Intermediate Accounting
Thomas H. Beechy
Schulich School of
Business,
York University
Joan E. D. Conrod
Faculty of Management
Dalhousie University
Powerpoint slides by:
Michael L. Hockenstein  Commerce Department • Vanier College
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Accounting for Tax Losses
Chapter 17
17-2
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
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Tax Benefits of a Loss
 When a corporation prepares its tax return and

ends up with a taxable loss instead of taxable
income, the corporation is entitled to offset the
loss against past and future taxable income as
follows:
 the loss can be carried back for three years
 any remaining loss can be carried forward
for seven years.
If the sum of the previous three years’ and next
seven years’ taxable income turns out to be less
than the loss, any remaining potential benefit is
lost
17-3
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
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Tax Benefits of a Loss (cont.)
 There is no problem in accounting for the tax



benefits of the loss carrybacks because there is no
uncertainty about whether or not the company will
actually receive the benefit
Income taxes will be reduced in future periods as a
result of the tax loss carryforward
Should the benefit of reduced future taxes be
recognized in the period of the loss, or only in the
period in which the benefits are realized?
The general principle is that the tax benefits of tax
losses should be recognized in the period of the
loss, to the extent possible
17-4
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
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Tax Loss vs. Tax Benefits
 To help avoid confusion, it is necessary to keep track



separately of the amount of the tax loss and the
amount of the tax benefit
The tax loss is the final number of taxable loss on the
tax return
The tax benefit is the present and future benefit that
the company will be able to realize from the tax loss
through a reduction of income taxes paid to
governments
Basically: Tax benefit = Tax loss x Tax rate
17-5
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

Tax Loss Carrybacks
 A tax loss carryback entitles the corporation to recover

income taxes actually paid in the previous three years
Fabian Corporation was established in 20X1
Fifth year it suffered a tax loss of $500,000
Year
20x1
20x2
20x3
20x4
20x5
Taxable
income
$100,000
$240,000
$160,000
$300,000
$(500,000)
Tax
rate
40%
40%
35%
37%
38%
Income taxes
paid
$40,000
$96,000
$56,000
$111,000
-
17-6
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
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Tax Loss Carrybacks (cont.)




The loss will be carried back to the preceding three
years to recover taxes previously paid
Normally a loss is carried back to the earliest year
first, and then applied to succeeding years until the
loss is used up
Note that the tax is recovered at the rate at which it
was originally paid
The tax rate in the year of the loss (i.e., 38% for
20X5) is irrelevant for determining the amount of
taxes recoverable via the carryback
17-7
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Tax Loss Carrybacks (cont.)
In this example, the carryback completely utilizes the 20x5 tax loss of
$500,000. Fabian will record the benefit of that carryback as follows:
Income tax receivable [B/S]
189,000
Income tax expense (recovery) [I/S]
189,000
The credit to income tax expense reflects the fact that it is a recovery of
taxes paid in earlier years. A company will usually label this amount as
‘provision for income tax’ or ‘income tax recovery’ in its income
statement. If any part of the tax loss is attributable to discontinued
operations or extraordinary items, the recovery must be allocated to the
relevant components of income, as was described in the last chapter for
intraperiod allocation.
17-8
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

Tax Loss Carrybacks (cont.)
Recovery maximization strategy, the carryback would
be applied as follows:
Year Carryback Tax rate Tax recovery
20x2
$240,000
40%
$ 96,000
20x4
$260,000
37%
$ 96,200
Totals
$500,000
$192,200
Maximizing the carryback tax recovery is a viable
strategy, but it is a bit of a gamble
17-9
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

