Catherine Duffy: Hi, I'm Catherine Duffy. Welcome to this video series to take you through the Accounting
for Loss Carrybacks and Loss Carryforwards. This accounting scenario that we're going
to go through is going to be a fairly straight forward one, so nothing too complicated. Just
to give you an idea of how you would handle it. Now the whole example here is based on
today's tax laws, so today's laws say that you can carryback a loss that you incur, a
taxable loss. If you're a corporation, you can carry a back for up to three years, and
ask for a refund of any taxes you paid in the last three years. That's different from
what it is for personal taxes. Unfortunately, if you incurred a loss for personal taxes
this year, you're not allowed to ask for money back from taxes you paid in the prior years.
Wish you could, but you can't.
Corporations, they would look back three years ago and say, "Hey, did I pay any money then?"
If I did, ask for some money back. If that covered off the whole loss, if you ... Then
everything is done, you ask for that money back this year. If there was still more loss
to apply, then you would look at two years ago, and you'd look at three years .... Or
one year ago. You'd do that. Now if you still have tax losses that you did not use up by
carrying them back to the prior three years, then you hold onto those, and make a note
on your tax return. You carry them forward, and you can carry them forward in check every
single year for the next twenty years. As soon as you have a taxable income situation
in a year, you can apply the loss against it and reduce how much tax you have to pay
in that year. You can do that until you use up your tax loss carryforward or until the
twenty years runs out, whichever happens first.
In this example that we're going to use, I've made a very simple assumption that there are
no permanent differences, no timing differences, so there's no deferred taxes in this situation
at all. You just make the simple assumption in this particular company that the accounting
income for tax, before tax equals the taxable income, which is not a very realistic assumption,
but what you learn in these examples will ... You can apply that even if you've got
permanent differences or timing differences. Here are the facts that we're going to use
to through this example on loss carrybacks and carryforwards.
We're currently sitting in the Fiscal Year 2017 for this company, but just some information
you need to understand. For 2014, 15, and 16, these were the taxable income situations,
and this is the current tax that was paid, and as we said at the start of the videos,
that we're assuming there's no timing differences, so there was no deferred tax entries that
needed to be made in those years. Now we're in 2017, and we have a taxable loss of $80,000,
so how do we do the accounting for that? That's what we're going to work through in the next
few stages.
Now we're ready to start doing the calculation of the tax entries for 2017, and the first
entry that we're going to do is a calculation of the current tax. This is our rough work
to compute what our journal entry should be for our current tax expense. We've got taxable
income that was given in the facts of this question of $80,000, and it was actually a
taxable loss situation of $80,000. Okay, so we'll take that loss and we'll look back to
up to three years ago, so three years ago was 2014, and we'll see if there was any taxable
income paid. We know from the facts of this question that there was.
We will carry back our loss to 2014. In the facts of the question, they stated that we
paid tax on taxable income of $5,000, so we're going to ask for a refund of the tax that
we paid on that $5,000 income. $5,000 times the tax rate equals a $1,500 refund that we
want to ask for. The tax rate we're using here is not the 2017 tax rate. It's the tax
rate of the year that you paid the tax on, so you can only ... You ask for the money
back based on what you ... The rate you paid it at, not based on the current year's rate,
whether the rate's higher or lower this year. It doesn't matter. Use the rate from 2014.
That leaves us with a taxable loss of $75,000, so we still have more loss that we can carry
back, so let's check 2015. If you look back to the facts of 2015, we paid tax on taxable
income of $10,000 at a tax rate of 28%, so the refund we're going to ask back this year
in 2017, is a refund of $2,800 based on the carryback to 2015 tax year, but we still have
loss remaining. We still have $65,000 in loss remaining. We're going to go back to our last
year, and look and see if we can use up any of this loss by carrying it back to last year,
so our carry back to 2016, the last tax year that we had.
In 2016, we had taxable income of $15,000, and we paid tax on that taxable income at
the rate of 26%, so we're going to ask for a refund of the full $3,900 that we paid in
tax last year, but we still have a loss remaining, so a remaining loss. We have a remaining loss
of $50,000, but we can't carry back any more years and ask for a refund this year, so what
we can do is make note of that $50,000, and we're going to carry that forward for the
next twenty years, or hopefully faster than twenty years, but it can take up to the next
twenty years to ask for a reduction of our taxes based on this loss.
Just to wrap up the current tax piece though, we've got these three refunds here. They add
up to $8,200 in refund. $8,200 of refund, so we'll do a journal entry to request a refund
of taxes here. Debit income tax recoverable, and a credit income tax benefit for $8,200.
Now it's time to do the deferred tax calculation to set up any deferred tax asset that we might
need to record that represents the benefit that we could have from this loss carryforward.
We ended the year in 2017. We have a loss carryforward of $50,000, and as the Accountant
you have to ask yourself, "Do we think we can actually use up this loss carryforward
in the next twenty years of time?" In the real world, probably the answer is an obvious,
"Yes," because how many companies are going to last for twenty more years if they're incurring
loss ... Carry losses every year, so we've got assume we're going to be in a taxable
situation sometime in the next twenty years.
However, just to illustrate the differences in the accounting, I'm going to make the assumption
that we think ... We estimate that we are only going to be able to use 80% in the next
twenty years. That we're only going to have enough taxable income to use up 80% of that
loss carryforward, so 20% cannot be used ever. That affects our accounting in 2017, because
what we're going to say to ourselves is, "Okay, we've got this last carryforward of $50,000,
but we only think we can use 80% of it. 80% of $50,000 is a $40,000 loss, and it's going
to be based on that $40,000 loss that we're going to establish our deferred tax asset,
or the benefit that we expect we're going to get in future years when we're able to
reduce our taxes by this loss carryforward." We'll look at future ... We're doing the deferred
tax calculation, so it's not the current tax rate that we want. It's the future tax rate
that we want, so if the future tax rate is different, we should use it.
The facts that were given in this question at the beginning, we said that starting in
2018, the tax rate is 21%, so the $40,000 loss times the 21% rate will be ... Says that
we need to set up a deferred tax asset of $8,400, so we need the deferred tax asset
in 2017 to record this loss carryforward. Debit deferred tax asset $8,400, credit deferred
tax benefit, the income statement account, $8,400, so that is our ... The value that
we're seeing the loss carryforward is to us now. The 20% that we don't think we'll ever
use, we're not going to set up any deferred tax asset for that. If we change our mind
next year or the year after or anytime in the next twenty years, that's okay. We'll
just do our calculation of what we think the deferred tax asset is, and we'll adjust the
value to what we think it is, but for now, we'll just assume that we can only use 80%
of this. Okay. We'll take a break here, and when you're ready, you can continue in the
next video.