Hello all. Can someone please help me with the logic of this question: There is a company with X amount of Deferred Tax Assets and Y amounts of Allowance for these assets in Years 2016 and 2017. In 2017 Allowance was $115 lower than 2016. If the valuation allowance had been the same in 2017 as it was in 2016, the company would have reported $115 higher:
net income.
deferred tax assets.
income tax expense
3 is correct. The reduction in the valuation allowance resulted in a corresponding reduction in the income tax provision.
Why does this happen? I assume that since Allowance is deducted in Income Statement than the EBT would be 115 higher since this deduction is lower than previous. I don`t get though why is there a reduction in income tax provision when we know we have a higher tax expense??? Thanks.
Remember that DTA and DTL can be used to reconcile taxes payables (tax accounts) to income tax expenses (reporting accounts) using the following formula:
Income tax expense = taxes payable +(ΔDTL - ΔDTA)
Since Δ DTA would be zero, taxes payable would be higher in this case. Regards, Oscar
Rev100 - 50cash exp= 50 ebt -10%tax=45 Net Income (5 tax expense)
Suppose out of this 100 revenue company also got 15 in unearned revenue. For tax purpose NI= 115-50=65 - 10%tax= 58.5 (6.5 tax payable) (1.5 deferred tax asset)
Now what would happen if for this exact situation we would add allowance of 1. Then Tax Exp= 6.5-0.5=6
This is correct by the formula as you explained but intuitively since this allowance would actually decrease earnings how come I would pay more tax? This is what confuses me.
The unearned revenue that govt recognizes as income would attract a tax. Thus, 15 attracts 1.5 in tax. Don’t confuse this with the first question that you posted.
Now coming to the first question that you posted about allowance:
valuation allowance arises when you pay the taxes to the government but you are unable to adjust later in the books of accounts, maybe because your company never is profitable.