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

Expert Solution

A deferred tax asset represents a reduction in tax whose recognition is delayed due to certain deductible temporary differences and carryforwards. A valuation allowance is a reserve created to offset the amount of a deferred tax asset.

In the given question, valuation allowance at the beginning is $2,700 and at the end is $3,900. Thus, there is an increase in valuation allowance by $1,200 ($3,900-$2,700) implying there is a increase in Deferred tax asset. Increase in deferred tax asset arises as there can be certain additional deductibe temporary differences or carryforwards which arises if the company anticipates insufficient or decrease in profits.

Thus, the firm most likely expect future earnings will decrease if there is an increase in valuation allowance.

Hence the answer is B) decrease.

The other options will not apply because if the firm's future earnings increases, tax liability will increase resulting in lower Deferred tax asset and reduction in valuation allowance. And if the firm earninng remains relatively stable, no new deferred tax asset would have been created and there would be no movement in valuation allowance. In the question, valuation allowance has increased and hence these two options (increase / remains relatively stable) dont apply.

jeff jeffy answered 1 year ago

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