MGAD65H3 Lecture Notes - Lecture 13: Fide, Dividend, Accrual

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14 Oct 2017

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Ch13 planning the use of a corporation and shareholder- manager. The shareholder of the ccpc is usually the president, ceo, or director of that corporation. > choose the compensation package( salary vs dividend) to min the income tax. Dividend: lower personal tax but pay from co after tax income, recovery of rdtoh. Sala(cid:396)(cid:455) : (cid:396)edu(cid:272)e (cid:272)o"s i(cid:374)(cid:272)o(cid:373)e, i(cid:374)(cid:272)lude i(cid:374) rrsp (must pay a reasonable amount of salary according to the value of the service his/her provided)=> if the co income above sbd limit, a reasonable bonus can reduce income. Accrued employee remuneration (such as salaries, wages, and retiring allowances, bonus and pension benefits) that are not paid before the year-end of the corporation must be paid within 179 days after the year-end to be deductible. If the corp. does not pay within 179 days of the year-end, then the accrued employee remuneration is deductible in the year it is paid instead of the year it is accrued.

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Selected transactions of Shadrach Computer Corporation duringNovember and December of 2016 are as follows:

Nov.	1	Borrowed money from the bank byissuing a non-interest-bearing, $58,000, 90-day note. The note isdiscounted on a 12% basis.
	9	Sold 125 computers with a 1-yearassurance-type warranty for $5,600 each on credit (ignore cost ofgoods sold). Past experience indicates that warranty costs average$110 per computer.
	12	Sold 125 software packages at $270each on credit (ignore cost of goods sold). With each softwarepackage, Shadrach offered a premium in the form of a USB drive forthe return of one proof of purchase. The offer expires June 30,2017. The cost of each USB drive is $5, and Shadrach estimates that80% of the premiums will be redeemed; therefore, 100 USB driveswere purchased on credit.
	20	Paid $2,000 in fulfillment of thewarranty agreement on several of the computers sold on November9.
	30	Accrued monthly vacation pay.Shadrach has 80 employees who are each paid an average of $180 perday. Shadrach has a policy of allowing each employee 12 daysâ paidvacation per year; the related liability is recorded on a monthlybasis. Employees are paid monthly.
	30	Paid monthly payroll. Grosssalaries were $430,000. No vacations were taken during November.Income tax withholdings of 20% are applicable to the salaries ofall employees. A F.I.C.A. tax of 8% for both employees andemployers is also applicable. These rates apply to all salariesbecause no employeeâs salary has exceeded the maximum wage limit.The state allows the corporation a 1% unemployment compensationmerit-rating reduction from the normal rate of 5.4%. The federalunemployment rate is 0.6%. Prior to October, each individualemployee had accumulated a gross salary in excess of $7,000 for2016.
Dec.	14	Twenty proofs of purchase werereturned from the November 12 sale.
	29	An individual filed suit againstShadrach for damages caused in a November 5 accident that resultedwhen a member of the sales force hit the individualâs car while onpersonal business. The amount of the suit filed was $1,450. Becausethe employee was on personal business, the companyâs insurancecompany will not pay the claim. In Shadrachâs attorneyâs opinion,the amount of the suit is reasonable; furthermore, the companybelieves it is likely to lose the suit.
	31	Accrued monthly vacation pay.
	31	Paid monthly payroll. Grosssalaries were $433,000. The salaries included $6,500 of vacationpay in the sales force and $3,300 of vacation pay in the officestaff. The F.I.C.A. tax rate still applies to all wages because noemployeeâs salary exceeded the maximum wage limit.
	31	Recorded presidentâs bonus. Thepresident receives a 10% bonus on any income over $240,000, beforededucting income taxes and the bonus. Shadrachâs effective incometax rate is 30%, and income before income taxes and bonus for 2016was $560,000. The bonus will be paid in January 2017.

	Required:
	Prepare journal entries torecord the preceding transactions of Shadrach Computer Corporationfor 2016. Include year-end accruals. Round all calculations to thenearest dollar.

Chart of Accounts

CHARTOF ACCOUNTS

Shadrach Computer Corporation

General Ledger

	ASSETS
111	Cash
121	Accounts Receivable
132	Inventory of Premiums
152	Prepaid Insurance
181	Equipment
189	Accumulated Depreciation

	LIABILITIES
211	Accounts Payable
221	Bonus Payable
222	Liability for CompensatedAbsences
224	FICA Taxes Payable
225	Federal Income Taxes WithholdingPayable
231	Salaries Payable
240	Estimated Warranty Liability
241	Estimated Premium Liability
245	Estimated Liability fromLawsuit
250	Unearned Revenue
260	Notes Payable
261	Discount on Notes Payable
271	Federal Income Taxes Payable

