10.6 Accounting Considerations for Valuation Allowances Related to Share-Based Payment DTAs

ASC 718-740

30-2 Subtopic 740-10 requires a deferred tax asset to be evaluated for future realization and to be reduced by a valuation allowance if, based on the weight of the available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. Differences between the deductible temporary difference computed pursuant to paragraphs 718-740-25-2 through 25-3 and the tax deduction that would result based on the current fair value of the entity’s shares shall not be considered in measuring the gross deferred tax asset or determining the need for a valuation allowance for a deferred tax asset recognized under these requirements.

ASC 718-740-30-2 prohibits an entity from considering the current price of the grantor’s stock in the measurement of the DTA and adjusting the gross amount of the DTA to reflect the current price.

When an entity is evaluating the need for a valuation allowance, it should apply the guidance in ASC 740-10-30-17 through 30-23. That is, whether the entity needs to record a valuation allowance depends on whether it is more likely than not that there will be sufficient taxable income to realize the DTA. See Chapter 5 for a broader discussion of valuation allowance considerations.

Therefore, even if the award is deep out-of-the-money to a degree that its exercise is unlikely or the award’s intrinsic value on the exercise date is most likely to be less than its grant-date fair value, the entity should not record a valuation allowance unless and until it is more likely than not that future taxable income will not be sufficient to realize the related DTAs.

See Section 5.3.2.2.2 for a discussion of the effects of excess tax deductions for equity-classified share-based payment awards on the assessment of future taxable income.

Example 10-9

On January 1, 20X6, an entity grants 1,000 “at-the-money” employee share options, each with a grant-date fair-value-based measure of $7. The awards vest at the end of the third year of service (cliff vesting), have an exercise price of $23, and expire after the fifth year from the grant date. The entity’s applicable tax rate is 25 percent. On December 31, 20Y0, the entity’s share price is $5. The entity has generated taxable income in the past and expects to continue to do so in the future.

In each reporting period, the entity would record compensation cost on the basis of the number of awards expected to vest, the grant-date fair-value-based measure of the award, and the amount of services rendered. Contemporaneously, a DTA would be recorded on the basis of the amount of compensation cost recorded at the entity’s applicable tax rate. On December 31, 20Y0, even though the likelihood that the employee will exercise the award is remote (i.e., the award is “deep out-of-the-money”) and the DTA therefore will not be realized, the entity would not be allowed to write off any part of the gross DTA or to provide a valuation allowance against the DTA until the award expires unexercised (January 1, 20Y1) assuming there is sufficient future taxable income to realize that DTA on December 31, 20Y0. The entity would be able to record a valuation allowance against the DTA only when it is more likely than not that the entity will not generate sufficient taxable income to realize the DTA.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.