Honk started a new business, Hank's Donut World (HWW for shorth in June of last yeac He has requested your advice on the following specific tax malters associated with HW's first year of operations. Hank has est imated HWrs income for the first year as follows: HW operates as a sole proprietorship, and Honk reports on a calendar year Hank uses the cash method of accounting and plans to do the same with HW (HW has no inventory of donuts because unsold donuts are not salable). HW does not purchase donut supplies on credit, nor does it generaly make sales on credi. Hank has provided the following details for specific first-yeat transactions. 1. A smbli minoraty of HW clents complained about the catering service. To mitigate these complaints, Hank's policy is to refund dissatisfied elents 50 percent of the catering fee. By the end of the first yeat, only fwo HW clients had complained but had not yef been paid refunds. The expected refunds amount to $2,550, and Hank reduced the reported catering fees for the first year to reflect the expected refund. 2. In the frst year, HW recelved a 57.260 payment from a client for catering a monthly breakfast for 30 consecutive months beginning in December, Because the payment didnt relate to last yeac, Hank excluded the entire amount when he calculated catering revenues. 3. In July, HW paid $2,520 to ADWAN Company for an advertising campaign to distribute filers advertising HW's catering service. Unfortunately, this campaign violated a city code restricting advertising by fiers, and the city fined HW $420 for the violation. HW paid the fine, and Hark included the fine and the cost of the campalgn in "other business" expenditures. 4. In July, HW also paid 58.808 for a 24 -month insurance policy that covers HW for accidents and casualties beginning on August 1 of the first yeac. Hank deducted the entire $8,808 as accident insurance premilums. 5. In May of the first yeac, Honk signed a contract to lease the HNW donut shop for 10 months, In conjunction with the contrect, Hank. paid \$2,340 as a damage deposit and $8,900 for tent (\$890 per month). Hank explained that the damage deposit was refundable at the end of the lease. At this vime. Hank also poid $36,120 to lease kachen equipment for 24 months (51,505 per month) Both leeses began on June 1 of the first year, In his estimate, Harik deducted these amounts (547,360 in total) as rent expense. 6. Hank signed a contract hiring WEGO Catering to help cater breakfasts. At year-end, WEGO asked Hank to hold the last catering poyment for the yeac, $9.930, untli after January 1 fapparently because WE 60 didn't want to report the income on its tax return . The last check was delivered to WEGO in January after the end of the first yeac. However, because the poyment related to the first year of operations, Hank included the $9,930 in last year's catering expense. 7. Hark believes that the key to the success of HiW has been hiring Jimbo Jones to supervise the donut ptoduction and manage the shop. Because Jimbo is such an important employee, HW purchissed a "key-employee" term-ife insurance policy on his ille. HW pald a $5.950 premium for this policy, and it wili pay HW a 540.000 death benefit if Jimbo passes away any time during the next 12 . months. The term of the policy began on Septembet 1 of last yeat, and this payment was included in "other business" expenditures. 8. In the first yeac, HW catered a large breaidast evert to celebrate the city's anniversary. The city agreed to poy $8.120 for the event, but Hank folgot to notify the city of the outstanding bill until January of this year. When he mailed the bil in January. Hank decided to discount the charge to 56.180. On the bill, Hank thanked the mayor and the city council for their patronage and asked them to "send a limle more business our way." This bill is not reflected in Hanik's est mate of HWrs income for the first year of operations. Required: a-t and a-2. Hank files his personal tax return on a calendar yoas, bot he has not yet fled last year's personal tax return, nor has he fled a tax return reporting HWrs resuats for the first year of oporations. Idently when Hank should flo the tax return for HW and calculate the amount of taxable income generated by HeN last year b. Determine the taxable income that HW will generate if Hank chooses to account for the butiness under the accrual method. Note: Do not round intermediate calculations. Hank started a new business, Hank's Donut World (HW for short), in June of last year. He has requested your advice on the following specific tax matters associated with HW's first year of operations. Hank has estimated HW's income for the first year as follows: HW operates as a sole proprietorship, and Hank reports on a calendar year. Hank uses the cash method of accounting and plans to do the same with HW (HW has no inventory of donuts because unsold donuts are not salable). HW does not purchase donut supplies on credit, nor does it generally make sales on credit. Hank has provided the following details for specific first-year transactions. 1. A small minority of HW clients complained about the catering service. To mitigate these complaints, Hank's policy is to refund dissatisfled cllents 50 percent of the catering fee. By the end of the first year, only two HW clients had complained but had not yet been paid refunds. The expected refunds amount to $2,550, and Hank reduced the reported catering fees for the first year to reflect the expected refund. 2. In the first year, HW received a $7,260 payment from a client for catering a monthly breakfast for 30 consecutive months beginning in December. Because the payment didn't relate to last year, Hank excluded the entire amount when he calculated catering revenues. 3. In July, HW paid $2,520 to ADMAN Company for an advertising campaign to distribute flier advertising HW's catering service. Unfortunately, this campaign violated a city code restricting advertising by fllers, and the city fined HW $420 for the violation. HW paid the fine, and Hank included the fine and the cost of the campaign in "other business* expenditures. 4. In July, HW also paid $8,808 for a 24 -month insurance policy that covers HW for accidents and casualties beginning on August 1 of the first year. Hank deducted the entire $8,808 as accident insurance premiums. 5. In May of the first year, Hank signed a contract to lease the HW donut shop for 10 months. In conjunction with the contract, Hank paid $2,340 as a damage deposit and $8,900 for rent ( $890 per month). Hank explained that the damage deposit was refundable at the end of the lease. At this time, Hank also paid $36,120 to lease kitchen equipment for 24 months (\$1,505 per month), Both leases began on June 1 of the first year. In his estimate, Hank deducted these amounts ( $47,360 in total) as rent expense. 6. Hank signed a contract hiring WEGO Catering to help cater breakfasts. At year-end, WEGO asked Hank to hold the last catering payment for the year, $9,930, until after January 1 (apparently because WEGO didn't want to report the income on its tax return). The last check was delivered to WEGO in January after the end of the first year. However, because the payment related to the first year of operations, Hank included the $9,930 in last year's catering expense. 7. Hank belleves that the key to the success of HW has been hiring Jimbo Jones to supervise the donut production and manage the shop. Because Jimbo is such an important employee, HW purchased a "key-employee" term-life insurance policy on his life. HW paid a $5,950 premium for this policy, and it will pay HW a $40,000 death benefit if Jimbo passes away any time during the next 12 months. The term of the policy began on September 1 of last year, and this poyment was included in "other business" expenditures. 8. In the first year, HW catered a large breakfast event to celebrate the city's anniversary. The city agreed to pay $8,120 for the event, but Hank forgot to notify the city of the outstanding bill until January of this year. When he mailed the bill in January. Hank decided to discount the charge to $6,180. On the bill, Hank thanked the mayor and the city council for their patronage and asked them to "send a little more business our woy." This bill is not reflected in Hank's estimate of HW's income for the first year of operations. a-1 and a-2. Hank files his personal tax return on a calendar year, but he has not yet filed last year's personal tax return, nor has he filed a tax return reporting HW's results for the first year of operations. Identify when Hank should file the tax return for HW and calculate the amount of taxable income generated by HW last year. b. Determine the taxable income that HW will generate if Hank chooses to account for the business under the accrual method. Note: Do not round intermediate calculations
