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Accounting

for
Income Taxes
in
Interim Periods

Interim Reporting
Prescribes an estimated annual Effective Tax Rate
(ETR) approach for calculating a tax provision for
interim periods. Conventional wisdom might lead
one to believe that using such an approach to record
an interim period income tax provision simplifies
the otherwise laborious process of computing a
discrete tax provision for each interim period.

Interim Reporting
Accounting for income taxes in interim
periods is far from simple. The ETR approach
presents a number of unique complexities and
challenges and in certain circumstances, can
lead to counterintuitive results.

Interim Reporting
Some of the key considerations and
complexities in accounting for income taxes
during interim periods following this general
outline:

Interim Reporting
Estimated annual effective tax rate approach
should generally be used to determine the tax
(or benefit) related to ordinary income. Certain
items do not meet the definition of ordinary
income, the tax effects of such items should be
computed and recognized as discrete items
when they occur.

Interim Reporting
There are limited exceptions to the use of the
estimated annual effective tax rate approach
and also limitations on the amount of benefits
that can be recognized for losses, credits and
rate differentials in loss periods.

Interim Reporting
There are a number of additional situations
that present unique challenges when
accounting for income taxes in interim
periods.

ASC 740-270-25-1
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 yearto-date operating results, referred to as ordinary
income (or loss) and specific events that are discretely
recognized as they occur.

ASC 740-270-25-2
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.

ASC 740-270-25-3
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.

ASC 740-270-25-4
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.

Accounting Standard Codification (ASC)


740-270-25-4
Tax benefit shall be recognized in the manner
described in 470-270-45-4 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, cont.

Accounting Standard Codification (ASC)


740-270-25-4
Cont. in the case of a change in judgment
about realizability of the related deffered tax
asset in future years, the effect shall be
recognized in the interim period in which the
change occurs.

Accounting Standard Codification (ASC)


740-270-25-5
Effect 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 recorded after the effective dates
prescribed in the statutes and

Accounting Standard Codification (ASC)


740-270-25-5
Reflected in the computation of the
annual effective tax rate beginning
no earlier than the first interim
period that includes the enactment
date of the new legislation.

Accounting Standard Codification (ASC)


740-270-25-5
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

Accounting Standard Codification (ASC)


740-270-25-6
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 expenses (benefit) for
the current year.

Accounting Standard Codification (ASC)


740-270-25-7
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.

Accounting Standard Codification (ASC)


740-270-30-12
Taxes related to significant unusual
or extraordinary items that will be
separately reported or reported net
of their related tax effect also shall
be excluded from the estimated
annual effective tax rate calculation.

Accounting Standard Codification (ASC)


740-270-30-12
This description of significant
unusual or extraordinary items
includes unusual items, infrequently
occurring items, discontinued
operations and extraordinary items.

Accounting Standard Codification (ASC)


740-270-45-3
Extraordinary items and discontinued
operations that will be presented net of
related tax effects in interim financial
statements.
Unusual or infrequently occurring items that
will be separately disclosed as a component
of pretax income from continuing operations
and the tax (or benefit) related to such items
shall be included in the tax (or benefit)
related to continuing operations.

Method of Computing
an Interim Tax Provision

Accounting Standard Codification (ASC)


740-270-25-2
Provides the following guidance for
calculating an income tax provision
in an interim period:
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.

Method of Computing an Interim Tax


Provision
Determining the Elements and
Tax Effects of Ordinary Income

Method of Computing an Interim Tax


Provision
Definition of Tax (or benefit)
Related to Ordinary Income
Since the tax effects of current-year
ordinary income receive different
interim accounting treatment than
the tax effects of other types of
income during the same period, the
definition of a tax (or benefit)
related to ordinary income
becomes important. ASC 740-27020 defines these terms as follows:

Method of Computing an Interim Tax


Provision
Definition of Tax (or benefit) Related
to Ordinary Income
a. Ordinary Income (or loss) refers to income
(or loss) from continuing operations
before income taxes (or benefits)
excluding significant unusual or
infrequently occurring items.
Extraordinary items, discontinued
operations and cumulative effects of
changes in accounting principles are also
excluded from this term.

Method of Computing an Interim Tax


Provision
Definition of Tax (or benefit)
Related to Ordinary Income
The term is not used in the income
tax context of ordinary income vs.
capital gain. The meaning of
unusual or infrequently occurring
items is consistent with their use
in the definition of the term,
extraordinary item.

Method of Computing an Interim Tax


Provision
Definition of Tax (or benefit)
Related to Ordinary Income
b. Tax (or benefit) is the total income
tax expense (or benefit) including
the provision (or benefit) for income
taxes both currently payable and
deferred.

Method of Computing an Interim Tax


Provision
Items excluded from the
Definition of Ordinary Income

Significant Unusual or Infrequent Items


ASC 270-10-45-11A prescribes that
extraordinary items, gains or losses
from disposal of a component of an
entity and unusual or infrequently
occurring items shall not be prorated
over the balance of the fiscal year.
Deciding whether events should be
classified as unusual or infrequent
can be challenging.

Significant Unusual or Infrequent Items


Ordinary Income (or loss) in ASC 740-27020 refers to the definition of the term
extraordinary item in ASC 225-20-20,
which provides the following:
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.

Significant Unusual or Infrequent Items


Ordinary Income (or loss) in ASC 740-27020 refers to the definition of the term
extraordinary item in ASC 225-20-20,
which provides the following:

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.

Significant Unusual or Infrequent Items


While both of these criteria should be
met to classify an event or
transaction as an extraordinary item,
only one of theses factors is required
for an item to be excluded from the
estimated annual effective tax rate.

