Duncan Corporation Case
Duncan Corporation is an internet-based retailer and delivers products ordered online by shipping the goods directly to customers in all 50 states. Duncan does not have a brick-andmortar store presence in any state, but does operate distribution centers in various states across the country, including Virginia. Consistent with its practice in all 50 states, Duncan does not collect or remit sales tax to Virginia In recent court rulings, Virginia has taken the position that operating a distribution center within a state constitutes nexus and this would subject that company to collect and remit sales tax on all sales within that state. As of December 31, 2017, Duncan has operated its distribution center in Virginia for five years and has never collected or remitted sales tax to Virginia. Although the company considers the risk of detection to not be probable, Duncan has estimated the total amount of sales tax payable to the state for the past five years to be $50 million plus $6 million in interest and $4 million in penalties. On March 15, 2018, Mr. Clancy, the governor of Virginia, established a tax amnesty program. The program provides that any unregistered taxpayer who voluntarily registers to collect sales tax on a prospective basis will be forgiven (1) 50 percent of all unpaid sales tax and (2) all interest and penalties on unpaid taxes. Duncan management decides to take advantage of this program. On June 15, 2018, Duncan completes the necessary paperwork and other actions to participate in the program and pays Virginia $25 million to settle its obligation through December 31, 2017.
You are a staff accountant working on the audit of Duncan Corp. You have been asked by the audit partner to write a memo on the appropriate accounting treatment for Virginia sales tax.
Your analysis should include (1) the accounting treatment for the unpaid sales tax included in the financial statements for the year-ended December 31, 2017 (assume the 2017 financial statements were issued on February 28, 2018), (2) the accounting treatment for Duncan’s decision to participate in the tax amnesty program announced on March 15, 2018, and (3) the accounting treatment for the $25 million payment made on June 15, 2018.
When discussing any of the accounting treatments, you should reference the appropriate FASB guidance which dictates the treatment (see case instructions). Journal entries can be included to assist with your description of the appropriate treatment.
• Please use the following page formatting for the assignment: o One-inch margins o double-spacing, single side only o Size 12 Times New Roman font
• The minimum length should be 4 pages, excluding references, with double spacing. Maximum length . • Your case write-up should be organized as an internal research memo from an associate of an accounting firm to the audit partner. • It should have the following sections: o Executive summary (a one paragraph condensed description of the issue and your suggested solution). o Analysis: ▪ Description of the issue (facts) ▪ Analysis of facts o Conclusion o References
• The memo should be well organized,
Duncan corporation is a company that does not hold any brick and mortar stores in any of the states in USA. It still has operation and sales in 50 states of the country. Like other states the company has also been operating in the state od Virginia for a tenure of approximately five years. Just like any other state the company uses its distribution centers in the state to manage its operations. Due to the absence of any store the company has had a policy of not collecting and remitting sales tax. The same policy has been used in Virginia as well. Due to a recent legislation in the state now any company which has a distribution center in the state will be liable to pay sales tax. The company has estimated that the total tax liability for them will be $50 million with an additional interest of $6 million and a fine of $4 million.
As the legislation is new the state has introduced a tax amnesty program under which the company will be liable to pay only 50% of the tax liability with the interest and fine being waved off. The company has decided to use the program and pay off the liability. Under this decision the complete tax liability of $50 million along with the interest and fine will be introduced as a liability in the balance sheets and a counter asset will be created to balance it which will be a provision account for the payment of the tax. The deduction in payable tax will be taken as an extraordinary income post tax. The final payment will be recorded be debiting $25 million from the new liability and asset head and reducing the cash available to pay the tax.
Description of Facts
Duncan corporation has distribution centers in the state of Virginia where it operates from for its sales just like any other US state. It does not own any store in the state however. The company has had a long-standing practice that due to the absence of any brick and mortar store in any state, the company neither collects nor remits any sales tax to the government of any state. Its treatment to sales tax in Virginia is consistent with the same.
There has been a recent change in the rules of the state of Virginia itself that all the companies which have a distribution center in the state will have to collect and remit sales tax. Based on the estimates of the company the total amount of sales tax due for the entire duration of operation of the company in state of Virginia, which is a period of five years, is approximately $50 million. The company does not expect the government to be able to detect the fact and thinks that there is minimal risk in not paying previous tax.
As the governor of Virginia has introduced the tax amnesty program, the company plans to use that program to its advantage. Including the interest and penalty the total liability of the company is $60 million. But the program waives off the interest and the penalty on non-payment of tax. The company will also have to pay only 50% of estimated liability. Thus, the tax liability has also decreased to just $25 million.
Analysis of Facts
At this point the first and most important aspect to be noted is that the court ruling is a new ruling and the Duncan company had not broken any law by not remitting any sales tax till date. As the new law has just been enacted, the liability to pay the previous tax only comes up now and was not earlier part of any obligation of the company.
The company has been prudent in analyzing the penalty it is liable for instead of knowing that there is minimum chance of the government finding out that they have not paid sales tax. The company has also estimated the interest of $6 million and the penalty of $ 4 million. The intent of the company to be proactive and be ready to pay all its liabilities is more than commendable.
The decrease in the total liability of the company due to the tax amnesty program introduced by the government of Virginia has reduced the total cash liability of the company by more than 50%. There has been a 50% reduction in the pending tax itself and in addition to that the penalty and interest has been waived off. This will help the company a lot.
According to the ASU 2016-12  which is for revenue from contracts with customers, the companies will have a choice of election policy where they can choose to either treat the tax as a liability or as an expense. They will also have a choice of showing it as a part of the transaction to the customers. As the treatment of the policy is backdated and the company will soon be paying the tax, it will be prudent for the company to mark the required amount to be paid as an upcoming liability. Thus, a head will have to be created under both assets and liabilities. The liability will be simple and straight forward where the tax liability of complete $50 million will be shown as unpaid tax liability in the current liability section of the balance sheet. For the same there will also be an entry in the assets where the cash available with the company will have to be moved. The asset account will be named provision for sales tax and will have the same value as the liability account.
According to ASU 2018-02  the policy announcement of tax amnesty program will lead to an extraordinary gain for the company. Though with the new amendment the reduction in the tax liability will be shown as a gain in the income statement for the year 2018. This will lead to a debit entry in the liability section which will reduce the tax liability and similarly the asset entry will also be decreased due for the provision of sales tax. The income statement entry will be after the operating income section which will show the extraordinary gain.
The payment of tax in June is a simple payment transaction by the ASB 606  rule. The company will reduce the liability and asset accounts by $25 million. There will be an entry in income statement as well as the cash flow statement as there will actually be a transfer of cash this time. Till now there were only change in heads and no actual transaction.
Due to the enactment of the new rule from the state of Virginia the company ended up paying $25 million in sales tax in the end. That is a big cost to the company but for continuing operation in the state that was a mandatory requirement. There was a requirement of extraordinary treatment of accounts due to the sudden addition of the tax liabilities. However, from now the company will yearly add tax liabilities and have a constant provision account to pay the same.
ASU 2016-12: REVENUE FROM CONTRACTS WITH CUSTOMERS (TOPIC 606):
Retrieved from: https://asc.fasb.org/imageRoot/91/82860791.pdf
ASU 2018-02: Reclassification of certain tax effects from accumulated other comprehensive income:
Retrieved from: https://asc.fasb.org/imageRoot/10/116661310.pdf
ASB 606: REVENUE FROM CONTRACTS WITH CUSTOMERS:
Retrieved from: https://asc.fasb.org/imageRoot/32/79982032.pdf
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