You have been asked to prepare the Schedule 1 (reconciliation of accounting net income to taxable income
Question:
You have been asked to prepare the Schedule 1 (reconciliation of accounting net income to taxable income ) for X Ltd., a Canadian controlled private corporation (20% retail and 80% manufacturing business). The following income statement and miscellaneous financial information for the year ended December 31st. 2021 has been provided to you for this purpose.
Sales……………………………………………………………………………………………………...$5,600,000
Cost of sales……………………………………………………………………………….2,400,000
Gross Profit…………………………………………………………………………….$3,200,000
EXPENSES:-
General and administrative expenses……………………………….$400,000
Depreciation & Amortization…………………………………………….. 100,000
Interest………………………………………………………………………………. 80,000………......... (580,000)
Gain on disposal of fixed assets……………………………………………………………………...... 85,000
Net Income before taxes……………………………………………………………………………..…$2,705,000
Income taxes:-
Current………………………………………………….……………………….$600,000
Deferred………………………………………………….…………………… 340,000……………… (940,000)
Net Income after taxes………………………………………………………………………………….$1,765,000
During your review of the working paper file and last year’s tax return, you have made the following note to yourself, because you think that there might be tax implications associated with these items.
i. Included in the cost of sales is a reserve for a possible decline in the market value of finished goods inventory of $57,000. There is also an obsolescence reserve of $200,00 for some raw materials that were purchased from a supplier and were later found to be defective and worthless. So far the supplier has refused to allow X to return the materials for a refund.
ii. The gain on disposal of fixed assets consists of the accounting gain on the sale of some land for $415,000 on May 30th.2021 and the sale of a limited franchise for $4,000 on July 15th,2021. X had purchased the land on January 15th. 2021 for $325,000. The land was purchased with the intention of it being used to expand the manufacturing operations. After purchasing the property X received some bad publicity and complaints regarding the expansion plan as the land was relatively close to a new subdivision. The management group of X decided to sell the land and expand its operation on its current location instead. Real estate commission of $15,000 was paid in relation to the sale. X expanded its manufacturing space by constructing a new building adjacent to its current manufacturing plant. The construction of the new building started on March 1st. 2020 and was completed on June 30th, 2021. The completed cost on this building was $1,200,000.
The licence was purchased in 2018 for $6,000 and at the time it was sold the undepreciated capital cost was $6,000. At the time of sale it was the only asset in the class.
The CCA rate on new residential buildings is 6%.
iii. General and administrative expenses include:-
a. Donations of $63,000 to registered charities and $1,000 to
political parties of Canada……………………………………………………………………….$64,000
b. Accrued bonuses paid July 5th..2022…………………………………………………….. 44,000
c. Golf club membership fees paid on behalf of the President……………………10,000
d. Costs of issuing shares…………………………………………………………………………….80,000
e. Accrual for a potential settlement to a former employee for an injury received on the job.
X was informed of the pending lawsuit on December 18th.2021…………………60,000
f. Salaries and benefits. This account shows contributions for certain employees to the Company’s registered pension plan. The pension plan is a defined contribution plan where the employer is obliged to match dollar for dollar the employees’ contributions.
Salaries…………….……….……….Contribution to RPP
President…………………………………..$300,000………………..............$18,000
Vice-President……………………………$200,000………………..............$15,000
Accountant…………………………………$80,000…………………...............$7,000
g. Appraisal costs on the new building…………………………………………................................$.5,000
h. Payments made to the Sunlife Insurance Company for:-
Group term life insurance on all employees………………………………………..$3,000
$200 per month premium on life insurance policy on President………….$2,400
On May 1st. 2021, the Bank made a loan to the Company and held the insurance policy of the President as collateral.
Required:
Prepare the requested reconciliation. Clearly show all your supporting schedules.
