Net Operating Loss (NOL) Explained

What is a net operating loss (NOL) and how do you account for it? In this CPA exam lecture, Professor Farhat explains net operating losses for CPA, CMA, and EA candidates and accounting students — covering how an NOL arises, carryforward rules after the Tax Cuts and Jobs Act, recording a deferred tax asset, the 80 percent limitation, and when a valuation allowance is required. Ideal for anyone studying intermediate accounting, accounting for income taxes, and FAR-topic net operating losses.
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Video Timeline & Key Concepts:
0:00 — Introduction
0:06-1:22 — What a net operating loss is and why losses can offset future income
1:51-2:18 — Carryforward rules under the Tax Cuts and Jobs Act
3:19-3:45 — Recording a deferred tax asset for the future tax savings
5:50-6:20 — Using the NOL to offset up to 80 percent of future taxable income
8:18-9:40 — When a valuation allowance is required under the more-likely-than-not standard
10:59-12:15 — Weighing negative and positive evidence for a valuation allowance
Frequently Asked Questions:
What is a net operating loss?
A net operating loss occurs when a company's tax deductions exceed its taxable income for the year. Tax law allows the business to carry the loss forward to offset taxable income in future profitable years.
Can a net operating loss be carried back to prior years?
Under the Tax Cuts and Jobs Act, net operating losses arising in recent years generally cannot be carried back. Instead they are carried forward indefinitely to offset income in future periods.
How is a net operating loss recorded in the accounts?
When an NOL is incurred, the company records a deferred tax asset representing the future tax savings expected when the loss offsets future taxable income.
What is the 80 percent limitation?
In a future profitable year, the carried-forward net operating loss can generally offset only up to 80 percent of that year's taxable income. The remaining loss continues to carry forward to later years.
When is a valuation allowance required for an NOL?
A valuation allowance is required when it is more likely than not that some or all of the deferred tax asset will not be realized. The company weighs negative evidence, such as a history of losses, against positive evidence, such as a strong earnings history or sales backlog.
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