Final answer:
Joshuantic, Inc. must establish a valuation allowance against the deferred tax asset if it believes it may not realize the asset, affecting its balance sheet and income statement.
Step-by-step explanation:
When a company like Joshuantic, Inc. has cumulative unfavorable temporary differences of $80,000 leading to a recording of a $16,800 deferred tax asset, management must assess the likelihood of realizing this asset in the future. A deferred tax asset represents an amount that the company can reduce its taxable income by in future periods, stemming from temporary differences between accounting income and taxable income.
If Joshuantic believes that it may not be able to realize this asset, typically because future earnings may not be sufficient to take advantage of this tax credit, it must provide a valuation allowance against the deferred tax asset. This valuation allowance is an accounting practice that companies use to recognize the possibility that a deferred tax asset might not be fully realized. The effect of a valuation allowance is to reduce the value of the deferred tax asset on the balance sheet, which indirectly increases the company's tax expense in the income statement.
In short, if Joshuantic believes the deferred tax asset is not realizable, it will need to set up a valuation allowance, which reflects a more conservative position on the balance sheet and ensures that the financial statements are presenting an accurate picture of the company’s financial health.