Question

In: Accounting

What is the purpose of establishing a valuation allowance for income tax accounting? What theoretical accounting...

What is the purpose of establishing a valuation allowance for income tax accounting? What theoretical accounting concept does this reflect? What is the impact of this journal entry on the balance sheet and income statement?

Solutions

Expert Solution

Items on a company's balance sheet that may be used to reduce taxable income in the future are called deferred tax assets. The situation can happen when a business overpaid taxes or paid taxes in advance on its balance sheet. These taxes are eventually returned to the business in the form of tax relief. Therefore, overpayment is considered an asset to the company. A deferred tax asset is the opposite of a deferred tax liability, which can increase the amount of income tax owed by a company.

Deferred tax assets are often created due to taxes paid or carried forward but not yet recognized on the income statement. For example, deferred tax assets can be created due to the tax authorities recognizing revenue or expenses at different times than that of an accounting standard. This asset helps in reducing the company’s future tax liability. It is important to note that a deferred tax asset is recognized only when the difference between the loss-value or depreciation of the asset is expected to offset future profit.

  • A deferred tax asset is an item on the balance sheet that results from overpayment or advance payment of taxes.
  • It is the opposite of a deferred tax liability, which represents income taxes owed.
  • A deferred tax asset can arise when there are differences in tax rules and accounting rules or when there is a carryover of tax losses.
  • Beginning in 2018, most companies can carryover a deferred tax asset indefinitely.

The simplest example of a deferred tax asset is the carryover of losses. If a business incurs a loss in a financial year, it usually is entitled to use that loss in order to lower its taxable income in the following years. In that sense, the loss is an asset.

There are some key characteristics of deferred tax assets to consider. First, starting in the 2018 tax year, they can be carried forward indefinitely for most companies, but are no longer able to be carried back.

The second thing to consider is how tax rates affect the value of deferred tax assets. If the tax rate goes up, it works to the company’s favor because the assets’ values also go up, therefore providing a bigger cushion for a larger income. But if the tax rate drops, the tax asset value also declines. This means that the company may not be able to use the whole benefit before the expiration date.


Related Solutions

What is a negative income tax? What is the purpose of it?
What is a negative income tax? What is the purpose of it?
Exercise 16-13 (Algo) Deferred tax asset; income tax payable given; previous balance in valuation allowance [LO16-4]...
Exercise 16-13 (Algo) Deferred tax asset; income tax payable given; previous balance in valuation allowance [LO16-4] At the end of 2020, Payne Industries had a deferred tax asset account with a balance of $105 million attributable to a temporary book-tax difference of $420 million in a liability for estimated expenses. At the end of 2021, the temporary difference is $320 million. Payne has no other temporary differences. Taxable income for 2021 is $756 million and the tax rate is 25%....
What is the purpose of federal income tax? Why is the goal of a fair income...
What is the purpose of federal income tax? Why is the goal of a fair income tax system so hard to achieve?
What is meant by valuation by comparables? What is the purpose of comparing valuation levels of...
What is meant by valuation by comparables? What is the purpose of comparing valuation levels of multiple companies? Please provide an example of how you might use the valuation by comparables approach
Delta had a deferred tax asset of $200 million with no valuation allowance on December 31,...
Delta had a deferred tax asset of $200 million with no valuation allowance on December 31, 2020. At the end of 2021, Delta had a deferred tax asset of $230 million before assessing the need for a valuation allowance. For the year 2021, Delta's income taxes payable is $85 million. At the end of 2021, Delta determined that it was more likely than not that 20% of its deferred tax assets will not be realized. What amount should Delta report...
KLH Company reported the following in the footnotes for its deferred tax assets (DTA): Valuation allowance...
KLH Company reported the following in the footnotes for its deferred tax assets (DTA): Valuation allowance for DTA at the beginning of the year $2,700 Valuation allowance for DTA at the end of the year $3,900 Based on this information, the firm most likely expects future earnings to: A) increase B) decrease C) remain relatively stable
What allowance in tax legislation is there for businesses that are managed on behalf of a...
What allowance in tax legislation is there for businesses that are managed on behalf of a trust? Discuss in 80 to 100 words.
Accounting for income tax The accounting profit before tax for the year ended 30 June 2017...
Accounting for income tax The accounting profit before tax for the year ended 30 June 2017 for Aldee Ltd amounted to $235,000. It included the following income and expense items: $ Royalties (exempt income) 15,000 CR Interest revenue 16,000 CR Annual leave expense    9,000 DR Doubtful debts expense 3,800 DR Depreciation - plant (15% per year, straight-line) 47,250 DR Depreciation - motor vehicles (20% per year, straight-line) 20,000 DR Insurance expense 14,000 DR Rent expense 42,000 DR Warranty expense...
Outline key aspects and principles of the Income Tax Law covering concepts of: Tax Accounting, Income...
Outline key aspects and principles of the Income Tax Law covering concepts of: Tax Accounting, Income test definitions that include reportable superannuation and FBT, application of CGT, FBT and termination payment rules for individuals, GST.
Q. Explain briefly economic, accounting and tax concepts of income in US income tax. plz no...
Q. Explain briefly economic, accounting and tax concepts of income in US income tax. plz no pic or handwriting thanks
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT