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Documentation of Valuation of Deferred Tax Assets

Eric Lau's Profile

How do I demonstrate that a deferred tax asset requires or does not require an allowance?  When the realization of the DTA is based on projected future taxable income, other than the forecasted amounts, what else are useful documentations?

Answers

Topic Expert
Keith Perry
Title: Director of Global Accounting
Company: Agrinos, Inc.
(Director of Global Accounting, Agrinos, Inc.) |

Eric,

I assume you're talking about GAAP reporting. In large part this will be "what the auditors say is good enough." Good enough typically means being able to demonstrate that you *can* earn sufficient amounts to utilize the asset; that your plans explicitly exclude any actions that might compromise the asset; that your plans explicitly include activities that will utilize the asset.

A very consistent earnings history (think GE) is a good place to start.

Earnings volatility, cyclical market pressures, intent to change operations (like purchase a competitor), etc will all compromise the asset.

Once you get to the point of needing an allowance, the question is "how much"? Personally, if you're not public, I just write the whole thing down as it isn't worth the time structuring and discussing the allocation model.* However, if you want to do it, to the extent that you can show earnings stability, you use that.

Note that there seems to be a bit of a gray area here. If you say you are going to use the tax asset because you're going to take certain actions, and you don't, that you signed off in the report that you were going to take those actions seems to tie your hands a little (imho).

*While telling the management team how you've shown it, so they understand that the asset really is still there.

Eric Lau
Title: Regulatory Reporting Manager
Company: Bank of Hawaii
(Regulatory Reporting Manager, Bank of Hawaii) |

Thanks Keith,
What's the typical time horizon to consider when demonstrating that we can "earn" sufficient amount? For example, if a three-year forecast only utilizes a portion of the tax assets, do we have to write down the remainder? Or we can justify the remainder based on the income trend and continuous operation?

Pat Voll
Title: Vice President
Company: RoseRyan
(Vice President, RoseRyan) |

Hi Eric - I think Keith’s answer is great. What I recommend to my clients is that they analyze positive and negative factors, and document the factors they looked at and reasons for their conclusion. This includes looking at historical pre-tax book income and the outlook for future profitability. Historical info should be pretty straight-forward to obtain, but as Keith points out – looking at future profitability is not as straight-forward. Consider the company’s track record in developing meaningful projections (forecast to actuals), anticipated changes in operations (launch of a new product, new tax planning strategies, etc.). I would suggest you have the CFO sign off on the memo, as she/he would have a broad view of the business and relevant assumptions for future operations – being consistent is key. Communicating the impact of the valuation allowance to the overall financial statements (potential for restatement, loss of investor confidence, etc.) is important in getting everyone on board with this, assuming your DTA’s are significant.

Eric Lau
Title: Regulatory Reporting Manager
Company: Bank of Hawaii
(Regulatory Reporting Manager, Bank of Hawaii) |

Thanks Pat
I do have a management memo that briefly discusses and justifies the value of the DTA, but I can see how I can strengthen it. Thanks

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