Significant Unusual or Infrequent Items


ASC 740-270-30-13 provides that the
tax effect of significant unusual or
extraordinary items that are reported
separately within income from
continuing operations should be
excluded from the estimated annual
effective tax rate calculation and
instead be recorded on a discrete
basis in the period which the item
occurs.

Significant Unusual or Infrequent Items


ASC 740-270-30-12 also prescribes
discrete treatment for items that are
required to be reported net of their
related tax effect such as other
comprehensive income, discontinued
operations and extraordinary items.

Limited Exceptions for Certain Items


Barring the exceptions presented
below in Sections TX 17.1.1.3.1
through TX 17.1.1.4.8, Section TX
17.2.2 and Section TX 17.5.1, ASC
740-270 provides no latitude for
treating any other tax effects of
ordinary income on a discrete-period
basis.

Limited Exceptions for certain items


Accordingly, the tax effects of items
such as dividends-received
deductions and capital gains rates on
significant fixed asset dispositions
that are not considered unusual or
infrequent should be incorporated
into the estimated annual effective
tax rate rather that record discretely.

Tax-Exempt Interest
While deliberating the accounting
issues related to accounting for
income taxes in interim periods, the
FASB discussed the historical practice
of excluding tax-exempt interest
from ordinary income and effectively
treating it as discrete income even
though interest on tax-exempt
securities often forms a portion of
ordinary income of an entity that

Tax-Exempt Interest
Despite this mention of recording the
tax impacts of interest from taxexempt securities as they are
earned, the FASB decided not to
provide specific guidance on this
issue.

Tax-Exempt Interest
If not for the reference to the then
common practice of excluding taxexempt interest from the estimated
annual effective tax rate calculation,
tax-exempt interest would be treated
like any other rate reconciling item
related to current year ordinary
income.

Tax-Exempt Interest
FASB did not explicitly object to the
exclusion of tax-exempt interest from
the ETR calculation, we believe that
including or excluding tax-exempt
interest from the ETR calculation is
acceptable as long as the approach
is applied consistently.

Investment Tax Credits


ASC 740-270-30-14 provides
guidance for handling the impact of
investment tax credits when applying
the estimated annual effective tax
rate approach. Whether investment
tax credits are included or excluded
depends on the accounting
treatment selected. ASC 740-270-3014 states:

Investment Tax Credits


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,

Investment Tax Credits


Amortization of deferred investment
tax credits need to 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.

Leveraged Leases
ASC 740-270-30-15 states:
Paragraphs 840-30-30-14 and 84030-35-34 through 35-35 require that
investment tax credits related to
leases that are accounted for as
leveraged leases shall be deferred and
accounted for as a return on the net
investment in the leveraged leases
during the years in which the net
investment is positive

Leveraged Leases
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

After-Tax Equity Pickup for Investees


owned 50 percent or less
Typically appropriate to record equity
in the net income of a 50-percent-orless-owned investee based on its
interim statements on an after-tax
basis (i.e., the investee would
provide taxes in its financial
statements based on its own
estimated annual effective tax rate
calculation).

After-Tax Equity Pickup for Investees


owned 50 percent or less
Any incremental investors tax, the
incremental tax would not be
calculated as part of the investors
overall Effective Tax Rate (ETR)
calculation. Instead, this incremental
tax would be calculated based on a
separate ETR calculation

Other Items that do not Represent Tax


Effects Related to Ordinary Income
ASC 740-270-25-2 makes it clear that
the only items that should be spread
by means of the estimated annual
effective tax rate approach are the
tax effects of current-year ordinary
income (or loss)

Other Items that do not Represent Tax


Effects Related to Ordinary Income
Many items resulting from actions
that occurred during the year, but
not representing tax effects related
to current-year ordinary income,
should be recorded discretely in the
interim period in which they
occurred. Examples of these items
include the following:

Other Items that do not Represent Tax


Effects Related to Ordinary Income
Subsequent recognition,
derecognition or change in
measurement for an uncertain tax
position arising in prior periods due
to a change in judgment or
interpretation of new information
Interest and penalties recognized on
uncertain tax positions
Change in tax law

Other Items that do not Represent Tax


Effects Related to Ordinary Income
Change in tax status
Certain changes in the realizability of
deferred tax assets
Change in judgment regarding
unremitted foreign earnings and
other outside basis differences
Change in estimate related to a prioryear tax provision

Interest and Penalties recognized on


Uncertain Tax Positions
ASC 740-10-25-56 requires that
interest be accrued in the first period
in which the interest would begin
accruing according to the provisions
of the relevant tax law.

Interest and Penalties recognized on


Uncertain Tax Positions
Interest expense should be accrued
as incurred and should be excluded
from the ETR calculation. ASC 74010-25-57 indicates that a penalty
should be recorded when a position
giving rise to a penalty is taken or
anticipated to be taken on the
current years tax return.

Change in Tax Law


ASC 740-10-25-47 through 25-48,
ASC 740-10-45-15 and ASC 740-27025-5 through 25-6, adjustments to
deferred tax assets and liabilities as
a result of a change in tax law or
rates should be accounted for
discretely in continuing operations at
the date of enactment.

Change in Tax Law


Effects of a retroactive change in tax
rates should also be accounted for
discretely in continuing operations in
the interim period in which the law is
enacted.

Change in Tax Law


Prospective effects of a change in tax
law or rates on tax expense in the
year of enactment should be
reflected in the estimated annual
effective tax rate calculation.

