Allowance Valuation for Asbat Pharmaceuticals

Posted: August 26th, 2021

Student’s Name

Instructor’s Name

Course

Date

ACCT352 Research Case

To:CFO

From:Junior Accountant

Date: 31^st December 2020

Subject: Allowance Valuation for Asbat Pharmaceuticals

Purpose

The main objective of this memo is to establish whether there is a need for Asbat Pharmaceuticals to record valuation allowance for deferred tax asset account.

Analysis

To determine whether the valuation report is required, ASC 740 indicates that all evidence, both positive and negative, should be considered (Miller et al., 2016). SFAS 109 paragraph 99-103 on the basis for conclusion emphasizes that realized deferred tax asset is required, and unrealized deferred tax asset is prohibited (No, 2018). The following is the positive and negative evidence for the valuation allowance.

Positive Evidence

Asbat is experiencing losses due to research and development of a new drug that will be in the market in the next three years. They expect to make profits after the rollout of the drug. The pharmaceutical industry has many uncertainties concerning newly developed drugs, as clinical trials for the pre-market phase are stage III (Bobo et al., 2016). Only 25%-30% of drugs that reach stage III move to the next level, thus there is a high possibility that this drug will not be profitable. Therefore, the company may further suffer financially. Asbat has been successful in the past, both in developing narcotics and effectively running the business operations, but historical information may be irrelevant in the future (Miller et al., 2016). There is no reasonable ground to assume the drug will undergo all the four phases and be successful.

Subsequently, for a source of income to realize tax benefits, including future reversals, the temporary difference should relate to the source of the tax (Miller et al., 2016). The CEO illustrated the projections, and the company does not have any other source of taxable income to realize tax benefits. The company has no reversals of taxable income or temporary taxable differences in the prior financial period to realize tax benefits. Hence, Asbat’s tax benefit relies on the new drug success as the tax director stated that there would not be a tax-planning policy for this financial year.

From Figure 1, the most substantial proportion of the asset is deferred tax assets. Asbat’s total assets are $3,500,000, and the amount of the deferred tax asset in the year 2020 is $828,450. However, companies in the pharmaceutical industry have less than 10% as deferred tax to the total assets. It implies that the negative in the Asbat’s operations are not purely generated from the business operations. Therefore, the company does not expect tax refunds.

Figure 1: Percentage of Asbat’s deferred tax assets

Negative Evidence

According to No (2020), Asbat can realize tax benefits as it will generate sufficient taxable income in the future based on the CEO’s projections. Miller (2016) states that when a company has enough evidence to create taxable income, it can realize a tax benefit. However, Asbat Pharmaceuticals has no concrete proof of sufficient taxable income. So, the company cannot depend on the source of future taxable proceeds to determine if there is a need for the valuation allowance. Miller (2016) also identifies instances when negative evidence can be used in tax refunds, such as cumulative losses in the past years and unsettled circumstances that could affect future operations negatively. Asbat has no existing contracts to transform the business operations in the future adversely, and its historical earnings were healthy, so it has no sufficient evidence to record valuation allowance.

Conclusion

Asbat Pharmaceuticals should record a valuation allowance as it has strong negative evidence. I have based my argument on these two reasons. Initially, Asbat Pharmaceuticals has realized losses in the last consecutive years. Secondly, the deferred tax will be recognized in the foreseeable future when the new drug is released in the market.

Works Cited

Bobo, D., Robinson, K. J., Islam, J., Thurecht, K. J., & Corrie, S. R. Nanoparticle-based medicines: a review of FDA-approved materials and clinical trials to date. Pharmaceutical Research, 33(10), 2373-2387, 2016.

Miller, T., Miller, L., & Tolin, J. Provision for income tax expense ASC 740: A teaching note. Journal of Accounting Education, 35, 102-126, 2016.

No, A. S. A conceptual framework for financial reporting. Norwalk, CT: FASB, 2018. Print.