Question

GlobalTech, Inc. has a wholly-owned subsidiary, TechnoGlobe, Ltd., that has operated at a loss

for much of the decade leading up to 2019, followed by a couple of years of small earnings,
resulting in sizeable NOL carryforwards at the end of 2020. Before now, the managers of
GlobalTech had estimated sufficient income to make use of all of the NOL carryforwards, but
this year (2021), the managers of GlobalTech have determined that it is more likely than not that
there will only be enough future taxable income to make use of 30% of the pre-2019 NOL
carryforwards.
Question 1: What do the managers’ need to recognize on the financial statements of
TechnoGlobe, Ltd., and the consolidated financial statements of GlobalTech, Inc. as a result of
this new determination? Suppose there are currently $48 million of unused pre-2019 NOLs and
the enacted tax rate is 25 percent. Cite the relevant parts of the FASB ASC.
Suppose, after having prepared financial statements in accordance with your answer above, in
the following year (2022) GlobalTech’s managers are approached by consultants from DelErnst
Waterhouse MG who present tax-planning strategies designed to enable TechnoGlobe and
GlobalTech to realize the NOL carryforwards. While the law governing these tax-planning
strategies is not clear, it is believed that the tax positions taken are supported by substantial
authority, although just barely, and are certainly supported by at least a reasonable basis.
Question 2: If the managers implement these tax-planning strategies, can they alter the financial
statement actions they took previously?

Answer 1

Question 1:

GlobalTech needs to recognize a valuation allowance against its deferred tax asset for the portion of pre-2019 NOL carryforwards it now believes it will be unable to utilize.

This is by FASB ASC 740-10-35-4, which requires a valuation allowance when it is more likely than not that some or all of the deferred tax asset will not be realized.

The amount of the valuation allowance is calculated as the difference between the tax benefit originally recognized and the revised estimate of the tax benefit expected to be realized. In this case, the difference would be 70% of $48 million x 25% tax rate = $8.4 million.

This adjustment would be reflected on both TechnoGlobe's individual financial statements and the consolidated financial statements of GlobalTech.

Question 2:

Implementing tax strategies won't change previous financial actions. The initial valuation allowance should stay unchanged. Future adjustments are allowed if income estimates significantly shift. The strategies' legality and ethics must be carefully considered due to unclear laws.