Deferred Taxes & the Valuation Allowance at Lucent Technologies, Inc.

Deferred Taxes & the Valuation Allowance at Lucent Technologies, Inc.

Executive Summary

This memo presents the issue of deferred taxes and the valuation allowances with respect to the case of Lucent Technologies, Inc. The company had $7.6 billion in net deferred tax assets according to their book records at the end of fiscal year 2001. However, valuation allowance of the company was only $742 million. The issue under consideration is whether Lucent should increase its valuation allowance or not, and if yes, than by what amount.

FASB principle regarding accounting for income taxes clearly states that assessing the need of valuation allowance and its amount for deferred tax assets implies for judgment and extensive analysis of all the relevant positive and negative evidences presented for determining whether the company will be able to realize all or part of it deferred tax assets. In case when there are at least more than 50 percent chances presented that deferred tax assets will not be realized, then a valuation allowances should be established. Considering this principle, negative as well as positive evidences are analyzed in this report and the results represented that Lucent Technologies, Inc. will most probably not be able to realize its deferred tax assets. Hence, the company must increase its valuation allowance as it will not be able to generate enough income that can take full advantage of these tax breaks.

Analysis

Description of an Issue (facts)

At the end of fiscal year 2001, Lucent Technologies, Inc. had $7.6 billion in net deferred tax assets as per their book records. According to the guidance provided by FASB in Statement of Financial Accounting Standard on recording these items and required valuation allowance, it is used in order to lessen the carrying value of any deferred tax asset but only if it was more likely than not that the asset would not be realized.

Where, current valuation allowance of Lucent Technologies, Inc. was only $742 million, however the management believed that the company would realize the greater part of the $8.4 billion of gross deferred tax assets. This suggests that the company needed to generate positive taxable earnings in future time frame for offsetting their recognized tax assets and the increasing balances generated by their losses of that quarter. But the critical economic as well as market conditions indicate that the company will not be able to generate future earnings that are sufficient to realize the value. Thus, the issue involves decision regarding valuation allowance of the company.

Analysis of Facts

In order to decide whether Lucent Technologies should have increased their valuation allowance for deferred tax assets in the 3rd quarter ended on 30th June, 2002, and by how much amount must be based on the weight of all available evidences. According to FASB principles, evaluation of valuation allowance requirement and its amount for deferred tax assets significantly asks for finding and extensive study of all the related positive and negative evidences available to recognize whether the company will be ...