	EQUITY
311	Common Stock
331	Retained Earnings

	REVENUE
411	Sales Revenue

	EXPENSES
500	Cost of Goods Sold
511	Insurance Expense
512	Utilities Expense
521	Salaries Expense
522	Payroll Taxes Expense
532	Bad Debt Expense
540	Interest Expense
541	Depreciation Expense
551	Warranty Expense
552	Premium Expense
559	Miscellaneous Expenses
561	Loss from Accident
910	Income Tax Expense

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22) Boxer Corporation buysequipment in January of the current year with a 7-year class lifefor $15,000. The corporation expensed the $15,000 under Sec. 179.The deduction in the year of purchase for E&P purposes due tothe acquisition and expensing of the equipment is

	A. $14,000
	B. $15,000
	C. $1,500
	D. $3,000

23) Maxwell Corporation reportsthe following results:

Year	CurrentE&P	Distributions
2005	$6,000	$4,000
2006	5,000	1,000
2007	1,000	-0-

Maxwell's dividends-received deduction is

	A. $5,000
	B. $12,000
	C. $0
	D. $7,000

24) Identify which of thefollowing statements is false.

	A. At formation, acorporation's E&P depends on the amount of capital contributedby the shareholders.
	B. Adjustments totaxable income when computing E&P do not include tax exemptinterest.
	C. For E&Pdividend distribution purposes, property as defined in Sec. 317(a)includes money.
	D. The function ofE&P is to provide a measure of a corporation's economic abilityto pay dividends.

25) Exit Corporation hasaccumulated E&P of $24,000 at the beginning of the current taxyear. Current E&P is $20,000. During the year the corporationmakes the following distributions to its sole shareholder who has a$22,000 basis for her stock.

Date	AmountDistributed
April 1	$20,000
June 1	20,000
August 1	15,000
November 1	5,000

The treatment of the $15,000 August 1 distribution would be

	A. $4,000 is taxableas a dividend from accumulated E&P, and $11,000 is tax-free asa return of capital
	B. $5,000 is taxableas a dividend from current E&P and $10,000 is tax-free as areturn of capital
	C. $15,000 is taxableas a dividend; $5,000 from current E&P and the balance fromaccumulated E&P
	D. $15,000 is taxableas a dividend from accumulated E&P

26) Current E&P does notinclude

	A. tax-exemptinterest income
	B. life insuranceproceeds where the corporation is the beneficiary
	C. federal income taxrefunds from prior years
	D. All of the theseare included

27) Identify which of thefollowing statements is true.

	A. Section 179property must be expensed ratably over a 5-year period whencomputing E&P.
	B. Losses on propertysales to related parties are not deductible when computingE&P.
	C. Distributions madeout of accumulated E&P are allocated ratably between multipledistributions made during the tax year.
	D. All arefalse.

28) Crossroads Corporationdistributes $60,000 to its sole shareholder Harley. Crossroads hasearnings and profits of $55,000 and Harley's basis in her stock is$20,000. After the distribution, Harley's basis is

	A. $20,000
	B. $60,000
	C. $5,000
	D. $15,000

29) Hogg Corporation distributes$30,000 to its sole shareholder, Ima. At the time of thedistribution, Hoggs' E&P is $14,000 and Ima's basis in herstock is $10,000. Ima's gain from this transaction is

	A. $20,000 capitalgain
	B. $30,000 capitalgain
	C. $6,000 capitalgain
	D. $14,000 capitalgain

30) One consequence of aproperty distribution by a corporation to a shareholder is

	A. the amount of thedistribution is increased by any liability assumed by theshareholder
	B. any liabilitiesassumed by the shareholder do not reduce the shareholder'sbasis
	C. the shareholder'sbasis in the distributed property is the same as the distributingcorporation's basis
	D. the holding periodof the distributed property includes the holding period of thedistributing corporation

31) Identify which of thefollowing statements is true.

	A. The distributingcorporation's E&P must be reduced by the FMV of nontaxablestock rights distributed to shareholders.
	B. A stock redemptioncan be used to withdraw some assets from a corporation prior to asale of the business.
	C. A shareholder canredeem part of his stock and recognize a capital gain if thecorporation has only one shareholder.
	D. All arefalse.

32) Which of the following isnot a reason for a stock redemption?

	A. desire byremaining shareholders to retain control
	B. No outside marketexists for the stock.
	C. Redemption ofshares is a good corporate investment.
	D. desire byshareholders to reduce the corporate tax liability

33) Elijah owns 20% of ParkCorporation's single class of stock. Elijah's basis in the stock is$8,000. Park's E&P is $28,000. If Park redeems all of Elijah'sstock for $48,000, Elijah must report dividend income of

	A. $0
	B. $48,000
	C. $40,000
	D. $28,000

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It is now late May 2018 and you, CPA, have just finished meetingwith your partner, Ms. Wong. Ms. Wong wants your help with someclients of hers.

