Answer: understates tax expenses and overstates the value of the deferred tax assets.

## Explanation A valuation allowance is established when it's more likely than not that some portion of deferred tax assets will not be realized. - **Understating the valuation allowance** means the company is not setting aside enough reserve for potential non-realization of deferred tax assets. - This action **understates tax expenses** because the valuation allowance reduces net deferred tax assets and increases tax expense. - It also **overstates the value of deferred tax assets** on the balance sheet because insufficient allowance is being taken. Therefore, understating the valuation allowance leads to understated tax expenses and overstated deferred tax assets, making the company appear more profitable and having more valuable assets than reality.

Author: LeetQuiz Editorial Team