Temporary Differences in a Loss Year
 It is quite possible for temporary differences (and
permanent differences) to convert a pre-tax
accounting profit to a tax loss. For example,
assume the following facts for Michelle Ltd. for the
fiscal year ending 31 December 20X8:
 net income before taxes of $100,000, after
deducting depreciation expense of $150,000
 CCA totaling $280,000 deducted on the tax return
17-10
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Temporary Differences in a Loss Year
(cont.)
 net book value of capital assets of $1,700,000 and
UCC of $1,200,000 on 1 January 20X8, a
temporary difference of $500,000 that is reflected
in an accumulated future income tax liability
balance of $200,000 at 1 January 20X8
 no permanent differences
 taxable income in the three-year carryback period
of $360,000
 tax rate of 40% in the current and previous years
17-11
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Temporary Differences in a Loss Year
(cont.)
Michelle Ltd.’s taxable income for 20x8 will be computed as follows:
Accounting income subject to
$100,000
tax
Temporary difference:
Depreciation
+150,000
CCA
–280,000
Taxable income (loss)
$ (30,000)
The CCA/depreciation temporary difference of $130,000 is recorded as usual, with
an increase in the deferred tax credit balance on the balance sheet and a charge to
the income tax expense for $52,000 (i.e., $130,000 × 40%):
Income tax expense [I/S]
52,000
Future income tax liability – capital assets
52,000
[B/S]
The $30,000 tax loss is carried back, which results in a tax recovery (@40%) of
$12,000:
17-12
Income tax receivable – carryback benefit [B/S]
12,000
© 2003
McGraw-Hill Ryerson Limited, Canada
 12,000
Income taxCopyright
expense
[I/S]
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Adjusting Temporary Differences
 Since the company had available taxable

income in the carryback period against which
the loss can be offset, good tax strategy calls
for taking the maximum allowable CCA in 20X8
in order to obtain a refund of taxes previously
paid
If the company did not have taxable income in
the preceding three years, a tax loss in 20X8
would not permit the company to realize any
tax benefit in 20X8
17-13
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
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Adjusting Temporary Differences (cont.)
 Instead of having a tax loss, the company can


simply reduce the amount of CCA that it
deducts on its tax return for 20X8 by $30,000,
from $280,000 to $250,000
CCA is an optional deduction, up to the
permitted limit
A company will have a higher amount of
undepreciated capital cost (and CCA) in future
years if it claims less CCA in the current year
17-14
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

Tax Loss Carryforwards
 If the three-year carryback does not completely use



up the tax loss, a company is permitted to carry the
remaining loss forward and apply it against taxable
income over the next seven years
The accounting question, however, is whether the
future tax benefit of the carryforward can be
recognized in 20X5, the period of the loss
Companies usually want to recognize the benefits of
a loss carryforward because that recognition
decreases the apparent accounting loss
The income tax recovery is a credit entry in the income
statement, reducing the amount of the reported loss
17-15
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

Tax Loss Carryforwards (cont.)
In the Fabian Corporation example, the tax benefit of the $500,000
tax loss in 20x5 was fully realized through the carryback. But
suppose instead that the loss in 20x5 was $1,000,000. Then the
carryback could utilize only $700,000 of the loss:
Year
Carryback
Tax rate
Tax recovery
20x2
$240,000
40%
$ 96,000
20x3
$160,000
35%
$ 56,000
20x4
$300,000
37%
$111,000
Totals
$700,000
$263,000
The tax benefit ($263,000) relating to $700,000 of the $1 million
tax loss was realized through the carryback; the tax benefit is both
realized (as a monetary asset – a receivable) and recognized in
20x5. After the carryback, there is a carryforward of $300,000
remaining
17-16
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
The Basic Principle---“More Likely Than Not”

The criterion for recognizing the future benefits is
simply that “the amount recognized should be limited
to the amount that is more likely than not to be
realized” [CICA 3465.24]. The recommendation is
that:
 at each balance sheet date, . . .a future income tax
asset should be recognized for all deductible
temporary differences, unused tax losses and
income tax reductions. The amount recognized
should be limited to the amount that is more likely
than not to be realized. [CICA 3465.24]
 an event is more likely than not when the
probability that it will occur is greater than 50%.
[CICA 3465.09(i)]
17-17
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

The Basic Principle---“More Likely Than Not”
(cont.)
 In deciding whether the probability is greater than

