Valuation of Deferred Tax Assets — Intermediate Accounting

When is a valuation allowance required for a deferred tax asset? This intermediate accounting lecture explains how to value deferred tax assets (DTA), when a valuation allowance must be recorded under the more-likely-than-not standard, and how to prepare the related income tax expense journal entries. Built for accounting students and CPA candidates studying deferred taxes and the FAR section of the exam.
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Video Timeline & Key Concepts:
0:00 — Introduction
0:33 — Why a deferred tax asset is an asset and when it must be written down
4:10 — The valuation allowance as a contra-asset reported at net realizable value
5:15 — Journal entries: debit income tax expense, credit valuation allowance, and reversals
7:01 — Year-over-year numerical example calculating the allowance
16:17 — Multiple choice practice computing total income tax expense
Frequently Asked Questions:
When is a valuation allowance required?
A valuation allowance is required when it is more likely than not — a chance of more than 50 percent — that some or all of a deferred tax asset will not be realized in future periods.
Why use a valuation allowance instead of writing down the deferred tax asset directly?
Companies use a contra-asset valuation allowance so the gross deferred tax asset remains visible while the balance sheet reports the asset at its net realizable value. This preserves information and allows the allowance to be reversed later.
What journal entry records a valuation allowance?
You debit income tax expense and credit the valuation allowance. If the company later expects to realize the benefit, the entry can be reversed to restore the deferred tax asset.
What happens when a company becomes profitable again?
If future realization becomes more likely than not, the previously recorded valuation allowance is reversed, which reduces income tax expense in the period of reversal.
How does a valuation allowance affect income tax expense?
The valuation allowance increases income tax expense when established, and in many problems the income tax expense functions as the plug figure that balances the journal entry.
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