Deferred tax assets and liabilites

CFA Level I FRA
#1

CFA1 Vol. 3 p.453 paragraph 1:

If a deferred tax asset or liability resulted in the past, but the criteria of economic benefits is not met on the current balance sheet date, then, under IFRS, an existing deferred tax asset or liability related to the item will be reversed.

I don’t get this, “reversed”… What exactly does it mean?

Thanks for any help!

#2

If the criteria of economic benefit is not met (= it is probable that the deferred tax asset/liability will not be recovered because there will not be sufficient future taxable income) then a valuation allowance is created. This allowance is a contra-item, e.g. contra-asset to DTA, reverses the deferred tax item.

In case in some future the criteria of economic benefit IS met, this valuation allowance is reduced again and the deferred item increases again.

At least that’s how I understand the whole shebang.

#3

This is true for DTAs; whether it’s true for DTLs, I don’t know: that’s not included in the CFA curriculum.

One step is missing, however: when you believe that a DTA won’t be realized and you create a valuation allowance account (a credit-balance, contra asset), you have to debit something: that something is a loss that goes on the income statement. So the reversal reduces net income.

#4

Thanks, guys.

So, you’re unsure about DTLs?

#5

Accountants are interesting. " Valuation Allowance" sounds so good, when in fact, it’s bad. They also are allowed to call overpaying for a firm “Goodwill”, when in fact, it should be called “Badwill”. I am just saying this is how I am able to log this stuff into my thick head. I know this is not exactly the original post but I thought this might help someone.

#6

You’re welcome.

Yes, I’m unsure about reversals of DTLs; you may create a contra liability account, or you may simply reduce the DTL. Either way, it isn’t part of the CFA curriculum, so they won’t ask you a question about it.