. See Section 740-270-30 for a description of and requirements related to the determination of the estimated annual effective tax rate.

35-2 The estimated annual effective tax rate is described in paragraphs 740-270-30-6 through 30-8. As indicated in paragraph 740-270-30-18, estimates of the annual effective tax rate at the end of interim periods are, of necessity, based on evaluations of possible future events and transactions and may be subject to subsequent refinement or revision. If a reliable estimate cannot be made, the actual effective tax rate for the year to date may be the best estimate of the annual effective tax rate.

35-3 As indicated in paragraph 740-270-30-6, at the end of each successive interim period the entity shall make its best estimate of the effective tax rate expected to be applicable for the full fiscal year. As indicated in paragraph 740-270-30-8, the rate so determined shall be used in providing for income taxes on a current year-to-date basis. The rate shall be revised, if necessary, as of the end of each successive interim period during the fiscal year to the entity’s best current estimate of its annual effective tax rate.

35-4 As indicated in paragraph 740-270-30-5, the estimated annual effective tax rate shall be applied to the year-to-date ordinary income (or loss) at the end of each interim period to compute the year-to-date tax (or benefit) applicable to ordinary income (or loss). The interim period tax (or benefit) related to ordinary income (or loss) shall be the difference between the amount so computed and the amounts reported for previous interim periods of the fiscal year.

35-5 One result of the year-to-date computation is that, if the tax benefit of an ordinary loss that occurs in the early portions of the fiscal year is not recognized because it is more likely than not that the tax benefit will not be realized, tax is not provided for subsequent ordinary income until the unrecognized tax benefit of the earlier ordinary loss is offset (see paragraphs 740-270-25-9 through 25-11). As indicated in paragraph 740-270-30-31, the limitations described in paragraph 740-270-25-9 shall be applied in determining the estimated tax benefit of an ordinary loss for the fiscal year, used to determine the estimated annual effective tax rate, and the year-to-date tax benefit of a loss. As indicated in paragraph 740-270-30-33, if the tax benefit relates to an estimated ordinary loss for the fiscal year, it shall be considered in determining the estimated annual effective tax rate described in paragraphs 740-270-30-6 through 30-8. If the tax benefit relates to a year-to-date ordinary loss, it shall be considered in computing the maximum tax benefit that shall be recognized for the year to date.

35-6 A change in judgment that results in subsequent recognition, derecognition, or change in measurement of a tax position taken in a prior interim period within the same fiscal year is an integral part of an annual period and, consequently, shall be reflected as such under the requirements of this Subtopic. This requirement differs from the requirement in paragraph 740-10-25-15 applicable to a change in judgment that results in subsequent recognition, derecognition, or a change in measurement of a tax position taken in a prior annual period, which requires that the change (including any related interest and penalties) be recognized as a discrete item in the period in which the change occurs.

35-7 See Example 1, Case C (paragraph 740-270-55-9) for an illustration of how changes in estimates impact quarterly income tax computations.

Related Implementation Guidance and Illustrations

Example 1: Accounting for Income Taxes Applicable to Ordinary Income (or Loss) at an Interim Date if Ordinary Income Is Anticipated for the Fiscal Year [ASC 740-270-55-2].
Example 2: Accounting for Income Taxes Applicable to Ordinary Income (or Loss) at an Interim Date if an Ordinary Loss Is Anticipated for the Fiscal Year [ASC 740-270-55-11].
Example 5: Accounting for Income Taxes Applicable to Ordinary Income if an Entity Is Subject to Tax in Multiple Jurisdictions [ASC 740-270-55-37].
Example 6: Effect of New Tax Legislation [ASC 740-270-55-44].

ASC 740-270-25-2 states:

The tax (or benefit) related to ordinary income (or loss) shall be computed at an estimated annual effective tax rate and the tax (or benefit) related to all other items shall be individually computed and recognized when the items occur. [Emphasis added]

The ASC master glossary defines ordinary income (or loss) as follows:

Ordinary income (or loss) refers to income (or loss) from continuing operations before income taxes (or benefits) excluding significant unusual or infrequently occurring items. Discontinued operations and cumulative effects of changes in accounting principles are also excluded from this term. The term is not used in the income tax context of ordinary income versus capital gain. The meaning of unusual or infrequently occurring items is consistent with their use in the definitions of the terms unusual nature and infrequency of occurrence.[1]

Ordinary income does not include items of comprehensive income outside of continuing operations (discontinued operations and OCI). Therefore, the tax effects of such items are excluded from the AETR. Other tax effects of items reported in equity are also excluded from the AETR.

Certain items or events related to continuing operations are specifically excluded from the estimated AETR, and their related tax effects are recognized discretely (i.e., numerator excludes tax effect and denominator excludes any pretax book income or loss), including:

Significant unusual or infrequent items (ASC 740-270-30-8).
Components of pretax income that are not estimable (ASC 740-270-30-17).
Exclusion of a jurisdiction from the AETR (ASC 740-270-30-36(a) and (b)).
Excess tax benefits and tax deficiencies from share-based payment awards (ASC 740-270-30-4).
Tax-exempt interest.
Interest expense when interest is classified as income tax expense.

7.2.1 Significant Unusual or Infrequent Items

In accordance with ASC 740-270-30-8, significant unusual or infrequently occurring items that are separately reported are specifically excluded from the definition of ordinary income and are therefore excluded from the AETR. To qualify for exclusion from the AETR, the item must be:

Significant.
Unusual or infrequently occurring:
- Unusual nature — “The underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into account the environment in which the entity operates” (ASC master glossary).
- Infrequency of occurrence — “The underlying event or transaction should be of a type that would not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates” (ASC master glossary).
Separately reported.

An entity records the tax effects of significant unusual or infrequently occurring items in the period in which the items occur and excludes those tax effects from the calculation of the estimated AETR. The example below illustrates an interim tax provision that includes a significant unusual or infrequently occurring item.

Example 7-2

Assume the following:

The entity computes its AETR for each quarter of 20X1 on the basis of estimated results expected for the full fiscal year ending December 31, 20X1.
The statutory tax rate and AETR in 20X1 is 25 percent.
In the third quarter, a significant unusual or infrequent loss was realized in the amount of $15,000, and only $10,000 of the loss is deductible for tax purposes.

The AETR estimate of 25 percent applied to ordinary income is not affected by the significant unusual or infrequent item. See ASC 740-270-55-24 through 55-36 for other examples.

7.2.2 Components of Pretax Income That Are Not Estimable

Generally, an entity can reliably estimate ordinary income (or loss); however, there may be instances in which the entity is unable to estimate part of its ordinary income (or loss). In situations in which an entity is unable to estimate a portion of its ordinary income (or loss), the guidance in ASC 740-270-25-3 applies:

If an entity is unable to estimate a part of its ordinary income (or loss) or the related tax (or benefit) but is otherwise able to make a reliable estimate, the tax (or benefit) applicable to the item that cannot be estimated shall be reported in the interim period in which the item is reported.

