deferred tax assets and liabilities are recognized based on the future tax consequen 600816

Ford Motor Company and Subsidiaries Excerpts from Note 22 2011 Annual Report

Valuation of deferred tax assets and liabilities

Deferred tax assets and liabilities are recognized based on the future tax consequences attributable to temporary differences that exist between the financial statement carrying value of assets and liabilities and their respective tax bases, and operating loss and tax credit carryforwards on a taxing jurisdiction basis. We measure deferred tax assets and liabilities using enacted tax rates that will apply in the years in which we expect the temporary differences to be recovered or paid.

Our accounting for deferred tax consequences represents our best estimate of the likely future tax consequences of events that have been recognized in our financial statements or tax returns and their future probability. In assessing the need for a valuation allowance, we consider both positive and negative evidence related to the likelihood of realization of the deferred tax assets. If, based on the weight of available evidence, it is more likely than not that the deferred tax assets will not be realized, we record a valuation allowance.

At the end of 2011, our US operations had returned to a position of cumulative profits for the most recent three-year period. We concluded that this record of cumulative profitability in recent years, our 10 consecutive quarters of pretax operating profits, our successful completion of labor negotiations with the UAW, and our business plan showing continued profitability, provide assurance that our future tax benefits more likely than not will be realized. Accordingly, at year-end 2011, we released almost all of our valuation allowance against net deferred tax assets for entities in the United States, Canada, and Spain.

At December 31, 2011, we have retained a valuation allowance against approximately $500 million in North America related to various state and local operating loss carryforwards that are subject to restrictive rules for future utilization, and a valuation allowance totaling $1 billion primarily against deferred tax assets for our South American operations.

Components of deferred tax assets and liabilities

The components of deferred tax assets and liabilities at 31 December were as follows (in millions):

Operating loss carryforwards for tax purposes were $8.5 billion at 31 December 2011, resulting in a deferred tax asset of $3.2 billion. A substantial portion of these losses begin to expire in 2029; the remaining losses will begin to expire in 2018. Tax credits available to offset future tax liabilities are $4.5 billion. A substantial portion of these credits have a remaining carryforward period of 10 years or more. Tax benefits of operating loss and tax credit carryforwards are evaluated on an ongoing basis, including a review of historical and projected future operating results, the eligible carryforward period, and other circumstances.

Required

(a) What are “net operating loss carry forwards,” and why did they give rise to deferred tax assets? Answer the same question for “tax credit carry forwards.”

(b) Why do depreciation and amortization give rise to deferred tax liabilities?

(c) What are the “valuation allowances” referred to in the financial statements and the notes?

(d) What happened to the valuation allowances in 2011? Give the appropriate summary journal entry. What was the effect on earnings for the year?

(e) What would Ford have reported as net income for 2011 if there had been no change in the valuation allowance?

(f) Describe, in detail, what happened in 2011 to allow Ford Motor Company to sharply reduce the allowance account.