FAQ: Accounting for Income Taxes (ASC 740)
In recent years, accounting for income taxes (ASC 740) has become a major concern for public companies as income taxes has been one of the SEC’s top areas of focus. Complying with ASC 740 is a particularly complex challenge for public companies that involves significant tax and financial reporting requirements. For those without an internal tax department, it’s an even bigger challenge.
The following frequently asked questions are designed to provide a greater understanding of accounting for income taxes, its implications for public companies, and how companies can manage their compliance requirements.
What is ASC 740?
ASC 740 governs accounting for income taxes and requires businesses to analyze and disclose income tax risks.
This Financial Accounting Standards Board topic establishes standards of financial accounting and reporting for the effect of income taxes on a company’s financial results. ASC 740 provides a way to recognize a company’s income tax expense for financial reporting under U.S. generally accepted accounting principles (GAAP) by measuring the differences between the tax bases of assets and liabilities and the carrying amounts of assets and liabilities recognized for financial reporting. ASC 740 also provides standards for measuring, recognizing and reporting uncertain tax positions.
Who does ASC 740 apply to?
The accounting for income taxes principles and requirements apply to domestic, foreign, public and private entities in the preparation of financial statements in accordance with U.S. GAAP. Non-profit organizations with activities that are subject to income taxes are also subject to ASC 740.
However, the level of complexity in applying these standards significantly increases for public companies.
Why is accounting for income taxes more complex for public companies?
Public companies must comply with the rules of the Sarbanes-Oxley Act of 2002 (SOX), which require certain tax internal controls. Controls around accounting for income taxes have been a source of material weakness in many public companies that have led to the restatement of their financial statements.
Generally, tax internal controls under SOX must meet the following three objectives:
- Independence: Generally derived through the use of an independent tax expert.
- Completeness: Yearly and quarterly provisions must capture all of the company’s key issues.
- Accuracy: The company’s CFO and controller must adequately review and understand the tax calculation and this calculation must be accurate.
Why should public companies be concerned about ASC 740?
Many recent SEC comments on the disclosures in public registrant’s filings have centered on income taxes. The comments have included questions regarding vague income tax disclosures, undistributed earnings of foreign subsidiaries and, perhaps most notably, whether a company’s deferred tax assets can be realized.
How can public companies manage their ASC 740 compliance requirements?
You might be a CFO who is fortunate enough to have the resources of a sophisticated internal tax department that can produce tax accrual workpapers that can be audited by your independent outside auditors.
However, if you’re not one of the lucky ones, you may want to consider engaging a tax service provider who has the capabilities to calculate and prepare your global income tax provision; analyze uncertain tax positions; and prepare the related footnote disclosures in the company’s financial statements in accordance with ASC 740 and U.S. GAAP – that can withstand the scrutiny of your outside auditors.
Contact a member of Kaufman Rossin’s tax team to learn more about your compliance obligations under ASC 740 and how we can help.