Income Statement: Dec. 31, 2020 TRIAL BALANCE Debit Credit Dec 31, 2020 ADJUSTED TRIAL BALANCE Debit Credit ADJUSTMENTS Debit Credit SCHEDULE M-1 Debit Credit Form 1120 PAGE 1 INCOME/ EXPENSE Debit Credit Account Name 600,000 600,000 600,000 300,000 3,000 300,000 3,000 8,600 0 17,600 8,600! Sales Purchases Accounting expenses Advertising Amortization of Org Exp. Charitable contributions Depreciation Federal income taxes Insurance Interest expense Key person life insurance premium Legal expenses Miscellaneous expenses Officers' salaries Payroll taxes Repairs Salaries State income taxes Gain of Sale of MND stock Dividend income Totals Net Income 300,000 3,000 8,600 0 17.600 9,000 48,000 9.000 200 200 800 ov 5,500 9,000 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 48,000 9,000 200 200 800 ov 5,500 2,100 0 12,500 6,500 120,000 8,000 0 0 0 u 0 0 0 0 0 0 0 0 0 0 0 0 17.600 9,000 48.000 9,000 200 200 800 5,500 2,100 0 12,500 6,500 120.000 8,000 2,100 0 12,500 6.500 120,000 8,000 18,000 2,000 620,000 18,000 2,000 620,000 0 0 0 0 0 18,000 2,000 620,000 550,800 69.200 620,000 550.800 69,200 620,000 550,800 69,200 620,000 620,000 0 620,000 0 620,000 Balance sheet: Dec. 31, 2020 TRIAL BALANCE Debit Credit ADJUSTED TRIAL BALANCE Debit Credit ADJUSTMENTS Debit Credit Account Name O O 0 0 229,200 0 35,000 10,000 15,000 55,000 Oo 9,000 0 0 0 0 0 9,000 0 0 Cash Inventory Equipment Land Building Building Improvements Accumulated Depreciation - Bldg. & Impr. Accumulated Depreciation - Equipment Organization Expense Accumulated Amortization - Org Exp. Accounts Payable Salaries Payable Notes Payable Accrued State Tax Payable Accrued Federal Income Tax Capital stock Retained earnings (prior) Dividends paid Current earnings Totals 0 229,200 0 0 0 35,000 10,000 0 15,000 0 55,000 0 0 0 0 0 0 0 0 0 0 0 0 0 0 45,000 20,000 93,000 8,000 0 0 0 0 0 45,000 20,000 93,000 8,000 0 100,000 0 0 69,200 344,200 100,000 0 0 69,200 344,200 0 0 $344,200 0 344,200 I. Adjusting Entries (all except tax accrual. To be given to client) 1. Inventory adjusting entry (given to client because the books are wrong). The facts in problem 2-48 are where you get the information. They said they took a physical count and inventory was $16,000. The inventory on the books ($0) does not reflect the actual inventory per the physical count ($16,000). So, you need to adjust the inventory asset account and the Ending Inventory account on the income statement (I assume you have my Excel spreadsheets I posted on BB). One debit and one credit. Post that entry to the balance sheet and income statement. Easy. You don't need to calculate Cost of Goods Sold (COGS) until you do the tax return. There is no COGS account because they don't use a perpetual inventory system (1.e., they don't debit COGS and credit Inventory every time they sell something). They use a periodic system where COGS is calculated per the formula: Beg Inv + Purchases - Ending Inv=COGS. Normally, when you prepare the tax return you would need to calculate COGS by adjusting the Purchases account for the inventory difference. But the inventory adjustment and the beginning inventory is zero and the inventory on the books is zero, so the Purchases account will equal COGS in this problem. That is not usually the case. 2. Reclassify Officer's Compensation from Salary. Officer's Comp is in Salary Expenses and should be separated. 3. Capitalize Organization Expenses as an asset and reduce the expense accounts (Legal, etc.). 4. Record the amortization of the Organization Expenses. See Ch. 1. II. After making these entries you should have an adjusted trial balance. Then look at the income statement tab and the far-right columns that say Schedule M-1. Enter in Schedule M-1 columns (debit or credit) any difference between GAAP rules and tax rules. See my instructions for more detail. Look over all the bullet points in the problem and make any other M-1 adjustments. This will require some knowledge of tax rules that we have discussed in Ch. 1. These are one-legged entries in a sense. They change only one account. There is a db or st to an expense account and the other side is to Net Income at the bottom. You will need these entries when you do the tax return for Sch. M-1 on page 4. M-1 entries are not given to the client to book, because the books are not wrong. The books are GAAP based. We are just converting the income statement to a tax-based income statement and calculating taxable income. III. After you make all M-1 adjustments you will have a Net Income number at the bottom. This is line 28 of the tax return. From this number subtract the Dividend Received Deduction (which we learned how to calculate in Ch. 1). The result is Taxable Income. Multiply that by 21% to get the tax. Subtract the estimated taxes they have paid in - $48,000, to get what they owe or overpaid. IV. Make a tax accrual adjusting entry for the amount they owe or overpaid in step 3. Only two accounts are involved: Federal Income Tax expense (currently $48.000, which is only the estimates paid) and Accrued Federal Income Tax (zero on the books). This is an adjusting entry and is given to the