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INCOME TAX PROCEDURE
Proposition D The Radio Manufacturing Company was organized July 1, 1910, and incorporated under the Laws of the State of California. The offices of the Company are located at 516 Mission Street, San Francisco. A public accountant is furnished with the following Comparative Balance Sheet prepared by the Company's chief accountant and is asked to prepare an Income Tax Return for the fiscal year ending June 30.
THE RADIO MANUFACTURING CO.
Comparative Balance Sheet
End of Year $ 34,363.00
Beginning of Year Cash...
$ 23,220.00 Notes Receivable.
40,000.00 Accounts Receivable..
250,664.00 Inventories: Raw Materials..
46,980.00 Finished Goods.
108,756.00 Deferred Admr. Expense.
900.00 Invest. in Bonds-Nat'l Acme Co...
27,000.00 Invest. in Com. Stock-Nat'l Acme Co... 36,000.00 Sinking Fund
169,200.00 Machinery and Equipment.
196,200.00 Good Will..
90,000.00 Discount on Bonds.
17,100.00 Discount on Stock.. Organization Expenses.
1,260.00 22,000.00 27,000.00 18,405.00
5,850.00 191,151.00 207,450.00 90,000.00 16,200.00
A Balance Sheet audit reveals that the statements submitted are correct and show the true financial condition of the Company as of beginning and end of year under audit. An analysis of the Profit and Loss and Surplus accounts follows:
Profit and Loss Account
4,500.00 525.00 5,310.00 3,780.00 10,800.00
Surplus Account Balance at Beginning of Year.....
$ 85,140.00 Net Profits for Current Year..
81,319.00 Cash Dividends: February 26-5% (Common)......
$ 6,750.00 March 17–15% (Common).
20,250.00 July 1–7% (Preferred).
12,600.00 Appropriation for Sinking Fund Reserve.
9,000.00 Balance at End of Year...
$166,459.00 $166,459.00 The corporation was formed to take over the assets and good will of The American Manufacturing Co. The vendors received $84,150.00 preferred stock on account of the tangible assets, and $90,000.00 common stock for the good will. Land owned by G. R. Hill, the principal stockholder, was turned over to the corporation in exchange for 60 shares of preferred stock, although its value was $15,000.00. The valuation of $15,000.00 is substantiated by appraisals made at that time. Common stockholders donated back to the corporation onehalf of their holdings for the purpose of raising working capital; this stock was sold in 1910 at 90, and the discount absorbed in the operating expenses of 1910 and 1911. On July 1,
1916, an additional 1,000 shares of preferred stock were sold at 108, and the premium credited to Surplus. A stock dividend in common stock was declared and paid on the same date amounting to $50,000.00. On July 1 of the current year a stock dividend amounting to $45,000.00 was declared out of Capital Surplus and paid. On July 5, 500 shares of common stock were sold at 98.
Organization expenses originally amounted to $4,500.00. From time to time amounts have been charged off against operating profits.
The stock and bonds of the National Acme Co. represent purchases in 1910 at par-360 shares of stock and 27 $1,000.00 bonds. 90 shares of stock and 5 bonds were sold June 18 of the current year at $150.00 and $895.00 each, respectively. On March 1, 1913, the stock was selling for $110.00 and the bonds at $850.oo.
Bad debts charged off during the year amounted to $2,340.00; bad debts recovered and credited to the reserve, $540.00. Interest of $405.00 was allowed by the sinking fund trustee during the year on funds in his possession.
G. R. Hill, the president and general manager of the corporation, receives a salary of $7,500.00 per year. He owns 60 shares of preferred stock and 750 shares of common stock. H. M. Jameson, the vice-president and factory manager, receives a salary of $4,500.00 per year. He owns 100 shares of preferred stock and 250 shares of common stock. W. O. York, the secretary-treasurer, receives a salary of $3,750.00 per year. He owns 25 shares of preferred stock and 100 shares of common stock.
The account for repairs is charged with salaries and wages amounting to $1,750.00 and supplies costing $464.00.
The following schedule shows the amount of sales and bad
Solution Working Sheet. A Working Sheet should be prepared as a means of compiling and classifying the information which will be needed in the preparation of the return. In Unit Four a Working Sheet is illustrated in connection with the preparation of a return for an individual. That form of Working Sheet is not well adapted to the preparation of a return for a corporation for the reason that it does not exhibit the Balance Sheets of the corporation as at the beginning and end of the taxable year. The Working Sheet for this problem is illustrated on pages 124 and 125.
