Investors Punish GM Stock, in Part on Large Deferred Tax Adjustment.

Implications: Investors fled General Motors following the release of its Q3 results.  The reported loss for the quarter was $38.96 billion of which 99% of the loss ($38.6 billion) resulted from the write-down of deferred tax assets.  Have investors overreacted to the noncash charge or is the decline in market value justified?

Analysis: At the close of Q3, GM management determined that deferred tax assets (i.e., the after tax value of NOLs, tax credits, etc.) reflected on the Company's balance sheet were overstated based upon the accounting guidelines for deferred tax assets ("DTAs").  Apparently, management determined that it is no longer "more-likely-than-not" that the Company will realize the benefits of $38.6 billion in tax attributes (e.g., NOLs, tax credits) in the future.

The more-likely-than-not threshold under Financial Accounting Standard 109 is defined to be "more than 50%".  For example, management may have concluded, as of Q2, that there was a 55% probability of realizing these tax attributes in the future.  However, as of Q3, the probability may have slipped to 45% with respect to $38.6 billion of tax attributes.  The reduction in the probability of future realization likely resulted from the Company's consistent history of losses in recent periods.  In other words, NOL carryforwards and tax credits only have value to the extent that the Company becomes profitable in the tax jurisdictions in which those tax attributes reside.  If it is not more-likely-than-not that this will occur before those tax attributes expire, the assets must be taken off the balance sheet through the recording of a valuation allowance (and thus a corresponding charge to earnings).
 
Interested parties should realize that if circumstances change such that it once again becomes more-likely-than-not that the attributes will be realized in the future, some or all of the $38.6 billion will once again be reflected on the balance sheet with a corresponding tax benefit reflected on the income statement.  The bottom line is that the "more-likely-than-not" test is an all or nothing test in that no deferred tax asset can be recorded on the balance sheet if the probability of future realization is less-likely-than-not (e.g., 45%) while the entire asset can be recognized if the probability of future realization is more-likely-than-not (e.g., 55%).