Hey all, I came across a question in Schweser’s qbank which I don’t follow:
Which of the following situations will most likely require a company to record a valuation allowance on its balance sheet?
A) A firm is unlikely to have future taxable income that would enable it to take advantage of deferred tax assets. B) To report depreciation, a firm uses the double-declining balance method for tax purposes and the straight-line method for financial reporting purposes. C) A firm has differences between taxable and pretax income that are never expected to reverse.
Correct answer: A
Any help with explanation would be much appreciated. Did I mention I hate FRA?! 🙁
@cfachris, thanks soo much for explaining this! So valuation allowance is the RESERVE against DTA….. I think I need to bang my forehead on the wall a few times as I missed that word in the reading and got extremely confused 😐
Hope your preparations are going well, appreciate that you took time help!
I hate FRA too, DTA and DTL make my head spin as is.
I’ll have a go, hope this is right:
C itself is the definition of a permanent differences between taxable income and pre-tax income. Permanent differences do not give rise to deferred taxes, thus no valuation allowances would be required.
Deferred tax assets (DTA) is created when taxable income is greater than accounting profit, and the company expects to recover the difference in the future. However, a valuation allowance is a reserve created against DTA if there is doubt on the amount of DTA that can be realized in the future. So the answer is A as we need to have valuation allowance against the DTA as the firm is unlikely to be able to take advantage of it in its future operations.