Question

LossCo reported a net operating loss of $21 million for financial reporting and tax purposes. Taxable income last year and the previous year, respectively, was $22 million and $17 million. The enacted tax rate each year is 25%. Assume that LossCo qualifies as a type of company that is allowed to carry back an NOL to two prior taxable years, using the earliest year first. Prepare the journal entry to recognize the income tax benefit of the net operating loss.

Answer 1

To recognize the income tax benefit from LossCo's $21 million NOL, a journal entry is made debiting Income Tax Benefit and crediting Deferred Tax Asset for the same amount. The tax benefit is realized through a carryback, which offsets taxable income from prior years and results in an income tax refund.

Step-by-step explanation:

Journal Entry for Income Tax Benefit of Net Operating Loss (NOL)

To recognize the income tax benefit from a net operating loss (NOL), LossCo can carry back the $21 million NOL to offset taxable income from the previous two years, provided that the tax laws allow such a carryback. Since the taxable income was $22 million for last year and $17 million for the previous year, and the tax rate for both years is 25%, LossCo can fully offset the income of the previous two years. The journal entry to record the tax benefit would be:

• Debit: Income Tax Benefit $21 million (to record the benefit from NOL)
• Credit: Deferred Tax Asset $21 million (to recognize the future economic benefit from the NOL carryback)

It's important to note that the carryback effect would be first applied to the earlier year ($17 million at 25%), then any remaining NOL would be applied to the next year ($4 million at 25%). This results in an income tax refund of $5.25 million (25% of $21 million) for LossCo due to the NOL carryback.