Question
Simon and Theodore are father and son and have each been operating reasonably successful businesses independent of each other. They have recently concluded that their
Simon and Theodore are father and son and have each been operating reasonably successful businesses independent of each other. They have recently concluded that their individual strengths would be more successful if they combined their businesses together and have been formulating a plan to bring their businesses together as a single entity. They have been operating their businesses as separate sole proprietorships but now want to both put them together and obtain some legal liability protection.
Alvin is Theodores best friend since grade school. Alvin would like to participate in the new business venture but has limited cash to contribute. He has offered to do all the start up accounting and legal work in exchange for a portion of the new business. Even though Simon is not sure about Alvins work ethic, he agrees to let Alvin become part of the new business.
The assets and liabilities they each contribute are included in the excel spreadsheet under the tab Assets Contributed.
On February 1, 2012, the contributions are finally completed and all of the legal agreements signed by all of the parties. Simon contributed his existing business, with the exception of the land and building he owns where the business will be operated. Theodore contributed all of his business assets and liabilities. Alvin contributed a little bit of cash and his services prior to the final contributions which were valued at $75,000. The new entity was formed in January 2012 in anticipation of the contributions by each party.
As it turns out, at least looking at the trial balance included in the excel spreadsheet (tab Trial Balance), the combining of the two businesses has resulted in increased sales and profits and the new business entity is very successful.
Alvin turns out to be a pretty good financial accountant and has completed the trial balance as of the end of the year. You have had a number of discussions with Alvin and have found out the following information about the new business. The name of the company is AST Records. The business is manufacturing vinyl records for various recording artists. As a part of the business, the company not only manufactures the vinyl albums but also does the art work for the album cover. Alvin has chosen the accrual method for book purposes and sees no reason why the tax returns should be anything different. Inventory is a significant part of the revenue production process. Since the entity was just formed at the beginning of the year, there were no reserves or other accruals as of the start date of February 1, 2012. Because the company has turned out to be more successful than they ever planned, there is a significant amount of cash on the balance sheet at the end of the year. Simon has taken some of the extra cash and made investments in various stocks (other than DaveCo, all are less than 20% ownership of the stock investment) and bonds to provide at least some interest and dividend income. All of the equity investments are presented at fair market value using the fair value accounting method, while the debt investments (bonds) are accounted for using the available for sale method. Alvin knew enough about this method that he correctly included the increase in value from original cost in the Other Comprehensive Income account (but did not do so net of tax which you can safely ignore for purposes of this exam).
During the year, some of the equipment contributed by Simon was sold for a book loss. Additionally, Simon sold some investments for gains and losses. All of the necessary details are included on tabs Fixed Asset Sales and Sale of Investments.
In August, Simons friend Dave approached Simon with an idea for a related business. Dave thought opening a recording studio for local bands would fit well with the existing vinyl record business and proposed a new venture. Simon was initially skeptical but agreed to form a new corporate subsidiary of AST Records along with Dave. AST contributed $450,000 in cash to the new entity in exchange for 45% of the common stock of the new company called DaveCo. Dave contributed some assets and his services for the remaining 55% interest. Alvin knows that if you own between 20% and 50% of a business, then you account for it using the Equity Method for GAAP, but he has no idea what you do for tax purposes. The details on DaveCo are included on tab DaveCo Rollforward. You do NOT need to worry about the formation of DaveCo as that is not part of this project.
As mentioned earlier, Simon retained ownership of the land and building where AST Records is located. AST pays Simon monthly rent of $9,000 that is payable on the first of each month for the PRECEEDING month.
Alvin, Simon, and Theodore are all employees of AST Records as well as owners. Simon made a choice early on that all employees would be paid once per month on the 1st of each month for the past months work. This was so he would never pay anyone in advance for work they had not yet done. AST Records has four employees in addition to Alvin, Simon and Theodore, all of whom have been with the company since February 1, 2012. None of the accrued vacation balance at the end of the year was paid within 2 months of year end.
During the year, the company needed some new fixed assets. Details of the acquisition dates and book depreciation calculations are included on the tab Book Depreciation.
Here are some details to help you finish the forms (do not get caught up in googling things such as whether I have the proper zip code, etc. that just wastes your time):
AST FEIN: 99-7654321
AST Records
1234 Album Drive
Las Vegas, NV 80024
Simon and Theodore live together at
4567 Chipmunk Lane
Las Vegas, NV 80024
Alvin lives at
9876 Burbank Road
Las Vegas, NV 80025
Below are the Social Security numbers for each of the owners:
| Simon | 555-55-5556 |
| Theodore | 333-33-3334 |
| Alvin | 111-11-1112 |
The ownership of AST is as follows:
Simon 74%
Theodore 23%
Alvin 3%
REQUIREMENT
Calculate taxable income for AST Records. You MUST show your work for every calculation (see the final requirement) that comes into calculating the taxable income. Note that the book income on the trial balance is NOT equal to taxable income so there is a fair amount of work you must do to complete this requirement. You will start with book net income (Trial balance attached) and reconcile it to taxable income.
