Huang Inc., a private business following ASPE, has a contract with its president, Ms. Shen, to pay her a bonus during each of the years 2017, 2018, and 2019. Huang has the practice of paying Ms. Shen her bonus in quarterly payments at the end of March, June, September, and December of the following fiscal year. Statutory deductions are applied through the payroll system when the quarterly bonus payments are made. Assume a corporate income tax rate of 30% during the three years. The profit before deductions for bonus and income tax was $250,000 in 2017, $308,000 in 2018, and $350,000 in 2019. The president's bonus of 12% is deductible for corporate income tax purposes in each year and is to be calculated as follows:
1. In 2017, the bonus is to be based on profit before deductions for bonus and income tax.
2. In 2018, the bonus is to be based on profit after deduction of bonus but before deduction of income tax.
3. In 2019, the bonus is to be based on profit before deduction of bonus but after deduction of income tax.
Instructions
(a) Calculate the amounts of the annual bonus and the corporate income tax for each of the three years.
(b) Determine the classification of any balances owing to Ms. Shen at the year end of December 31, 2017 under each of the formulas.
(c) Assume now that Huang issues quarterly financial statements. How would Huang record the bonus expense in each quarter of 2017?
(d) What difference, if any, would apply in parts (a) through (c) above if Huang had followed IFRS?
(e) Because Huang has a calendar year end, the final calculation of the annual bonus due to Ms. Shen is made following the completion of the year end. Year-end procedures and final adjustments to the accounts include the accrual of Ms. Shen's bonus. Ms. Shen would like to receive advances on her bonus during the year, similar to commission payments made by Huang to its sales force. Under this proposal, Huang would continue to make quarterly payments as was done in past years and for amounts based on the total previous year's bonus for the first three quarters. Ms. Shen does not want any of the advances received toward the annual bonus to go through the payroll system when received. She wishes to postpone the income tax payment until the following calendar taxation year. The fourth and final quarterly payment in March of the following year would constitute the payment of the full annual bonus. For this final payment, the full amount of the annual bonus would be recorded through payroll, personal income tax deductions would be withheld, and the advances to date would be repaid from the net amount. If the balance owing after deductions does not cover the advances, Ms. Shen is to repay Huang by the end of April of that year.
1. Taking the perspective of the Canada Revenue Agency, do you believe that what is being proposed is acceptable for tax purposes? In your opinion, should the accounting and tax treatment be the same? Should the advances be recorded as salaries and wages expense when paid and therefore taxed when paid, or treated as a reduction of an accrued liability?
2. Do you believe the proposal from Ms. Shen is ethical? Why or why not?