Explore BrainMass

Determine the effect of transactions on Joe's taxable business income

Joe operates a business that locates and purchases specialized assets for clients, among other activities. Joe uses the accrual method of accounting but he doesn't keep any significant inventories of the specialized assets that he sells. Joe reported the following financial information for his business activities during year 0. Determine the effect of each of the following transactions on the taxable business income.

a. Joe has signed a contract to sell gadgets to the city. The contract provides that sales of gadgets are dependent upon a test sample of gadgets operating successfully. In December, Joe delivers $12,000 worth of gadgets to the city that will be tested in March. Joe purchased the gadgets especially for this contract and paid $8,500.

b. Joe paid $180 for entertaining a visiting out-of-town client. The client didn't discuss business with Joe during this visit, but Joe wants to maintain good relations to encourage additional business next year.

c. On November 1, Joe paid $600 for premiums providing for $40,000 of key man insurance on the life of Joe's accountant over the next 12 months.

d. At the end of the year (year 1), Joe's business reports $9,000 of accounts receivable.
Based upon past experience, Joe believes that at least $2,000 of his new receivables will be uncollectible.

e. In December of year 0, Joe rented equipment for a large job. The rental agency required a minimum rental of three months ($1,000 per month), but Joe completed the job before year-end.

f. Joe hired a new sales representative as an employee and sent her to Dallas for a week to contact prospective out-of-state clients. Joe ended up reimbursing his employee $300 for airfare, $350 for lodging, $250 for meals, and $150 for entertainment. Joe requires the employee to account for all expenditures in order to be reimbursed.

g. Joe uses his BMW (a personal auto) to travel to and from his residence to his factory. However, he switches to a business vehicle if he needs to travel after he reaches the factory. Last month, the business vehicle broke down and he was forced to use the BMW both to travel to and from the factory and to visit work sites. He drove 120 miles visiting work sites and 46 miles driving to and from the factory from his home.

h. Joe paid a visit to his parents in Dallas over the Christmas holidays. While he was in the city, Joe spent $50 to attend a half-day business symposium. Joe paid $200 for airfare, $50 for meals during the symposium, and $20 on cab fare to the symposium.

Solution Preview

A. These are deferred revenue and expense. They will not affect tax of current accounting year assuming it ends Dec 31. They will be recognized the following March.

B. Since the entertainment did not include business, The 50% rule applies. He can deduct $90.

C. The prepaid insurance will be accrued and allocated over 12 months. For current accounting year $100 will be recognized as a deductible expense. ($600/12= $50 a month. Nov+Dec +$100)

D. Amounts recorded in Accounts receivable were recorded as revenue when it ...