You have just been promoted to assistant controller of Doncast company. One of your responsibilities is to calculate income tax expense and any deferred tax assets or liabilities.

The company took a lot of debt five years ago to finance a major expansion, and the recent rise in interest rates, along with a decline in sales, has resulted in a large operating loss for the current year. Unfortunately, the decline in sales is likely to continue until the economy improves. Economists are not predicting an upturn for several years. In the meantime, the interest payments have tripled, and the company is scheduled to begin repaying the principal on the loan next year. There has been talk of layoffs and even bankruptcy.

You have computed the current year's loss and the refunds due as a result of the loss carryback to the two previous years. The remaining loss will be reported as a loss carryforward and a deferred tax asset.

You are concerned that the company may not have any future earnings and have computed a valuation allowance for the deferred tax asset that reduces it substantially.

You take your calculations and journal entries to your boss, the controller, and she's pleased about the refunds the company will get. However, when she sees the journal entry for the valuation allowance, she refuses to approve it. "The company needs every asset it can report," she says. "Besides, these numbers are just your estimates. No one knows for sure what will happen in the future, so there's no good reason to make this entry."

Based on your analysis of the information provided, respond to the following questions:

How a loss carryback can arise?

What is the timeframe for using a loss carryback?

Why would a valuation allowance be used?

Is one warranted in this situation?

What would happen if the company did become profitable and could use the entire loss carryback?

What is your evaluation of the ethical issues that would arise as result of your boss refusing to approve the valuation allowance?

What is your analysis of the stakeholders involved, and how will they be affected?

Justify your answers with examples and reasoning.