When it is determined that DTL will not be reversed we are suppose to remove it from liabilities and add it to equity. Are we suppose to add that same amount to Net Income? Is it considered a gain because we no longer have to pay for it so we add it to Net income? please take a look at Qbank question #38549 ( it is one of those 5 paragraph 6 part questions).
I believe you are correct on adding to equity, but im not sure what to do with the adjustment to net income. Good question!
Not my thing, but reversing a tax valuation allowance account causes an increase in net income. Seems to me that these ought to have similar accounting treatment…
I think what the book looks at is those situations where companies that are expected to continue to grow and add capex will effectively always be replacing their PPE related DTL’s, effectively causing a portion of them to never reverse. In that case you make an analytical adjustment to equity (not an actual entry on the books), and don’t touch net income since it doesn’t relate to the current period and you don’t want to understate current period net income. If you don’t expect it to reverse because of a change in tax law, then as JDV said you run it through the income statement, but on the books, not just analytically.
JoeyDVivre Wrote: ------------------------------------------------------- > Not my thing, but reversing a tax valuation > allowance account causes an increase in net > income. Seems to me that these ought to have > similar accounting treatment… i like how you incorporated the word valuation allowance in there…someone’s on top of their studying
My thoughts … Yes, a DTL that will not be realized should be considered as equity and not a liability. The classic example is depreciation-driven tax differences that typically are temporary (i.e. should reverse), but ultimately never will because the company is in a high-growth phase. Keep in mind that a DTL is created when the positive difference of [I/S Tax - Tax Tax] (my lingo, sorry). In other words, you’re accruing for more tax than you’re paying - normally this is a wash because it reverses. However, if you never have to make good on that obligation because, say, you’re pushing the temporary depreciation-related differences out further and futher via continuous capital expenditures, then you can effectively disregard it as a liability. As for a valuation allowance, that only applies to DTAs and, specifically, to the portion of the DTA that will not be realized. An obvious but important relationship is that the higher the allowance, the lower the DTA. Equally obvious, DTAs are reported as B/S assets. HTH
hmmm, with the original question, is it actually a GAIN though, or is not just NOT a loss? see what im getting at? cos they also say that, if you’re uncertain about its reversal, then simply ignore it… i wouldnt think you’d run it through net income, cos it doesnt actually increase ur earnings in the current period
yea that was my orginial question too. Since this original post I think I have figured it out. Although it will not be explicitly added back to NI as a gain, it will have an impact on NI. The decrease in DTL will affect income tax expense since income tax expense=taxes payable + delta DTL- delta DTA. Since we remove the tax liability, delta DTL will decrease by the amount added to equity, hence causing tax expense to go down, hence causing NI to go up.
hmmmm makes sense… so would the analyst have to explicitly make these adjustments to income tax expense aswell?? but yeh, good reasoning you use…
I dont think you need to make an explicit adjustment to Net Income. When you realize that the DTL would not be reversed, you just move it from Liability to Equity. But, it still stays on the Liability side of the Balance sheet by an equal amount. So, you dont need to make any adjustments to the Income statement. The impact to Net Income from this comes in the form that you do not need to pay it in the future. Consider this. You have a deferred tax liability of 30k Next year you would need to pay 10k, so in the next year you pay 10k, expense it on the income statement and reduce the liability by 10k from the DTL. So, you have 20k of DTL remaining. The year after that you realize that the 20k DTL would never get reversed, so instead of keeping it under DTL you just classify it as equity. There is no explicit impact on the impact statement. Just that if it had to be reversed, then it would have shown up as an interest expense.