Reference no: EM132863828 , Length: word count: 750

Sonny Corporation has never been audited before the current year. An audit is now needed by a CPA because the company is expanding rapidly and plans to issue stock to the public. A CPA firm has been doing preliminary evaluations of the Sonny Corporation's accounts and records. One major problem involves the valuation of inventory under GAAP. Sonny Corporation has been valuing its inventory under the cost method and no write-downs have been made for obsolescence. A review of the inventory indicates that obsolescence and excess spare parts in the inventory are two major violations of Accounting Periods and Methods. The CPA states that for GAAP the company will be required to write down its inventory by 25% of its stated amount, or $100,000, and charge this amount against net income from operations for the current period. Otherwise, an unqualified (i.e., a "clean opinion") will not be rendered. The company controller asks your advice regarding the tax consequences from the obsolescence and spare parts inventory write-downs for the current year and the procedures for changing to the lower-of-cost-or-market (LCM) method for tax purposes. Sonny Corporation uses a calendar year for both book and tax purposes, and the date of your contact with the company is December 1 of the current year.

Question 1: Explanation of the taxpayer's business and issue at hand (heading: Facts).

Question 2: Explanation of the IRS rules regarding the matter (also part of Facts).

Question 3: Tax laws and applicable court cases to support the deductions, where applicable (heading: Analysis).

Question 4: Conclusion as to the recommendations to the company (heading: Conclusion).