Changes in Valuation Allowance and Income Tax Expense

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alpha668

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CFAI Text Reading 31, EOC Q18 & its solution (Vol 3 P.527 & 530)
I just can’t get it. I have three questions.
1. Is it that there is an increase ($115) in valuation allowance (from $1,245 to 1,360, rather than a decrease as stated in the solution) if the valuation allowance had been the same in 2007 as it was in 2006 ?
2. Is it that the increase ($115) in the valuation allowance that reduced the income tax expense ?
2. Is the income tax provision has same meaning as income tax expense ?
 
We start with
Income Tax Expense = taxes payable + yDTL - yDTA
If 2007 valuations allowance = 1,360,
Net DTA = 18851 - 1360 = 17,491
yNet DTA from 2006 to 2007 = 17,491 - 15,557 = 1,934
Income Tax Expense would decrease by 1,934.
If 2007 valuation allowance = 1,245,
Net DTA = 18851 - 1245 = 17,606
yNet DTA = 2,049
Income Tax Expense would decrease by 2,049
Thus, Income Tax Expense would be higher if val. allowance = 1360
Re the provision. I am pretty sure on this, but stand to be corrected. At the end of a financial period, a firm never really knows exactly how much tax they are going to have to pay. They make a ‘provision’ and balance it out in the next period.
All the best,
M.
 
krugermark,
Thank you for your response ! I now understand why income tax expense (provision) will be higher.
I just want to confirm with you by “yDTL” and “yDTA”, do you mean change in DTL and change in DTA ? Thanks again !
 
birdec wrote:
If the valuation allowance goes up, DTA goes down
Click to expand...
Here the 2007 DTA is remain unchanged and the change is in valuation allowance ! It seems the scenario is different from yours.
 
krugermark,
Sorry, I am again confused by another question: Q20 on Schweser Note, Book 3 P.251
Why the eranings are expected to decreaseb ? Is it because the recognized valuation allowance is increased from $ 2700 to $ 3900 and this means the more DTA (tax benefits) will not be realized due to the expected decreases in earnings (pre-tax income) ?
 
alpha668 wrote:
birdec wrote:
If the valuation allowance goes up, DTA goes down
Click to expand...
Here the 2007 DTA is remain unchanged and the change is in valuation allowance ! It seems the scenario is different from yours.
Click to expand...
If 2007 valuation allowance = 1,245,
Net DTA = 18851 - 1245 = 17,606
yNet DTA = 2,049
 
Hi alpha,
Correct. The firm anticipates future earnings not being high enough to take advantage of the DTA, so the valuation allowance is increased.
And from earlier, yes, “yDTA” means “change in DTA”.
M.
 
krugermark,
Thank you very much for your further explanations.
Income Tax Expense = taxes payable + yDTL - yDTA shall be a correct equation.
However, I found in the last paragraph at the bottom on CFAI Text Vol 3 P.495. It is stated :
On the income statement, the company’s income tax expense will be the sum of the DTL and income tax payable.
Am I missing something ?
 
However, the DTA will reduce DTL if I remember well. Often times company actually measure their deferred taxes by reducing any DTL from their DTA which gives you a net amount for deferred taxes. The net amount can be a liability or an asset depending on which is higher. In the chapter on income taxes there is a exhibit which shows how DTA and DTL are reconciled and then reported on the balance sheet.
 
I think the last paragraph at the bottom on CFAI Text Vol 3 P.495 shall state :
On the income statement, the company’s income tax expense will be the sum of the change in DTL and income tax payable. But I am not sure if I am right.
As can be seen on P.486 : $7,753 + $257 = $ 8,010 (for 2006).
 
CFAI Text 2013 Vol. 3 p.451:
A Company’s taxable income is the basis for its income tax payable (a liability) or recoverable (an asset), which is calculated on the basis of the company’s tax rate and appears on its balance sheet. A company’s tax expense, or tax benefit in the case of a recovery, appears on its income statement and is an aggregate of its income tax payable (or recoverable in the case of a tax benefit) and any changes in DTA or DTL.
I think that we need to take into account the DTA in the period. Anyone can clarify ?
 
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