Change in Tax Status


ASC 740-10-25-32 through 25-34, the
effect of a voluntary change in tax
status should be recognized
discretely on:
(1)The date that approved is granted
by the taxing authority
(2)The filing date, if approval is
unnecessary.

Change in Tax Status


Entire effect of a change in tax status
should be recorded in continuing
operations in accordance with ASC
740-10-45-19.

Certain Changes in the Assessment of


the Realizability of Deferred Tax
ASC 740-270-25-7, the tax effect of a
change in the beginning-of-the-year
balance of a valuation allowance
caused by a change in judgment
about the realizability of the related
deferred tax asset that results from
changes in the projection of income
expected to be available in future
years should be recognized discretely
in the interim period in which the

Certain Changes in the Assessment of


the Realizability of Deferred Tax
Change in judgment about the
realizability of deferred tax assets
resulting from changes in estimates
of current-year ordinary income
and/or deductible temporary
differences and carryforwards that is
expected to originate in ordinary
income in the current year should be
considered in determining the
estimated effective tax rate.

Certain Changes in the Assessment of


the Realizability of Deferred Tax
Change in judgment should not be
recorded discretely in the interim
period in which it changes.

Change in Judgment Regarding Unremitted


Foreign Earnings and Other Outside-Basis
Differences
Company will sometimes change its
intentions about whether it will
indefinitely reinvest undistributed
earnings of foreign subsidiaries or
corporate joint ventures that are
essentially permanent in duration
and thus whether it will record
deferred taxes on outside basis
differences.

Change in Judgment Regarding Unremitted


Foreign Earnings and Other Outside-Basis
Differences
Tax effect of the change in judgment
for the establishment/reversal of the
deferred tax liability related to the
outside basis difference that had
accumulated as of the beginning of
the year should be recorded in
continuing operations in the interim
period during which the intentions
changed.

Change in Judgment Regarding Unremitted


Foreign Earnings and Other Outside-Basis
Differences
A portion of the outside basis difference
that accumulated as of the beginning of
the year may include the effects of
currency movements that:
(1) had been previously recorded through
a Cumulative Translation Adjustment (CTA)
as the company had already established a
deferred tax liability;

Change in Judgment Regarding Unremitted


Foreign Earnings and Other Outside-Basis
Differences
A portion of the outside basis
difference that accumulated as of the
beginning of the year may include the
effects of currency movements that:
(2) were not recorded through CTA as
the company did not recognize a
deferred tax liability on the CTA portion
of the outside basis difference.

Change in Judgment Regarding Unremitted


Foreign Earnings and Other Outside-Basis
Differences
In either situation, the effect of that
currency movement on the outside
basis difference as of the beginning
of the year reflected in continuing
operations in the period in which the
change in judgment occurred.

Change in Judgment Regarding Unremitted


Foreign Earnings and Other Outside-Basis
Differences
This treatment is consistent ASC 74030-25-19, which indicates that the
tax effect of a subsidiarys
undistributed earnings:
should be charged to expense in
the period during which the
circumstances change
should not be recorded as an
extraordinary item

Change in Judgment Regarding Unremitted


Foreign Earnings and Other Outside-Basis
Differences
Tax effect of the change in intensions
on unremitted earnings of the
current year should be reflected in
the determination of the companys
ETR. Any tax effect related to
currency movements associated with
current-year unremitted earnings
that increases or decreases the
deferred tax liability would be
attributed to CTA for the period.

Change in Estimate Related to a PriorYear Tax Provision


Estimated annual effective tax rate
approach should only be used to
record the tax effect of current-year
ordinary income. A change in
estimate in the current year that is
related to a prior-year tax provision
does not constitute a tax effect on
current-year income.

Change in Estimate Related to a PriorYear Tax Provision


Effects of this change should be
recorded discretely in the period
during which the change in estimate
occurs. The next section presents
guidance for determining whether a
change in the prior-year tax provision
is an error or a change in estimate.

Discerning an Error from a Change in


Accounting Estimate in Income TaxesRevised June 2015
Following guidance is intended to assist
professionals with judgments as to when
changes in tax positions reflected in prior
periods or changes in income tax
amounts accrued in prior periods
constitutes financial reporting errors
rather than changes in estimates. The
following circumstances are among those
intended to be covered by this guidance:

Discerning an Error from a Change in


Accounting Estimate in Income TaxesRevised June 2015
The discovery that the tax reported
in a prior years return was either
understated or overstated
(regardless of whether an amended
return has been filed);
The discovery that a tax return or tax
payment filing requirement was not
met;

Discerning an Error from a Change in


Accounting Estimate in Income TaxesRevised June 2015
The discovery of misapplication of
ASC 740 or related accounting
principles; or
A change in the amount of tax
expense or benefit initially
recognized related to a prior
reporting period

Discerning an Error from a Change in


Accounting Estimate in Income TaxesRevised June 2015
Example of Errors
A tax accrual is intentionally misstated
(without regard to materiality)
A mechanical error is made when
calculating the income tax provision (e.g.,
if meals and entertainment expenditures
were deducted twice instead of being
added back to taxable income or if the
wrong disallowance rate was applied

Discerning an Error from a Change in


Accounting Estimate in Income TaxesRevised June 2015
Example of Errors
Misapplications of ASC 740 and
related accounting principles and
interpretations are made. For
example, the company failed to
record a tax benefit or contingent
tax liability at the balance sheet
date

Discerning an Error from a Change in


Accounting Estimate in Income TaxesRevised June 2015
Example of Errors
that should have been recognized in
accordance with such guidance
considering the facts and
circumstances that existed at the
reporting date and that were
reasonably knowable at the date the
financial statements were issued.