One client, Garden Supplies Co. (GSC) has had a new shareholderbuy shares. Ms. Wong wants you to tell her if GSC is a resident ofCanada for tax purposes in 2018 and describe the personal taxconsequences that Mrs. Gardiner will have from her 2018 share sale.You can ignore the acquisition of control rules. Also, given thelist of GSCâs 2018 expenditures in Exhibit I, calculate the total2018 expenses that are deductible in 2018 when computing net incomefor tax purposes. GSC is very profitable and wants to claim themaximum amount of deductions possible. You do not need to commenton non-deductible items.

Note: Additional information about GSC is provided in ExhibitI.

Another client, Mr. Rich, who is a non-resident of Canada, hasjust purchased a newly built townhouse in Canada for $1,500,000that he plans to rent out. The home was purchased on May 1, 2018and will be rented out starting on July 1, 2018. What Canadianincome tax obligations will Mr. Rich face in 2018? If you have anyrecommendations that will reduce Mr. Richâs Canadian income taxobligations (in 2018 or in future years) with respect to his rentalproperty, then you should provide them. Additional informationabout Mr. Rich is provided in Exhibit II.

Ms. Wong wants you to draft a memo to her answering herquestions. She says you can ignore provincial income taxes, ignoreforeign taxes and ignore any income tax treaties. Explain youranswers, show all your detailed calculations and give IncomeTax Act (ITA) section, subsection and paragraph (whereapplicable) references and Income Tax Regulations sectionand subsection references in order to support your answers. Whengiving references you must be specific. Do not just list multiplereferences!

Exhibit I

Garden Supplies Co.

Garden Supplies Co (GSC) is a private company that wasincorporated in Canada in 1963 by Mr. Taft. Mr. Taft subscribed for1,000 common shares in return for $100 (in aggregate). GSC does nothave any other shares outstanding

GSC has a December 31^st year-end and its board ofdirectors meetings are typically held in the United States(U.S.)

GSC operates gardening supply stores in Canada and it startedwith one store in Toronto in 1963. Now it has 10 stores throughoutCanada

In 2005, Mr. Taft sold his shares to Mrs. Gardiner for $1M inaggregate (which was their FMV at the time)

In late January 2018, Mrs. Gardiner sold 600 of her GSC commonshares for $3,000 per share to Marcus Jones, an armâs length person(she still owns 400 common shares of GSC)

In January 2018, Mrs. Gardiner paid $3,500 to a charteredbusiness valuator to value her GSC shares and paid $2,500 in legalfees related to her sale of GSC shares

The FMV of GSC was determined to be $3M

Mrs. Gardiner incurred $300 of safety deposit box rental fees in2018 and she keeps her GSC share certificates in her safety depositbox

Assume GSC is not a qualified small business corporation

Marcus Jones is a non-resident of Canada

In 2018 GSC incurred the following expenditures:

Income taxes paid of $124,500

Salary and wages expense paid of $390,000

In addition, GSC accrued a bonus payable to Mrs. Gardiner of$70,000 for work performed in 2018. This bonus will not be paiduntil May 31, 2019

Interest expense paid of $5,000 on a bank loan used to financebusiness operations

Dividends paid to shareholders of $55,000

Warranty expense accrued of $25,000 (based on estimated warrantycosts). The actual cost in 2018 of servicing warranties was$20,000

Purchased new shelving units to display merchandise on April 1,2018 for $200,000

Purchased new computer software for $3,000 on January 1,2018

Purchased goodwill for $40,000 as part of a business acquisitionon January 1, 2018

Purchased a patent, with an 18-year legal life remaining onDecember 31, 2018 for $10,000

Accrued office supply expenses of $12,000, for suppliespurchased (and used) in late 2018. Payment of this account payablewas made in early 2019

Paid $7,000 for Toronto Blue Jays (baseball) tickets used totake large customers out to games

Incurred $4,000 of legal fees related to obtaining bankfinancing, and

Incurred lobbying expenses of $1,300 for matters related to thebusiness

Assume all expenditures are reasonable unless otherwiseindicated

Assume the prescribed interest rate is 1% at all times

Exhibit II

Mr. Rich

Mr. Richâs rental income is property income; i.e., he is notrunning a business

Mr. Rich wants to minimize his Canadian rental income and hedoes not have any other Canadian income

Mr. Rich has prepared the following (assume that all theexpenses below are paid in 2018 and are reasonable):

Mr. Richâs Canadian Rental Income

For the year-ended December 31, 2018

Gross rental revenue ($4,000 permonth) $24,000

Mortgage interest ($2,200 permonth) $13,200

Property taxes ($610 permonth) $3,660

Maintenance and repairs ($500 permonth) $3,000

Insurance ($200 permonth) $1,200

Total expenses $21,060

Netincome $2,940

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MGAD65H3 Lecture Notes - Lecture 13: Fide, Dividend, Accrual

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