Question - Herda Company started operations in 2012. Although it has grown steadily, the company reported accumulated operating losses of $425,000 in its first four years in business.
In the most recent year (2016), Herda appears to have turned the corner and reported modest taxable income of $35,000. In addition to a deferred tax asset related to its net operating loss, Herda has recorded a deferred tax asset related to product warranties and a deferred tax liability related to accelerated depreciation.
Given its past operating results, Herda has established a full valuation allowance for its deferred tax assets. However, given its improved performance, Herda management wonders whether the company can now reduce or eliminate the valuation allowance. They would like you to conduct some research on the accounting for its valuation allowance.
Required: Write two memos addressing the following three questions. One memo should answer the questions using IFRS.
Briefly explain to Herda the importance of future taxable income as it relates to the valuation allowance for deferred tax assets.
What are the sources of income that may be relied upon to remove the need for a valuation allowance?
What are tax-planning strategies? From the information provided, does it appear that Herda could employ a tax-planning strategy to support reducing its valuation allowance?