Accordingly, the pretax amount of ordinary income (or loss) that cannot be reliably estimated and the related tax effects should be excluded from the entity’s estimate of its AETR in all periods, and the tax effects of the item that cannot be estimated should be recorded discretely in the interim period in which that item is reported.

Examples of such items may include (but are not limited to) impairment losses and foreign exchange gains or losses that would not already be excluded from the entity’s estimate of its AETR (e.g., because they are significant unusual or infrequently occurring items).

7.2.3 Exclusion of a Jurisdiction From the AETR

ASC 740-270-30-36 states that for entities subject to tax in multiple jurisdictions, the “interim period tax (or benefit) related to consolidated ordinary income (or loss) for the year to date shall be computed . . . using one overall estimated annual effective tax rate.” However, ASC 740-270-30-36 contains exceptions to this general guidance, which can lead to the exclusion of a jurisdiction from the AETR.

7.2.3.1 Loss Jurisdiction for Which No Tax Benefit Can Be Recognized

ASC 740-270-30-36(a) states:

If in a separate jurisdiction an entity anticipates an ordinary loss for the fiscal year or has an ordinary loss for the year to date for which, in accordance with paragraphs 740-270-30-30 through 30-33, no tax benefit can be recognized, the entity shall exclude ordinary income (or loss) in that jurisdiction and the related tax (or benefit) from the overall computations of the estimated annual effective tax rate and interim period tax (or benefit). A separate estimated annual effective tax rate shall be computed for that jurisdiction and applied to ordinary income (or loss) in that jurisdiction in accordance with the methodology otherwise required by this Subtopic.

An entity must use judgment in determining whether a tax benefit can be recognized. ASC 740-270-30-30 states that “a tax benefit shall be recognized for a loss that arises early in a fiscal year if the tax benefits are expected to be either” (1) “[r]ealized during the year” or (2) “[r]ecognizable as a deferred tax asset at the end of the year in accordance with the requirements established in Subtopic 740-10.” See ASC 740-270-30-32 and Example 2, Case D, in ASC 740-270-55-21 for guidance on situations in which, as ASC 740-270-30-32 states, the “reversal of existing taxable temporary differences may be a source of evidence in determining whether a tax benefit requires limitation.”

The examples below illustrate the guidance in ASC 740-270-30-36(a) with respect to an entity subject to tax in multiple jurisdictions, one of which anticipates an ordinary loss for the year. In the example below, no amount of tax benefit can be recognized for the forecasted loss; in Example 7-4, however, a tax benefit can be recognized for a portion of the forecasted loss.

Example 7-3

Assume the following:

An entity operates through separate corporate entities in three countries: A, B, and C.
The entity has no unusual or infrequently occurring items during the fiscal year and anticipates no tax credits or events that do not have tax consequences.
The full year’s forecasted pretax income (loss) and anticipated tax expense (benefit) for the three countries are shown below.
The entity can reliably estimate its ordinary income (loss) and tax (in dollars) in the three countries for the fiscal year.
An ordinary loss is anticipated for the current year in Country C. Under ASC 740-270-30-30 through 30-33, no tax benefit can be recognized for this loss. Accordingly, in accordance with ASC 740-270-30-36(a), the corporate entity in Country C is excluded from the computation of the overall AETR.

Computation of the overall estimated AETR is as follows:

Quarterly tax computations are as follows:

This example is consistent with Example 5, Case B, in ASC 740-270-55-41.

If an entity is able to recognize any benefit (even a relatively small one) attributable to the anticipated ordinary loss in a separate jurisdiction, the entity cannot exclude ordinary income (or loss) in that jurisdiction and the related tax expense from the overall computation of the estimated AETR. When recognizing a tax benefit for any of the anticipated ordinary loss for the fiscal year or the ordinary loss for the YTD, an entity must include the ordinary loss in the separate jurisdiction and the related tax in the computations of the estimated AETR and interim-period tax (or benefit). When determining whether any tax benefit can be recognized for an ordinary loss in a separate jurisdiction, an entity must consider local tax laws and whether a tax benefit can be recognized for the ordinary loss (e.g., whether the entity can use the losses in a consolidated tax return, can employ income/loss sharing or group relief with other entities in the same jurisdiction, can carry back current-year losses to offset prior-year income, or can recognize a benefit in a different jurisdiction attributable to the loss jurisdiction).

Example 7-4

Assume the same facts as in Example 7-3 except that the entity will be able to recognize a small tax benefit of $1,000 related to the ordinary loss in Country C as a result of a carryback claim. Because the entity can recognize some benefit related to the current-year loss, the income (loss) in Country C should not be removed from the computation of the overall AETR.

Computation of the overall estimated AETR is as follows:

Quarterly tax computations are as follows:

7.2.3.1.1 Foreign Losses Providing a Tax Benefit by Reducing a GILTI Inclusion

Questions arise about whether an entity should exclude ordinary losses in foreign subsidiaries from the estimation of its AETR under ASC 740-270-30-36(a) if the entity concludes that it is not more likely than not that the entity will realize the tax benefits of losses in those foreign jurisdictions, but those losses will provide tax benefits for U.S. tax purposes by reducing the entity’s GILTI inclusion.

We believe that there are two acceptable views.

Under one view, both the loss from the foreign subsidiary and the corresponding U.S. tax benefit related to the reduction in the GILTI inclusion would be contemplated in the estimation of the AETR. ASC 740-270-30-36(b) states, in part:

The tax (or benefit) related to ordinary income (or loss) in a jurisdiction may not be limited to tax (or benefit) in that jurisdiction. It might also include tax (or benefit) in another jurisdiction that results from providing taxes on unremitted earnings, foreign tax credits, and so forth.

Accordingly, because there is a benefit in the U.S. jurisdiction, ordinary losses and the related U.S. benefit derived by reduced GILTI inclusion would be included in the overall AETR.

Under the alternative view, however, the U.S. tax benefit related to the reduction in GILTI inclusion would be included in the estimation of the AETR, but the ordinary loss from the foreign subsidiary would not. ASC 740-270-30-36(a) states:

Under this second view, because the guidance in ASC 740-270-30-36 appears to suggest application on a jurisdiction-by-jurisdiction basis, the ordinary loss from the loss jurisdiction and the related tax (or benefit) in that separate jurisdiction would be excluded. However, the U.S. tax benefit related to the reduction in GILTI inclusion would be included in the estimation of the AETR unless the U.S. jurisdiction is also a loss jurisdiction.

7.2.3.1.2 Zero-Tax-Rate Jurisdictions and Nontaxable Entities

ASC 740 does not provide explicit guidance on how to adjust a parent entity’s consolidated estimated AETR (if at all) when a portion of its business is conducted by entities that either are operating in a zero-tax-rate jurisdiction or are nontaxable.