50%, management may consider “tax-planning
strategies that would, if necessary, be implemented to
realize a future income tax asset” [CICA 3465.25(d)]
Tax planning strategies include such actions as:
 reducing or eliminating CCA in the year of the loss
and future years
 amending prior years’ tax returns to reduce or
eliminate CCA
 recognizing taxable revenues in the carryforward
period that might ordinarily be recognized in later
periods
17-18
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
The Basic Principle---“More Likely Than Not”
(cont.)
 Favourable evidence that support recognition:
 existing sufficient taxable temporary differences
which would result in taxable amounts against
which the unused tax losses can be utilized
 existing contracts or firm sales backlog that will
produce more than enough taxable income to
realize the future income tax asset based on
existing sales prices and cost structures
17-19
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
The Basic Principle---“More Likely Than Not”
(cont.)
 an excess of fair value over the tax basis of
the enterprise’s net assets in an amount
sufficient to realize the future income tax asset
 a strong earnings history exclusive of the loss
that created the future deductible amount
together with evidence indicating that the loss
is an aberration rather than a continuing
condition (for example, an extraordinary item)
17-20
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

The Basic Principle---“More Likely Than Not”
(cont.)
 On the other hand, unfavourable evidence
includes:
 a history of tax losses expiring before they have
been used
 an expectation of losses in the carryforward period
 unsettled circumstances that, if resolved
unfavourably, would adversely affect future
operations and profit levels on a continuing basis in
future years. [CICA 3465.27]
17-21
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
Reducing CCA
 One way of increasing the likelihood that a


company will fully utilize a carryforward is to
eliminate CCA in the carryforward years
Not claiming CCA has the effect of increasing
taxable income, against which the carryforward
can be used
After the carryforward benefits have all been
realized, the company can resume deducting full
CCA to reduce its future net income
17-22
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
Reducing CCA (cont.)
 A further strategy is to amend prior years’

returns to reduce or eliminate CCA
The relevant time frame is the three previous
years to which carrybacks apply
17-23
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
Reassessment in Years Subsequent to
the Loss Year




If the future benefits of loss carryforwards are
recognized in the year of the loss, the benefit should
be given intraperiod allocation, as appropriate to the
cause of the loss
Once the future tax benefit of a tax loss carryforward
has been recognized as an asset, the asset is
subject to review at each balance sheet date
If the probability of realization drops to 50% or less,
the future income tax asset should be reduced
[CICA 3465.31(a)]
If an asset is unlikely to recover its carrying value,
either through use or through sale, it should be
written down
17-24
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
Example of Recognition Alternatives
 Suppose that Parravano Ltd., a private

company that has been in business for five
years, incurs a loss of $500,000 in 20X5
The company has no temporary differences,
and therefore the pre-tax accounting loss is the
same as the loss for income tax purposes
17-25
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
Example of Recognition Alternatives
(cont.)
 The history of the company’s earnings since the
company began operations is as follows:
 the tax rate has been constant at 40% from 20X1
through 20X5
 in 20X5, Parravano can carry back $170,000 of the
loss to recover taxes paid in 20X3 and 20X4, a total
of $68,000
 Under any scenario, the starting point for
recording the income tax expense is to record the
carryback benefit
17-26
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
Example of Recognition Alternatives
(cont.)
Year
20x1
20x2
20x3
20x4
Taxable
income
(loss)
$ 100,000
(60,000)
140,000
30,000
Taxes paid
(recovered)
$
40,000
(24,000)
56,000
12,000
Income tax receivable – carryback benefit [B/S]
68,000
Income tax expense (recovery) [I/S]
68,000
A carryforward of $330,000 remains. Recognition of the future benefits of the
carryforward depends on management’s conclusions regarding the likelihood of
realizing the benefits. The following scenarios illustrate recognition of the benefits
of tax loss carryforwards under various possible assumptions concerning the
likelihood of realization.
17-27
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
Example of Recognition Alternatives
(cont.)
 Scenario 1
Assuming future recovery is judged to be probable
in the year of the loss
 if the probability of realizing the future tax benefit of
the carryforward is > 50% when the 20X5 financial
statements are being prepared, the estimated
future benefit of the carryforward is recognized in
the year of the loss
17-28
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
Example of Recognition Alternatives
(cont.)
 Scenario 2
Now, suppose instead that, due to Parravano’s
erratic earnings history, realization of the benefit
of the carryforward is judged not to be probable
 the entry to record the tax benefit in 20X5 would
then be limited to the amount of taxes recovered
through the carryback
17-29
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