Discerning an Error from a Change in


Accounting Estimate in Income TaxesRevised June 2015
Example of Errors
The company chose to estimate
rather than obtain an amount for
tax provision purposes at the
balance sheet date that was
readily accessible in the
companys books and records
and the actual amount differs
from the estimate.

Discerning an Error from a Change in


Accounting Estimate in Income TaxesRevised June 2015
Example of Errors
In assessing whether information
was (or should have been) readily
accessible, consideration should
be given to the nature, complexity,
relevance and frequency of
occurrence of the item.

Discerning an Error from a Change in


Accounting Estimate in Income TaxesRevised June 2015
Example of Errors
In this regard, it would be expected
that companies would develop
internal control processes to properly
consider relevant information
relating to frequently occurring or
recurring items that could be
significant.

Discerning an Error from a Change in Accounting Estimate in Income


Taxes-Revised June 2015

Example, a company would be


expected to have an adequate
internal control system to track
meals and entertainment charges, to
the extent such amounts create a
material permanent difference in the
companys tax return.

Discerning an Error from a Change in


Accounting Estimate in Income TaxesRevised June 2015
If there is a significant difference between the
estimate made when closing the books and
the actual amount reported on the tax return,
this would seem to constitute an error.
This is not to suggest that the level of
precision is expected to be completely
accurate or that all differences between
estimates and actual amounts constitute
errors.

Discerning an Error from a Change in


Accounting Estimate in Income TaxesRevised June 2015
A relatively insignificant difference
between an estimate and the actual
amount provides evidence that the
companys control system is
adequate and that such an
adjustment should be treated as a
change in estimate in the period
identified.

Discerning an Error from a Change in


Accounting Estimate in Income TaxesRevised June 2015
Conversely, consider a company that
had never before repatriated foreign
earnings (and had not provided
deferred taxes on such amounts in
accordance with ASC 740-30-25-17).
The company decides late in its fiscal
year to repatriate some or all of the
foreign earnings.

Computing
the
Tax Provision Attributable
to
Ordinary Income

Estimated Annual Affective Tax Rate


Metholology
With limited exceptions, ASC 740270 requires companies to calculate
the estimated annual effective tax rate
for current-year ordinary income,
including both the current and
deferred provisions determined under
ASC 740.

Estimated Annual Affective Tax Rate


Metholology
Project taxable income for the year,
which is in turn used to estimate the
annual provision for taxes currently
payable, it is necessary to estimate
temporary differences and rate
differentials entering into the current
provision.

Estimated Annual Affective Tax Rate


Metholology
The temporary differences used to
estimate the current provision are then
included in the projected year-end
temporary differences used to estimate the
annual provision for deferred taxes,
including any change in the valuation
allowance. These estimates should be
updated on each interim financial reporting
date.

Estimated Annual Affective Tax Rate


Metholology
As a practical matter, however, there may
be circumstances in which the estimated
annual effective tax rate can be
appropriately estimated by considering only
rate differentials. These situations often
involve temporary differences that are
expected to have offsetting effects in the
current and deferred provisions (i.e., the
effect on the

Estimated Annual Affective Tax Rate


Metholology
current provision would be equal in amount
but opposite in direction to the effect on the
deferred provision). If additional
complexities arise (e.g., the enacted tax
rate varies between years or a valuation
allowance for beginning or ending deferred
provisions must typically be made to
develop an appropriate estimated annual
effective tax rate.

Best Current Estimate

General
The estimated annual effective tax
rate should represent the best
estimate of the composite tax
provision in relation to the best
estimate of worldwide pretax book
ordinary income.

Best Current Estimate


General
The composite tax provision should
include federal, foreign and state income
taxes, including the effects of:
(1)credits,
(2)Special deductions (e.g., Internal
Revenue Code Section 199 deduction
under the American Jobs Creation Act
or percentage depletion)

Best Current Estimate


General
The composite tax provision should
include federal, foreign and state
income taxes, including the effects of:
(3) Capital gains taxed at different
rates,
(4) Valuation allowances for
current-year changes in temporary
differences and losses or income
arising during the year.

Best Current Estimate


General
The estimated annual ETR is then
applied to year-to-date ordinary
income to compute the year-to-date
interim tax provision on ordinary
income.

Best Current Estimate

General
The difference between the year-todate interim tax provision and the
year-to-date interim tax provision as of
the preceding interim period
constitutes the tax provision for that
quarter.

Best Current Estimate

Treatment of Nonrecognized
Subsequent Events on the ETR
If a significant pretax nonrecognized
subsequent event occurs after the
interim balance sheet date before
financial statement issuance, an
important questions arises.

Best Current Estimate

Treatment of Nonrecognized
Subsequent Events on the ETR
Should the companys best current
estimate of annual pretax ordinary
income be updated for the
nonrecognized subsequent event, or
should the best current estimate only
use information that existed as of the
balance sheet date?

Best Current Estimate

Treatment of Nonrecognized
Subsequent Events on the ETR
Example, assume that, subsequent
to the interim balance sheet date, a
significant new customer contract was
signed. Alternatively, assume a severe
hurricane loss was suffered by an
insurance company.

Best Current Estimate

Treatment of Nonrecognized
Subsequent Events on the ETR
In both instances, the subsequent
event significantly changed the
companys current estimate of its
annual pretax ordinary income and
thereby its estimated annual effective
tax rate.

