If I understand this correctly, a company must disclose a valuation allowance if the amount (or part of the amount) of the deferred taxes they have on the book is likely to not be recognized. What would cause a company to not be able to recognize their deferred tax assets? would it be year after year losses so that they are unable to subtract the asset from any of current tax expense? How long are you allowed to carry a tax asset forward?
If the company believes that its future orders and Income would not be able to justify using the DTA it would never reverse. So they would put a valuation allowance on the Income stmt. This could also be bcos the company does not continue to grow at the same speed and does not purchase enough assets in future. If company has similar DTA’s in the past that it was not able to take benifit of and the company does not have enough future income to justify the DTA, the valuation allowance should be added. But it is totally the managements descretion to put the valuation allowance or not.
If a company in a cyclical business sustains heavy losses going forward, it may loose its NOLs set to expire in the 2 year carry back- 20 year carry forward. If the tax benefit from using past NOLs to offset future income cannot be realized due to sustained losses by the company, it must write down the previously estimated DTA. Another case is when a company in a buying spree acquires targets with NOLs. Since the acquirer effectively inherits the targets NOLs (if any), and since there is a change in control, the inherited NOLs are subject to a sec. 382 limitation which caps the amount of NOLs the parent can use in any given year. If the acquirer sustains losses in a downturn, and cannot fully utilize the acquired NOLs to offset positive taxable income (due to its own losses) and with various limitations from 382, 383, etc. the acquirer would have to write down the previously estimated deferred tax asset as a valuation allowance. This is why GM and I think one of the other Big 3 auto makers had a significant write down of DTAs in one of its quarters due to its own inability to generate sufficient income to offset NOLs from previous acquisitions and losses set to expire in the 20 year carry fwd. Also differences between tax and book accounting for depreciation, amortization, book/tax goodwill amortization can also generate DTAs or DTLs, so it is the responsibility of your CFO to frequently re-assess the likelihod of future tax benefits expiring unused which would trigger a writedown of the DTA on B/S.
thanks a lot wessun, you sound very knowledgeable about the subject.