Deferred Tax Assets
Deferred tax assets (or liabilities) show investors the value of steps a company has taken which strengthen or weaken its future tax position. A deferred tax asset represents some tax advantage the company will benefit from in the future, while a deferred tax liability represents some additional tax penalty the company believes it is exposed to down the line.
Deferred tax assets can arise for a number of reasons:
Sometimes, a company expects it will not be able to realize the the benefits of its deferred tax assets. For example, If a company loses $10 million, it would record a deferred tax asset representing the decrease in taxes on its next $10 million in earnings. However, if the company doesn't expect profits for the next several years, and doesn't expect to earn $10 million in the seven-year time horizon before these deferred tax assets expire, it can't record them at full value - because the company won't be able to take advantage of this tax benefit.
If a company expects there is more than 50% chance it will not be able to realize some of its deferred tax assets (because it future income won't be large enough to take full advantage of these tax breaks), it must report a valuation allowance to account for this.
A valuation allowance depends a great deal on management assumptions - who's to say how high a company's future profits will be, and therefore whether the company will be able to take advantage of its deferred tax assets? If management changes its assumptions about future earnings, the valuation allowance changes, and the difference is reported as earnings, today. So, management at companies with valuation allowances can directly change reported earnings today by changing assumptions about earnings tomorrow. Changing a valuation allowance is one way that management can manage or manipulate its earnings.