The exception in ASC 740-270-30-36(a) should not be extended to exclude nontaxable entities or entities that are operating in a zero-tax-rate jurisdiction from the overall computation of the AETR. We do not believe that the exception in ASC 740-270-30-36(a) (discussed in Section 7.2.3.1) is applicable in such circumstances because this paragraph contains a cross-reference to the discussion on realizability of a benefit for current-year losses in ASC 740-270-30-30 through 30-33 and does not focus on nontaxable entities or entities operating in a zero-tax-rate jurisdiction for which no benefit would inherently be recorded. Accordingly, such entities should generally be reflected in the computation of an entity’s AETR regardless of whether they have a profit or loss for the year.

Example 7-5

Entity P is a nontaxable flow-through entity that has a wholly owned subsidiary, S, a taxable C corporation that operates in a jurisdiction in which the tax rate is 25 percent. Estimated annual pretax income for P and S is $900 and $100, respectively. Estimated annual consolidated pretax income and tax expense are $1,000 and $25, respectively, resulting in an estimated AETR of 2.5 percent. The YTD pretax income of P and S is $370 and $30, respectively. The YTD interim tax expense is $10 ($400 YTD consolidated pretax income multiplied by 2.5 percent).

Example 7-6

Entity P operates in a jurisdiction in which the tax rate is 25 percent and has a wholly owned subsidiary, S, that operates in a jurisdiction in which the tax rate is 0 percent. Estimated annual pretax income (loss) for P and S is $1,100 and ($100), respectively. Estimated annual consolidated pretax income and tax expense are $1,000 and $275, respectively, resulting in an annual estimated AETR of 27.5 percent. The YTD pretax income (loss) for P and S is $430 and ($30), respectively. The YTD interim tax expense is $110 ($400 YTD consolidated pretax income multiplied by 27.5 percent).

7.2.3.2 Inability to Estimate AETR in Dollars or Unreliable Estimate of Ordinary Income (or Loss) or Related Tax Expense (or Benefit)

ASC 740-270-30-36(b) states:

If an entity is unable to estimate an annual effective tax rate in a foreign jurisdiction in dollars or is otherwise unable to make a reliable estimate of its ordinary income (or loss) or of the related tax (or benefit) for the fiscal year in a jurisdiction, the entity shall exclude ordinary income (or loss) in that jurisdiction and the related tax (or benefit) from the overall computations of the estimated annual effective tax rate and interim period tax (or benefit). The tax (or benefit) related to ordinary income (or loss) in that jurisdiction shall be recognized in the interim period in which the ordinary income (or loss) is reported. The tax (or benefit) related to ordinary income (or loss) in a jurisdiction may not be limited to tax (or benefit) in that jurisdiction. It might also include tax (or benefit) in another jurisdiction that results from providing taxes on unremitted earnings, foreign tax credits, and so forth.

ASC 740-270-30-36(b) provides additional exceptions to the general rule that the interim period tax (or benefit) related to consolidated ordinary income (or loss) for the YTD should be computed by using one overall estimated AETR. It indicates that if an entity is (1) unable to estimate an AETR in a foreign jurisdiction in dollars or (2) unable to make a reliable estimate of (a) its ordinary income (or loss) or (b) the related tax (or benefit) for the fiscal year, the entity should exclude that jurisdiction from the overall AETR.

An entity may not be able to reliably estimate an AETR in a foreign jurisdiction in dollars2 if the relevant foreign exchange rate is highly volatile. The determination of what constitutes a “reliable estimate” is a matter of judgment.

7.2.4 Excess Tax Benefits and Deficiencies Related to Share-Based Payment Awards

When a share-based payment award is granted to an employee, the fair value of the award is generally recognized over the vesting period, and a corresponding DTA is recognized to the extent that the award is tax deductible. The tax deduction is generally based on the intrinsic value at the time of exercise (for an option) or on the fair value upon vesting of the award (for restricted stock), and it can be either greater (excess tax benefit) or less (tax deficiency) than the compensation cost recognized in the financial statements.

ASC 740-270-30-4, ASC 740-270-30-8, and ASC 740-270-30-12 require entities to account for excess tax benefits and tax deficiencies as discrete items in the period in which they occur (i.e., entities should exclude them from the AETR). Therefore, the effects of expected future excesses and deficiencies should not be anticipated. The tax effects of the expected compensation expense should be included in the AETR.

Example 7-7

If, in the first quarter, an exercise of stock options results in a tax deficiency, but it is anticipated that in the second quarter a large excess tax benefit will result, an entity should still record an income tax expense related to the tax deficiency in the first quarter. In the second quarter, if an excess tax benefit does result, the income tax expense recorded in the first quarter resulting from the deficiency can be reversed as income tax benefit.

7.2.4.1 Interim Tax Effects of Awards Expected to Expire Unexercised During the Year

When estimating the AETR for the current interim period, an entity should not include the estimated effects of the expiration of awards expected to occur in a future interim period. For example, if share-based payment awards are expected to expire unexercised in the second quarter because they are “deep out of the money,” the entity should not consider the anticipated income tax expense as a result of the write-off of the related DTAs when estimating the AETR to compute the tax provision for the first quarter. Instead, the entity should record the income tax expense related to the write-off of the DTA upon expiration of an award in the period in which the awards expire unexercised. See Chapter 10 for general guidance on the accounting for income taxes associated with share-based payments and Section 10.2.4.2 for guidance related to the accounting for awards that expire unexercised.

7.2.4.2 Measuring the Excess Tax Benefit or Tax Deficiency Associated With Share-Based Compensation: Tax Credits and Other Items That Affect the ETR

Entities may receive tax credits or deductions for qualifying expenditures, which often include employee share-based compensation costs (e.g., the research and experimentation credit and the FDII deduction) that lower the entity’s ETR and can affect the determination of the excess tax benefit or tax deficiency that must be (1) accounted for under ASC 718-740-35-2 and (2) treated as a discrete item in the period in which the excess tax benefit or tax deficiency occurs. Accordingly, the excess tax benefit or deficiency of a share-based compensation deduction may differ from the amount computed on the basis of the applicable jurisdiction’s statutory tax rate multiplied by the excess or deficiency of the tax compensation deduction over an award’s corresponding compensation costs recognized for financial reporting purposes (e.g., “direct tax effects”).

Under U.S. GAAP, there are several acceptable approaches to determining the excess tax benefits or deficiencies that must be accounted for discretely under ASC 718-740-35-2:

One acceptable approach is to consider only the direct tax effects of the share-based compensation deduction. Under this approach, an entity would multiply its applicable income tax rate, as described in ASC 740-10-30-8, by the amount of cumulative share-based compensation cost and the deduction reported on a tax return to determine the amount of the DTA and the actual tax benefit, respectively. The income tax rate for each award should be computed on the basis of the rates applicable in each tax jurisdiction, as appropriate. Under this approach, the indirect effects of the deduction are not considered. The actual tax benefit is computed by multiplying the tax deduction by the applicable income tax rate in effect in the period in which the award is settled, which, in the absence of a change in enacted tax rate or tax law, would generally equal the rate used when the associated DTA was recognized (e.g., the jurisdiction’s statutory tax rate).
A second acceptable approach would be to perform a full ASC 740 “with-and-without” computation. Under this approach, the entire incremental tax effect of the actual tax deduction would be compared with the entire incremental tax effect of the cumulative amount of compensation cost recognized for book purposes as if it were the actual tax deduction. The difference would be the amount of excess tax benefit or tax deficiency.
A third acceptable alternative would be to compare the entire incremental tax effect of the actual tax deduction with the DTA recognized to determine the excess tax benefit or tax deficiency.

