Question

LOL (the “Company”), an SEC registrant with a calendar year-end, is a manufacturer and distributor of sports equipment. The Company was created in 1989 and is headquartered in Southern California. The Company has manufacturing operations and numerous sales and administrative locations in the United States. LOL files a consolidated U.S. federal tax return. (This case will not consider the evaluation of the state jurisdictions; it will only consider the federal jurisdiction.)

As LOL’s auditors, you are now performing the Company’s year-end audit for the fiscal year ended December 31, 2010, and have the following information available to you:

• LOL draft income statement and excerpt from tax footnote as of December 31, 2010 (Handout 1).

• A deferred tax asset realization analysis showing pre-tax book income projections (Handout 2).

• The projected income schedule (realization analysis above) projects organic growth beginning in 2012 after stemming the decrease in pre-tax book income.

• LOL does not have the ability to carry back any losses to prior periods. • A significant customer declared bankruptcy in 2010; therefore, the Company wrote off all accounts receivable from this customer. The Company is considering the exclusion of such expense when evaluating whether future income is objectively verifiable.

• The Company does not have a history of operating losses or tax credit carryforwards expiring unused.

• The Company has identified the following possible tax-planning strategies: o Selling and leasing back manufacturing equipment that would result in a taxable gain of $20 million. o Selling the primary manufacturing facility at a gain to offset existing capital loss carryforwards.

Additional Facts — Intraperiod Allocation Consideration Assume that a valuation allowance of $105 million is recorded as of December 31, 2010 ($150 million deferred tax asset (DTA) less $45 million reversing deferred tax liabilities (DTL)). Further assume that during 2010, the Company recognized a loss of $50 million in accumulated other comprehensive income (AOCI) related to a pension adjustment from a loss in investment value. The Company’s effective tax rate, without the recognition of a valuation allowance, is 37 percent.

Additional Facts Assume that a valuation allowance of $105 million is recorded as of December 31, 2010 ($150 million DTA less $45 million reversing DTLs). Further assume that the Company’s projection for 2011 pre-tax book income of $0 is accurate, but the Company sells a component of the business and recognizes the component as a discontinued operation. The discontinued operations earn $20 million before tax, and the continuing operations lose $20 million before tax for a net pre-tax book income of $0. As described above, the Company has a full valuation allowance.

Required:

• Question 7a — Is there a tax benefit on the loss of $20 million from continuing operations?

• Question 7b — Is there a tax provision on the $20 million of income from discontinued operations?

Answer 1

7a) It will be considered as seperate component of a income before extraordinary items.. Which will not be included for taxabe income.. There fore it is also known as net of tax.. It will give a tax benefit of $ 20 million.. It allows to carry forward taxable loss fom current period to future period.

7b) Income generated from discontinued operations will always be chargeable to tax under the head "profit and gains from business and operations" It will be chargeable at the normal tax rates chargeable to company.