TalkTech Inc. is a manufacturer and wholesaler of cellular communication products. TalkTech Inc's customers are retailers who promote TalkTech Inc's products to the general public. TalkTech Inc. has an October 31 year-end. You are conducting a review of TalkTech Inc's year-end accounting records for its 2012 fiscal year and have been provided with the following information.
TalkTech Inc. has the following recorded reserves:
AccountOpeningAdditionsSubtractionsClosing
Warranty reserve$35,000$10,000 $17,500$27,500
Allowance for
Doubtful accounts32,0007,500 5,00034,500
TalkTech Inc. provides a 1-year warranty on most of its products. The warranty is for defects in workmanship or component parts. This warranty is provided as part of the purchase price of TalkTech Inc's products. TalkTech Inc. honours its own warranties. The 2012 addition of $10,000 represents a standard percentage of sales made in the 2012 fiscal period. The 2012 subtraction of $17,500 represents an amount actually paid to honour warranties.
The addition of $7,500 to the allowance for doubtful accounts is a result of the application of TalkTech Inc's annual year-end aging analysis. In conversation with the controller of TalkTech Inc. you determine that this $7,500 increase in the allowance for doubtful accounts was computed by applying the company's historical collection percentages to the aged accounts receivable balances. Also, during its 2012 fiscal period, TalkTech Inc. wrote off $5,000 (the subtraction noted above) of amounts previ¬ously expensed and included in the opening allowance for doubtful accounts. TalkTech Inc. also ended up collecting $1,500 of previously written-off bad debts.
In an attempt to attract a particular retail customer, TalkTech Inc. provided this new customer with an incentive to make a large initial purchase of its products. On April 1, 2012, TalkTech Inc. sold $300,000 worth of cellular phones to CellBlock Limited. TalkTech agreed to the following payment terms in an attempt to entice CellBlock Limited to make the purchase:
• $100,000 due and payable May 1, 2012; and
• $50,000 due and payable January 1 each year starting January 1, 2013 through January 1, 2016.
The cost of the good sold under this contract was $180,000. The delivery date for the cellular phones sold under this contract was May 1, 2012.
One of TalkTech's customers, Phones'N'Things, was experiencing financial trouble. As a result, TalkTech Inc. had agreed to make shipments only if payments were received well in advance of the anticipated shipping dates. Under the terms of this agreement, TalkTech Inc. received $40,000 from Phones'N'Things on September 30, 2012. This payment was an advance payment for a shipment of new technology cellular phones which TalkTech Inc. expected to be shipping to customers commencing February 1, 2013. In the event that TalkTech Inc. was unable to honour its contract with Phones'N'Things, a full refund of the $40,000 was payable.
REQUIRED
(A) Prepare a schedule showing the effect of the above information on income for tax purposes of TalkTech Inc. for the year ended October 31, 2012. From this comparison, determine any adjustments that would be necessary to reconcile accounting income and income for tax purposes for the year.
(B) What would be the tax consequences if the $5,000 subtraction in the allowance for doubtful accounts in 2011 included an account receivable of $800 which was written off only because it has been outstanding for more than 180 days. In fact, it has been outstanding for one year and is part of the opening allowance of $32,000. This $800 could still be collected and there has been no serious attempt to collect it. In fact, the remainder of that customer's account is current and further sales have been made to that customer.