The Bowerman Warehouse Corporation (BWC) is organized in Oregon and operates 15 retail and grocery stores in several of the western US states. BWC is owned by a small group of private equity investors. BWC follows generally accepted accounting principles (GAAP). It uses a the same fiscal year (ending June 30) for tax and book purposes. It is not subject to a state or federal alternative minimum tax this year, and it holds no minimum tax credits. BWC's balance sheet shows the deferred tax assets and liabilities that were created in prior years.

BWC's CFO has asked for your assistance in generating information needed for the corporation's financial statements. The financial accounting records of BWC for the current year produce the summarized trial balance (see below). Other information is available from last year's tax file and supporting records. Follow all of the public company disclosure rules of ASC 740, without regard to materiality or significance.

Additional Information

BWC's CFO informs you that the company does not project that it will generate any additional net capital gains in the next five years. This fact jeopardizes the corporation's ability to use its $75,000 capital loss carryforward before the five-year period expires. Management agrees to create a valuation allowance in the amount of 60 percent of the carryforward amount.

BWC's CFO is concerned that some of its current-year accelerated cost recovery will be disallowed after an IRS audit is completed. The BWC tax department has constructed the following table of the likely outcomes of the audit negotiations on this point.

Total Cost Recovery Deduction, as Negotiated with IRS

Probability of the Parties Agreeing to This Amount

$350,000

10%

$300,000

45%

$250,000

35%

$150,000

10%

BWC's delivery truck drivers were responsible for $50,000 in speeding tickets, all of which the company paid during the current year.

Inventories are recorded using the LIFO (last-in-first-out) method of accounting. In addition, for tax purposes some expenses must be capitalized using the UNICAP rules. In the last fiscal year, $280,000 were capitalized for tax; in the current fiscal year, UNICAP amounted to $250,000. Assume that all inventory turns over more than once per year.

BWC holds life insurance policies on its five officers. Premiums in the current year amounted to $200,000. No deaths occurred in the current year; thus, no life insurance proceeds were collected.

BWC sold some of its business assets for a net gain of $95,000. Net book value of these assets was $1,160,000 at the time of the sale. For tax purposes, adjusted basis was $600,000.

BWC contributed $1,000,000 to its defined benefit retirement plans, but due to carryovers $1,350,000 qualified for an income tax deduction in the current year.

BWC's tax department reported a $70,000 total of documented expenses for meals and entertainment.

Interest income in the current year was $70,000 from corporate bonds and $15,000 from municipal bonds.

BWC holds a $260,000 NOL carryforward, for both state and federal purposes. (BWC has elected to forego any federal NOL carryback. None of the states in which BWC holds an NOL allows a carryback at this time.)

Of the accounts receivable $10,000 were written off in the current year.

BWC accrued a current-year tax expense of $250,000 federal and $25,000 state.

Stat tax rates for BWC are 34% federal and 6% for the states (blended). Thus, if needed, the applicable federal tax rate net of the state tax deduction is 32 percent (rounded). Unless otherwise noted, state income tax laws piggyback onto federal income tax provisions in all states in which BWC has nexus. None of the states with which BWC has nexus allows a deduction for book federal income tax expense.

There are no enacted state or federal income tax rate changes that apply to BWC.

Requirements:

(1)Using the information provided in the Trial Balance, compute book income before taxes for BWC.

(2)Identify and measure BWC's book-tax differences. Classify each of the book-tax differences as temporary or permanent.

(3)Determine BWC's total tax provision for the year (i.e., the "tax accrual").

(4)Compute the corporation's effective tax rate to be reported to management. Reconcile the effective tax rate with the stat rate.

(5)Summarize BWC's changes in its Deferred Tax Assets/Liabilities for the year, and prepare the journal entry indicated by the change in the net deferred tax balance.

(6)Prepare the journal entry to reflect this ASC 740 valuation allowance.

(7)Prepare the journal entry to reflect the disclosure related to the possible outcome of the IRS audit relative to the current year's net deferred tax liability (ignore any accrued interest for that time.)

Trial Balance

Item

June 30, 2017

June 30, 2016

Cash

$ 992,365

$ 2,518,222

Accounts Receivable

$ 1,350,000

$ 1,875,000

Allowance for Doubtful Accounts

$ (35,000)

$ (40,000)

Accounts Receivable - Related Parties

$ 885,000

$ 1,500,000

Merchandise Inventories (LIFO)

$ 9,790,000

$ 8,675,000

Prepaid Expenses and Other Current Assets

$ 910,000

$ 1,060,000

Land

$ 1,280,000

$ 1,280,000

Buildings

$ 3,640,000

$ 3,630,000

Accumulated Depreciation - Buildings

$ (2,885,000)

$ (2,800,000)

Leasehold Improvements

$ 12,725,000

$ 15,600,000

Accumulated Depreciation - Leasehold Improvements

$ (9,850,000)

$ (12,400,000)

Trade Fixtures and Equipment

$ 37,620,000

$ 40,000,000

Accumulated Depreciation - Trade Fixtures and Equipment

$ (31,200,000)

$ (35,500,000)

Transportation Equipment

$ 1,295,000

$ 1,420,000

Accumulated Depreciation - Transportation Equipment

$ (900,000)

$ (1,250,000)

Property Held Under Capital Lease

$ 5,490,000

$ 7,100,000

Accumulated Depreciation - Capital Leases

$ (3,410,000)

$ (5,200,000)

Deposits and Other Assets

$ 945,000

$ 825,000

Deferred Federal Income Tax Asset

$ 321,198

Deferred State Income Tax Asset

$ 60,300

Accounts Payable

$ (8,998,143)

$ (9,100,000)

Other Current Liabilities

$ (797,000)

$ (555,000)

Federal and State Tax Accrual

$ (275,000)

$ (1,400,000)

Current Tax Liability - Federal

$ (142,595)

Current Tax Liability - State

$ (26,770)

Accrued Salaries and Wages

$ (2,950,000)

$ (2,930,000)

Current Portion of Long-term Debt

$ (711,000)

$ (652,000)

Deferred Federal Income Taxes - Current Liability

$ (3,419,720)

Deferred State Income Taxes - Current Liability

$ (642,000)

Contracts and Notes Payable (Long-Term)

$ (4,255,000)

$ (3,300,000)

Common Stock

$ (448,000)

$ (448,000)

Additional Paid-in Capital

$ (6,400,000)

$ (6,400,000)

Retained Earnings

$ (14,948,000)

$ (14,620,000)

Treasury Stock

$ 15,120,000

$ 15,120,000

Dividends

$ 250,000

$ 250,000

Sales Revenues

$ (165,500,000)

$ (176,000,000)

Cost of Goods sold (LIFO)

$ 119,200,000

$ 128,800,000

Operating and Administrative Expenses

$ 40,580,000

$ 39,210,000

Depreciation and amortization

$ 4,850,000

$ 5,300,000

Bad Debt Expenses

$ 5,000

$ 4,000

Loss (Gain) on Sale of Assets

$ (95,000)

$ (275,000)

Unrealized Loss (Gain) on Held-for-Sale Securities

$ (45,000)

$ (100,000)

Interest Income

$ (85,000)

$ (98,000)

Interest Expense

$ 540,000

$ 880,000

State Income Tax Expense

$ 51,000

Federal Income Tax Expense

$ 1,650,000