A company has a Deferred Tax Asset (DTA) of $100,000 arising from NOL carryforwards. Management determines it is 'more likely than not' that only 60% of the DTA will be realized. What is the journal entry to record the Valuation Allowance?

Answer options:

Dr. Income Tax Expense $60,000; Cr. Valuation Allowance $60,000

Dr. Income Tax Expense $40,000; Cr. Valuation Allowance $40,000

Dr. Valuation Allowance $40,000; Cr. Income Tax Benefit $40,000

No entry needed.

How to approach this question

1. Determine % NOT realized. 2. Calculate Allowance ($ * % Not Realized). 3. Entry: Dr Tax Expense, Cr Valuation Allowance.

Full Answer

B.Dr. Income Tax Expense $40,000; Cr. Valuation Allowance $40,000✓ Correct

A valuation allowance is recognized if it is more likely than not that some portion of the DTA will not be realized. Unrealized portion = 40%. $100,000 * 40% = $40,000. This increases tax expense.

Common mistakes

Calculating allowance on the realized portion (60%) instead of the unrealized portion (40%).

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