Use of one of the approaches described above to measure the excess tax benefit or tax deficiency constitutes an accounting policy that should be applied consistently to all awards and related tax effects.

7.2.5 Tax-Exempt Interest

It is acceptable for an entity to either include or exclude tax-exempt interest income when computing its estimated AETR. However, if tax-exempt interest income is included in ordinary income, we believe that the resulting tax benefit (permanent difference) should be included in the calculation of the estimated AETR. Whichever method is elected should be consistently applied.

As described in paragraph 80 of Interpretation 18, the FASB did not provide explicit guidance requiring a specific approach and instead stated, “the accounting practice . . . for tax-exempt interest income in interim periods appears to be uniform.” Comments received from respondents suggest that the common practice at the time among financial institutions was to exclude tax-exempt interest income from the estimated tax rate calculation.

7.2.6 Interest Expense When Interest Is Classified as Income Tax Expense

ASC 740-10-45-25 indicates that interest recognized for the underpayment of income taxes can be classified in the statement of operations as either income tax or interest expense, depending on the entity’s accounting policy election.

An entity that has adopted an accounting policy to include interest expense for the underpayment of income taxes as a component of income taxes in accordance with ASC 740-270 should not recognize interest expense through the estimated AETR for interim reporting purposes. This is because the interest expense relates to prior-year UTBs and is not based on taxes for current-year income and expense amounts. This conclusion was confirmed with the SEC staff.

Footnotes

[1]

Although the phrase “unusual or infrequently occurring items” is consistent with the definition in ASC 220 of “infrequency of occurrence” and “unusual nature,” the reference in ASC 220 applies to items that are not classified as a separate component of continuing operations.

Although the standard refers to “dollars,” we believe that this concept would apply to any reporting entity that has difficulty estimating an AETR in a foreign jurisdiction in its reporting currency.

7.3 Items Excluded in Part From the AETR

Certain items that may affect the AETR can also result in amounts recorded separately from the AETR, such as certain changes in:

Valuation allowances (ASC 740-270-30-7, ASC 740-270-30-11, and ASC 740-270-25-4).
Tax laws and rates (ASC 740-270-25-5 and ASC 740-270-30-11).
Changes in recognition and measurement of UTBs.
Assertions related to outside basis difference exceptions.

These events often affect both beginning-of-the-year tax balances as well as taxes related to current-year activities.

7.3.1 Valuation Allowances

ASC 740-270-30-7 states that “[t]he tax effect of a valuation allowance expected to be necessary” at the end of the year for a DTA originating in the current year should be included in the AETR.

A valuation allowance on beginning-of-the-year DTAs may increase or decrease during the year. ASC 740-270-30-11 states that “[t]he effects of changes in judgment about beginning-of-year valuation allowances . . . shall be excluded from the estimated annual effective tax rate calculation.” However, ASC 740-270-25-4 indicates that “[t]he tax benefit of an operating loss carryforward from prior years shall be included in the effective tax rate computation if the tax benefit is expected to be realized as a result of ordinary income in the current year” (emphasis added).

The examples below illustrate this concept.

Example 7-8

Valuation Allowance on Originating DTA

Assume that during the first quarter of fiscal year 20X1, Entity A, operating in a tax jurisdiction with a 50 percent tax rate, generates a tax credit of $3,000 that, under tax law, will expire at the end of 20X2. At the end of the first quarter of 20X1, available evidence about the future indicates that taxable income of $1,000 and $3,000 will be generated during 20X1 and 20X2, respectively. Therefore, a valuation allowance of $1,000 [$3,000 tax credit – ($4,000 combined forecasted taxable income of 20X1 and 20X2 × 50%)] will be necessary at the end of 20X1. The estimated pretax book income for the full fiscal year is $10,000. The $9,000 difference between book income and taxable income is attributable to tax-exempt income.

Because the valuation allowance relates to the tax attribute originating during the current year, the tax consequences of the $1,000 valuation allowance on the credits are included in the AETR.

The AETR and first-quarter tax expense are computed as follows:

Thus, if pretax accounting income is $5,000 during the first quarter of 20X1, a benefit for income taxes of $750 ($5,000 × [–15%]) would be recognized and net income of $5,750 would be reported for that interim period.

Example 7-9

Decrease in Valuation Allowance on Beginning-of-the-Year DTAs

Assume the following:

At the beginning of fiscal year 20X1, Entity X has a DTA of $4,000 that relates to $20,000 of NOLs that all expire in 20X5. A full valuation allowance is recorded against the DTA because X believes, on the basis of the weight of available evidence, that it is more likely than not that the DTA will not be realized.
Entity X has no other DTAs or DTLs.
Entity X’s tax rate is 20 percent.
At the beginning of the year, X estimates that it will earn $1,000 of income before tax in each of the quarters in 20X1.
Income before tax for the first quarter of 20X1 totals $1,000.
Income before tax for the second quarter of 20X1 totals $1,000.
At the end of the second quarter, X estimates, on the basis of new evidence, that it will earn $30,000 of taxable income in 20X2–20X4. Accordingly, X concludes that it is more likely than not that all of its DTAs will be realized.
The AETR is 0% ($0 projected tax expense ÷ $4,000 forecasted income).

The following table illustrates X’s tax expense (or benefit) in each of the four quarters of 20X1:

Because X estimated that it will earn income of $1,000 in each quarter in the current year, $800 of valuation allowance will be reduced through the AETR ($4,000 projected annual income × 20% tax rate) in accordance with ASC 740-270-25-4. Also in accordance with ASC 740-270-25-4, the remaining valuation allowance of $3,200 will be reduced discretely in the second quarter because the reduction is resulting from changes in judgment over the realizability of the DTA in future years.

Example 7-10

Increase in Valuation Allowance on Beginning-of-the-Year DTAs

Assume that Entity B operates in a tax jurisdiction with a 50 percent tax rate and is computing its ETR for fiscal year 20X2 at the end of its first quarter. At the end of the previous year, 20X1, B recorded a DTA of $4,000 for a tax credit carryforward generated in that year that, according to tax law, expires in 20X3, and B reduced that DTA by a valuation allowance of $1,000 on the basis of an estimate of taxable income of $3,000 in 20X2 and $3,000 in 20X3.

