During the meeting in the afternoon, you ask Knepp and Lopez if there were permanent or temporary differences in 2012 and whether they will continue into 2013. They responded that they were not aware of any differences for either 2012 or 2013. However, in 2013 Conner and Martin were given life insurance policies. The insurance premium on these policies amounted to $80,000 per year. CM2 also anticipates investing in local county bonds which should earn about $7,000 investment income in 2013. Both of these items are reported on the forecasted income statement. In addition, Knepp tells you that depreciation expense recorded for tax will be $30,000 higher than that recorded for the books. That is, the book value of the fixed assets for GAAP will be $30,000 higher compared to their book value reported on the tax return.

Knepp then mentions that CM2 will begin offering a six-month warranty on its RFID product. The forecasted income statement includes estimated warranty expense accrual of $100,000; one-fourth of this amount will be settled in 2013 through actual claims being filed. You remember from your Intermediate Accounting class that for tax purposes, only the cash expense incurred in doing the work is deductible.

A) The memo should include in the background section a description of the entry that would be made if a valuation allowance must be recorded against the deffered tax asset if Connor and Martin believe that the future benefits from the deffered tax asset probably will not be realized.

B) Also include in the Backgorund section of the memo to Conner and Martin an explanation of how there might be the potential for earnings management when recording valuation allowancs for deffered tax assets