Hank started a new business, Hankâs Donut World (HW for short),in June of last year. He has requested your advice on the followingspecific tax matters associated with HWâs first year of operations.Hank has estimated HWâs income for the first year as follows:(Do not round intermediate calculations.)
Revenue: Donut sales $ 298,000 Cateringrevenues 96,390 $ 394,390 Expenditures: Donutsupplies $ 153,220 Cateringexpense 39,640 Salaries to shopemployees 64,000 Rentexpense 49,940 Accidentinsurance premiums 8,952 Other businessexpenditures 9,610 - 325,362 Net Income
$ 69,028
HW operates as a sole proprietorship and Hank reports on acalendar year. Hank uses the cash method of accounting and plans todo the same with HW (HW has no inventory of donuts because unsolddonuts are not salable). HW does not purchase donut supplies oncredit nor does it generally make sales on credit. Hank hasprovided the following details for specific first-yeartransactions.
A small minority of HW clients complained about the cateringservice. To mitigate these complaints, Hankâs policy is to refunddissatisfied clients 50 percent of the catering fee. By the end ofthe first year, only two HW clients had complained but had not yetbeen paid refunds. The expected refunds amount to $2,850, and Hankreduced the reported catering fees for the first year to reflectthe expected refund.
In the first year, HW received a $7,440 payment from a clientfor catering a monthly breakfast for 30 consecutive monthsbeginning in December. Because the payment didnât relate to lastyear, Hank excluded the entire amount when he calculated cateringrevenues.
In July, HW paid $2,880 to ADMAN Co. for an advertising campaignto distribute fliers advertising HW's catering service.Unfortunately, this campaign violated a city code restrictingadvertising by fliers, and the city fined HW $480 for theviolation. HW paid the fine, and Hank included the fine and thecost of the campaign in âother businessâ expenditures.
In July, HW also paid $8,952 for a 24-month insurance policythat covers HW for accidents and casualties beginning on August 1of the first year. Hank deducted the entire $8,952 as accidentinsurance premiums.
On May of the first year, Hank signed a contract to lease the HWdonut shop for 10 months. In conjunction with the contract, Hankpaid $2,460 as a damage deposit and $9,200 for rent ($920 permonth). Hank explained that the damage deposit was refundable atthe end of the lease. At this time, Hank also paid $38,280 to leasekitchen equipment for 24 months ($1,595 per month). Both leasesbegan on June 1 of the first year. In his estimate, Hank deductedthese amounts ($49,940 in total) as rent expense.
Hank signed a contract hiring WEGO Catering to help caterbreakfasts. At year-end, WEGO asked Hank to hold the last cateringpayment for the year, $10,170, until after January 1 (apparentlybecause WEGO didnât want to report the income on its tax return).The last check was delivered to WEGO in January after the end ofthe first year. However, because the payment related to the firstyear of operations, Hank included the $10,170 in last yearâscatering expense.
Hank believes that the key to the success of HW has been hiringJimbo Jones to supervise the donut production and manage the shop.Because Jimbo is such an important employee, HW purchased aâkey-employeeâ term-life insurance policy on his life. HW paid a$6,250 premium for this policy and it will pay HW a $40,000 deathbenefit if Jimbo passes away any time during the next 12 months.The term of the policy began on September 1 of last year and thispayment was included in âother businessâ expenditures.
In the first year, HW catered a large breakfast event tocelebrate the cityâs anniversary. The city agreed to pay $8,480 forthe event, but Hank forgot to notify the city of the outstandingbill until January of this year. When he mailed the bill inJanuary, Hank decided to discount the charge to $6,420. On thebill, Hank thanked the mayor and the city council for theirpatronage and asked them to âsend a little more business our way.âThis bill is not reflected in Hankâs estimate of HWâs income forthe first year of operations.
a.
Hank files his personal tax return on a calendar year, but hehas not yet filed last yearâs personal tax return nor has he fileda tax return reporting HWâs results for the first year ofoperations. Explain when Hank should file the tax return for HW andcalculate the amount of taxable income generated by HW lastyear.