At the end of the first quarter of 20X2, assume that B’s estimate of future taxable income expected in 20X3 is revised from $3,000 to $2,000, and B’s estimate of taxable income expected in 20X2 continues to be $3,000. Pretax book income and taxable income for 20X2 are expected to be the same, and no new tax credits are expected during the year. Because the additional valuation allowance of $500 ($1,000 reduction in estimated 20X3 taxable income × 50%) relates to a change in judgment about the realizability of the related DTA in future years, the entire effect is recognized during the first quarter of 20X2. Thus, if B had pretax accounting income of $2,000 in the first quarter of 20X2 and its AETR for the full fiscal year is 50 percent, it would record income tax expense of $1,500, as computed below, and net income of $500 for the first quarter of 20X2.

7.3.1.1 Recognition of the Tax Benefit of a Loss in an Interim Period

Under ASC 740-270-25-9, the “tax effects of losses that arise in the early portion of a fiscal year shall be recognized only when the tax benefits are expected to be . . . [r]ealized” either during the current year or “as a deferred tax asset at the end of the year.” ASC 740-270-25-10 indicates that an “established seasonal pattern of loss in early interim periods offset by income in later interim periods” is generally sufficient to support a conclusion that realization of the tax benefit from the early losses is more likely than not. In addition, in accordance with ASC 740-270-30-31, limitations on the recognition of a DTA are “applied in determining the estimated tax benefit of an ordinary loss for the fiscal year.” This benefit is “used to determine the estimated annual effective tax rate and the year-to-date tax benefit of a loss.” The term “ordinary loss” in this context excludes significant unusual or infrequently occurring items that will be separately reported or reported net of their related tax effects. The tax benefit of losses incurred in early interim periods would not be recognized in those interim periods if available evidence indicates that the income is not expected in later interim periods.

If the tax benefits of losses that are incurred in early interim periods of a fiscal year are not recognized in those interim periods, an entity should not provide income tax expense on income generated in later interim periods until the tax effects of the previous losses are offset. In accordance with ASC 740-270-30-7, the “tax effect of a valuation allowance expected to be necessary for a deferred tax asset” at the end of a fiscal year for deductible temporary differences and carryforwards that originate during the current fiscal year should be spread throughout the fiscal year by an adjustment to the AETR.

7.3.2 Changes in Tax Laws and Rates Occurring in Interim Periods

Under ASC 740-270-25-5, the effects of new legislation are recognized upon enactment, which in the U.S. federal jurisdiction is the date the president signs a tax bill into law. The tax effects of a change in tax laws or rates on taxes currently payable or refundable for the current year are reflected in the computation of the AETR beginning in the first interim period that includes the enactment date of the new legislation. The effect of a change in tax laws or rates on a DTL or DTA is recognized as a discrete item in the interim period that includes the enactment date and accordingly is not allocated among interim periods remaining in the fiscal year by an adjustment of the AETR. If the effective date of a change in tax law differs from the enactment date, affected DTAs or DTLs are remeasured in the interim period that includes enactment; however, the remeasurement should include only the effects of the change on items that are expected to reverse after the effective date. For example, if an entity has two temporary differences that may be affected by a tax law change and expects one to reverse before the effective date of the change and the other to reverse after the effective date, the one that reverses after the effective date would be remeasured for the change in tax law in the interim period of enactment.

7.3.2.1 Retroactive Changes in Tax Laws

Certain changes in tax laws are applied retroactively. When provisions of a new tax law are effective retroactively, they can affect both the current-year measure of tax expense or benefit (either current or deferred) and the tax expense or benefit attributable to income recognized in prior annual periods that ended after the effective date of the retroactive legislation. The effect (if any) on the prior annual period is recognized in the interim period (and annual period) that includes the date of enactment. Such an effect might be reflected as a change to current tax accounts, deferred tax accounts, or both. Amounts pertaining to the prior annual accounting period must be recognized entirely in the period that includes the enactment date and should not be reflected in the current-period AETR.

When retroactive legislation is enacted in an interim period before the fourth quarter of the annual accounting period, the effect on the current annual accounting period is generally recognized by updating the AETR in the period of enactment for the effect of the retrospective legislation. That updated AETR is then applied to the YTD ordinary income through the end of the interim period that includes the enactment date. The cumulative amount of tax expense or benefit for the current year is then adjusted to this amount, which effectively “catches up” the prior interim periods for the change in law. The impact on the entity’s balance sheet should be consistent with its normal policy for adjusting the balance sheet accounts (current and deferred) on an interim basis. For further discussion, see Section 7.5.3.

In certain circumstances, an entity might not use the AETR approach to account for its interim income tax provision (generally because the entity cannot make a reliable estimate; for more information, see Section 7.2.2). In these situations, an entity would be required to determine the actual effect of retrospective legislation on income tax expense (or benefit) and balance sheet income tax accounts.

An entity that has not yet issued its report for the interim or annual period that ended before enactment cannot consider the enactment in preparing that report; however, the effect that the retroactive legislation will have on the period being reported should still be disclosed. To determine the amount to disclose in such circumstances, the entity generally must perform computations similar to those described above.

The example below illustrates the accounting for a change in tax rate retroactive to interim periods of the current year.

Example 7-11

Entity C, operating in a tax jurisdiction with a 35 percent tax rate, is computing its AETR for each quarter of 20X2. Entity C’s estimated annual ordinary pretax income is $8,000, which it earns in equal amounts during each quarter of fiscal year 20X2. At the end of the previous year, C recorded a DTA of $350 for a $1,000 liability on the financial statements that is deductible on the tax return when paid. As the payments are made, they reduce the liability throughout the year, as shown in the following table:

Entity C has another temporary difference related to an accumulated hedging loss in the statement of OCI. The following table summarizes the gain (loss) activity during each quarter of 20X2:

The table below illustrates C’s estimated AETR calculation for fiscal year 20X2 at the end of the first quarter. As discussed in Section 7.2, the changes in OCI are excluded from the AETR calculation.

Estimated AETR Calculation on March 31, 20X2

Estimated Change in DTA on March 31, 20X2

At the end of May, legislation was enacted that increased the tax rate for 20X2 and years thereafter to 40 percent. The effect of the change in the tax rate related to the DTA is recognized on the enactment date as a discrete item, and the effect of the change on taxes currently payable is recognized by adjusting the AETR in the interim period of the change.

On the enactment date, the balance sheet liability was $900 and the cumulative loss in OCI was $500. The following table illustrates the calculation of the deferred tax expense that is recorded as a discrete amount and the amount that is recognized through the AETR:

Estimated Change in DTA on June 30, 20X2

Estimated AETR Calculation

Because of the enacted tax rate increase, the DTA related to the cumulative $500 loss in OCI for hedging activity on the enactment date must also be adjusted. The $25 tax benefit ($500 cumulative loss × 5% change in tax rate) related to the adjustment to the DTA for the tax rate increase is a discrete item that is part of continuing operations and therefore affects the tax expense in the quarter of enactment.

