PROBLEM: Consider Otis Optics from Q1096. Otis recorded $500,000 in sales revenue in 2018. The…

PROBLEM: Consider Otis Optics from Q1096. Otis recorded $500,000 in sales revenue in 2018. The company is subject to a 35% tax rate. Otis recorded a deferred tax asset of $38,500 in 2018 because of a $110,000 basis difference in warranty liabilities ($110,000 * 35%). Based on its assessment of all positive and negative evidence associated with this deferred tax asset, management has assessed that it is more likely than not that it will not realize 40% of the deferred tax asset. Ignore cost of goods sold. What are the necessary journal entries to record the deferred tax asset and valuation allowance? Prepare a partial 2018 income statement and balance sheet for Otis Optics and compare it with the financial statements from Example 17.6 that do not include a valuation allowance. What is the effective tax rate in the two examples? Provide the footnote reconciliation of the federal statutory income tax rate to the effective tax rate in both dollars and percentages, incorporating the use of the valuation allowance.

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