# Deferred Tax Assets: Loss Carryforwards &uation Allowance ## Step-by-Step Solution ### 1. **Should the Company Recognize Deferred Tax Assets (DTAs)?** A company can recognize DTAs if it is **probable** (more likely than not, i.e., >50%) that future taxable income will be available against which loss carryforwards and deductible temporary differences can be utilized (per IAS 12/ASC 740). - The company has: - **Three years of losses** (loss carryforwards created) - **Forecasts of strong taxable income** (from a new contract, tax law changes, and reversal of temporary differences) **Conclusion:** If the forecasted taxable income is credible and sufficient to absorb the loss carryforwards and deductible temporary differences, the company should recognize a DTA. --- ### 2. **Evidence Required to Support Recognition** To recognize DTAs, the company must provide **convincing evidence** of future taxable income, such as: - **Firm contracts** (e.g., government contract signed and enforceable) - **Official documentation** of tax law changes that increase taxable income or allow greater deductions - **Detailed forecasts** showing reversal of existing deductible and taxable temporary differences - **Historical evidence** (if available) showing ability to generate profits --- ### 3. **Role of Taxable Temporary Differences** **Taxable temporary differences** are differences that will result in **taxable amounts in future periods** when the related asset or liability is recovered or settled. - These differences create **future taxable income**. - They can serve as **"sources"** of taxable income to realize DTAs. - If taxable temporary differences are expected to reverse in the same period as loss carryforwards, they provide **objective evidence** supporting DTA recognition. --- ### 4. **Impact of Tax Planning Strategies** Tax planning strategies can: - Accelerate taxable income (e.g., selling appreciated assets) - Defer deductions - Restructure operations to realize tax benefits If the company can **implement prudent and feasible tax planning strategies** to generate taxable income before loss carryforwards expire, these can **support DTA recognition**. --- ### 5. **Circumstances Requiring Valuation Allowance Reversal** A **valuation allowance** (under US GAAP) or a **reduction of DTA under IFRS** is required if it's **not probable** the DTA will be realized. **Reversal Required When:** - **New evidence** (e.g., signed government contract, enacted tax law) makes it more likely than not that sufficient taxable income will arise. - **Forecasts become robust and credible**, overcoming prior negative evidence (e.g., history of losses). - **Temporary differences or loss carryforwards** are now expected to be utilized before they expire. **The company should reverse (reduce or eliminate) the valuation allowance** when realization of the DTA becomes probable, based on all available evidence. --- ## **Final Answer (Summary Table)** | Step | Key Point | Explanation | |------|-------------------------------------------------------------------|--------------------------------------------------------------------------------------------------| | 1 | Recognize DTA if probable of realization | Strong, credible forecasts (contracts, law changes, reversals) support recognition | | 2 | Evidence required | Firm contracts, legal documentation, detailed projections, historical profit evidence | | 3 | Role of taxable temporary differences | Provide future taxable income, supporting DTA utilization | | 4 | Impact of tax planning strategies | Can create/accelerate taxable income, further supporting DTA realization | | 5 | When to reverse valuation allowance | When new evidence makes DTA realization more likely than not (e.g., new contract, law changes) | --- **In summary:** The company should recognize deferred tax assets if it is probable that it will have sufficient taxable income (from contracts, law changes, or temporary difference reversals) to utilize loss carryforwards and other deductible differences. Sufficient, objective evidence must support this. Taxable temporary differences and credible tax planning strategies can further support recognition. The valuation allowance must be reduced or reversed when realization becomes probable based on new, convincing evidence.