Net Operating Loss
Lesson:
A net operating loss (NOL) occurs when a business’s allowable tax deductions for the year exceed its gross income. In other words, the business has a tax loss rather than taxable income. The tax rules let you use that loss to offset taxable income in other years, subject to limits.
As of 2020, carrybacks (applying losses against previous years' profits) are generally not permitted.
Carryforwards (applying losses against future years' profits) are allowed with no time limit. We refer to the future tax benefits as deferred tax assets, and they are kept on the balance sheet as an asset.
As an auditor, you're trying to make sense of a firm's finances, but you're having trouble figuring something out.
Here's what you know:
- The firm that is not involved in farming or insurance experienced a net operating loss (NOL) of $281.
- It is more likely than not that the firm will have sufficient future income to fully utilise the resulting tax benefits.
- The firm's tax rate is 11%.
What journal entries should be made, and how far backward can the NOL be applied?
Answer:
- Carrybacks are no longer allowed, except in highly niche cases.
Net Operating Loss - Carryforward Deferred tax asset $30.91 Income tax benefit $30.91
Explanation:
- The only formula we need is for calculating the deferred tax asset.
NET OPERATING LOSS * TAX RATE = DEFERRED TAX ASSET - Plugging in the numbers we see:
$281 * 11% = DEFERRED TAX ASSET - And finally, if we perform the calculation, we know that:
$30.91 = DEFERRED TAX ASSET