Question

Fore Farms reported a pretax operating loss of $268 million for financial reporting purposes in 2021. Contributing to the loss were (a) a penalty of $4 million assessed by the Environmental Protection Agency for violation of a federal law and paid in 2021 and (b) an estimated loss of $20 million from accruing a loss contingency. The loss will be tax deductible when paid in 2022.

The enacted tax rate is 25%. There were no temporary differences at the beginning of the year and none originating in 2021 other than those described above. Taxable income in Fores’s two previous years of operation was as follows:
2019$120million2020$96million
Required:
1. Prepare the journal entry to recognize the income tax benefit of the net operating loss in 2021. Assume Fore will carry back its NOL to prior years.
2. What is the net operating loss reported in 2021 income statement?
3. Prepare the journal entry to record income taxes in 2022 assuming pretax accounting income is $288 million. No additional temporary differences originate in 2022.

Answer 1

The journal entry to recognize the income tax benefit of Fore Farms' net operating loss in 2021 would debit Income Tax Benefit and credit Deferred Tax Asset for $67 million. The net operating loss in the 2021 income statement is $268 million. For 2022, the journal entry to record income taxes assuming a pretax income of $288 million is a debit to Income Tax Expense and a credit to Income Tax Payable for $72 million.

Step-by-step explanation:

Income Tax Benefit and Net Operating Loss

The question pertains to determining the income tax benefit from a net operating loss (NOL) that Fore Farms reported for financial reporting purposes and creating the journal entries accordingly. To address the student's requirements:

1. The journal entry in 2021 to recognize the income tax benefit due to the NOL, assuming a tax rate of 25% and carrying back the NOL to previous profitable years, would be:

Credit: Deferred Tax Asset $67 million

2. The net operating loss reported in the 2021 income statement would be $268 million, as it reflects the full amount of loss before any tax effects.

Debit: Income Tax Expense $72 million (25% of $288 million)

Credit: Income Tax Payable $72 million

Note: As no additional temporary differences are stated for 2022, and the previous year's NOL has already been accounted for, no additional entries relating to NOL are required for 2022.