The following table summarizes the quarterly income tax on the basis of the above calculations:

Quarterly ETR Calculation

Quarterly OCI Changes

The effect of the change in tax rates should be (1) reported as a separate line item in income tax expense from continuing operations or (2) disclosed in the footnotes. For further discussion, see Chapter 14.

7.3.2.2 Impact of Delayed Effective Dates and the Administrative Implementation of New Legislation

ASC 740-270-55-49 states, in part:

The effect of the new legislation shall be reflected in the computation of the annual effective tax rate beginning in the first interim period that includes the enactment date of the new legislation.

ASC 740-270-55-45 through 55-49 illustrate this guidance:

ASC 740-270

Legislation Effective in a Future Interim Period

55-45 The assumed facts applicable to this Example follow.

55-46 For the full fiscal year, an entity anticipates ordinary income of $100,000. All income is taxable in one jurisdiction at a 50 percent rate. Anticipated tax credits for the fiscal year total $10,000. No events that do not have tax consequences are anticipated.

55-47 Computation of the estimated annual effective tax rate applicable to ordinary income is as follows.

55-48 Further, assume that new legislation creating additional tax credits is enacted during the second quarter of the entity's fiscal year. The new legislation is effective on the first day of the third quarter. As a result of the estimated effect of the new legislation, the entity revises its estimate of its annual effective tax rate to the following.

55-49 The effect of the new legislation shall be reflected in the computation of the annual effective tax rate beginning in the first interim period that includes the enactment date of the new legislation. Accordingly, quarterly tax computations are as follows.

7.3.3 Changes in Judgment Related to UTBs

An entity may change its judgment regarding (1) the validity of a tax position based on the more-likely-than-not recognition threshold or (2) the measurement of the greatest amount of benefit that is more likely than not to be realized in a negotiated settlement with the taxing authority.

For interim financial reporting purposes, the accounting for a change in judgment about a tax position taken or to be taken in the current year is different from the accounting for a change in judgment about a tax position taken in a prior fiscal year. To maintain consistency with the existing requirements of ASC 740-270 for interim reporting, ASC 270, ASC 740-10-25-15, and ASC 740-270-35-6 require the following accounting:

The effect of a change in judgment regarding a tax position taken in a prior fiscal year is recorded entirely in the interim period in which the judgment changes (similarly to taxes on a significant, unusual, or infrequently occurring item).
The effect of a change in judgment regarding a tax position taken in a prior interim period in the same fiscal year is allocated to the current and subsequent interim periods by inclusion in the revised AETR.

7.3.3.1 Changes in Judgment Regarding a Tax Position Taken in the Current Year

The example below demonstrates changes in judgment regarding a tax position taken in the current year.

Example 7-12

In the first quarter of 20X7, an entity:

Estimates that its ordinary income for fiscal year 20X7 will be $4,000 ($1,000 per quarter). Assume a tax rate of 25 percent.
Enters into a transaction that is expected to permanently reduce its 20X7 taxable income by $1,000; thus, its total tax expense for the year is expected to be $750, or ($4,000 - $1,000) × 25%. Assume that the transaction meets the recognition threshold and that the full $250 will be recognized under ASC 740.

Accordingly, for each quarter in 20X7 (provided that earnings are ratable), ordinary income and income tax expense are expected to be $1,000 and $188, respectively.

During the second quarter of 20X7, the entity receives new information indicating that the tax position related to the $1,000 deduction no longer meets the more-likely-than-not recognition threshold but does meet the minimum threshold required to avoid penalties if the position is taken on the tax return; thus, the company intends to still take the uncertain tax position on the 20X7 tax return. Therefore, in preparing its second-quarter financial statements, the entity updates its estimate of the AETR as follows:

On the basis of the new information received in the second quarter, the entity should report the following ordinary income and income tax expense for each quarter during 20X7:

The effect of the change in judgment over a tax position taken in the current fiscal year is recognized by changing the estimated AETR to 25 percent, which does not reflect any benefit for the tax position. Of the $250 total change representing the loss of the tax benefit previously thought to be more likely than not, a $125 UTB is recognized in the second quarter and the remaining UTB of $125 is recognized in the third and fourth quarters.

7.3.3.2 Changes in Judgment Regarding a Tax Position Taken in the Prior Year

The example below demonstrates changes in judgment regarding a tax position taken in the prior year.

Example 7-13

In the first quarter of 20X7, an entity estimates that its AETR for the year will be 30 percent.

In the second quarter of 20X7, the entity receives new information indicating that a tax position taken in 20X6 no longer meets the more-likely-than-not recognition threshold. The benefit recognized for that tax position in the 20X6 financial statements was $400. No similar tax positions were taken or are expected to be taken in 20X7.

Assuming that ordinary income for each of the quarters is $1,000, the entity determines income tax expense in each of the quarters in 20X7 as follows:

The effect of the change in judgment regarding the tax position taken in 20X6 is recorded as a discrete item in the second quarter of 20X7, the period in which the judgment changed, and does not affect the AETR to be applied to 20X7 ordinary income.

7.3.4 Changes in an Indefinite Reinvestment Assertion

An entity may change its indefinite reinvestment assertion related to an investment in a foreign subsidiary or foreign corporate joint venture that is essentially permanent in duration. For interim income tax reporting purposes, the DTL related to the beginning-of-the-year outside basis difference that is expected to reverse in the foreseeable future is recorded as a discrete item in the period of the change in assertion. However, the amounts pertaining to the current year (e.g., current-year earnings) will be captured within the estimated AETR in accordance with ASC 740-270-35-6. For the same reasons discussed in Section 6.2.4.1, the adjustment for the beginning-of-the-year outside basis difference is (1) generally allocated to continuing operations and (2) calculated by using the exchange rate at the beginning of the year.

7.4 Intraperiod Tax Allocation in Interim Periods

ASC 740-270

45-1 Subtopic 740-20 establishes requirements to allocate total income tax expense (or benefit) of an entity for a period to different components of comprehensive income and shareholders’ equity. That process is referred to as intraperiod tax allocation. This Section addresses that required allocation of income tax expense (or benefit) in interim periods.

45-2 Section 740-20-45 describes the method of applying tax allocation within a period. The tax allocation computation shall be made using the estimated fiscal year ordinary income together with unusual items, infrequently occurring items, and discontinued operations for the year-to-date period.

45-3 Discontinued operations that will be presented net of related tax effects in the financial statements for the fiscal year shall be presented net of related tax effects in interim financial statements. Unusual or infrequently occurring items that will be separately disclosed in the financial statements for the fiscal year shall be separately disclosed as a component of pretax income from continuing operations, and the tax (or benefit) related to those items shall be included in the tax (or benefit) related to continuing operations. See paragraphs 740-270-25-12 through 25-14 for interim period recognition guidance when an entity has a significant unusual or infrequently occurring loss or a loss from discontinued operations. See paragraphs 740-270-45-7 through 45-8 for the application of interim period allocation requirements to recognized income tax expense (or benefit) and discontinued operations. See Example 7 (paragraph 740-270-55-52) for an illustration of the income statement display of these items.

