Question

Scenarios The date is January 10, 2023, and Martton Hotels' CFO George Smith is looking with dismay at his company's financial performance during 2022. Already facing stiff competition from other hotel chains as well as Airbnb, Maryton had run an operating loss in 2020 and 2021 and had responded by engaging in a broad effort to refresh hotel décor and update wi-fi and other infrastructure. That effort concluded in late 2021 and seemed to be showing success in early 2022. However, a variant of the COVID-19 virus reached pandemic status in mid-2022, and business and leisure travel fell off considerably. Occupancy rates at Maryton properties plunged, producing a $10 million pre-tax net operating loss for 2022. Maryton's CEO has asked that George "work some of his accounting magic" to "put a positive spin on things" and minimize Maryton's net loss, hoping to calm concerns being voiced by investors and lenders. Based on the above information, please answer the following: 1. Assume Maryton has a 25% tax rate. Prepare a joumal entry that records the tax effects of its NOL, assuming that no valuation allowance is necessary and that the CARES Act does not apply. Calculate Maryton's net income or net loss under that scenario. Joumal entry to record the tax effects of NOL: Maryton's net income (or loss). Please show calculations: 2. Repent requirement 1, but now assume that a valuation allowance is necessary that completely offsets any new deferred tax asset that Maryton is adding as a result of its NOL canyforward. Joumal entry to record the tax effects of NOL: Maryton's net income (or loss). Please show calculaisions: 3. Consider your answers to requirements 1 and 2. What "accounting magic" might Smith work to minimize Maryton's net loss? Does Smith face an ethical dilemma? If Smith chooses to "put a positive spin on things" and minimize Maryton's net loss, who could benefit, and who could be injured? Identify at least three parties that could benefit and lose from Smith's action to "put a positive spin on things".

Answer 1

To address the tax effects of Martton Hotels' $10 million NOL, an entry debiting Income Tax Benefit and crediting Deferred Tax Asset would be made, reducing the net loss to $7.5 million. If a valuation allowance is justified, it would offset the deferred tax asset, keeping the net loss at $10 million. CFO George Smith faces an ethical dilemma if he uses accounting strategies to overly minimize the net loss, potentially misleading investors and creditors.

Step-by-step explanation:

Accounting for Net Operating Loss

When calculating the tax effects of Martton Hotels' Net Operating Loss (NOL) without a valuation allowance and with a 25% tax rate, the journal entry to record the tax benefit would be:

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• Debit: Income Tax Benefit $2.5 million (25% of $10 million)
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• Credit: Deferred Tax Asset $2.5 million

After this entry, Maryton's net loss would be reduced from $10 million to $7.5 million due to the recognition of the deferred tax asset.

However, with a valuation allowance that offsets the deferred tax asset:

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• Debit: Income Tax Benefit $2.5 million
• 
  
• Credit: Deferred Tax Asset $2.5 million
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• Debit: Valuation Allowance $2.5 million
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• Credit: Income Tax Benefit $2.5 million

This would leave Maryton's net loss at $10 million since the valuation allowance neutralizes the deferred tax asset.

Ethical Dilemma and Stakeholders Affected

CFO George Smith does indeed face an ethical dilemma if he chooses to engage in aggressive accounting methods to minimize net loss. In doing so, the immediate beneficiaries could be:

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• Investors seeking to maintain confidence in the company
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• Lenders who may be assured of the company's future profitability
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• Company executives whose performance metrics could be temporarily improved

However, potentially injured parties may include:

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• Investors who make decisions based on a potentially misleading financial situation
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• Creditors who may extend additional credit under false pretenses
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• The market as a whole, which relies on accurate disclosures for proper functioning

Answer 2

In scenario one without a valuation allowance, the journal entry results in a lower post-tax net loss for Martton Hotels. With a valuation allowance however, the net loss remains unchanged as the tax benefit is offset. George Smith faces ethical considerations if attempting 'accounting magic' to make the company's financial performance seem better than it is.

Step-by-step explanation:

Understanding the Accounting for Net Operating Loss (NOL)

When Martton Hotels experiences a pre-tax net operating loss (NOL) of $10 million and has a 25% tax rate, the journal entry to recognize the tax benefit would be:

Debit Income Tax Benefit $2.5 million (25% of $10 million)

Credit Deferred Tax Asset $2.5 million

This results in a reduction of the net loss to $7.5 million post-tax. However, if a valuation allowance is needed for the full amount of the deferred tax asset, it negates the tax benefit and the net loss remains at $10 million:

Debit Valuation Allowance $2.5 million

Credit Deferred Tax Asset $2.5 million

Consider the implications of George Smith using "accounting magic." It could benefit certain stakeholders in the short term but harm others, involving an ethical dilemma. Primarily:

Investors might be misled by an overly optimistic portrayal of the company's finances.

Lenders could alter financing conditions based on skewed information.

Employees may face uncertainty if the company's true financial health is obscured.

Maintaining transparency and accuracy in financial reporting is essential to uphold ethical standards in accounting.