An analysis of the adjustments and exclusions follows:
(a) Bad Debts. Under the 1918 Revenue Act, it would be permissible to charge off only the actual amount of the loss on bad debts, or $2,340.00. Under the present Law it is allowable, with the permission of the Commissioner, to charge off the amount of the provision for bad debts, or in other words, the amount credited to the reserve, assuming of course, that this is a reasonable amount and is based upon a sound estimate. Under this provision, the amount to be treated as a deduction is $2,700.00.
Bad debts amounting to $540.00 were recovered during the year and credited to the reserve. Under the Law this constitutes taxable income and must be included in gross income.
(b) Dividends. A corporation must include the amount received as dividends from a domestic corporation in reporting its gross income. Corporations are, however, permitted to deduct these dividends in computing the net taxable income.
(c) Profit on Sales of National Acme Co. Stock. The Profit and Loss account shows a profit of $4,500.00 from the sale of National Acme Co. stock, whereas the return shows a profit of only $3,600.00. The difference is due to the fact that the profit in the Profit and Loss account is based on the cost of the stock, while in the return, the basis is the market value of the stock as on March 1, 1913. The difference of $900.00 may be treated as an exclusion in that it constitutes profit which need not be reported.
(d) Profit on Sales of National Acme Co. Bonds. The Profit and Loss account shows a loss from the sale of National Acme Co. bonds of $525.00 while the return shows a profit of $225.00. The loss stated in the Profit and Loss account is based on the cost of the bonds, whereas the profit stated in the return is based on the market value of the bonds on March 1, 1913. The amount of the actual loss must be set up as an exclusion because it cannot be claimed as a deduction. In addition to this, it is necessary to make an adjustment in order to set up the amount of taxable income which is $225.00.
(e) Income Taxes. Income taxes paid in excess of the reserve amounted to $3,780.00. This appears on the Working Sheet as an exclusion due to the fact that it does not constitute an allowable deduction.
(f) Organization Expenses. The Profit and Loss account shows that the amount of organization expenses written off is $450.00. This does not constitute an allowable deduction in the return. Expenses of organization of a corporation such as incorporation fees, attorney's and accountant's charges are ordinary capital expenditures. Only in the event that such expenditures are limited to purely incidental expenses may a taxpayer charge such items against income in the year in which they are incurred.
(g) Interest on Sinking Fund Investments. Interest amounting to $405.00 was allowed by the sinking fund trustee on funds in his possession. This does not appear in the Profit and Loss account perhaps on account of the fact that the trustee's report was not made until the end of the year and had not been recorded on the books.
On the following pages appear a photographic reproduction of pages one, two and three of Spangler's Income Tax Return. It will be noted that Schedule 1 of the return is not complete. This is due to the fact that the problem does not provide all of the required information. Of course, it would be necessary to provide a detailed explanation of any deduction claimed for depreciation. While in actual practice it is not a difficult matter to obtain this information from a set of books, it is purposely omitted in this problem which is given primarily for the purpose of exhibiting procedure in the preparation of returns.
2.214 .1287.8. 2.790. 5.310. .2.700.
16. Taxes (From Schedulo E) ......
(a) Salaries and wages. (Not included in Item 2, 12, or 11 above).
TOTAL DEDUCTIONS 18 ITEVE 12 TO 23.
COMPUTATION OF TAX
26. Net Income (Item 25 above)........
82 744. 27. Income Tax (124% of Item 28)........ 27. Les Credit of $2.000 (for domestic corpuration having a
30. 11 tho Not Income of a Domestic Corporation is Let Than net income of less than $25,250)..
$25,250, Enter the Amount in Excess of $25,000. 28. Balance (Item 26 minua Item 27)
31. Total Tax (Item 29 plus Item 30). 32. Lese: Income Tax Paid at Source (This credit can only be allowed to a nonresident foreign corporation)... 33. Income and Profite Taxes Paid to a Foreign country or to a Possession of the United States by domestic corporation..... 34. Balance of Tax (Item 31 minua Itoma 32 and 33)
An amended return must be marked "Amended" at top of return
Checia and drafts will be accepted only if payable at par
(Reproduction of Page 1 of Return)