Growth of Deferred Tax Assets and the Valuation Allowance

[keep_running]

Hello,
Gross DTA beginning = 10,500
Gross DTA end = 11,250
Valuation Allowance beginning = 2,700
Valuation Allowance end = 3,900
How come the firm’s earnings are expected to decrease over the period?

 

[cpk123]

DTA is a expected future tax benefit which the firm hopes it will realize. Here the amount of extra difference is $1200 (Delta DTA). That same Delta amount is showing up in the Valuation Allowance increase as well. This means the company is NOT hoping to realize some of that asset benefit too.

Quote:
Recognition of Valuation Allowance
Under U.S. GAAP, deferred tax assets must be assessed at each balance sheet date. If there is any doubt whether the deferral will be recovered, the carrying amount should be reduced to the expected recoverable amount. The asset is reduced by increasing the valuation allowance. Should circumstances change, so that it is more probable that the deferred tax benefits will be recovered, the deferred asset account will be increased (and the valuation allowance will be decreased)
One example where there will be a decrease in valuation allowance is when the carry forward period for tax losses increases. This is because there will be a higher possibility now (due to increase in period) that benefits will be realized from the deferred tax asset and would likely result in a decrease in the valuation allowance (i.e. increase in the deferred tax asset)

 

[keep_running]

Ok. So relative to my question, since the valuation allowance increases more than the gross DTA increase, net DTA is going down, which means that earnings are going to decrease because the firm is less likely to recover that benefit in the future?

 

[cpk123]

gross DTA increase here was EQUAL to the increase in valuation allowance. (Both are 1200 here).
but yes, your statement sounds right.

 

[S2000magician]

Tax expense (on the income statement) = taxes payable (on the tax return) + ΔDTL − ΔDTA
If the net DTA is going down, tax expense is going up, so net income is going down.