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ch26 Student: ___________________________________________________________________________ 1.A temporary difference originates in one period and reverses, or turns around, in one or more later periods. True False 2.Expenditures currently deducted in the tax return but not included with expenses in the income statement until subsequent years create deferred tax liabilities. True False 3.A deferred tax asset represents the tax effect of the temporary difference between the financial carrying value of an asset or liability and its tax basis. True False 4.Revenues from installment sales of property reported on financial statements in prior years and currently reported in the tax return create deferred tax assets. True False 5.Future taxable amounts result in deferred tax assets. True False 6.The classification of deferred tax assets is sometimes dependent on when the benefit will be realized. True False 7.The basic issue in deciding whether to record a valuation allowance for a deferred tax asset is if probable taxable income is anticipated to be insufficient to realize the tax benefit. True False 8.Changes in enacted tax rates that do not become effective in the current period affect deferred tax accounts only after the new rates take effect. True False 9.A net operating loss (NOL) carryforward creates a deferred tax liability that should be classified as current to the extent that the NOL will be recovered in the following year. True False 10.The tax benefit of a net operating loss carried back two years represents a current receivable for income tax to be refunded. True False TOPICJuly 29, 2022 ASC 740 governs how companies recognize the effects of income taxes on their financial statements under U.S. GAAP. This applies only to taxes based on income – not sales, payroll, or property taxes – per ASC 740-10. Valuation allowances impact the ASC 740 provision for income tax required by U.S. GAAP. Like most tax provision subjects, correctly handling valuation allowances requires tax and accounting expertise. Thankfully, practitioners no longer need to maintain cumbersome spreadsheets to document their assessment of whether a valuation allowance is required or calculate the allowance. Bloomberg Tax Provision offers a complete ASC 740 tax provision solution, allowing companies to easily handle valuation allowances. What is a valuation allowance for deferred tax assets?A valuation allowance is a mechanism that offsets a deferred tax asset account. A company should perform the analysis after considering the two-step recognition standard regarding uncertain tax positions. All available evidence – both positive and negative – should be considered to determine whether, based on the weight of that evidence, a valuation allowance for deferred tax assets is needed. This is not a question of tax law, but a question of judgement regarding the company’s future. For valuation allowances, the question is whether it is more likely than not that the deferred tax assets can actually be utilized by the company. A company may reach different conclusions in different tax jurisdictions concerning the need for a valuation allowance for the same entity or entities. This video includes an overview of the basic accounting concepts for valuation allowances, including sources of taxable income, positive and negative evidence, and tax planning strategies. [18:55] Download: The Essential Guide to ASC 740This easy-to-use guide breaks down the steps and helps you navigate the biggest hurdles with background, details, and examples of how ASC 740 interacts with various tax laws and corporate facts. When is a deferred tax asset valuation allowance required?ASC 740-10-30-18 states that future realization of the tax benefit of an existing deductible temporary difference or carryforward ultimately depends on whether the company has sufficient taxable income of the appropriate character (for example, ordinary income or capital gain) within the carryback/carryforward period available under the tax law. The following four possible sources of taxable income may be available under the tax law to realize a tax benefit for deductible temporary differences and carryforwards.
