ASC Insight Series

ASC 740- Income Taxes

17, September 2024

Purpose

ASC 740, Income Taxes, addresses financial accounting and reporting for the effects of taxes based on income. It provides guidance for the recognition and measurement of income tax expenses for financial reporting. Further, the topic focuses on the consequences of the differences between the tax bases of assets and liabilities, determined based on tax positions taken or expected to be taken and the carrying amounts of assets and liabilities recognized for financial reporting.

This publication provides an overview of the key accounting considerations and implementation matters relating to ASC 740 (Income Taxes). The technical views and accounting positions on the framework keep enhancing.

We sincerely hope you find this quick reference guide informative in identifying and evaluating the issues related to Income Taxes. We will be happy to participate in any discussions required to clarify our views, which are enclosed in the attached publication. We look forward to hearing from you.

Background

The tax consequences of many transactions recognized in the financial statements are included when determining income taxes currently payable in the same accounting period. Sometimes, tax laws differ from the recognition and measurement requirements of financial reporting standards, resulting in differences between tax bases of assets or liabilities and their reported amounts in the financial statements. These differences are called temporary differences and give rise to Deferred Tax Assets (DTAs) and Deferred Tax Liabilities (DTLs). Temporary differences ordinarily reverse when the related asset is recovered or the related liability is settled. A deferred tax liability or deferred tax asset represents the increase or decrease in taxes payable or refundable in future years as a result of temporary differences and carry forwards at the end of the current year.

The objectives of accounting for income taxes are to recognize:

The amount of taxes payable or refundable for the current year.
The deferred tax liabilities and assets resulting from future tax consequences of events recognized in the enterprise’s financial statements or tax returns.

To implement these objectives, the following basic principles should be observed at the date of the financial statements:

Under the asset/liability method of accounting for income taxes, the emphasis on the balance sheet is evident from the focus on the recognition of deferred tax liabilities and assets. The change in these liabilities and assets determines the income tax expense in addition to current taxes.

Total tax expense is the sum of current tax expense or benefit plus deferred tax expense or benefit. Total tax expense, both current and deferred, generally must be calculated for each tax-paying component of the entity in each tax jurisdiction.

Total tax expense = current tax expense/(benefit) + deferred tax expense/(benefit)

Summary of Topic

Scope and Scope Exceptions

Current tax expense or benefit is the amount of income taxes payable or receivable for the current year as determined by applying the provisions of the tax law to taxable income or loss for the year.

Scope In :

Entities to which ASC 740 applies:

ASC 740 is applicable for all entities (domestic and foreign) preparing financial statements under U.S. GAAP accounting framework. It also applies to not-for-profit entities with activities that are subject to income taxes.

In addition, guidance under ASC 740 shall also apply to consolidated subsidiaries, investees accounted for under the equity method, and entities that are combined due to common control.

Taxes included in the scope of ASC 740:

It applies to all federal, foreign, state, and local (including franchise) taxes based on income. In other words, any tax levied by a governmental taxing authority on a company based on its income is subject to the provisions of ASC 740.

Scope Out:

ASC 740 explicitly scopes out the following taxes:

Franchise tax to the extent it is based on capital, and there is no additional tax based on income.
Withholding taxes paid to the tax authority by the dividend payor on behalf of its shareholders, provided the tax is payable by the entity on dividend distributed to shareholders and shareholder receiving the dividend is entitled to a tax credit.

Taxes solely based on revenue or gross receipts, such as sales tax, would not be in scope of ASC 740.

Overview of deferred taxes on various captions on the balance sheet

The definition of temporary differences is fundamental to accounting for income taxes. Identifying such differences for which deferred taxes are to be
recognized is a critical step in accounting for income taxes. Some events recognized in the financial statements may not have tax consequences. Those do not give rise to temporary differences.

Deferred tax assets are recognized for deductible temporary differences, tax operating losses, and other carryforwards, and deferred tax liabilities are recognized for taxable temporary differences.

Implementation guidance on Key topics

This section provides implementation guidance on the key topics associated with the application of ASC 740, identified based on a review of annual financial statements of some of the US-listed companies:

Outside basis difference

Valuation allowance

ASC 740 mandates an assessment of an entity’s prospective realization of tax benefits from existing deductible temporary differences and carryforwards. This assessment involves scrutinizing all available evidence, considering both positive and negative factors, to ascertain the necessity of a valuation allowance. The eventual realization of deferred tax assets tax benefits hinges on the existence of certain conditions.

To read the this section in detail, download the pdf.

Uncertain tax position

Due to uncertainties associated with interpretation and application of tax laws, tax authorities may challenge and ultimately reject positions submitted in tax returns. Therefore, it may not be straightforward to recognize and measure the tax benefits arising from an uncertain position. ASC 740 provides a two-step model for recognizing, measuring, and disclosing uncertain tax positions.

Step 1: Recognition of tax benefit arising from uncertain tax position

Tax benefit from an uncertain position may be recognized only if it is more-likely than- not that the position is sustainable, which may be evaluated based solely on its technical merits and consideration of the relevant taxing authority’s widely understood administrative practices and precedents.