Best Current Estimate


Treatment of Nonrecognized
Subsequent Events on the ETR
ASC 740-270-35-3 indicates that, at
the end of each interim period during
the fiscal year, the estimated annual
effective tax rate should be revised, if
necessary, to reflect the entitys best
current estimate.

Best Current Estimate

Treatment of Nonrecognized
Subsequent Events on the ETR
One could reasonably conclude that the
companys best current estimated annual
effective tax rate should be based on
information available prior to the date of
issuance, even though some of that
information might be about influential factors
that did not exist or were not relevant until
after the interim balance sheet date.

Best Current Estimate

Treatment of Nonrecognized
Subsequent Events on the ETR
Conversely, AU Section 560.05
indicates that nonrecognized
subsequent events should not result in
the adjustment of the financial
statements. If any entity were to
incorporate a significant
nonrecognized subsequent event into
the development of an updated ETR,

Best Current Estimate

Treatment of Nonrecognized
Subsequent Events on the ETR
Some of the subsequent events
indirect effects would be recorded in
the results up until the balance sheet
date that preceded the nonrecognized
event.

Best Current Estimate

Treatment of Nonrecognized
Subsequent Events on the ETR
Since the effect of nonrecognized
subsequent events should not be
reflected in the financial statements,
one could reasonably conclude that
the effects of a nonrecognized
subsequent event should be excluded
from the interim calculation of the ETR.

Best Current Estimate

Treatment of Nonrecognized
Subsequent Events on the ETR
Companies that choose to consider
all available information up until
issuance date should be careful to
exclude items whose tax effects are
required to be recognized discretely in
the period that they occur, such as:

Best Current Estimate

Treatment of Nonrecognized
Subsequent Events on the ETR
(1)Changes in tax laws or rates;
(2)New information received after the
reporting date related to the
assessment of uncertain tax positions;
(3)Discontinued operations, extraordinary
items and other significant unusual or
infrequent items

Best Current Estimate

Treatment of Nonrecognized
Subsequent Events on the ETR
When there is a significant time lag
from the interim date to the date of
the issuance of the financial
statements (as may be the case with a
company reporting on a prior interim
period for the first time in connection
with a registration statement), it may
become

Best Current Estimate

Treatment of Nonrecognized
Subsequent Events on the ETR
Increasingly difficult to assert that
an event in the extended period should
affect the estimated annual effective
tax rate applied to the interim period.

Best Current Estimate


Treatment of Nonrecognized
Subsequent Events on the ETR
We generally believe that the
delayed issuance of the financial
statements should not result in a
different assessment of the estimated
annual effective tax rate than would
have been the case had the financial
statements been issued on a timely
basis.

Limitation on Benefits of Losses, Credits and Rate


Differential in Loss Periods

ETR approach is modified by ASC


740-270-30-30 through 30-34, which
limit the tax benefit recognized for a
loss in interim periods to the amount
that is expected to be:
(a)Realized during the year; or
(b) (b) recognizable as a deferred
tax asset at the end of the year.

Limitation on Benefits of Losses, Credits and Rate


Differential in Loss Periods

Those limitations should be applied


in determining both separate
jurisdiction and worldwide estimated
annual effective tax rates and the
year-to-date benefit for a loss. Those
limitations also apply to rate
differentials that would increase the
effective benefit rate during loss
periods.

Limitation on Benefits of Losses, Credits


and Rate Differential in Loss Periods
In applying the guidance in ASC 740-27030-30 through 30-34 related to the
realizability of deferred tax assets and the
need for a valuation allowance, the central
issue that a company needs to consider is
the valuation allowance that it expects to
recognize at year-end, including any
expected change in the valuation
allowance during the year. The company
cannot simply focus on the benefit of
losses in the current year.

Exceptions to the Use of the ETR


Approach
ASC 740-270 requires the use of an
estimated annual effective tax rate to
compute the tax provision for ordinary
income in all jurisdictions during an interim
period.
In determining that rate, there are two
exceptions to the general rule that requires
all jurisdictions (and all the tax effects on
current-year ordinary income) to be
included in the computation of the
consolidated worldwide ETR.

Exceptions to the Use of the ETR


Approach
If one of these exceptions applies and
one or more foreign jurisdictions are
excluded from the computation of the
worldwide ETR, the U.S. tax effects (e.g.,
remitted or unremitted dividend income
and related foreign tax credits) of the
operations in those foreign jurisdictions
are also excluded.

Exceptions to the Use of the ETR


Approach
State and municipal income tax
jurisdictions are subject to the same
limitations as foreign jurisdictions
with respect to what can be included
in the consolidated worldwide ETR.

Exceptions to the Use of the ETR


Approach
Jurisdiction with Pretax Losses
for which No Tax Benefit can be
recognized
When a company operates in a
jurisdiction that has generated
ordinary losses on a year-to-date basis
or on the basis of the results
anticipated for the full fiscal year and
no benefit can be recognized on those
losses.

Exceptions to the Use of the ETR


Approach
Jurisdiction with Pretax Losses
for which No Tax Benefit can be
recognized
ASC 740-270-30-36 (a) requires the
company to exclude that jurisdictions
income (or loss) from the overall ETR
calculation. A separate ETR should be
computed and applied to ordinary
income (or loss) in that jurisdiction.

Exceptions to the Use of the ETR


Approach
Jurisdiction with Pretax Losses
for which No Tax Benefit can be
recognized
In effect, any jurisdiction with losses
for which no benefit can be recognized
are removed from the base calculation
of the ETR. Assuming the reason for no
benefit is a full valuation allowance,
the separate ETR for that jurisdiction
would be zero.

