Tax Provision

The tax provision is the income tax expense a company reports in its financial statements, computed under ASC 740. Practitioners use the word for both the number and the process that produces it. It has two components: the current provision, which is the tax payable or refundable on the period's taxable income, and the deferred provision, which is the change during the period in the deferred tax assets and liabilities arising from temporary differences.

The computation runs in a fixed sequence, and doing it out of order is the most common cause of a provision that will not tie. Start from pretax book income by legal entity and jurisdiction. Identify permanent differences, which affect the effective rate but never reverse, and temporary differences, which reverse in future periods. Compute current tax by jurisdiction. Roll the deferred balances by comparing the tax basis and book basis of each asset and liability at the balance sheet date, measured at the enacted rate expected to apply when the difference reverses. Assess whether a valuation allowance is required against deferred tax assets, weighing all available positive and negative evidence, with a cumulative loss position in recent years being the negative evidence hardest to overcome. Measure and record liabilities for uncertain tax positions. Then prepare the rate reconciliation and the tax account rollforward, and only then book the entry.

Two artifacts show whether the provision holds together. The effective tax rate reconciliation explains the difference between the statutory rate and the reported effective rate, line by line, and every line should be a real driver rather than a residual. The tax account rollforward proves the balance sheet: opening balances, plus the current period provision, less payments, plus or minus other movements including items recorded in other comprehensive income and equity, equals closing balances that agree to the general ledger. A provision that produces a correct expense figure with an unexplained plug in the rollforward is not finished.

The return-to-provision true-up closes the annual loop. When the return is filed, months after the provision was booked, the actual figures differ from the estimate, and the difference is recorded in the period the return is filed. A large recurring true-up is a signal about the provision process rather than about the return.

Interim periods use a different mechanism. Under ASC 740-270 the expected annual effective tax rate is applied to year-to-date ordinary income, with discrete items such as settlements, rate changes, and certain equity compensation effects recorded entirely in the period they occur. Applying the statutory rate to quarterly income, which happens more often than it should, produces a different and wrong answer.

Because the provision sits at the end of the close, is prepared under time pressure, and is frequently the domain of one specialist, it is a well-documented source of control deficiencies. Preparing the supporting schedules earlier is usually a better remedy than reviewing the final number harder.

Related terms: ASC 740, Deferred Tax Asset and Deferred Tax Liability, Valuation Allowance, Book-Tax Differences

Most provision hours go into assembling schedules, not into judgment: trial balances by entity, fixed asset differences, accrual detail, and the prior-year return. Adopt's agents assemble that package so the specialist starts at the judgment. Sign up free.