Question

Below are the reported profits and losses of Amherst Company for the past several years along with their tax rates on income reported.

                                Income                                                 Tax rate
2012                       $100,000                                              30%
2013                       $ 20,000                                               30%
2014                       $100,000                                              40%
2015                       $(350,000)                                           40%
2016                       $75,000 30%
2017                       unknown 30%

Amherst elects to use both carry back and carry forward procedures with no valuation allowance and strongly anticipates future profits to recover losses.

Record the tax effect of the above in 2015.

                                                                                                                                                Dr.                          Cr.

Show the income tax section and loss section of the income statement for 2015.

Record the tax effect of the above in 2016.
                                                                                                                                                Dr.                          Cr.

Answer 1

The tax refund generated by the carryback would be calculated as:

	2012	2013	2014
Taxable Income	$100,000	$20,000	$100,000
Less: Carryback	$100,000	$20,000	$100,000
Taxable Income After Carryback	$0	$0	$0
Tax Rate	30%	30%	40%
Income Taxes Payable	$0	$0	$0
Taxes Paid	$30,000	$6,000	$40,000
Rebate	$30,000	$6,000	$40,000

The total tax benefit derived from the Net operating loss for the year 2015 is $350,000 x 40%, or $140,000. However, the carryback is only able to provide $30,000 + $6,000+$40,000 i.e. $76,000 of the benefit; so a carryforward is needed to capture the remaining benefit. The journal entry to record carryback transaction in 2015 would be

	Debit	Credit
Income Tax Refund Receivable	$76,000
Deferred Income Tax Asset	$64,000
Refund of Income Taxes From Loss Carryback		$76,000
Refund of Income Taxes From Loss Carryforward		$64,000

Amherst Company is having the taxable income in the year 2016 amounting to $ 75,000 with a tax rate of 30%. For this reason, the accounting department created a valuation account for the carryforward:

	Debit	Credit
Benefit Due to Loss Carryforward	$64,000
Allowance to Reduce Deferred Tax Asset to Expected Value		$64,000

Amherst Company is having the taxable income in the year 2016 amounting to $ 75,000 with a tax rate of 30% thereby absorbing the remaining tax benefit derived from the net operating loss.

Taxable Income	$75,000
Tax Rate	30%
Income Taxes Payable	$22,500
Less: Benefit from Carryforward	$22,500
Income Taxes Payable	$0

The journal entries to account for this transaction include:

	Debit	Credit
Income Tax Expense	$22,500
Deferred Tax Asset		$22,500

To the some extend, the valuation account needs to be eliminated from the company's books:

	Debit	Credit
Allowance to Reduce Deferred Tax Asset to Expected Value	$22,500
Benefit Due to Loss Carryforward		$22,500