ASC 740: Valuation Allowance vs. Uncertain Tax Positions

Question 1

At December 31, 20X5, North Co. has a deferred tax asset from accrued warranty costs that will be deductible when paid in 20X6 and 20X7. North also has a deferred tax liability from accelerated tax depreciation that will reverse in 20X6 and 20X7 in the same tax jurisdiction. North incurred cumulative pretax losses in 20X3 through 20X5. Management projects taxable income in 20X6 and 20X7, but the projection is not supported by firm contracts or similar objectively verifiable evidence. A tax law enacted before year-end reduces the tax rate for 20X6 and 20X7. Assume no tax-planning strategies are available and ignore uncertain tax positions. In deciding whether a valuation allowance is required on any portion of the warranty-related deferred tax asset, which factor should govern the analysis?

Accepted Answer

Whether sufficient taxable temporary differences will reverse in 20X6 and 20X7 in the same tax jurisdiction to provide a source of taxable income.

Question 2

At December 31, 20X5, Pine Co. has a $400,000 deductible temporary difference related to accrued warranty costs that will be deductible for tax purposes when paid in 20X6. The enacted tax rate is 25%. Based on all available evidence, management concludes it is more likely than not that only $40,000 of the related tax benefit will be realized. Assume no uncertain tax positions and no other income tax effects. Which accounting treatment is most appropriate at December 31, 20X5?

Accepted Answer

Recognize a deferred tax asset of $100,000 and a valuation allowance of $60,000.

Question 3

On December 31, 20X5, Pine Co. accrued warranty expense of $400,000 for financial reporting. The warranty costs will be deductible on Pine's tax returns only when paid. The enacted tax rate for the years of reversal is 25%. Pine has a recent cumulative loss history, no carryback availability, and no taxable temporary differences to support realization. After considering all available evidence, management concludes it is more likely than not that only $90,000 of the tax benefit related to this deductible temporary difference will be realized. Under ASC 740, which accounting treatment is most appropriate at 12/31/20X5?

Accepted Answer

Record a deferred tax asset of $100,000 and a valuation allowance of $10,000.

Question 4

At 12/31/20X5, Rowan Co. has recorded a $150,000 accrued warranty liability. The warranty expense reduced pretax financial income in 20X5, but the related amounts will be deductible for tax only when paid. Rowan has no carryback ability. Rowan is in a cumulative loss position for the last three years, and management has identified no tax-planning strategies and no other sources of taxable income. The only identified source of future taxable income is a $30,000 taxable temporary difference from revenue recognized for book in 20X5 that will be taxed in 20X6, and that difference will reverse in a period in which the warranty deductions can be used. The enacted tax rate is 25%. What net deferred tax asset related to the warranty liability should Rowan report at 12/31/20X5?

Accepted Answer

$7,500, because only the portion supported by the reversing taxable temporary difference is more likely than not realizable.

Question 5

At 12/31/20X5, Hale Corp., a calendar-year entity, has the following in its only tax jurisdiction and only tax‑paying component: - A deductible temporary difference of $900,000 from an accrued litigation loss that will reverse entirely in 20X6. - A taxable temporary difference of $600,000 from depreciation that will reverse entirely in 20X6. The enacted tax rate is 25% for both 20X5 and 20X6. Hale has a three‑year cumulative pretax loss as of 12/31/20X5. Assume there is no carryback availability, no prudent and feasible tax‑planning strategy, and no objectively verifiable positive evidence other than the scheduled reversal of the $600,000 taxable temporary difference. What is the required response in Hale's 20X5 financial statements regarding deferred taxes?

Accepted Answer

Recognize a deferred tax asset of $225,000, a deferred tax liability of $150,000, and a valuation allowance of $75,000; the net deferred tax amount reported is zero.

Question 6

At December 31, 20X5, Alder Co. operates in a single tax jurisdiction and has a three-year cumulative pretax loss. Management concludes that, because of the weight of negative evidence, the only source of taxable income that is more likely than not available to realize deferred tax assets is the scheduled reversal of existing taxable temporary differences. No carryback is available, no prudent and feasible tax-planning strategy has been identified, and no other future taxable income is considered objectively supportable. Alder's temporary differences are as follows: - Deductible temporary differences from accrued warranty costs: $300,000 reversing in 20X6 and $500,000 reversing in 20X7 - Taxable temporary differences from accelerated tax depreciation: $500,000 reversing in 20X6 and $200,000 reversing in 20X7 As of December 31, 20X5, the enacted tax rate is 30% for amounts reversing in 20X6 and 25% for amounts reversing in 20X7. What valuation allowance should Alder record against its deferred tax assets at December 31, 20X5?

Accepted Answer

$75,000

Question 7

At December 31, 20X5, Pine Co. has a deductible temporary difference of $240,000 from accrued warranty costs. The enacted tax rate for the periods of reversal is 25%. Assume the temporary difference is valid for tax purposes, there are no uncertain tax positions, and no tax rate change is expected. After evaluating available positive and negative evidence, Pine concludes it is more likely than not that only $45,000 of the related tax benefit will be realized. What net deferred tax asset should Pine report at December 31, 20X5?

Accepted Answer

$45,000

Question 8

Pine Co. claimed a material deduction on its Year 1 tax return based on a position with uncertain support. At year-end, management believes an audit is unlikely, and outside counsel believes Pine would probably preserve a meaningful portion of the tax benefit through settlement if the return were challenged. Assume the position falls within ASC 740, all relevant facts are known at year-end, and no tax law changes occur after year-end. Under U.S. GAAP, which governing factor determines whether Pine may recognize any tax benefit from this position before determining the amount to recognize?

Accepted Answer

Whether, on its technical merits and assuming examination with full knowledge of the relevant facts, the position is more likely than not to be sustained

Question 9

At 12/31/20X5, Raven Corp claimed a $400,000 deduction on its 20X5 tax return. For financial reporting under ASC 740 (Income Taxes), Raven concludes the position will be examined by the taxing authority, which will have full knowledge of all relevant facts. Based solely on technical merits, management assigns the following probabilities to the amount of the deduction that would ultimately be sustained: $400,000 (30%), $300,000 (25%), $200,000 (20%), and $0 (25%). Assume a 20% tax rate, no interest or penalties, and that this is Raven's only uncertain tax position. Which is the best conclusion about the tax benefit Raven should recognize in its 20X5 financial statements?

Accepted Answer

Recognize a $60,000 tax benefit, because $300,000 is the largest deduction amount that, when outcomes are ordered from largest to smallest and probabilities are accumulated, yields a cumulative probability greater than 50% (300,000 × 20% = $60,000).

Question 10

Holt Co. claimed a tax position on its Year 1 return that would reduce income taxes payable by $300,000 if fully sustained. At December 31, Year 1, Holt concludes the position meets the ASC 740 recognition threshold based on its technical merits, assuming the taxing authority has full knowledge of the relevant facts. Holt estimates the possible tax benefits realizable upon ultimate settlement as follows: $0 (5%), $120,000 (35%), $180,000 (30%), and $300,000 (30%). Under ASC 740, what factor governs the amount of tax benefit Holt should recognize in its Year 1 financial statements?

Accepted Answer

The largest amount of tax benefit that is cumulatively more than 50% likely to be realized upon ultimate settlement

Tax Item	Amount
Benefit: 40%	$120,000
Benefit: 20%	$90,000
Benefit: 15%	$60,000
Benefit: 15%	$30,000
Benefit: 10%	$0

ASC 740: Valuation Allowance vs. Uncertain Tax Positions

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