Net Operating Losses

Question 1

When do you have a net operating loss?

Answer 1

Deductions exceed taxable income

Negative taxable income

Question 2

How do you record a net operating loss carry forward?

Answer 2

DB: Deferred Tax Asset
CR: Income tax benefit (contra-income tax expense account, so it has a credit balance)

Question 3

How long can an NOL be carried forward? How much can you deduct in a given year?

Answer 3

Indefinitely to absorb taxable income

NOL carry forward may offset UP TO 80% of taxable income in a given year (80% limitation)

Question 4

Word of Caution: If they exam asks you how much tax was saved, how would you calculate?

Answer 4

The value of a 5,000 NOL at a tax rate of 30%- $1,500 dollars saved.

Question 5

EXAMPLE QUESTION: A company experiences a net operating loss of $11,000 of year 5 and has an enacted tax rate of 40%.

What is the DTA?

In year 6, the company has taxable income of $1,500, how much of the DTA can be used?

Answer 5

$11,000 X .40 = 4,400

Year 6: (1,500 X .8) = $1,200
1,200 X .40 = $480 can be used of the DTA

Journal Entry:
Income Tax Expense. $480
Deferred Tax Asset. (480)

Journal Entry:
Income Tax Expense. $120
Income Tax Payable or Cash (120)