What is the tax base and carrying amount of the following:
Accounts recieveable: included on the income statement of ES company is a provision for foubtful debt of $125,000. The accounts receivable amount reflected on the balance sheet, after taking the provison inton account, amounts to $1,500,000. The tax authorities allow a deduction of 25% of the gross amount for doubful debt.
The book says that carrying amount = $1,500,000 while the tax base = ($1,500,000 + $125,000) - (25% * [$1,500,000 + $125,000]) = $1,218,750.
I believe the reason for including the allowance for doubtful accounts is explained a few pages prior: “should it be doubtful tha fture economic benefits will be realized from a temporary difference…temporary difference will not lead o creation of DTA/DTL…Under U.S. GAAP, a valuation allowance is established.”
However I am not sure why you wouldn’t apply the valuation allowance to the carrying amount.
First: The difference in the tax base and carrying amount of the asset (A/R) here is due to different rules for recognition of bad debts in tax laws and GAAP. In this case as per GAAP a provision for doubtfull debts in the amount of $125,000 is taken based on the real expectation that some customers will default in paying their bills. So, the carrying amount here is $1,625,000 - $125,000 = $1,500,000.
However the tax authorities allow a deduction of 25% of the gross amount of the A/R, hence $1,625,000 minus 25% = $1,218,750.
This difference in in the asset bases will leard to a DTL in the magnitute of ($1,500,000 - $1,218,750) x tax rate.
Second: The valuation allowance you are reffering to is a total diffrent thing. A valuation allowance is applied to the DTA if it is not expected that some of the previous build deffered tax assets could be recovered in the future (e.g. due tue decreasing profit expectations). This however has nothing to do with allowances for bad debts.