Jurisdiction with Pretax Losses for which No Tax Benefit can be Recognized

Zero-rate Jurisdiction
ASC 740-270 does not specifically address
whether a zero-rate jurisdiction should or
should not be included in the ETR
computation. As there is conceptual support
for either inclusion or exclusion of a zerorate jurisdiction, we believe this is an aspect
of accounting for income taxes for which
diversity in practice can be expected. The
following are four acceptable approaches:

Zero-rate Jurisdictions

Approach A: Always exclude pre-tag


ordinary income or loss from a zerorate jurisdiction from the ETR
computation. This view is premised
on the theory that the income in a
zero-rate jurisdiction is effectively
tax-exempt. The exclusion of pre-tax
income from a zero-rate jurisdiction
is analogous to the optional
treatment of tax-exempt income

Zero-rate Jurisdictions
Approach B: Exclude pre-tax ordinary
income or loss from a zero-rate jurisdiction
from the ETR computation if there is a yearto-date loss in that jurisdiction. The rationale
for this view is based on the notion that a
loss ultimately will not provide a tax benefit.
Support for this view can be found in ASC
740-270-30-36(a) which requires the
exclusion of jurisdictions with year-to-date
losses if no tax benefit can be recognized for
the year-to-date loss or for an anticipated
full-year loss.

Zero-rate Jurisdictions
Approach C: Exclude pre-tax
ordinary income or loss from a zerorate jurisdiction from the ETR
computation only if a loss is
anticipated for the full fiscal year.
This view concludes that ASC 740270-30-36(a) is not directly
applicable because it addresses
positive tax rate jurisdictions in
circumstances where a loss would be

Zero-rate Jurisdictions
This view would not exclude income
or loss when year-to-date loss is
anticipated to reverse in subsequent
periods. This view in effect
represents a modified analogy to the
principle in ASC 740-270-30-36(a).

Zero-rate Jurisdictions
Approach D: Always include pre-tax
ordinary income or loss from a zerorate jurisdiction the ETR computation
because the underlying principle in
ASC 740-270 is that, absent a
specific requirement or exception, all
current-year ordinary income or loss
should be included in the ETR
computation.

Zero-rate Jurisdictions
This view differentiates the exception in ASC
740-270-30-36(a) as only applying to taxable
jurisdictions for which a valuation allowance
may be necessary. This view is premised on
the notion that the ETR approach is known to
yield, at times, seemingly illogical results in
particular periods, yet there are only two
narrowly drawn exceptions to full-inclusion,
both of which are described with reference to
an entity that is subject to tax.

Zero-rate Jurisdictions
Approach used should be considered an
accounting policy election to be applied
consistently to all zero-rate jurisdictions of
the reporting entity. If it is clearly evident
that the approach applied to zero-rate
jurisdictions has reporting consequences
that would be significantly different than
had one or more of the other acceptable
approaches outlined above been applied,
appropriate disclosure should be considered.

Jurisdictions for which a Reliable Estimate


cannot be made
General Overview
ASC 740-270-30-36(b) provides the
following two situations in which a company
should exclude a jurisdiction from the overall
computations of the estimated annual
effective tax rate:
1. If a company operates in a foreign
jurisdiction for which a reliable estimate
of the annual effective tax rate in terms of
the parent entitys functional currency
cannot be made.

Jurisdictions for which a Reliable


Estimate cannot be made
General Overview
ASC 740-270-30-36(b) provides the
following two situations in which a
company should exclude a jurisdiction from
the overall computations of the estimated
annual effective tax rate:
2. If a reliable estimate of ordinary income
for a particular jurisdiction cannot be made.

Jurisdictions for which a Reliable


Estimate cannot be made
General Overview
Presumably the first situation would
arise when the exchange rate between
the parent companys functional
currency and the foreign currency is
highly volatile (this does not commonly
occur in practice).

Jurisdictions for which a Reliable


Estimate cannot be made
General Overview
With respect to the second situation,
the FASB acknowledged that
determining whether an estimate is
reliable requires the use of
professional judgment and may involve
the assessment of probability.

Jurisdictions for which a Reliable


Estimate cannot be made
General Overview
Example, in some cases, a small
change in an entitys estimate ordinary
income could produce a significant
change in the ETR, an estimate of the
ETR would not be reliable if a small
change in ordinary income were likely
to occur.

Computing a Tax Provision when a


Reliable Estimate cannot be made
ASC 740-270-30-17 through 30-18
reads as follows:
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.

Computing a Tax Provision when a


Reliable Estimate cannot be made
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 ETR.

Computing a Tax Provision when a


Reliable Estimate cannot be made
This excerpt clarifies that the
estimated annual effective tax rate is
an estimate that is inherently subject
to changes.
This fact alone does not justify a
departure from the ETR approach.

Computing a Tax Provision when a


Reliable Estimate cannot be made
Whether a reliable estimate of
ordinary income or loss or the related
tax can be made is a matter of
judgment. If management is unable
to estimate only a portion of its
ordinary income, but is otherwise
able to reliably estimate the
remainder, the tax applicable to that
item should be reported in the
interim period in which the item

Computing a Tax Provision when a


Reliable Estimate cannot be made
An estimated annual effective tax
rate must be applied to the
remainder of ordinary income and
the related tax that can be reliably
estimated.

Effects of Naked Credits on the


Estimated Annual Effective Tax Rate
When a company is incurring losses
and has a full valuation allowance,
the increase of a deferred tax liability
that does not serve as a source of
income for the recognition of a
deferred tax asset will trigger an
estimated tax for the current year.