Example of Recognition Alternatives
(cont.)
 Scenario 3 Partial recognition
It is possible that a company’s management may
decide that only part of the benefit is more likely
than not to be realized
 the entry to record the tax benefit in 20X5 would
then be limited to the future tax benefit for which
the probability of the carryforward is > 50%
 the benefits from the remaining tax loss
carryforward can be recognized in a later period,
if the probability of realization becomes > 50%
17-30
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

Example of Recognition Alternatives
(cont.)
 Scenario 4 Write-off of previously
recognized benefit
Like any other asset, the future benefit of a tax
loss carryforward must continue to have
probable future benefit
 if an asset no longer is likely to be recoverable
or realizable, it must be written down to its
probable future benefit
17-31
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
Which Tax Rate?
 Which tax rate should be used to record the
amount of a future tax asset or liability?
 The CICA Handbook recommends that future tax
assets and liabilities should be recognized at the
rate(s) that are expected to apply when the
temporary differences reverse, “which would
normally be those enacted at the balance sheet
date” [CICA 3465.56]
17-32
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

Which Tax Rate? (cont.)
 The word “normally” is used because, in

Canada, the government can announce
changes in tax rates prior to the legislation
actually being enacted
The CICA Handbook therefore refers to the
substantively enacted income tax rate, and
recommends that the substantively enacted
rate be used instead of the actual rate at the
balance sheet date
17-33
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
Tax Rate Changes



Once a future income tax asset has been recorded
for a tax loss carryforward, the balance of that
account must be maintained at the tax rate that is
expected to be in effect when the carryforward is
utilized
Suppose that the tax rate goes down to 38% before
Parravano actually uses any of the carryforward
The asset will have to be revalued to $330,000 
38%, or $125,400. This change will be included as
part of the annual re-evaluation of the FIT asset or
liability
17-34
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Copyright © 2003 McGraw-Hill Ryerson Limited, Canada

Tax Rate Changes (cont.)

Income tax expense
($132,000 - $125,400)(I/S)
$6,600
Future Income Tax Asset—
Carryforward Benefit (B/S)
$6,600
17-35
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
Intraperiod Allocation of Tax Loss
Carryforward Benefits
 When the future benefit of a tax loss

carryforward are recognized in the period of
the loss, the benefits will be reported in the
same manner as the related loss
However, if the benefits are recorded in a
period following the loss, any income
statement impacts will not be given intraperiod
allocation
17-36
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
Intraperiod Allocation of Tax Loss
Carryforward Benefits (cont.)
 The income statement recognition will be as
follows:
 if the tax loss carryforward benefit is recognized
in the year of the loss, the tax benefit will be
offset against the extraordinary items
 if the tax loss carryforward is recognized a
subsequent year, the tax benefit will be reported
in income before discontinued operations and
extraordinary items, regardless of the
classification of the loss in the prior period
17-37
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
Disclosure
 The only CICA Handbook recommendation for

income statement presentations is that income tax
expense related to continuing operations should
be shown on the face of the income statement
Further disclosure relating to tax losses consist
only of the following:
 the current tax benefit from tax loss carrybacks and
carryforwards, segregated between (1) continuing
operations and (2) discontinued operations and
extraordinary items
 the amount and expiry date of unrecognized tax
losses
17-38
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
Differential Reporting



Companies that have elected to use differential
reporting will report on a taxes payable basis in a
loss year as well as in profitable years
When differential reporting is used, only the
amount of taxes actually recovered through
carrybacks in the loss year will be reported as
income tax recovery
When carryforwards are used to reduce taxes in
following years, the reduced amount of tax actually
paid is reported as income tax expense
17-39
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