Chapter 16, Problem 16.10P

1.

To determine

Net Operating Loss Carryforward

The net operating loss is considered as negative taxable income. When the tax-deductible expenses exceed the taxable revenues, the net operating loss is carry forwarded as it helps in getting deductions in future taxable amount.

Net Operating Loss Carryback

The net operating loss is considered as negative taxable income. It can be used in other fiscal year to offset the taxable income. The net operating loss carry back helps the companies to get reduction in the taxes from the past profitable years, in the form of tax refund, for the tax paid on the profit earned on those years.

Temporary Difference

Temporary difference refers to the difference of one income recognized by the tax rules and accounting rules of a company in different periods. Consequently, the difference between the amount of assets and liabilities reported in the financial reports and the amount of assets and liabilities as per the company’s tax records, is known as temporary difference.

Multiple Temporary Difference

It is very unlikely to have a single temporary difference in any company. In that case, the same concept of temporary difference will be applicable for multiple temporary difference. In case of multiple temporary difference, we have to categorize all temporary difference into future taxable amount and future deductible amounts. The total amount of future taxable amounts multiplied by future tax rate will generate deferred tax liability and total amount of future deductible amount multiplied by future tax rate will generate deferred tax asset.

To prepare: The journal entry to recognize the income tax benefit of the net operating loss in 2016 through carryback option.

Explanation of Solution

Determine the amount of income tax payable and deferred tax liability:

Particulars	Prior years		Current Year 2016 (in millions)	Future Deductible Amounts (Total) (in millions)
	2014	2015	2016
Accounting loss			(135)
Permanent differences:
Fines paid			5
Temporary differences:
Loss contingency			10	(10)
Taxable loss			(120)
Loss carryback	(75)	(30)	105
Loss carryforward			15	(15)
			0	(25)
Enacted tax rate	40%	40%	40%	40%
Tax payable (refundable)	(30)	(12)	0
Deferred tax asset				(10)

Table (1)

Determine desired balance of deferred tax asset:

Particulars	Amount ($)
Ending balance	$10
Less: Beginning balance	0
Change in balance	$(10) (1)

Table (2)

The journal entry at the end of 2016 to record the income taxes in the books is as follows:

Date		Account Titles and Explanation	Post Ref.	Debit ($) (in millions)	Credit ($) (in millions)
2016
		Receivables- income tax refund (2)		42
		Deferred Tax Asset (1)		10
		Income tax benefit – operating loss (3)			52
		(To record income taxes)

Table (3)

Working notes:

Determine the total receivables- income tax refund.

$\begin{array}{c}\text{Receivable - Income tax refund}=\text{Tax}\text{payable}\left(2016\right)+\text{Tax}\text{payable}\left(2017\right)\\ =\$30+\$12\\ =\$42\end{array}$ (2)

Determine the total income tax benefit.

$\begin{array}{c}\text{Income tax benefit}=\text{Receivables - Income tax refund}+\text{Deferred tax asset }\\ =\$42+\$10\\ =\$52\end{array}$ (3)

• Income Tax Refund (receivable) is an asset account and it increased by $42 million. So debit it.
• Deferred tax asset is an asset and is increased by 10 million. Therefore, debit deferred tax asset account with $10 million.
• Income tax benefit – operating loss (to balance) is equity and increased by $52 million. Therefore, credit stockholders’ equity with $52 million

2.

To determine

To show: The lower portion of the 2016 income statement that reports the income tax benefit of the net operating loss.

Explanation of Solution

The lower portion of the 2016 income statement that reports the income tax benefit of the net operating loss is as follows:

Particulars	Amount ($)	Amount ($)
Operating loss before income taxes		(135)
Less: Income tax benefit
Tax refund from loss carryback	42
Future tax benefits	10	52
Net loss		(83)

Table (4)

3.

To determine

To prepare: The journal entry to record the income taxes in 2017 assuming pre-tax accounting income is $60 million.

Explanation of Solution

Determine the amount of income tax payable and deferred tax liability:

Particulars	Current Year 2017 (in millions)	Future Deductible Amounts (Total) (in millions)
Pretax accounting income	60
Temporary differences:
Loss contingency	(10)
Operating loss carry forward	(15)
Taxable income	35
Enacted tax rate	40%	40%
Tax payable (refundable)	14 (5)
Deferred tax asset		0

Table (5)

Determine desired balance of deferred tax asset:

Particulars	Amount ($)
Ending balance	$0
Less: Beginning balance	(10)
Change in balance	$(10) (4)

Table (6)

The journal entry at the end of 2017 to record the income taxes in the books is as follows:

Date		Account Titles and Explanation	Post Ref.	Debit ($) (in millions)	Credit ($) (in millions)
2017
		Income Tax Expense (6)		24
		Deferred Tax Asset (4)			10
		Income Tax Payable (5)			14
		(To record income taxes)

Table (7)

Working Notes:

Calculate the value of income tax expenses

$\begin{array}{c}\text{Income tax expense=}\left(\text{Income tax payable +Deferred tax asset}\right)\\ \text{= }\left(\text{\$14 million + 10 million}\right)\\ \text{=\$24}\text{million}\end{array}$ (6)

• Income Tax Expense is an expense account and it decreases the value of shareholders’ equity account. So, debit Income Tax Expense account with $24 million.
• Deferred tax asset is an asset and decreased by $10 million. Therefore, credit deferred tax asset account with $10 million.
• Income Tax Payable is a liability account has increased because the taxable income has increased. So, credit Income Tax Payable account with $14 million.