Effects of Naked Credits on the


Estimated Annual Effective Tax Rate
The impact of this naked credit
should be included in a companys
ETR calculation. This inclusion would
be required whether the jurisdiction
with the naked credit is included in
an entitys worldwide ETR calculation
or excluded from the worldwide ETR
calculation and treated as a separate
jurisdiction with a stand-alone
estimated annual ETR under ASC

Effects of Naked Credits on the


Estimated Annual Effective Tax Rate
Discrete treatment is appropriate when
the annual estimate of the tax rate is not
considered a reliable estimate.
This may happen when a company
determines a wide range of potential
estimated annual effective tax rates
because pretax income is at or near
breakeven and it has significant
permanent items such as the deferred tax
effect from a naked credit.

Effects of Naked Credits on the


Estimated Annual Effective Tax Rate
Consideration should be given to
whether the company has the ability
to estimate its ETR, given the range
of possible outcomes.
The inability to estimate the ETR in a
jurisdiction would cause the tax
provision for that jurisdiction to be
calculated on a discrete basis under
ASC 740-270-30-36(b).

Tax Effects Other Than the Tax on


Current-Year Ordinary Income
ASC 740-270-25-2 requires that the
entire tax (or benefit) related to all
items other than the tax effect on
ordinary income should be
individually computed and
recognized when the items occur.

Tax Effects Other Than the Tax on


Current-Year Ordinary Income
Example of these items include the tax
effects related to discontinued operations,
other comprehensive income, additional
paid-in capital and items in continuing
operations that represent tax effects not
attributable to current-year ordinary income.
The tax effects represented by these items
should be computed and reflected in
accordance with the intraperiod allocation
rules

Intraperiod Allocation in Interim


Periods
General Overview
ASC 740-270-45 indicates that the
intraperiod allocation rules (ASC 74020-45) should be used to allocate the
interim provision throughout the
interim financial statements. Although
the with-and-without model is
basically the same for interim and
annual periods

Intraperiod Allocation in Interim


Periods
General Overview
The allocation of tax expense or benefit
for interim periods should be performed
using the estimated fiscal year income
and tax for ordinary income (or loss)
and the year-to-date income and tax for:
(1)an infrequent, unusual, or
extraordinary item,
(2) the gain or loss on disposal of a
discontinued operation, or

Intraperiod Allocation in Interim Periods


General Overview
The allocation of tax expense or
benefit for interim periods should be
performed using the estimated fiscal
year income and tax for ordinary
income (or loss) and the year-to-date
income and tax for:
(3) another component of the financial
statements (e.g., other comprehensive
income).

Intraperiod Allocation in Interim


Periods
If more than one of the above items
is present, the computation should
reflect the order of precedence that
will be assumed in annual financial
statements. Unusual or infrequent
items that are included in continuing
operations will ordinarily be
considered before any items that are
excluded from continuing operations.

Intraperiod Allocation in Interim


Periods
If more than one item is excluded
from continuing operations, the
process outlined in ASC 740-20-45-14
should be used to apportion the
remaining provision after the tax
expense or benefit allocated to
continuing operations is considered.
This allocation process should be
consistent with the process used in
the annual calculation.

Subsequent Revisions
Tax attributed to financial statement
components that are reported in an
early quarter can be subsequently
revised to reflect a change in the
estimate of tax related to annual
ordinary income or changes in yearto-date income or loss in other
components.

Subsequent Revisions
ASC 740-270 requires the
computation of the interim provision
to be performed on a year-to-date
basis. As a result, the tax provision
for a given quarter equals the
difference between the provision
recorded cumulatively for the year
(via the estimated annual effective
tax rate approach) less the amount
recorded cumulatively as of the end

Subsequent Revisions
Changes in circumstances from
quarter to quarter might make it
necessary to record the tax effects in
a financial statement category that
differs from the one in which the
company recorded the tax effects
during a previous quarter.

Subsequent Revisions
Goal of the ASC 740-270 model is to
treat the interim periods as
components of the current annual
period.
Intraperiod allocation, like the
estimated annual effective tax rate,
must be updated and recomputed
each quarter.

Intraperiod Allocations that Reflects Discontinued


Operations Prior to the Date on which they are
Classified as Held for Sale or Disposed Of

Once operations are classified as


discontinued, prior periods are
restated to reflect the now
discontinued operations prior to the
date on which those operations are
first reported as discontinued
operations,

Intraperiod Allocations that Reflects Discontinued


Operations Prior to the Date on which they are
Classified as Held for Sale or Disposed Of
ASC 740-270-45-6 through 45-8 provides
detailed rules for taking the tax
previously assigned to ordinary income
and the discontinued operations.
ASC 740-270-55-29 provides an
illustration of accounting for income
taxes applicable to income or (loss) from
discontinued operations at an interim
date.

Changes in Valuation Allowance


Need for a valuation allowance must
be reassessed at each interim
reporting date. Pursuant to ASC 740270-25-4 and depending on the
circumstances that lead to a change
in valuation allowance, the change
may be reflected in the estimated
annual effective tax rate or
recognized discretely in the interim
period during which the change in

Changes in Valuation Allowance


Any change in valuation allowance
that results from a change in
judgment about the realizability of
the related deferred tax assets
resulting from changes in the
projection of income expected to be
available in future years is reported
in the period during which the
change in judgment occurs.

Changes in Valuation Allowance


No portion of the effect should be
allocated to subsequent interim
periods through an adjustment to the
estimated annual effective tax rate
for the remainder of the year.