Step 2: Measurement of tax benefit to be recorded

Record the tax benefit that is greater than 50% likely to be realized upon settlement with a taxing authority.

The aforesaid guidance prohibits the use of a valuation allowance as a substitute for the derecognition of tax positions.

The amount of benefit recognized in the statement of financial position may differ from the amount taken or expected to be taken in a tax return for the current year. These differences represent unrecognized tax benefits. A liability is created (or the amount of a net operating loss carryforward or amount refundable is reduced) for an unrecognized tax benefit because it represents an entity’s potential future obligation to the taxing authority for a tax position that was not recognized. A tax position recognized in the financial statements may also affect the tax bases of assets or liabilities and thereby change or create temporary differences.

Public entities must provide both a) tabular reconciliation of the beginning and ending aggregate unrecognized tax benefits and b) its impact on the effective tax rate. Further, all entities must provide details of tax uncertainties for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months.

Taxation of Stock based compensation

ASC 718, Stock-based compensation, provides specific guidance on accounting for income taxes and clarifies the applicability of ASC 740 related to stock-based compensation. Entities must recognize the fair value of stock-based awards as compensation costs from the grant date over the vesting period. Tax deduction for the expense usually occurs later and is based on the award’s intrinsic value. This causes a difference between book base and tax basis, resulting in a deductible temporary difference on account of the “excess of book base over tax basis”. Deferred tax assets are created as compensation costs are recognized.

For equity-classified awards, compensation costs are determined at the grant date and recognized over the service period, with potential deferred tax assets for timing differences. At settlement, any excess tax deduction is recorded as an income tax benefit, while any shortfall is recorded as an expense.

For liability-classified awards (e.g., cash-settled stock appreciation rights), the liability and related deferred tax assets are remeasured periodically, matching the total tax deduction on settlement to the cumulative book compensation cost, avoiding excess tax benefits or deficiencies.

Income tax accounting for equity-classified, nonqualified stock-based compensation award

An entity that grants a nonqualified stock option to an employee is generally entitled to a tax deduction equal to the intrinsic value of the option on the exercise date. Entities generally expense stock options for book purposes before a tax deduction arises, thus creating a temporary difference and the initial recognition of a deferred tax asset under ASC 740.

The amount of the deferred tax asset will almost always differ from the amount of the entity’s realized tax benefit. This is because the deferred tax asset is based on the compensation cost the entity recorded for book purposes, which is determined based on fair value on the grant date. The ultimate tax deduction is based on intrinsic value on the exercise date for a stock option.

Key disclosure requirements

Disclosures remain an essential element of financial reporting for all reporting entities. These provide users of financial statements with information to assess an entity’s operations and related tax risks, tax planning, and operational opportunities that affect its tax rate and prospects for future cash flows. The following summarizes key disclosure requirements for entities related to Income tax and temporary differences:

Amendments to Income Tax disclosure requirements under ASC 740 (ASU 2023-09)

With the objective to improve an entity’s income tax disclosure information in the financial statements and to address requests from the users of financial statements for greater transparency about income tax information, including jurisdictional information, the Financial Accounting Standards Board (“FASB” or “Board”), issued an Accounting Standards Update No. 2023-09 (ASU) on December 14, 2023. The ASU enhances annual income tax disclosures about the tax risks and opportunities in an entity’s worldwide operations. The two primary amendments resulting in incremental information include disaggregating existing income tax disclosures related to the effective tax rate reconciliation and income taxes paid.

Further, the amendment also requires reporting entities to disclose Income (or loss) from continuing operations before income tax expense (or benefit) disaggregated between domestic and foreign, and Income tax expense (or benefit) from continuing operations disaggregated by federal (national), state, and foreign.

Comparison with IFRS

Both ASC 740, Income Taxes under USGAAP, and IAS 12, Income Taxes under IFRS, provide guidance on accounting for income taxes. In general, both accounting frameworks are based on the application of a balance sheet model and have similar objectives related to the recognition of:

(a) Amount of taxes payable or refundable for the current year.

(b) DTAs and DTLs for future tax consequences of events that have been recognized in an entity’s financial statements or tax returns.

However, there are still some differences between two GAAPs in terms of the application of principles. The following table summarizes the key differences:

Topics in this article

Accounting & Reporting Consulting

FRM Regulatory Pulse- August 2026

Executive Summary The second edition of the Uniqus "Regulatory Pulse" bulletin covers key regulatory developments and supervisory themes observed across India and the Middle East over the quarter ended June 2026. Consistent with the series, this publication focuses on banking...

Sustainability & Climate Pulse- August 2026

In the News Global Record Climate Finance by Multilateral Development Banks Reaches USD 163 Billion in 2025 In a significant boost for global climate action, multilateral development banks (MDBs) achieved a record climate finance total of USD 163 billion in...

FASB’s Proposed Accounting Standards Update

Executive Summary On June 10, 2026, the FASB issued a proposed Accounting Standards Update that would clarify the discount rate used to measure the benefit obligation under Subtopic 715-30, Compensation—Retirement Benefits—Defined Benefit Plans—Pension, for certain market-return cash balance plans. The...