Question

On 1/1/20X2, Zorro Riders Company bought Inquisition Company for $60,000,000 in a business combination accounted for under the acquisition method. Goodwill was not involved. The tax basis of the net assets is $240,000,000. Therefore, deductible temporary differences equal $180,000,000. The tax rate is 21%. It has been determined that a valuation allowance for the entire amount of the deferred tax asset is required. However, at year- end 20X3, it is determined that the valuation allowance account is no longer needed. Show Income results for 20X2 and 20X3

Answer 1

Since the carrying amount of the assets in books of Zorro Riders Company is $ 60,00,0000 and tax base for same is $ 240,000,000. It means tax base is greater than carrying amount (or carrying amount is less than tax base) the temporary deductible difference of $ 180,000,000 will create a DTA in books (Deffered Tax Asset). Creation of DTA leads to higher tax expense recognised in books.

DTA is to be recoreded in books only if it is probable that entity will have fututre taxable profit to set off the deductible temporary difference or entitty has tax palnning opportunities through which it intends to set off such deductible temporary difference.

Amount of valuation allowance = $180,000,000 * 21% = $37800000

Following will be the impact of creating a valuation allowance of DTA on income of year ended 20x2 and 20x3

Particulars	20x2	20x3
Profit Before Tax	XXXXX	XXXXX
Less: Tax Expense	(XXXX)	(XXXX)
Add/ (Less): Deferred Tax Asset	($37800000)	$37800000
Profit After Tax	XXXX - $37800000	XXXX +$37800000