The decisions to establish a deferred tax asset valuation allowance and, if so, what amount to...

 

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The decisions to establish a deferred tax asset valuation allowance and, if so, what amount to record are subjective assessments. Readily observable criteria do not exist, and the dollar amounts can be very large. There is potential for misuse in both directions, i.e. being too aggressive and minimizing the size of the allowance to reduce its negative effect on current income versus being too conserva- tive and creating a "cookie jar" allowance to be released in the future when earnings are "needed". For an example of how large a valuation allowance can be relative to the rest of the financial state- ments, consider Ford Motor Company's 2011 valuation allowance reversal. In its Income Tax foot- note in 2011, Ford states that: Our accounting for deferred tax consequences represents our best estimate of the likely future tax consequences of events that have been recognized in our financial statements or tax returns and their future probability. In assessing the need for a valuation allowance, we consider both positive and negative evidence related to the likelihood of realization of the deferred tax assets. If, based on the weight of available evidence, it is more likely than not that the deferred tax assets will not be realized, we record a valuation allowance. From 2007 through 2012, Ford's deferred tax assets, valuation allowances and deferred tax liabili- ties are: 2007 Total gross deferred tax assets Less: valuation allowance Total net deferred tax assets Total deferred tax liabilities 23,612.0 2008 28,966.0 2009 2010 27,186.0 23,370.0 2011 22,285.0 2012 22,722.0 (8,560.0 (17,268.0) (17,396.0) (15,664.0) (1,545.0) (1,923.0) 15,052.0 11,698.0 9,790.0 7,706.0 20,740.0 20,799.0 14,586.0 Net deferred tax assets/ (liabilities) 466.0 10,625.0 1,073.0 8,732.0 6,838.0 6,311.0 6,084.0 1,058.0 868.0 14,429.0 14,715.0 Ford issued a press release disclosing its earnings results for 2011. Two key points in the press re- lease were: Full year pre-tax operating profit was $8.8 billion, an increase of $463 million from a year ago. Full year net income was $20.2 billion, an increase of $13.6 billion from a year ago. Net income includes a favorable one-time, non-cash special item of $14.1 billion from release of almost all of the valuation allowance against net deferred tax assets in the fourth quarter. The table below shows Ford's profit before taxes, provision for (benefit from) income taxes and net income for the years ended 2008 through 2012. Income before income taxes. Provision for (benefit from) 2008 (14,896.0) 2009 2,599.0 2010 7,149.0 2011 8,681.0 2012 7,638.0 income taxes Net income (loss) 63.0 (14,833.0) (113.0) 2,712.0 592.0 6,667.0 (11,541.0) 20,222.0 2,026.0 5,612.0 The press release and the income statement illustrate the potential magnitude of the valuation re- versal. Valuation allowances built up over many years can be released all at once, possibly even resulting in a negative tax provision in a year when a company reports positive pre-tax income. 1. What was Ford's tax rate in each year from 2008 through 2012? Briefly comment on the tax rates. The decisions to establish a deferred tax asset valuation allowance and, if so, what amount to record are subjective assessments. Readily observable criteria do not exist, and the dollar amounts can be very large. There is potential for misuse in both directions, i.e. being too aggressive and minimizing the size of the allowance to reduce its negative effect on current income versus being too conserva- tive and creating a "cookie jar" allowance to be released in the future when earnings are "needed". For an example of how large a valuation allowance can be relative to the rest of the financial state- ments, consider Ford Motor Company's 2011 valuation allowance reversal. In its Income Tax foot- note in 2011, Ford states that: Our accounting for deferred tax consequences represents our best estimate of the likely future tax consequences of events that have been recognized in our financial statements or tax returns and their future probability. In assessing the need for a valuation allowance, we consider both positive and negative evidence related to the likelihood of realization of the deferred tax assets. If, based on the weight of available evidence, it is more likely than not that the deferred tax assets will not be realized, we record a valuation allowance. From 2007 through 2012, Ford's deferred tax assets, valuation allowances and deferred tax liabili- ties are: 2007 Total gross deferred tax assets Less: valuation allowance Total net deferred tax assets Total deferred tax liabilities 23,612.0 2008 28,966.0 2009 2010 27,186.0 23,370.0 2011 22,285.0 2012 22,722.0 (8,560.0 (17,268.0) (17,396.0) (15,664.0) (1,545.0) (1,923.0) 15,052.0 11,698.0 9,790.0 7,706.0 20,740.0 20,799.0 14,586.0 Net deferred tax assets/ (liabilities) 466.0 10,625.0 1,073.0 8,732.0 6,838.0 6,311.0 6,084.0 1,058.0 868.0 14,429.0 14,715.0 Ford issued a press release disclosing its earnings results for 2011. Two key points in the press re- lease were: Full year pre-tax operating profit was $8.8 billion, an increase of $463 million from a year ago. Full year net income was $20.2 billion, an increase of $13.6 billion from a year ago. Net income includes a favorable one-time, non-cash special item of $14.1 billion from release of almost all of the valuation allowance against net deferred tax assets in the fourth quarter. The table below shows Ford's profit before taxes, provision for (benefit from) income taxes and net income for the years ended 2008 through 2012. Income before income taxes. Provision for (benefit from) 2008 (14,896.0) 2009 2,599.0 2010 7,149.0 2011 8,681.0 2012 7,638.0 income taxes Net income (loss) 63.0 (14,833.0) (113.0) 2,712.0 592.0 6,667.0 (11,541.0) 20,222.0 2,026.0 5,612.0 The press release and the income statement illustrate the potential magnitude of the valuation re- versal. Valuation allowances built up over many years can be released all at once, possibly even resulting in a negative tax provision in a year when a company reports positive pre-tax income. 1. What was Ford's tax rate in each year from 2008 through 2012? Briefly comment on the tax rates.