Memo

Topics: Balance sheet, Taxation, Taxation in the United States Pages: 5 (1462 words) Published: March 4, 2014
Date: 2/19/14
To: CEO of LOL
From: Auditor
Re: The realization and valuation of DTAs

Mr. CEO:

The following paragraphs explain why a valuation of temporary taxable differences is necessary and how, with the guidance of the Accounting Standards Codification (ASC), we came to this conclusion. According to ASC 740-10-30-23, "The more negative evidence that exists, the more positive evidence is necessary and the more difficult it is to support a conclusion that a valuation allowance is not needed for some portion or all of the deferred tax asset. A cumulative loss in recent years is a significant piece of negative evidence that is difficult to overcome." The fact that LOL is in a cumulative loss position, has experienced historic losses, and has recently lost a significant customer supports the above quote and is the foundation to our recommendation. This lack of positive evidence proves that it is more likely than not that future taxable income will not be able to fully realize the DTAs. Other components, such as sources of future taxable income, tax planning strategies, historic data, and events currently affecting future taxable income were considered in our evaluation of LOL's situation, and the evidence gathered is presented as follows.

Sources of Taxable Income:
In order to realize the tax benefit of an existing deductible temporary difference or carryforward, sufficient taxable income must exist. ASC 740-10-30-18 provides us with four possible sources of taxable income that do realize a tax benefit for deductible temporary differences and carryforwards. These sources are:

“Future reversals of existing taxable temporary differences
Future taxable income exclusive of reversing temporary differences and carryforwards
Taxable income in prior carryback years if carryback is permitted under the tax law
Tax planning strategies”
LOL does not have the ability to carryback any losses to prior periods nor does it have a history of tax credit carryforwards, thus these sources of income do not pertain to LOL. Future reversals of existing taxable temporary differences can and will be considered in estimating future taxable income as well as certain tax planning strategies. Taxable temporary differences and their impact on future taxable income are covered next.

Reversing Taxable Temporary Differences:
According to LOL’s inventory of deferred tax balances sheet, the deferred tax liabilities section includes depreciation of 15MM, indefinite lived intangible assets (trademark) of 50MM, and prepaid expenses of 30MM. Of these, the indefinite lived intangible assets (trademark) of 50MM should not be measured as a source for future taxable income because their will not likely be any impairment of the trademark. The sale of such an asset in the foreseeable future is also not likely. So, depreciation and prepaid expenses totaling 45MM are the only deferred income tax liabilities that should be considered when computing future taxable income and will then play a role in the realization of certain DTAs.

Issues Involved with LOL’s Future Taxable Income:
To fully realize LOL’s DTAs the company must have positive evidence to prove the existence of future taxable income. Taken from LOL’s consolidated statement of operations we can see that they are currently in a cumulative loss position (negative evidence) as of the past three years given to us (2008-2010). ASC 740-10-30-21 states that, “forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years.” It goes on to describe other examples of negative evidence.

“A history of operating loss or tax credit carryforwards expiring unused
Losses expected in early future years (by a presently profitable entity)
Unsettled circumstances that, if unfavorably resolved, would adversely affect future operations and profit levels on a continuing basis in future years
A...
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