# Deferred Tax Effect on Net Income

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:

1. \$200,000 increase.
2. \$300,000 increase.
3. \$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?)

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In your example the increase in tax liability is Deferred Tax Liability, not DTA. Decreasing depreciation will increase the liability.