Deferred tax liability - Schweser question

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Answer: A - The DTL is not expected to reverse in the foreseeable future. The liability should be treated as equity at its full value.

I can’t see from where we derive that this DTL will not reverse in the forseeable future. Please help!

If the company continues to grow, it will continue to invest in depreciable assets. It will use accelerated depreciation for tax purposes on these new assets, and straight-line for its financial statements. The assumption is that the excess depreciation (for taxes) on these new assets will more than offset the negative excess depreciation for the old assets (when the accelerated depreciation in later years is less than the straight-line depreciation), so the DTL will continue to grow every year for the foreseeable future.

If the DTL continues to grow, the company never experiences the liability of higher taxes in the future; thus, the DTL is treated as if it were equity.



so opposite is true for DTA - if company will struggle in foreseeble future DTA is not going to be returned and analyst should decrease assets and equity by amount of DTA , is it right ? thanks


You’re welcome.

Thanks a lot, S2000mag! enlightened And thanks to you too, passa11!

My pleasure.

Hey I have some confusion not very related to this particular post.

But see, a DTL occurs when taxable income is less than the income before tax right? To calculate the taxable income, which depreciation method is used? Is it double-declining method since the higher expense in the first couple of years will be higher, and it will result in lower current taxable income? To get the income before tax, the straight-line method is used, therefore the depreciation expense is smaller and the income before tax will be higher.

Is that correct?


If DTA is not likely to be reversed, it needs to be reduced by a contra-asset account called valuation allowance right? Why is equity decreased also?

Because the balance sheet has to balance. If assets desrease then either liabilities or equity (or both) must decrease. If you expect that you cannot use a DTA, there is no liability that is affected, so equity is reduced.

Because the valuation account is essentially created from the firms existing ‘reserves’

The DTA is of future benefit for the firm. However, if it cannot be realised it essentially becomes a liabiliy. All of a sudden you no longer have this tax deductable allowance which you have accounted for. Therefore, to offset this, you need to borrow something to offset it with. Hence equity decreases. Think assets = liabilities + equity.

As always the magician will be able to explain much better.

It doesn’t become a liability; it becomes a nothing: not positive (not an asset) and not a negative (not a liability); nothing.

Thank you for clarifying as always.