Question

Fore Farms reported a pretax operating loss of $137 million for financial reporting purposes in 2021. Contributing to the loss were (a) a penalty of $5 million assessed by the Environmental Protection Agency for violation of a federal law and paid in 2021 and (b) an estimated loss of $12 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. Required: 1. Prepare the journal entry to recognize the income tax benefit of the net operating loss in 2021. 2. What is the net operating loss reported in 2021 income statement

Answer 1

To recognize the 2021 income tax benefit from the net operating loss, multiply the $137 million loss by the 25% tax rate to determine the tax benefit, which is $34.25 million, reflected as a Deferred Tax Asset. The net operating loss on the income statement remains $137 million.

Step-by-step explanation:

To recognize the income tax benefit of the net operating loss in 2021, we first need to determine the tax benefits of the $137 million operating loss, the $5 million EPA penalty, and the $12 million estimated loss contingency.

In this case, the entire $137 million loss is tax-deductible. However, the $12 million estimated loss contingency will be tax deductible when actually paid in 2022, not in 2021. Yet, for financial accounting purposes, we recognize the benefit in the year that the loss is reported. Therefore, the income tax benefit will be based on the full $137 million loss.

The journal entry to recognize the income tax benefit is:

• Debit: Income Tax Benefit $34.25 million
• Credit: Deferred Tax Asset $34.25 million

To calculate the benefit, multiply the $137 million by the tax rate of 25% (137 million * 0.25 = $34.25 million).

The net operating loss reported in the 2021 income statement is $137 million since that is the pretax operating loss before considering the tax benefit.

Answer 2

The situation under which the operational expense of the company exceeds the sales over a specified amount of time, typically a quarter or year, is defined as the operating loss.

Accounting profits relates to the interest that a corporation holds from paying for the related operating tax expenditures.

Computation of Taxable Operating Loss (2021)

Account Title Amount (In million)

Pre-tax operating Income (Loss) ($137.00)

Add: Non-deductible penalty $5.00

Add: Estimated loss contingency deductible in 2022 $12.00

Taxable operating income (Loss) ($120.00)