JanOne Inc (JAN)

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Implications of Valuation Allocation
A deferred tax asset is a reduction in future cash outflow (taxes to be paid). But, the asset has value only if the firm expects to pay taxes in the future. For example, an Net Operating Loss (NOL) carry-forward is worthless if the firm does not expect to have positive taxable income for the next 20 years. Since accounting is conservative, firms must reduce the value of their deferred tax assets by a deferred tax-asset valuation allowance. This is a contra-asset account CR (credit) balance on the balance sheet - just like accumulated depreciation or the allowance for uncollectible accounts) that reduces the deferred tax asset to its expected realizable value.

Increasing the valuation allowance increases deferred income tax expense; decreasing the allowance does the opposite. Changes in the allowance affect income tax expense. Although the need for an allowance is subjective, its existence and magnitude reveals management's expectation of future earnings. Management can use changes in the allowance to "manipulate" NI by affecting income tax expense. Analysts should scrutinize these types of changes.



Read more: Tax Deferred Liabilities https://www.investopedia.com/exam-guide/cfa-level-1/liabilities/tax-deferred-liabilities.asp#ixzz5IMAuqw4D
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