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need for a valuation allowance

Discuss some of the positive and negative evidence used to establish the need for a valuation allowance for a tax loss carryforward. Also, indicate the effect of the valuation allowance on the free cash flow forecast.

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Recognizing deferred tax assets probably is the most complex and subjective area of Financial Accounting Standards Board Statement no. 109, Accounting for Income Taxes. Companies must reduce deferred tax assets by a valuation allowance if, based on available evidence, it is "more likely than not" (a likelihood of more than 50%) some or all of the deferred tax assets will not be realized.

The underlying principle of Statement no. 109 is that deferred tax assets and liabilities should be recognized for the future tax consequences of past events. Both are measured and recorded based on the expected tax consequences when the underlying temporary differences (book- versus tax-basis differences) generate taxable income or deductions in the future. In addition to temporary differences, deferred tax assets also are recognized for tax attributes such as operating and capital losses and tax credit carryforwards.

Future realization of the tax benefit of an existing deductible temporary difference or tax attribute carryforward depends on the existence of sufficient taxable income of the appropriate type within the appropriate periods. Under Statement no. 109, taxable income ...

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Discuss some of the positive and negative evidence used to establish the need for a valuation allowance for a tax loss carryforward. Also, indicate the effect of the valuation allowance on the free cash flow forecast.

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