ABC Inc. is in the business of airframe maintenance, modification and retrofit services, avionics and aircraft interior installations, the overhaul and repair of aircraft engines, and other related services. The following are excerpted from its income statement for the year ended December 31, 2008.

Due to the nondeductibility of amortization of goodwill, the company’s tax expense was higher by \($1,076\) than would be expected based on the statutory tax rate of 35%. State taxes further added another \($927\) to the tax expense. However, the reduction in the valuation allowance decreased the accounting income tax expense. In addition, several other items caused the tax expense to deviate from the tax liability. Since these items by themselves are immaterial, no separate breakdowns are available.
The following breakdowns are available for the balance sheet values of deferred tax assets and liabilities:

The book value of the company’s inventories increased from \($91,130\) at the end of 2007 to \($127,777\) at the end of 2008.

Required:

1. Prepare a schedule reconciling the statutory and effective tax rates of ABC Inc. for the year ended 2008.

2. Provide the journal entry to record the income tax expense for 2008, showing separately the effects on deferred tax asset, valuation allowance, and deferred tax liability.

3. For each component of deferred tax asset/liability, provide possible reasons for the change in its values from 2007 to 2008.

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($ in thousands) Earnings (loss) before income taxes Income tax benefit (provision) Net earnings (loss) The details for the income tax expense or provision follow. Income Tax Expense Current Deferred Income tax expense 2008 $10,891 (3,267) $ 7,624 2008 $1,756 1,511 $3,267