Question

In RadioShack’s 2013 annual report, the company reported deferred tax assets of $259.3 million, offset by a valuation allowance of $228.8 million. Disclosure note 10 reported, in part:

“We had deferred tax assets associated with our federal net operating losses, which will expire in 2033, of $132 million as of December 31, 2013. … We continue to provide a valuation allowance against all of our U.S. federal and state deferred tax assets in 2013. … We considered all available positive and negative evidence in evaluating whether these deferred tax assets were more likely than not to be realized. The significant negative evidence of our losses generated before income taxes in 2012 and the unfavorable shift in our business could not be overcome by considering other sources of taxable income, which included the reversal of taxable temporary differences and tax-planning strategies.”

Required:

1. As a potential investor, what significance would you place on the existence of operating loss carryforwards?
2. What might contribute to RadioShack’s need to record a valuation allowance?

Answer 1

Question 1

A potential investor will generally does like operating losses for the fact that the losses will further increase post considering non-operating costs. A company which is incurring losses at operating level means that it's business model has failed and needs to be fixed on priority basis. Non-operating costs which include costs like interest, G&A expenses can in general be controlled by measures like debt restructuring, cutting of unnecessary G&A spends like indirect staff etc. However, if the company is incurring losses at operating level, it is very critical and in most cases they are due to mis-management, poor customer focus, not using latest technologies in production/sales etc.

Hence, a potential investor should perform a detailed due diligence before investing in the company. Till the issues resulting in operating losses are fixed or a long term plan is prepared, it is advised not to invest.

Question 2

Radioshack has been recording valuation allowance on its deferred tax assets based on the analysis that it will not be able to convert the benefit of deferred tax assets currently available due to operating losses. Though in the given case, they are available for relatively longer tenure till 2033, it's very unfortunate that the company does not expect the operating loss streak to be reversed in short time and due to that, the company has truly provided an allowance for the same. Though it can be construed as a conservative approach, it can be construed as a good decision. The company,however can reverse the allowance at a future date when it's operating parameters have improved. But, till then it can continue to provide allowance in its books of accounts.