ABC Corporation, a multinational company, operates in various jurisdictions and prepares its financial statements in accordance with Generally Accepted Accounting Principles (GAAP). In recent years, ABC has experienced fluctuations in its taxable income, leading to the establishment of tax valuation allowances.

Scenario: ABC Corporation reported a net loss in the current fiscal year due to challenging market conditions and temporary setbacks in its operations. As a result, the company is evaluating the need for tax valuation allowances to account for its deferred tax assets.

Steps Taken:

Assessment of Deferred Tax Assets:

ABC Corporation conducts a thorough assessment of its deferred tax assets, including tax credits, NOLs, and temporary differences between book and tax accounting.

Evaluation of Future Taxable Income:

The company analyzes its historical and projected future taxable income to determine whether it is more likely than not that deferred tax assets will be realized.

Factors considered include past profitability, industry trends, future business plans, and anticipated tax planning strategies.

Establishment of Valuation Allowances:

Based on the assessment, ABC Corporation determines that it is necessary to establish tax valuation allowances to reduce the carrying amount of deferred tax assets to the amount expected to be realized.

Valuation allowances are recorded as a contra-asset on the balance sheet and charged to income tax expense in the income statement.

Disclosures in Financial Statements:

ABC Corporation provides comprehensive disclosures in its financial statements regarding the establishment, utilization, and changes in tax valuation allowances.

These disclosures enhance transparency and enable stakeholders to understand the impact of valuation allowances on the company's financial position and performance.

Objective Type Question:

What is the purpose of establishing tax valuation allowances in financial reporting?

A) To overstate deferred tax assets on the balance sheet.

B) To reduce the carrying amount of deferred tax assets to the amount expected to be realized.

C) To increase income tax expense in the income statement.

D) To minimize transparency in financial reporting.