Question 2 (55 marks)

The following information is taken from the financial statements and audit working papers of Eldridge Asset Sales Inc. ("EASI") for its fiscal year ended December 31, 2018.

Eldridge Asset Sales Inc.

Condensed Unaudited Income Statement

For the Year Ended December 31, 2018

Sales

$16,650,000

Cost of goods sold

(14,050,000)

Gross profit

$2,600,000

Selling expenses

$975,000

General and administrative expenses

195,000

(1,170,000)

Net income before provision for income taxes

$1,430,000

Provision for income taxes current

$220,000

future

310,000

(530,000)

Net income after tax

$900,000

Included in sales for the year is a deposit of $8,200 received from a customer for goods that will be delivered next year.

The following items were deducted in arriving at the above net income:

1.During the year, a warehouse worker managed to remove valuable inventory worth $8,000 during the night shift by taking it out in his lunch box.

2.Late in the year, it became apparent that during the next year new competitive products would come on the market which would drive the price of EASI's products down. They expect this decline to take place in about six months. As a result, they decided to set up a reserve for a decline in the inventory value in the amount of $17,000. They have never set up this kind of reserve before.

3.Because EASI's products come back for repair under their warranty program, they set up a reserve for this expense on their financial statements. Last year the reserve was $76,000. This year they increased the reserve to $97,000.

4.Charitable donations were made in the amount of $9,000.

5.Golf club membership fees in the amount of $2,600 were paid for the sales manager who used the club regularly to close sales.

6.The sales manager incurred expenses related to meals and entertainment at the golf club in the amount of $2,300.

7.Management bonuses of $96,000 were accrued at December 31, 2018 ($35,000 was not paid until June 30, 2019 due to lack of sufficient funds).

8.The December holiday banquet for the employees cost $15,000.

9.EASI had a dispute with one of its major suppliers over the use of the supplier's product. As a result of a court decision, the supplier was awarded damages for breach of contract in the amount of $38,000.

10.In order to raise money for expansion, the company mortgaged the real estate it used in the business. It incurred accounting fees of $5,000 and appraisal fees of $2,000 related to this financing. The mortgage has a 10-year term and a 30-year amortization period.

11.A number of years ago, the company issued a bond at a discount. They have been amortizing this discount at the rate of $7,000 per year ever since, including this year.

12.During the year, the company bought the shares of another company. In completing this transaction, legal fees of $8,500 were incurred.

13.During the year, they borrowed to buy new equipment. The interest expense related to this was $23,000.

14.Instead of borrowing money at the bank, the company decided to pay their income tax instalments late. This resulted in an interest charge from the Canada Revenue Agency in the amount of $390.

15.A life insurance policy was taken out on the president's life in order to provide funding for the company in the event of his death. Life insurance premiums on this policy amounted to $4,600.

16.Business interruption insurance premiums of $3,300 were paid to protect the company in the event a fire forced them to close for a period of time.

17.Computer software costing $750 related to word processing was expensed because they always bought the upgrades each year.

18.Amortization expense on the fixed assets was $86,000.

19.An examination of the capital cost allowance schedule for 2018 provided the following opening balances for the undepreciated capital cost for each class of EASI's assets:

Class 3

Bbuilding............................................

$208,734

Class 8

Office furniture and equipment................

60,000

Class 10

Trucks for transportation of goods

80,000

Class 12

Ssmall tools.........................................

5,000

Class 13

Lleasehold improvements.......................

187,500

Class 44

Patent and rights limited life...................

90,000

The following additional information was found in the 2018 fixed asset schedules working paper files.

A. The building which cost $697,426 in 1987 was sold for $150,000. It was the only building in Class 3 at the time of its sale. A new building was purchased (non used) in April 2018 for $750,000. Also, in February 2018 a lot adjacent to the new building, was purchased for $100,000 for use as a parking lot by employees and visitors. This lot was paved at a cost of $25,000. A fence was erected around an outside storage area near the new building at a cost of $40,000.

BNew office furniture was purchased for $20,000. This purchase replaced old assets which were sold for $5,000. None of the old assets was sold for more than capital cost.

CThree small trucks purchased in 2013 for $12,000 each were traded in for three new trucks. Each new truck was priced at $15,000, but this was reduced by a trade-in credit of $2,500 for each old truck.

D.Some small tools were sold for a total of $7,000. All of these tools were sold at a price less than their capital cost.

E. Leasehold improvements had been made to a leased warehouse at a cost of $225,000 in 2016. Theremaining length of the lease in that year was six years with two successive renewal options of three years each. Further leasehold improvements were made to this warehouse in 2018 at a cost of $21,000.

F.During 2018, an unlimited life franchise was purchased for $48,000.

G. Accounting gains and losses on the above asset sales netted to nil.

Required:

Based on the foregoing information, compute the minimum income from business for tax purposes for Eldridge Asset Sales Inc. in respect of its 2018 fiscal year, under the provisions of the Act.

Assume all expenses are reasonable in the circumstances.

Note Your answer should incude the following.

1. The reason for the adjustments in the calculation

2. The reason if an items omitted from the calculation.

3. Income Tax Act (ITA) section, subsection and paragraph (where applicable) references in order to support your answer to question.

4. Follow the sequence of information given above 1 to 18

5. State your assumptions if any

6.Show all calculations whether or not they seem relevant to the final answer.

7. Cross refer the information numbers in your answers.