45-4 Paragraph 740-20-45-3 requires that the manner of reporting the tax benefit of an operating loss carryforward recognized in a subsequent year generally is determined by the source of the income in that year and not by the source of the operating loss carryforward or the source of expected future income that will result in realization of a deferred tax asset for the operating loss carryforward. The tax benefit is allocated first to reduce tax expense from continuing operations to zero with any excess allocated to the other source(s) of income that provides the means of realization, for example, discontinued operations, other comprehensive income, and so forth. That requirement also pertains to reporting the tax benefit of an operating loss carryforward in interim periods.

45-5 Paragraph 740-270-25-11 establishes the requirement that when the tax effects of losses that arise in the early portions of a fiscal year are not recognized in that interim period, no tax provision shall be made for income that arises in later interim periods until the tax effects of the previous interim losses are utilized.

Specific Requirements Applicable to Discontinued Operations

45-6 This guidance addresses specific requirements for the intraperiod allocation of income taxes in interim periods when there are discontinued operations.

45-7 When an entity reports discontinued operations, the computations described in paragraphs 740-270-25-12 through 25-14, 740-270-30-11 through 30-13, and 740-270-45-2 through 45-3 shall be the basis for the tax (or benefit) related to the income (or loss) from operations of the discontinued operation before the date on which the criteria in paragraph 205-20-45-1E are met.

45-8 Income (or loss) from operations of the discontinued operation, prior to the interim period in which the date on which the criteria in paragraph 205-20-45-1E are met occurs, will have been included in ordinary income (or loss) of prior periods and thus will have been included in the estimated annual effective tax rate and tax (or benefit) calculations described in Sections 740-270-30 and 740-270-35 applicable to ordinary income. The total tax (or benefit) provided in the prior interim periods shall not be recomputed but shall be divided into two components, applicable to the remaining ordinary income (or loss) and to the income (or loss) from operations of the discontinued operation as follows. A revised estimated annual effective tax rate and resulting tax (or benefit) shall be computed, in accordance with Sections 740-270-30 and 740-270-35 applicable to ordinary income, for the remaining ordinary income (or loss), on the basis of the estimates applicable to such operations used in the original calculations for each prior interim period. The tax (or benefit) related to the operations of the discontinued operation shall be the total of:

The difference between the tax (or benefit) originally computed for ordinary income (or loss) and the recomputed amount for the remaining ordinary income (or loss)
The tax computed in accordance with paragraphs 740-270-25-12 through 25-14; 740-270-30-11 through 30-13; and 740-270-45-2 through 45-3 for any unusual or infrequently occurring items of the discontinued operation.

See Example 4 (paragraph 740-270-55-29) for an illustration of accounting for income taxes applicable to income (or loss) from discontinued operations at an interim date.

The requirements within ASC 740-20 to allocate the total income tax expense (or benefit) of an entity to different components of comprehensive income and shareholder’s equity are applicable to interim periods (the “with-and-without” intraperiod allocation model; see Chapter 6). ASC 740-270-45-2 states, in part, that “[t]he tax allocation computation shall be made using the estimated fiscal year ordinary income together with unusual items, infrequently occurring items, and discontinued operations for the year-to-date period.”

The intraperiod allocation of tax effects in an earlier quarter may be revised in a later quarter. For example, a tax effect may be allocated to an item other than income from continuing operations during the first quarter of the fiscal year. However, as a result of the occurrence of unanticipated events in a later quarter of the same fiscal year, the allocation of the tax effect to that item could change (e.g., a component classified as a discontinued operation might be sold in the current year, whereas the entity’s initial expectation was that it would not be sold until the subsequent year). The change in tax effect should be reflected as an adjustment of the original allocation. The objective should be to properly reflect the intraperiod allocation of tax expense for the annual period. The intraperiod tax allocation should be adjusted at each interim date, if necessary, to achieve that goal.

This approach is consistent with the example in ASC 740-270-55-28, which illustrates the accounting in interim periods for income taxes applicable to unusual or infrequently occurring items. However, this conclusion does not apply to the interim-period effects of changes in tax law or rates. As discussed in ASC 740-10-45-17, the effects of changes in tax law or rates on prior interim periods should be included in the current interim period as part of income from continuing operations.

Example 7-14

In the first and second quarters of 20X1, an entity generates tax benefits from unrealized losses on an AFS debt security, which results in the recognition of a DTA. In accordance with ASC 740-20-45-11(b), the expense related to the unrealized losses is recorded net of tax through OCI. On the basis of the entity’s expected future earnings, no valuation allowance on the DTA is deemed necessary. No further tax benefits are generated in the third and fourth quarters.

Beginning in the third quarter and through the end of the fiscal year, unanticipated events result in continued operating losses for the entity; by year-end, a full valuation allowance on the DTA is necessary. Although the recognition of the benefit of the DTA in OCI was appropriate in the first and second quarters, the application of the intraperiod allocation approach to the YTD income in the third quarter would result in there being no tax benefit allocated to OCI, and a valuation allowance should be recognized through OCI in the fourth quarter.

For the annual period, there is no impact on the intraperiod tax allocation because the need for a valuation allowance occurred in the same annual period in which the DTA was generated. If the valuation allowance was not required until the subsequent year, the change in the valuation allowance would be allocated to income from continuing operations, in accordance with ASC 740-20-45-4.

Example 7-15

In the first quarter of 20X0, an entity is evaluating whether to release a valuation allowance against an NOL DTA on the basis of an expected gain on a sale of a discontinued operation (assume that the income from the sale is of the appropriate character for the entity to realize the DTA and is the only source of income during the year).

When there is uncertainty about the timing of the sale, the entity should determine, by using its best estimate, the period in which the sale will be finalized. If management expects to sell the component in the current year, the entity should follow Approach 1 below. If management does not expect to sell the component in the current year, the entity should follow Approach 2 below. Whichever approach is applied on the basis of an entity’s facts and circumstances, the objective to properly reflect the intraperiod allocation of tax expense for the annual period should be met.

Approach 1 — Allocate the anticipated benefit to discontinued operations in the quarter and YTD period in which income is available to offset the DTA (which would be the period in which the sale occurs in this example, in accordance with ASC 740-270-25-4). If management’s expectation regarding the timing of the sale of the component changes in a subsequent interim period such that the sale is now expected to occur in the subsequent year, the anticipated benefit should be recognized in continuing operations in the quarter in which it becomes apparent, on the basis of the entity’s best estimate, that the transaction will not occur in the current year.
Approach 2 — Allocate the anticipated benefit to income from continuing operations in the first quarter and, if income from discontinued operations becomes available in a subsequent quarter and YTD period and is sufficient to offset the DTA (which would be the period in which the sale occurs in this example), reclassify the benefit to income from discontinued operations.

See Section 6.2.2 for further guidance on accounting for changes in valuation allowances resulting from items other than continuing operations.

