Question

Fores Construction Company reported a pretax operating loss of $260 million for financial reporting purposes in 2018. Contributing to the loss were (a) a penalty of $15 million assessed by the Environmental Protection Agency for violation of a federal law and paid in 2018 and (b) an estimated loss of $20 million from accruing a loss contingency. The loss will be tax deductible when paid in 2019.

The enacted tax rate is 40%. There were no temporary differences at the beginning of the year and none originating in 2018 other than those described above. Taxable income in Fores’s two previous years of operation was as follows:

2016	$	135	million
2017		80	million

Required:
1. Prepare the journal entry to recognize the income tax benefit of the net operating loss in 2018. Fores elects the carryback option.
2. What is the net operating loss reported in 2018 income statement?
3. Prepare the journal entry to record income taxes in 2019 assuming pretax accounting income is $120 million. No additional temporary differences originate in 2019.

Answer 1

Requirement 1

($ in millions)                   
                                                                                                           Current              Future
                                                                             Prior Years             Year              Deductible
                                                                             2016     2017             2018               Amounts
                                                                                                                                        [total]

Accounting loss                                                                            (260)
Permanent difference:
   Fine paid                                                                        15
Temporary differences:
   Loss contingency                                                            20                (20)
Taxable loss                                                                  (225)                   
   Loss carryback                                  (135)    (80)         215                     
   Loss carryforward                                                            10                (10)     
                                                                                            0                (30)     
Enacted tax rate                                     40% 40%       40%              40%
   Tax payable (refundable)                    (54)    (32)             0
   Deferred tax asset                                                                                (12)

                                                                                                                                            ¯

                             Deferred tax asset:

Ending balance (balance currently needed)                                                         $ 12
Less: beginning balance                                                              (0)
   Change needed to achieve desired balance                                         $12

                                                                                                                                                                                                           

       Journal entry at the end of 2018

       Receivable – income tax refund ($54 + 32)                                     86
       Deferred tax asset (determined above)                                       12
            Income tax benefit (to balance)                                                    98

Requirement 2

         ($ in millions)
       Operating loss before income taxes                                   $260         
          Less: Income tax benefit:
            Tax refund from loss carryback                       $86
            Future tax benefits                                            12          98
       Net operating loss                                                            $ 162

Requirement 3

($ in millions)                  
                                                                                      Current                                   Future
                                                                                         Year                                   Deductible
                                                                                         2019                                    Amounts
                                                                                                                                            

Pretax accounting income                                                                                    120
Temporary differences:
   Loss contingency                                          (20)                                    
   Operating loss carryforward                          (10)                                    
Taxable income (income tax return)                     90                                    0
Enacted tax rate                                               40%                             40%
   Tax payable                                                  36
   Deferred tax asset                                                                                   0

                                                                                                                                              ¯

                             Deferred tax asset:

Ending balance (balance currently needed)                                                         $   0
Less: beginning balance                                                            (12)
   Change needed to achieve desired balance                                      $(12)

                                                                                                                         

       Journal entry at the end of 2019

       Income tax expense (to balance)                                                         48                   
            Deferred tax asset (determined above)                                            12
            Income tax payable (determined above)                                         36