How do Net Operating Losses (NOLs) affect a company’s 3 statements?
The easier way:
We will first reduce the taxable income by the portion of the net operating losses that we will be able to make use of each year, apply the applicable tax rate, and then remove the new tax number from the previous pre-tax income number (which should stay the same).
Then we will need to deduct the portion of the NOL balance that was used up (which should be a part of the Deferred Tax Asset line item).
The more complex way:
We will create a book vs. cash tax schedule where we calculate the Taxable Income based on NOLs, and then look at what we would pay in taxes without the NOLs.
Then we record the difference as an increase to the Deferred Tax Liability (DTL) on the Balance Sheet.
This method reflects the fact that we are saving on cash flow – since the amount of DTL, which is a liability item, is increase – while correctly separates the NOL impact into book vs. cash taxes.