KPMG Deferred Tax Issues

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KPMG Deferred Tax Issues: Valuation Allowance

Issue 1: Conclude on the appropriateness of the engagement team’s decision for valuation allowance.

1. Clarify Issues & Objectives

ASC 740-10-05-5 defines a deferred tax asset as:

A deferred tax asset is measured using the applicable enacted tax rate and provisions of the enacted tax law. A deferred tax asset is reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.

ASC 740-10-05-5 also states the following:

There are two basic principles related to accounting for income taxes, each of which considers uncertainty through the application of recognition and measurement criteria:
a. To recognize the estimated taxes payable or refundable on tax returns for the current year as a tax liability or asset
b. To recognize a deferred tax liability or asset for the estimated future tax effects attributable to temporary differences and carryforwards.

The main concern in this case is whether the engagement team’s decision not to include a valuation allowance for Riggers’ deferred tax asset is an appropriate representation of the economics of the given situation. A valuation allowance to reduce a deferred tax asset is required if evidence indicates it is more likely than not that some or all of the asset will not be realized. Evidence, in this case, relies upon several assumptions that led the engagement team to conclude that no valuation allowance is necessary. The primary assumptions include estimations surrounding future profit margins and rig efficiency. The accuracy and dependability of these assumptions have a significant effect on the appropriateness of the deferred tax asset recognition. In order to determine the accuracy of the decision not to allocate any valuation allowance, an evaluation of the current assumptions and relevant information is required.

2. Consider Alternatives

ASC

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