| AST RECORDS | |||
| GAAP BASED TRIAL BALANCE | |||
| AS OF DECEMBER 31, 2012 | |||
| CASH | 2,352,750 | ||
| INVESTMENTS, AT FMV | 3,685,950 | ||
| ACCOUNTS RECEIVABLE | 325,000 | ||
| ALLOWANCE FOR DOUBTFUL ACCOUNTS | (12,600) | ||
| INVENTORY | 576,550 | ||
| INVENTORY RESERVE | (24,000) | ||
| COMPUTERS - CONTRIBUTED | 36,000 | ||
| COMPUTERS - PURCHASED | 175,000 | ||
| MACHINERY - CONTRIBUTED | - | ||
| MACHINERY - PURCHASED | 8,000,000 | ||
| SOFTWARE - PURCHASED | 250,000 | ||
| OTHER EQUIPMENT - PURCHASED | 1,000,000 | ||
| ACCUMULATED DEPRECIATION - COMPUTERS CONTRIBUTED | (23,000) | ||
| ACCUMULATED DEPRECIATION - COMPUTERS PURCHASED | (26,736) | ||
| ACCUMULATED DEPRECIATION - MACHINERY CONTRIBUTED | - | ||
| ACCUMULATED DEPRECIATION - MACHINERY PURCHASED | (428,571) | ||
| ACCUMULATED DEPRECIATION - OTHER EQUIPMENT PURCHASED | (38,194) | ||
| ACCUMULATED DEPRECIATION - SOFTWARE PURCHASED | (75,000) | ||
| INTANGIBLES | - | ||
| EQUITY INVESTMENT IN DAVECO | 495,000 | ||
| WAGES PAYABLE - EMPLOYEES | (54,000) | ||
| WAGES PAYABLE - SIMON | (6,000) | ||
| WAGES PAYABLE - THEODORE | (4,000) | ||
| WAGES PAYABLE - ALVIN | (5,000) | ||
| WITHHOLDING TAXES PAYABLE | (12,500) | ||
| ACCRUED PAYROLL TAXES | (7,580) | ||
| ACCRUED VACATION PAYABLE | (75,600) | ||
| ACCRUED WARRANTY | (73,459) | ||
| ALLOWANCE FOR SALES RETURNS | (12,450) | ||
| ACCRUED RENTAL | (9,000) | ||
| ACCOUNTS PAYABLE | (99,500) | ||
| LONG-TERM DEBT | (900,000) | ||
| DEFERRED REVENUE | (55,600) | ||
| FEDERAL INCOME TAXES PAYABLE | (1,603,788) | ||
| NOTES PAYABLE | (9,000,000) | ||
| OWNERS CONTRIBUTIONS | (1,685,257) | ||
| DISTRIBUTIONS TO OWNERS | 1,000,000 | ||
| OTHER COMPREHENSIVE INCOME - INVESTMENTS | (685,950) | ||
| RETAINED EARNINGS | - | ||
| GROSS SALES | (13,450,650) | ||
| SALES RETURNS | 95,460 | ||
| INCOME FROM EQUITY METHOD INVESTMENT | (90,000) | ||
| COST OF GOODS SOLD | 6,500,950 | ||
| (GAIN)/LOSS ON SALE OF FIXED ASSETS | 115,476 | ||
| (GAIN)/LOSS ON SALE OF INVESTMENTS | (70,000) | ||
| INTEREST INCOME | (145,000) | ||
| DIVIDEND INCOME FROM INVESTMENTS | (198,645) | ||
| INTEREST EXPENSE | 336,000 | ||
| MEALS & ENTERTAINMENT | 50,000 | ||
| PENALTY EXPENSE | 3,000 | ||
| PROPERTY TAX EXPENSE | 112,000 | ||
| PAYROLL TAX EXPENSE | 98,000 | ||
| REPAIR EXPENSE | 47,500 | ||
| ADVERTISING EXPENSE | 190,000 | ||
| RENT EXPENSE | 99,000 | ||
| OFFICER LIFE INSURANCE PREMIUM EXPENSE | 3,250 | ||
| BAD DEBT EXPENSE | 15,600 | ||
| ACCOUNTING FEES | 17,500 | ||
| LEGAL FEES | 3,500 | ||
| FEES PAID TO ALVIN | 75,000 | ||
| WARRANTY EXPENSE | 73,459 | ||
| INSURANCE EXPENSE | 95,465 | ||
| DEPRECIATION EXPENSE | 906,883 | ||
| VACATION EXPENSE | 105,000 | ||
| WAGES EXPENSE | 429,000 | ||
| FEDERAL TAX EXPENSE | 1,603,788 | ||
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Financial Management Principles And Applications
Authors: J William Petty, Sheridan Titman, Arthur J Keown, John D Martin, Peter Martin, Michael Burrow, Hoa Nguyen
6th Edition
1442539178, 9781442539174
