Fashion Designs, Inc. (FD) is a manufacturer of high- end women’s clothing. The firm is involved in the manufacture and design of the clothing. FD has been in this business for many years and has historically reported strong earnings. However, its earnings have been declining in recent years. In the two years prior to the current year, it reported only a very small net income. In the current year, it incurred a $ 10,000,000 loss due to several factors:
• The economy as a whole was in a slump.
• There is a general consensus among buyers that its designs are becoming dated and are not appealing to the new generation of consumers.
However, there are a few buyers that still like the designs by FD. In fact, FD currently has nearly completed the negotiations for a large contract with one of its primary buyers.
The management of FD has begun an overhaul of the business to address buyer concerns. Unfortunately, this process will take some time— possibly several years. And, of course, there is uncertainty about the feasibility of any turnaround plan for the business. To make matters worse, FD is facing a discrimination lawsuit that could ultimately result in a large payout.
Fashion Designs is a U. S. GAAP reporter and has no book- tax differences. Because the firm incurred a net operating loss this year and has had very little net income in the two preceding years, it will record a deferred tax asset for the NOL carryforward.
Based upon your judgment, should Fashion Designs record a valuation allowance to offset its deferred tax asset? If so, should it record a full valuation allowance (i. e., the valuation allowance amount would equal the deferred tax asset amount) or just a partial valuation allowance? If a partial allowance, what percentage of the deferred tax asset should it offset with the allowance? Justify your answer. (Consider consulting paragraphs 21 and 22 of FASB ASC 740- 10- 30.)