Question

Buffco began operations in 20X1, and although it has grown steadily, the company reported accumulated operating losses of $530,000 in its first four years in business. In the most recent year, 20X5, Buffco appears to have turned the corner and reported modest taxable income of $40,000. In addition to a deferred tax asset related to its net operating loss, Buffco has recorded a deferred tax asset related to product warranties and a deferred tax liability related to accelerated depreciation.

Given its past operating results, Buffco has established a full valuation allowance for its deferred tax assets. However, given its improved performance in 20X5, Buffco management would like to know if they can reduce or eliminate the valuation allowance.

Required:

In a short research paper (1 – 2 pages), discuss the following issues as they relate to Buffco and provide the appropriate FASB ASC references. Create a clear and organized research paper that accomplishes the goals of the assignment, employs appropriate tools (FASB ASC), and demonstrates good composition skills, effective organization, and effective writing style.

• The importance of future taxable income as it relates to the valuation allowance for deferred tax assets.
• The sources of income that may be relied upon to remove the need for a valuation allowance.
• Possible tax-planning strategies for the purpose of reducing a valuation allowance.
• From the information provided above, discuss whether or not it appears that Buffco could employ a tax-planning strategy to support reducing its valuation allowance?
• Given its improved performance in 20X5 and the information gained from your research, should Buffco management reduce or eliminate the valuation allowance? Explain your conclusion.

Solution Preview

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The two basic principles that relate to accounting for income taxes are: (i) recognition of the estimated taxes payable or refundable for the current year as a liability or an asset, and (ii) recognition of deferred tax liability or asset for the estimated future tax effects that are attributable to temporary differences and carryforwards (FASB, 2015). Consequently, an entity must consider available positive and negative evidence when evaluating its ability to recover its deferred income tax assets. Accurate...

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