Question on NOLs
Hi guys,
I have a question on Net Operating Losses (NOLs) that has been stumping me for awhile, so was hoping to get some help on this.
Assuming
- EBT: Year 1 $100, Year 2 -$200, Year 3 $300
- Tax: 40%
- NOL: Starting balance $150
I understand that in Y1, the following happens:
- IS: PBT $100, Net income $60 (40% tax)
- Use $100 NOL (from the $150 balance), so NOL-adjusted net income is $0 (and remaining NOL balance is $50). The $100 use of NOL reduces DTA by $40 (tax rate x NOL used)
- CF: Net income $60 + Change in DTA $40 = $100
- BS: Cash +$100, DTA -$40 = $60. Retained earning +$60
I get a little confused when it comes to Y2 - which of the following scenarios is correct?
Scenario 1
- IS: PBT -$200, Net income $0 (no tax)
- Create $200 NOL (so balance is now $50 + $200 = $250). DTA increases by $80 (tax rate x NOL created)
- CF: Net income -$200 - $80 change in DTA = -$280
- BS: Cash -$280, DTA +$80 = -$200. Retained earning -$200
Scenario 2
- IS: PBT -$200, Net income -$120 (40% positive tax)
- Create $200 NOL (so balance is now $50 + $200 = $250). DTA increases by $80 (tax rate x NOL created)
- CF: Net income -$120 - $80 change in DTA = -$200
- BS: Cash -$200, DTA +$80 = -$120. Retained earning -$120
Between Scenario 1 and 2, Scenario 1 seems more logical to be (i.e. PBT = net income) but I struggle a bit with the concept that your cash position decreases by $280 when your PBT was -$200.
Thanks!
Hi MScCandidate1, any of these discussions helpful:
More suggestions...
If those topics were completely useless, don't blame me, blame my programmers...
bump
Scenario 2. You are saying that scenario 1 makes more sense to you because pretax income equals net income, but in actuality your net income is higher (i.e. less negative) than your pretax income to reflect the asset (DTA) you have just created.
You're forgetting a step in your calc., NOLs can only be applied to 80% of the taxable income so in Year 1 you would only be able to apply $80 to the $100 EBT with the remaining $20 of income being taxable. So you would only be utilizing $80 of the NOL beginning balance not $100.
This is correct.
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