Reference no: EM132223502 , Length: 6 pages

Question 1

Ziggy's Inc. is a retailer of highly specialized clothing that opened for business on May 1, 2016, in a leased store in a strip mall. A condensed income statement for Ziggy's Inc. for its year, ended December 31, 2018, shows the following:

Ziggy's Inc.

Condensed Income Statement

For the Year Ended December 31, 2018

unaudited

Sales	$ 1,932,000
Cost of sales	(1,439,000)
Gross profit	493,000
General and administrative expense	(279,000)
Other	(54,000)
Income before income taxes	160,000
Income tax expense	(13,000)
Net income	$    147,000

1. An analysis of the cost of sales account revealed that the inventory is valued at average cost within each of the different styles carried. Since the owner is still learning what has appeal, a "mark-down rack" has become a common fixture at the back of the store. The tagged prices of the mark-downs are less than their costs, at December 31, 2018 by $700. This difference has not been recorded in the financial statements.

2. Cost of goods sold includes a charge of $1,800 to set up an allowance for returns (at 0.1% of sales) that are not subsequently saleable at full retail price. No such allowance was recorded last year-end because the company only discovered that the allowance was necessary this year.

3. General and administrative expenses include the following:

Contributions to a registered pension plan made monthly for the two key employees, expensed by the corporation's accountant, were as follows:

	Registered Pension Plan	Employment compensation
President and CEO	$21,000	$190,000
Store manager	$12,800	$130,000

The pension plan is a defined contribution (money-purchase) plan. The contributions above were matched by equal contributions made by the employee.

4. The company paid the following amounts to Sun Insurance Limited during the year:

a)      Group term life insurance for the four full-time employees	$2,200
b)      $200,000 term life insurance policy on the president, which was included in the "Insurance" expense account	900
	$3,100

Ziggy's Inc. is the beneficiary of the insurance policy on the president. The term life insurance policy on the president was assigned to the bank as collateral for a $500,000 loan from January 1 through August 30, 2018. The loan was repaid on September 1, 2018 in favour of an operating line of credit.

5. The following selected information was taken from the "Promotions" account:

a)      Charitable donation to the local United Way	$   4,500
a)      Political contributions to the local politicians	2,500
b)      Hockey tickets given to suppliers as Christmas gifts	2,800
c)      Meals and entertainment incurred by the owner while negotiating with suppliers	2,000
d)      Golf green fees incurred while entertaining suppliers	1,800
e)      Two customer parties and one staff party - full costume occasions (staff and "significant others" make up about one-third of the attendees)	12,000
Account total	$ 25,600

6. The company's "Professional expense" account included the following legal and accounting fees:

a)  Accounting fees for yearend work and monthly bookkeeping	$15,000
b)Legal fees incurred on the purchase of capital assets during the year	2,000
c)Legal and accounting fees incurred in connection with negotiations for a line of credit at the bank	4,000
Account total	$21,000

7. In 2017, the company incurred fees of $1,000 to issue shares to the president and CEO.

8. Other expenses deducted in the financial accounting computation of income include:

a) Depreciation and amortization	$47,000
b)Interest on the loan and operating line of credit	7,500
c)Interest on insufficient income tax instalments	400
d)Purchase of additional store fixtures bought at a going-out-of-business sale; expensed due to their small dollar amount	1,500
e)Damages under a breach of contract suit initiated by a supplier	1,700
Total	$58,100

9. Added to the capital asset account for leasehold improvements this year is $15,000. This amount represents the store's share of new landscaping of the strip mall premises that was undertaken after road work was done in front of the mall.

10. You have correctly determined that Ziggy's Inc. is entitled to a $50,000 capital cost allowance amount claim in 2018.

Required:

Based on the foregoing information, Compute the income from business for tax purposes for Ziggy's Inc. for its 2018 fiscal year.
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.

Question 2

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.

B New 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.

C Three 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. The remaining 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.