Tax planning strategiesAccording to ASC 740-10-55-39, a qualifying tax planning strategy is an action that:
When evaluating the need for a valuation allowance, tax planning strategies include:
A plan that involves the repatriation of earnings from an entity whose earnings meet the indefinite reversal criteria does not constitute a tax planning strategy. The need to schedule temporary differencesIn assessing the need for a valuation allowance, a company that cannot forecast future income may be required to schedule the reversal of temporary differences to determine the amount of deferred tax liabilities (DTLs) expected to offset the DTAs. The company should use a systematic and logical methodology to schedule the reversals. If no other sources of taxable income are available, the company should record a valuation allowance against the residual amount of DTAs that are not offset by DTLs in the scheduling exercise. The 80% limitation on federal NOL utilization and the Section 163(j) interest deduction limitation, combined with the indefinite carryforward nature of those attributes, impact the way DTAs are scheduled to reverse. A valuation allowance is recorded solely against DTAs, not DTLs. To the extent that DTLs will reverse and allow the company to utilize all its DTAs, no valuation allowance is recorded. Consequently, it is common for companies that have determined that a valuation allowance is necessary to record a valuation allowance equal to the amount that DTAs exceed DTLs. Watch on demand: Valuation Allowances WebinarLearn about the basic concepts of accounting for valuation allowances including the following topics: Sources of taxable income, Positive and negative evidence, and tax consequences of valuation allowances. What evidence is used in a valuation allowance analysis?According to ASC 740-10-30-22, examples (not prerequisites) of positive evidence that might support a conclusion that a valuation allowance is not needed when there is negative evidence include, but are not limited to, the following:
Negative evidenceUnder ASC 740-10-30-21, forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years. Other examples of negative evidence include, but are not limited to, the following:
Weight given to positive and negative evidenceASC 740-10-30-23 states that an entity shall use judgment in considering the relative impact of negative and positive evidence. The weight given to the potential effect of negative and positive evidence shall be commensurate with the extent to which it can be objectively verified. The more negative evidence that exists, the more positive evidence is necessary, and the more difficult it is to support a conclusion that a valuation allowance is not needed for some portion or all of the deferred tax asset. A cumulative loss in recent years is a significant piece of negative evidence that is difficult to overcome. According to ASC 740-10-30-24, future realization of a tax benefit sometimes will be expected for a portion, but not all of a deferred tax asset and the dividing line between the two portions may be unclear. In those circumstances, application of judgment based on a careful assessment of all available evidence is required to determine the portion of a deferred tax asset for which it is more likely than not that a tax benefit will not be realized. In practice, companies will often record a valuation allowance in a period in which they report a cumulative pretax loss, adjusted for permanent items, based on the previous 12 quarters of activity. A company in that situation will typically not consider forecasts of future income as positive evidence. Valuation allowances and share-based compensationWith respect to DTAs associated with share-based awards, the existence of underwater options (i.e., options where the exercise price exceeds fair value) is not negative evidence in considering the need for a valuation allowance. However, if a deferred tax asset associated with underwater options is material, it should be disclosed. Become an expert: ASC 740 Resource CenterBloomberg Tax offers a variety of resources to assist companies with ASC 740, recognizing the effects of income taxes on their financial statements. How are valuation allowances accounted for under ASC 740?If the determination is made that a valuation allowance is necessary, the existence of DTLs related to indefinite-lived intangibles will result in a situation where the valuation allowance recognized either exceeds the amount of any net DTA or requires the recognition of a valuation allowance for a company in a net DTL position. Release of valuation allowanceA valuation allowance should be reversed in the period in which the positive evidence outweighs the negative evidence. The reversal of the valuation allowance will be recorded as a deferred income tax benefit. A company should give significant attention to the appropriate timing of releasing a valuation allowance. Companies should particularly focus on the interim period in which evidence becomes known or knowable with respect to the recognition or reversal of a valuation allowance. No backward tracing to other comprehensive incomeCertain items are recorded in other comprehensive income (OCI) rather than the income statement. These items include currency translation adjustments (CTAs), pension and post-retirement actuarial gains and losses and amortization of prior service costs, and unrealized gains and losses on available for sale (AFS) securities, among other items. To the extent a valuation allowance is established against an item recorded to the OCI, the valuation allowance will not be recorded to OCI but instead will be recorded