The tax return is due by Taxable income
b. Determine the taxable income that HW will generate if Hankchooses to account for the business under the accrual methodb
Taxable Income
Hank started a new business, Hankâs Donut World (HW for short),in June of last year. He has requested your advice on the followingspecific tax matters associated with HWâs first year of operations.Hank has estimated HWâs income for the first year as follows:(Do not round intermediate calculations.)
| Revenue: | |||||
| Donut sales | $ | 298,000 | |||
| Cateringrevenues | 96,390 | $ | 394,390 | ||
| Expenditures: | |||||
| Donutsupplies | $ | 153,220 | |||
| Cateringexpense | 39,640 | ||||
| Salaries to shopemployees | 64,000 | ||||
| Rentexpense | 49,940 | ||||
| Accidentinsurance premiums | 8,952 | ||||
| Other businessexpenditures | 9,610 | - | 325,362 | ||
Net Income | $ 69,028 | ||||
HW operates as a sole proprietorship and Hank reports on acalendar year. Hank uses the cash method of accounting and plans todo the same with HW (HW has no inventory of donuts because unsolddonuts are not salable). HW does not purchase donut supplies oncredit nor does it generally make sales on credit. Hank hasprovided the following details for specific first-yeartransactions.
A small minority of HW clients complained about the cateringservice. To mitigate these complaints, Hankâs policy is to refunddissatisfied clients 50 percent of the catering fee. By the end ofthe first year, only two HW clients had complained but had not yetbeen paid refunds. The expected refunds amount to $2,850, and Hankreduced the reported catering fees for the first year to reflectthe expected refund.
In the first year, HW received a $7,440 payment from a clientfor catering a monthly breakfast for 30 consecutive monthsbeginning in December. Because the payment didnât relate to lastyear, Hank excluded the entire amount when he calculated cateringrevenues.
In July, HW paid $2,880 to ADMAN Co. for an advertising campaignto distribute fliers advertising HW's catering service.Unfortunately, this campaign violated a city code restrictingadvertising by fliers, and the city fined HW $480 for theviolation. HW paid the fine, and Hank included the fine and thecost of the campaign in âother businessâ expenditures.
In July, HW also paid $8,952 for a 24-month insurance policythat covers HW for accidents and casualties beginning on August 1of the first year. Hank deducted the entire $8,952 as accidentinsurance premiums.
On May of the first year, Hank signed a contract to lease the HWdonut shop for 10 months. In conjunction with the contract, Hankpaid $2,460 as a damage deposit and $9,200 for rent ($920 permonth). Hank explained that the damage deposit was refundable atthe end of the lease. At this time, Hank also paid $38,280 to leasekitchen equipment for 24 months ($1,595 per month). Both leasesbegan on June 1 of the first year. In his estimate, Hank deductedthese amounts ($49,940 in total) as rent expense.
Hank signed a contract hiring WEGO Catering to help caterbreakfasts. At year-end, WEGO asked Hank to hold the last cateringpayment for the year, $10,170, until after January 1 (apparentlybecause WEGO didnât want to report the income on its tax return).The last check was delivered to WEGO in January after the end ofthe first year. However, because the payment related to the firstyear of operations, Hank included the $10,170 in last yearâscatering expense.
Hank believes that the key to the success of HW has been hiringJimbo Jones to supervise the donut production and manage the shop.Because Jimbo is such an important employee, HW purchased aâkey-employeeâ term-life insurance policy on his life. HW paid a$6,250 premium for this policy and it will pay HW a $40,000 deathbenefit if Jimbo passes away any time during the next 12 months.The term of the policy began on September 1 of last year and thispayment was included in âother businessâ expenditures.
In the first year, HW catered a large breakfast event tocelebrate the cityâs anniversary. The city agreed to pay $8,480 forthe event, but Hank forgot to notify the city of the outstandingbill until January of this year. When he mailed the bill inJanuary, Hank decided to discount the charge to $6,420. On thebill, Hank thanked the mayor and the city council for theirpatronage and asked them to âsend a little more business our way.âThis bill is not reflected in Hankâs estimate of HWâs income forthe first year of operations.
a.
Hank files his personal tax return on a calendar year, but hehas not yet filed last yearâs personal tax return nor has he fileda tax return reporting HWâs results for the first year ofoperations. Explain when Hank should file the tax return for HW andcalculate the amount of taxable income generated by HW lastyear.
| The tax return is due by | |
| Taxable income |
b. Determine the taxable income that HW will generate if Hankchooses to account for the business under the accrual methodb
| Taxable Income |
