Question

New Corp Ltd. has been in operation for five years but only recently has become profitable. In 2015, the company had significant accumulated tax loss carry forwards of $3,270,000 that were not recorded as assets because probability of use was considered low. In 2016, management determined that the probability of loss carry forward usage shifted, and it is now probable that the benefit of losses will be realized in the carry forward period. The tax rate is 30%.

Required:

1. Is this a change in policy, an error correction, or a change in estimate?

a. Change in estimate

b. Error correction

c. Change in policy

2. Provide the 2016 entry to record the benefit of the loss carry forwards. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

Answer 1

1. (A) Change in estimate

Reason: Beacuse change in estimate arises from the development of new information that alters the existing situation. Like in given case, the management is now probable that the benefit of losses will be realised in the carry forward period.

2. Such probabability that the benefit of losses will be realised in the carry forward period will lead to creation of Deferred Tax Asset. Beacuse the primary condition to create DTA is that entity is determined to generate substantial amount of profits to nullify the effect of DTA. Thus, the entry to record such benefit in 2016 will be as under:

Deferred Tax Asset A/c Dr $981000

Profit and Loss A/c Cr $981000

Calculation of DTA = Carry Forward Losses * Tax Rate

= $3270000 * 30%

=$981000