Question

Problem 16-14 (Static) COVID-19; Net operating loss; financial statement effects [LO16-7] Syer Company reports net operating income (loss) for financial reporting and tax purposes in each year as follows: 2016 2017 2018 2019 2020 $ 300 $ 100 $ 0 $0 $ (600) Syer’s 2020 NOL is driven by an unfortunate obsolescence of its primary product. Given great uncertainty in Syer’s future profitability, Syer’s management does not believe it is more likely than not that it will be able to realize deferred tax assets in future years. Syer’s federal tax rate decreased from 35% to 21% starting in 2018.

Required:
Assume that Syer does not account for its NOL under the CARES Act. Instead, Syer accounts for its NOL using the general requirement that NOLs be carried forward. Prepare the appropriate journal entry to record Syer’s 2020 income taxes, and indicate Syer’s 2020 net income(loss).
Now assume that Syer does account for its NOL under the CARES Act. Prepare the appropriate journal entry to record Syer’s 2020 income taxes, and indicate Syer’s 2020 net income(loss).

Answer 1

Syer Company is facing a net operating loss in 2020 and needs to record this for tax purposes. Without the CARES Act, they would record a valuation allowance against a Deferred Tax Asset with no immediate tax benefit. Under the CARES Act, they record an Income Tax Receivable benefiting from NOL carryback, reducing the net loss for the year.

Step-by-step explanation:

The student has provided financial data for Syer Company and wants to know how to account for net operating losses (NOLs) for tax purposes, both generally and under the CARES Act. The task is to prepare journal entries for Syer's 2020 income taxes and calculate the net income (loss) for that year. Since management doesn't expect future profits to be sufficient to realize deferred tax assets, normally no deferred tax asset would be recorded. However, the CARES Act allows businesses to carry back NOLs to previous tax years when they had taxable income, which can lead to a refund of taxes paid in those years.

Without accounting for the CARES Act:

• Debit Income Tax Expense for the amount of benefits that would be received if the NOLs were realized in future periods.
• Credit Deferred Tax Asset for the same amount.
• Record a full valuation allowance against the Deferred Tax Asset, meaning a Debit to Valuation Allowance and a Credit to Income Tax Benefit.

With the CARES Act, Syer would be able to realize immediate tax benefits:

• Debit Income Tax Receivable for the tax benefit due to NOL carryback allowed by the CARES Act.
• Credit Income Tax Benefit for the same amount, reflecting the reduction in taxes stemming from applying the NOL to past profits.

The net income(loss) for 2020 would be different in each scenario because in the first, there would be no immediate tax benefit recognized, while in the second scenario, the CARES Act would allow for an income tax benefit that would reduce the net loss for the year.