# 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?)

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