7.4.1 Recognition of the Tax Benefit of an Operating Loss Carryforward in an Interim Period

The method of intraperiod tax allocation for annual periods also applies to reporting the tax benefit of an operating loss carryforward in interim periods. ASC 740-20-45-3 indicates that an entity determines the tax benefit of an operating loss carryforward recognized in a subsequent year under ASC 740 in the same way that it determines the source of the income in that year and not in the same way that it determines the source of (1) the operating loss carryforward or (2) the “expected future income that will result in realization of a deferred tax asset” for the operating loss carryforward. The tax benefit is allocated first to reduce income tax expense from continuing operations to zero with any excess benefit allocated to other sources of income that provide a means of realization (e.g., gains from extraordinary items and from discontinued operations).

7.5 Other Considerations

Other complexities can arise when entities are determining the appropriate amount of income tax to recognize in an interim period. ASC 740-270 addresses some of these complexities.

7.5.1 Inability to Make a Reliable Estimate of the AETR

ASC 740-270-30-18 states:

Estimates of the annual effective tax rate at the end of interim periods are, of necessity, based on evaluations of possible future events and transactions and may be subject to subsequent refinement or revision. If a reliable estimate cannot be made, the actual effective tax rate for the year to date may be the best estimate of the annual effective tax rate.

If a company’s AETR is highly sensitive to changes in estimates of total ordinary income (or loss), the AETR may not be considered reliable. This may occur when, for example, an entity is expecting marginal ordinary income (or loss) and relatively significant permanent differences or tax credits.

In certain situations, a negative AETR may be projected (e.g., nondeductible expenses exceed pretax loss). Often these estimates are sensitive to ordinary income and may be an indicator that reasonable estimates cannot be made. If a reliable estimate of the AETR cannot be made, the best estimate of the AETR may be the actual ETR for the YTD.

7.5.2 Nonrecognized Subsequent Events

ASC 740-270-35-3 indicates that at the end of each successive interim period during the fiscal year, an entity should revise its estimated AETR, if necessary, to reflect its current best estimate.

Questions have arisen regarding whether an entity’s current best estimate of its AETR should include events that occurred after the interim balance sheet date but before its financial statements are issued or are available to be issued (i.e., a nonrecognized subsequent event as contemplated in ASC 855).

Generally, a nonrecognized subsequent event should not be reflected in the AETR (but should be disclosed if significant). This approach is based on ASC 855-10-25-3, which states that nonrecognized subsequent events should not result in the adjustment of the financial statements.

We are aware of an alternative approach in practice under which an entity’s current best estimate of its AETR is based on information available up to the date on which its financial statements are issued or are available to be issued, even though that might include information that did not exist or was not relevant until after the interim balance sheet date. Even under this approach, an entity would still be required to exclude items for which the tax effects must be recognized in the period in which they occur (e.g., changes in UTBs, changes in tax laws or rates, a change in tax status, an IPO, or a business combination). Entities should consult with their accounting advisers before applying this alternative approach.

7.5.3 Balance Sheet Effects of the Interim Provision for Income Taxes

In accordance with ASC 740-10, entities use a balance sheet approach to determine the annual provision for income taxes. However, for interim financial statements, ASC 740-270 requires entities to determine the YTD income tax expense or benefit by applying an estimated AETR to YTD ordinary income. Because of the inherent disconnect between the year-end balance sheet approach of ASC 740-10 and the interim income statement approach of ASC 740-270, questions have arisen about how to reflect the YTD expense or benefit on the balance sheet. That is, the YTD tax expense or benefit that an entity determines under ASC 740-270 will typically not reconcile to the balance sheet adjustments that would be required if the year-end balance sheet approach of ASC 740-10 were applied to the current and deferred tax accounts on an interim basis. ASC 740-270 neither addresses this disconnect nor provides guidance on how to record the balance sheet effects of recording the interim provision for income taxes.

An entity should generally adjust its income tax balance sheet accounts as of interim reporting periods in a manner that is representationally faithful to either the balance sheet approach of ASC 740-10 (with respect to the measurement of current and deferred taxes) or the income statement approach of ASC 740-270. For example, adjusting current and deferred taxes by developing a “split” AETR that consists of current and deferred components would appear to be representationally faithful to the income statement approach of ASC 740-270. Alternatively, calculating the actual deferred YTD tax expense (or benefit) and deriving the adjustment to current taxes (or calculating current taxes and deriving the adjustment to deferred taxes) would appear to be representationally faithful to the balance sheet approach of ASC 740-10 (at least with respect to one of the balance sheet components).

Other methods may also be acceptable depending on an entity’s specific facts and circumstances, including materiality considerations.

Because the method applied to adjust the income tax balance sheet accounts for interim reporting periods would not be disclosed in the annual financial statements, entities should consider disclosing the method applied in their interim financial statements.

Example 7-16

Company A is preparing interim financial statements and calculates an estimated AETR of 25 percent that, when applied to YTD ordinary income of $100, results in an interim expense for income taxes of $25.

To adjust its income tax balance sheet accounts for interim reporting purposes, A might apply one of the following methods:

Split estimated AETR — On a forecasted basis, A estimates an 80/20 split between the current and deferred portions of the annual provision for income taxes and applies this split to the interim provision to allocate the adjustment between current and deferred balance sheet accounts.
Calculate current taxes — Company A calculates its current taxes payable in accordance with tax law applied to YTD income and records a $40 liability. On the basis of the required AETR provision of $25, A adjusts the deferred taxes for the beginning of the year by $15 (a debit entry to the balance sheet).
Calculate deferred taxes — Company A calculates its deferred taxes as of the interim balance sheet date and adjusts its deferred taxes for the beginning of the year by $10 (a credit entry to the balance sheet). On the basis of the required AETR provision of $25, A recognizes a current liability of $15.

Note that in most cases, none of the methods above produce the same balance sheet and related expense or benefit that would arise if the balance sheet approach of ASC 740-10 were applied.

7.5.4 Required Interim Disclosures

ASC 740-270-50-1 notes that application of the interim-period requirements for reporting income taxes may result in “significant variations in the customary relationship between income tax expense and pretax accounting income.” Entities must disclose the reasons behind such variations in their interim-period financial statements if the differences are not readily apparent from the financial statements themselves or from the nature of the business of the entity.

In addition, for entities that are subject to SEC reporting requirements, management should consider the requirements in SEC Regulation S-X, Rule 10-01(a)(5), which states, in part:

The interim financial information shall include disclosures either on the face of the financial statements or in accompanying footnotes sufficient so as to make the interim information presented not misleading. Registrants may presume that users of the interim financial information have read or have access to the audited financial statements for the preceding fiscal year and that the adequacy of additional disclosure needed for a fair presentation may be determined in that context.

Accordingly, if any annual disclosures have significantly changed since the most recently completed fiscal year, management should update them in a manner sufficient to ensure that the interim information presented is not misleading. See Sections 14.4.1.6 and 14.4.3.3 for examples of situations in which management should consider updating an entity’s annual disclosures during an interim period.