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evaluation of the other two sources of taxable income ― Vol. 3

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Financial reporting in an uncertain economy
A closer look at income tax valuation allowances October 2009

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Additional text goes here. Notwithstanding early signs that the global recession may be waning, the uncertain economic future continues to constrict corporate America. As companies continue to incur losses, focus has heightened on income tax valuation allowance assessments by companies and their auditors, as well as the Securities and Exchange Commission staff, through the issuance of comment letters. Specifically, much of this focus is on whether deferred tax assets reflected on corporate balance sheets will ultimately be realized. When a deferred tax asset is not fully realizable, a valuation allowance must be established against the deferred tax asset to reduce it to a net amount that is realizable. The related expense is generally reflected in the income statement as an income tax expense. A clear understanding of the judgmental nature of valuation allowance accounting models is critical in addressing this issue.

The need for judgment
The accounting requirements for deferred tax assets are set out in ASC 740, "Income Taxes," which establishes a "more likely than not" threshold for recognizing deferred tax assets. The interpretation of this criteria has historically been (and continues to be) one of the most judgmental areas of accounting in practice. Performed on a jurisdictional basis, ASC 740 requires the following four sources of taxable income to be considered in assessing the need for a valuation allowance against deferred tax assets: • • • • Taxable income in prior eligible carryback year(s) Future reversals of existing taxable temporary differences