Changes in Valuation Allowance


The following changes in valuation
allowance should be considered in
determining the ETR for the year:
A change in the valuation allowance
related to deductible temporary
differences and carryforwards that
are expected to originate in ordinary
income in the current year.

Changes in Valuation Allowance


The following changes in valuation
allowance should be considered in
determining the ETR for the year:
A change in the valuation allowance for
beginning-of-year deferred tax assets that
results from a difference between the
estimate of annual ordinary income (which
includes the year-to-date amount) for the
current year and the estimate that was
inherent in the beginning-of-year valuation
allowance.

Changes in Valuation Allowance


If there is a reduction in the valuation
allowance for beginning-of-year
deferred tax assets that results from
income other than ordinary income
(e.g., discontinued operations), the
benefit should be reflected discretely
in year-to-date results (presuming of
course, that current-year continuing
operations and projections of future
income could not have supported the

Initial Recognition of Source-of-Loss


Items
Initial recognition of source-of-loss
items are generally excluded from
recognition in income but rather
recorded back to the source of the
prior year loss/benefit.

Initial Recognition of Source-of-Loss


Items
Example, the initial recognition of a
tax benefit of a windfall tax
deduction related to stock-based
compensation would be recognized
in additional paid-in capital. Tax
benefits related to source-of-loss
items would not enter into the ETR
calculation.

Exception to the Basic Intraperiod


Allocation Model
ASC 740-20-45-7 which describes the
exception to the basic with-and-without
approach to intraperiod allocation, must also
be considered in interim periods. If a
company has a valuation allowance and
expects:
(1) pretax losses from continuing operations;
and
(2) income in other components of the
financial statements

Exception to the Basic Intraperiod


Allocation Model
ASC 740-20-45-7 may have an effect
on the presentation of the interim
period financial statements and may
possibly result in the reporting of a
tax benefit (which would be
incorporated in the estimated annual
effective tax rate) in continuing
operations, even though no such
benefit would be computed using the
basic with-and without approach.

Tax Accounting Considerations of StockBased Compensation During Interim Periods


When an entity calculates its
estimated annual effective tax rate,
it should not anticipate or estimate
the incremental effects of windfalls
or shortfalls that may occur over the
balance of the year.

Tax Accounting Considerations of StockBased Compensation During Interim Periods


Example, if an option is due to expire
in the current year, the entity should
not anticipate that it will be exercised
and that a windfall will be
recognized, even though the fair
value of the underlying stock
exceeds the exercise price of the
option.

Tax Accounting Considerations of StockBased Compensation During Interim Periods


If an entity had disqualifying
dispositions for incentive stock
options (ISOs) or employee stock
purchase plans (ESPPs) in the past, it
should not anticipate future
disqualifying dispositions. The entity
should recognize windfalls and
shortfalls discretely in the period in
which they occur.

Tax Accounting Considerations of StockBased Compensation During Interim Periods


Example, If an entity does not have
a sufficient pool of windfall tax
benefits at the beginning of the year,
any shortfall should be recorded in
the income statement in the period
in which the shortfall occurred.

Tax Accounting Considerations of StockBased Compensation During Interim Periods


If a windfall is recognized later in the
year, the shortfall that was
recognized earlier in the year should
be reversed in the subsequent
quarter to the extent that it can be
offset against the windfall (because
the pool of windfall tax benefits is
determined on an annual basis).

Other Complexities

Business Combinations
Acquisition of a business can significantly
impact the acquiring companys
estimated annual effective tax rate.
Business combination is a transaction that
is not typically accounted for in periods
prior to the acquisition date, no effect
should be given to a business combination
in the estimated annual effective tax rate
before the interim period in which the
business combination is consummated

Business Combinations
Beginning with the interim period in which
the purchase is consummated, the estimated
annual effective tax rate for the year would
be calculated to reflect the expected results,
including the results of the acquired
company.
That rate would be applied to the
consolidated year-to-date ordinary
income/loss to compute the year-to-date tax
provision/benefit on ordinary income/loss.

Business Combinations
Second acceptable approach would
be to divide the annual period into
pre-acquisition and post-acquisition
periods and determine an estimated
annual effective tax rate for each of
the two periods.

Business Combinations
After the acquisition is consummated, the
tax provision would be the sum of the tax
provision for the pre-acquisition period
plus the tax computed by applying the ETR
for the post-acquisition period to the yearto-date, post-acquisition ordinary income.
This method may not be appropriate if rate
differentials that do not relate to the
acquired operations occur
disproportionately in the post-acquisition
period.

Different Financial Reporting and Tax


Year-End
If a corporations tax year-end date
differs from its financial reporting
year-end date, the basis for its tax
computation and the application of
the estimated annual effective tax
rate approach in interim statements
are impacted.

When Disclosure of Components of Interim


Tax Expense is Required
If interim statements are used in lieu of
annual statements (i.e., in a registration
statement), companies need to disclose
the components of interim income tax
expense in the same way that companies
present the disclosures required in annual
statements by SEC FRP 204, Disclosures
Regarding Income Taxes. Companies
must perform the following tasks:

When Disclosure of Components of Interim


Tax Expense is Required
Divide the aggregate interim income
tax expense calculated using the
estimated annual effective tax rate
approach between jurisdictions
Determine the current and deferred
portions of the interim income tax
provisions

Disclosures Revised June 2015


Guidance on required interim
financial statement disclosures can
now be found in FSB sections 29.2,
29.4.7.6 and 30.4.3.3.
SEC Regulations S-K, Item 303,
requires that a company include in
MD&A detailed disclosure of material
changes in financial condition and
the results of operations.