Financial Accounting and Reporting-CPA Practice Exam

What threshold must be met for a deferred tax asset to be considered realizable?

1. Realization is likely less than 40%

2. Realization is likely as probable as not

3. Realization is likely greater than 50%

4. Realization is always guaranteed

The correct answer is: Realization is likely greater than 50%

For a deferred tax asset to be considered realizable, it must be more likely than not that it will be utilized in the future to offset taxable income. This is quantified as a threshold greater than 50%. This means there is a greater than 50% probability that the company will have sufficient taxable income to use the deferred tax asset, which can reduce future tax liabilities. When evaluating realizability, entities assess all available evidence, both positive and negative, including the company's past performance, current circumstances, and forecasts of future profitability. If it is determined that it is more likely than not (greater than 50% likelihood) that the deferred tax asset can be realized, it is deemed realizable, which means the company can recognize the asset on its balance sheet. In contrast, if the likelihood of realization falls below 50%, the company must establish a valuation allowance against the deferred tax asset, reflecting the uncertainty about its future realization. This treatment aligns with the accounting standards that emphasize reliable measurement and presentation of deferred tax assets.