client. Income Statement: Dec. 31, 2020 TRIAL BALANCE Debit Credit Dec 31, 2020 ADJUSTED TRIAL BALANCE Debit Credit ADJUSTMENTS Debit Credit SCHEDULE M-1 Debit Credit Form 1120 PAGE 1 INCOME/ EXPENSE Debit Credit Account Name 600,000 600,000 600,000 300,000 3,000 300,000 3,000 8,600 0 17,600 8,600! Sales Purchases Accounting expenses Advertising Amortization of Org Exp. Charitable contributions Depreciation Federal income taxes Insurance Interest expense Key person life insurance premium Legal expenses Miscellaneous expenses Officers' salaries Payroll taxes Repairs Salaries State income taxes Gain of Sale of MND stock Dividend income Totals Net Income 300,000 3,000 8,600 0 17.600 9,000 48,000 9.000 200 200 800 ov 5,500 9,000 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 48,000 9,000 200 200 800 ov 5,500 2,100 0 12,500 6,500 120,000 8,000 0 0 0 u 0 0 0 0 0 0 0 0 0 0 0 0 17.600 9,000 48.000 9,000 200 200 800 5,500 2,100 0 12,500 6,500 120.000 8,000 2,100 0 12,500 6.500 120,000 8,000 18,000 2,000 620,000 18,000 2,000 620,000 0 0 0 0 0 18,000 2,000 620,000 550,800 69.200 620,000 550.800 69,200 620,000 550,800 69,200 620,000 620,000 0 620,000 0 620,000 Balance sheet: Dec. 31, 2020 TRIAL BALANCE Debit Credit ADJUSTED TRIAL BALANCE Debit Credit ADJUSTMENTS Debit Credit Account Name O O 0 0 229,200 0 35,000 10,000 15,000 55,000 Oo 9,000 0 0 0 0 0 9,000 0 0 Cash Inventory Equipment Land Building Building Improvements Accumulated Depreciation - Bldg. & Impr. Accumulated Depreciation - Equipment Organization Expense Accumulated Amortization - Org Exp. Accounts Payable Salaries Payable Notes Payable Accrued State Tax Payable Accrued Federal Income Tax Capital stock Retained earnings (prior) Dividends paid Current earnings Totals 0 229,200 0 0 0 35,000 10,000 0 15,000 0 55,000 0 0 0 0 0 0 0 0 0 0 0 0 0 0 45,000 20,000 93,000 8,000 0 0 0 0 0 45,000 20,000 93,000 8,000 0 100,000 0 0 69,200 344,200 100,000 0 0 69,200 344,200 0 0 $344,200 0 344,200 I. Adjusting Entries (all except tax accrual. To be given to client) 1. Inventory adjusting entry (given to client because the books are wrong). The facts in problem 2-48 are where you get the information. They said they took a physical count and inventory was $16,000. The inventory on the books ($0) does not reflect the actual inventory per the physical count ($16,000). So, you need to adjust the inventory asset account and the Ending Inventory account on the income statement (I assume you have my Excel spreadsheets I posted on BB). One debit and one credit. Post that entry to the balance sheet and income statement. Easy. You don't need to calculate Cost of Goods Sold (COGS) until you do the tax return. There is no COGS account because they don't use a perpetual inventory system (1.e., they don't debit COGS and credit Inventory every time they sell something). They use a periodic system where COGS is calculated per the formula: Beg Inv + Purchases - Ending Inv=COGS. Normally, when you prepare the tax return you would need to calculate COGS by adjusting the Purchases account for the inventory difference. But the inventory adjustment and the beginning inventory is zero and the inventory on the books is zero, so the Purchases account will equal COGS in this problem. That is not usually the case. 2. Reclassify Officer's Compensation from Salary. Officer's Comp is in Salary Expenses and should be separated. 3. Capitalize Organization Expenses as an asset and reduce the expense accounts (Legal, etc.). 4. Record the amortization of the Organization Expenses. See Ch. 1. II. After making these entries you should have an adjusted trial balance. Then look at the income statement tab and the far-right columns that say Schedule M-1. Enter in Schedule M-1 columns (debit or credit) any difference between GAAP rules and tax rules. See my instructions for more detail. Look over all the bullet points in the problem and make any other M-1 adjustments. This will require some knowledge of tax rules that we have discussed in Ch. 1. These are one-legged entries in a sense. They change only one account. There is a db or st to an expense account and the other side is to Net Income at the bottom. You will need these entries when you do the tax return for Sch. M-1 on page 4. M-1 entries are not given to the client to book, because the books are not wrong. The books are GAAP based. We are just converting the income statement to a tax-based income statement and calculating taxable income. III. After you make all M-1 adjustments you will have a Net Income number at the bottom. This is line 28 of the tax return. From this number subtract the Dividend Received Deduction (which we learned how to calculate in Ch. 1). The result is Taxable Income. Multiply that by 21% to get the tax. Subtract the estimated taxes they have paid in - $48,000, to get what they owe or overpaid. IV. Make a tax accrual adjusting entry for the amount they owe or overpaid in step 3. Only two accounts are involved: Federal Income Tax expense (currently $48.000, which is only the estimates paid) and Accrued Federal Income Tax (zero on the books). This is an adjusting entry and is given to the client