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.

Required:

• Question 2 — How much of the reversing taxable temporary differences may be considered in estimating future taxable income?

Handout 1 - LOL Draft Income Statement and Excerpt From Tax Footnote as of December 31, 2018 LOL Corporation Consolidated Statement of Operations Years ended December 31, 2018, 2017, and 2016 (in thousands) 2017 2018 2016 Revenues, net 2,000,0001,900,0001,800,000 Cost of goods sold 1,400,000 1,250,000 ,200,000 Gross profit 600,000 650,000 600,000 Selling, general, and administrative 500,000 500,000 400,000 expense Goodwill impairment 750,000 Operating income (loss) (650,000) 150,000 200,000 50,000 50,000 Interest expense, net 50,000 Income (loss) before provision for (700.000) 100,000 150,000 income taxes 36,00054000 Provision (benefit) for income taxes Net (loss) income 64,000 96,000 LOL Corporation Inventory of Deferred Tax Balances The components of net deferred income taxes are as follows: 2018 2017 Year ended December 31 (in thousands) Deferred income tax assets: Allowance for doubtful accounts 30,000 25,000 Tax loss carryforwards (pre-2018) 100,000 100,000 20,000 Accruals and other 25,000 150,000 150,000 Deferred income tax liabilities: (15,000) (20,000) Depreciation Indefinite lived intangible assets (trademark) (50,000) (50,000) (35,000 (20,000) (100,000) (90,000) Prepaid expenses Net deferred income taxes 60,000 50,000 Valuation allowance Net deferred tax asset (liability) 2??260,000 As of December 31, 2018, LOL had $475 million of net operating loss carryforwards. Of these, $25 million are capital losses and will expire in 2019, and the remaining $450 million are operating losses and will expire in 2033 Handout 2- LOL Deferred Tax Asset Realization Analysis Showing Pretax Book Income Projections LOL Corporation Deferred Tax Asset Realization Analysis in thousands) The documentation below was provided to auditors as part of their audit. Adjusted Pretax Book Goodwill Pretax Book Year Income (Loss) Impairment*Income (Loss Actual Results 2016 150,000 150,000 2017 100,000 100,000 2018 700,000 750,000 50,000 Projections 2019 2020 40,000 2021 80,000 85,000 90,000 2022 2023 2024 2025 95,000 100,000 2026 105,000 110,000 2027 2028 115,000 2029 120,000 The goodwill impaired is nondeductible. There was no basis in the goodwill for tax purposes, therefore, the impairment had no direct impact on the tax provision. In other words, the impairment of the goodwill for book purposes does not result in a corresponding deduction for tax purposes in any period. The book expense, therefore, does not affect the resulting taxes payable, and it results in an effective tax rate that differs (unfavorably) from the statutory tax rate

Answer 1

Temporary difference are such differences whose reversal on tax liability can be d in the forecoming years' tax p nt differences are such which are not capable of reversal in forecoming permane years Therefore, following taxable temporary differences should be considered while estimating the future taxable income: (i) Difference of Accruals and other (ii) Difference of Depreciation amount (iii) Difference of Indefinite lived intangible assets iv) Difference of Prepaid amount (v) Difference of Allowance for doubtful accounts Following are some permanent differences which are not capable of reversal in the forecoming years (i) The company has no ability to carry back any losses of prior periods. (ii) The company wrote off all accounts receivable and this charge is not reversible in future hence it is a permanent difference.