to income tax expense. Interim reportingFor interim reporting, if a portion of the valuation allowance recorded or removed relates to current year activity (i.e., earnings, permanent items, and reversals of temporary items), that amount is included in the annual effective tax rate calculation rather than adjusted discretely. Conversely, the amount of valuation allowance that relates to past and future earnings is released as a discrete item. See our tool: Calculate accurate provisionsThe most powerful ASC 740 calculation software on the market, Bloomberg Tax Provision, solves the technical and process issues involved in calculating your income tax provision. Examples of ASC 740 valuation allowancesThe following videos provide examples for accounting for valuation allowances under ASC 740. Example 1: Full U.S. Valuation AllowanceThis ASC 740 example includes a single U.S entity with a single state income tax
return. The U.S. entity has a history of losses and has concluded that a valuation allowance is required against its net deferred tax assets. The U.S. entity owns a CFC that has a history of profitability. [12:15] Example 2: U.S. Valuation Allowance ReleaseThis ASC 740 example includes a single U.S entity with a single state income tax return. The U.S. entity has a history of losses but has become profitable and has concluded that a valuation
allowance is no longer required against its net deferred tax assets. The U.S. entity owns a CFC that has a history of profitability. [9:13] Example 3: Controlled Foreign Corporation (CFC) Full Valuation AllowanceThis ASC 740 example includes a single U.S entity with a single state income tax return. The U.S. entity owns a CFC with a history of losses and has
concluded that a valuation allowance is required against its net deferred tax assets. [10:03] Example 4: CFC Valuation Allowance ReleaseThis ASC 740 example includes a single U.S entity with a single state income tax return. The U.S. entity owns a CFC. The CFC has a history of losses but has become profitable and has concluded that a valuation allowance is no longer required against its net deferred tax assets. This example discusses the
interim impacts of the valuation release regarding the component recognized in the Annual Effective Tax Rate versus as a discrete item. [8:02] Example 5: U.S. Valuation Allowance ReleaseThis ASC 740 example includes a single U.S entity with a single state income tax return. The U.S. entity has a history of losses but has become profitable and has concluded that a
valuation allowance is no longer required against its net deferred tax assets. This example discusses the interim impacts of the valuation release regarding the component recognized in the Annual Effective Tax Rate versus as a discrete item. The U.S. entity owns a CFC that has a history of profitability. [9:48] Our customers are talking about Bloomberg Tax ProvisionI’ve worked with tax software my entire career, and this program is a gem. It’s self-contained, simple, powerful, and efficient. Bloomberg Tax Provision does the prep right the first time. I can’t say enough good things about it. Sherri Throop Tax and Financial Reporting Manager Novo Building Products I’ve done implementations of other software, and this one was hands-down the easiest to get the hang of. It was just a matter of weeks before we had full implementation and recreation of our prior year provision ready to go. Corporate Tax Manager Flexential Navigate the ASC 740 tax provision with confidenceBloomberg Tax Financial Accounting brings expert context and unmatched content so that financial accounting professionals can navigate the nuances of U.S. GAAP with confidence. Access practitioner-authored analysis and interpretations in our Portfolios to help you develop and implement complex accounting strategies. Don’t have access? Request a demo. Get in-depth guidance and industry perspectives on emerging accounting issues
2022 Q4 Quarterly OutlookSeptember 15, 2022 4:20 PM Download our Q4 Quarterly Outlook now. This special edition report carefully examines the 2022 Inflation Reduction Act (H.R. 5376) – explaining changes to your tax provision and ... See for yourselfNot a subscriber? Get the tax expertise and tools with our provision software and research platform– request pricing now. What is a valuation allowance for deferred tax assets?What is a valuation allowance for deferred tax assets? A valuation allowance is a mechanism that offsets a deferred tax asset account. A company should perform the analysis after considering the two-step recognition standard regarding uncertain tax positions.
What is a valuation allowance account?What is a Valuation Allowance? A valuation allowance is a reserve that is used to offset the amount of a deferred tax asset. The amount of the allowance is based on that portion of the tax asset for which it is more likely than not that a tax benefit will not be realized by the reporting entity.
Is there a valuation allowance for deferred tax liabilities?A valuation allowance must be established for deferred tax assets when it is more-likely-than-not (a probability level of more than 50%) that they will not be realized. Reporting entities with gross deferred tax assets are required to undertake a valuation allowance assessment.
What type of account is deferred tax asset?What Is a Deferred Tax Asset? A deferred tax asset is an item on a company's balance sheet that reduces its taxable income in the future. Such a line item asset can be found when a business overpays its taxes. This money will eventually be returned to the business in the form of tax relief.
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