Please someone help me with this exercise. My question is written in the end of it. The following information is available for a company that prepares its financial statements according to US GAAP:
2015** 2014** Deferred tax assets $1,000,000 $800,000 Deferred tax liabilities $600,000 $700,000 Valuation allowance $500,000 $400,000
The overall effect on 2015 net income from the above changes in the company’s deferred tax accounts is closest to a:
- $200,000 increase.
- $300,000 increase.
- $200,000 decrease.
Solution
A is correct. A valuation allowance reduces the value of the deferred tax assets under US GAAP, so the total change in net income as a result of the changes in the three accounts can be calculated as follows:
Account** Change in Account from 2014 Effect of Change on Net Income Direction Dollar Effect Deferred tax assets $ 200,000 increase Increase $200,000 Deferred tax liabilities $100,000 decrease Increase 100,000 Valuation allowance $100,000 increase Decrease (100,000) Overall effect: A net increase of: **$200,000
How come an increase in DTA increase Net Income reported? Isn`t it supposed to be lower since we actually have created an incremental DTA because EBT are actually lower on accrual accounting than Tax accounting? For example: For Accounting Purposes----> 12(Revenue) - 2 (Depreciation) =10(EBT)- 1(10%tax)= 9 Net Income For Tax Purpose—> 12 (Revenue)-1(Depreciation allowed under tax reporting)=11(EBT)-1.1(10% Tax)=9.9 Net Income. (In this case we have a Deferred Tax Asset Created cause we actually paid 1.1 instead of 1 and the Net Income i actually lower 9 instead of 9.9 so why does the exercise says that an increase in DTA increases Net Income?)