Accounting Form 2

I. Title: Preparation of a Corporate Income Tax Return Using IRS Form 1120 II. Introduction: In prior learning demonstrations, you conducted tax research and prepared the 20X5 Form 1040 for Jerome and Debra Horowitz, one of the firm’s clients for many years. Given your outstanding performance conducting research and preparing the Horowitz’s tax return, your boss promoted you to the corporate income tax preparation department. Given your professional goal is to become a senior partner of the firm someday, moving up to the corporate tax department is right in sync with your career aspirations. This hypothetical tax case includes one (1) main activity:

! Preparing a federal corporate income tax return using IRS Form 1120. Throughout this learning demonstration, your professor will play the role of a senior partner in the taxation department with whom you discuss various issues and submit draft documents for approval in advance of communicating with clients. To successfully complete this Learning Demonstration, you must demonstrate your knowledge of and abilities to complete the following goals and competencies: Goal 1: Communication: Learners demonstrate ability to communicate clearly both orally and in writing.

o Competencies: ! 1.1 Organize document or presentation clearly in a

manner that promotes understanding ! 1.2 Develop coherent paragraphs or points so that each is

internally unified and so that each functions as part of the whole document or presentation

! 1.3 Provide sufficient, correctly cited support that substantiates the writer’s ideas

! 1.4 Tailor communications to the audience ! 1.5 Use sentence structure appropriate to the task, message

and audience ! 1.6 Follow conventions of Standard Written English

Goal 2: Critical Thinking: Learners demonstrate ability to apply logical, systematic decision-making processes to formulate clear, defensible ideas and to draw ethical conclusions.

o Competencies: ! 2.1 Articulate and frame the issue

! 2.2 Collect and evaluate information ! 2.3 Evaluate the underlying causes or conditions of

elements contributing to an issue ! 2.4 Use systems thinking to arrive at a decision in the

context of an issue ! 2.5 Apply ethical principles when determining actions.

Goal 3: Quantitative Reasoning: Learners demonstrate the ability to use mathematical operations and analytical concepts and operations to address problems and to inform decision-making

o Competency ! 3.1 Construct models that represent real-world problems or

processes ! 3.2 Develop visible representation of data ! 3.3 Analyze data using mathematical/algebraic operations ! 3.4 Use calculated results to inform the problem or process

Goal 4: Leadership, Facilitation, and Collaboration: Learners lead, facilitate, and collaborate with a variety of individuals and diverse teams to achieve organizational objectives.

o Competency ! 4.1 Demonstrate an ability to plan a particular objective or

goal

Goal 9: Functional Competencies for Federal Taxation: Learners demonstrate an applied understanding of U.S. federal income tax laws for individuals and business entities used in the professions and in accordance with U.S. Internal Revenue Code.

! Competencies: o 9.1 Legal and regulatory: Students demonstrate a general

understanding of the Internal Revenue Code. o 9.3 Measurement and reporting. Prepare a federal income tax

return for a corporation o 9.4 Decision Making: Apply tax laws, regulations, and court cases

to individual situations, identifying and communicating planning opportunities and compliance needs.

o 9.5 Communication: Effectively communicate relevant tax information based on specific reporting requirements of the U.S. Internal Revenue Service or other U.S. taxing authorities in U.S. commonwealths and territories.

As the newest member on the corporate tax department team, the senior partner assigns you to prepare corporate tax returns for Mike’s Sporting Goods, Inc.

Mike’s Sporting Goods, Inc., is a Maryland C-Corporation that sells athletic shoes and clothing to sports teams at the college level. The company was originally started by Mike Jones and three guys he met while attending UMUC, all of whom were state champions in various sports. Juan Delaross was a swimmer who won the state championship with his killer butterfly stroke in the 100-meter fly. Elroy Mulcane was the college champion in golf and Scott Barnett was the state cycling champion three years in a row. Mike won the state championship as a sprinter all four years of college.

Starting the company was Mike’s idea, he owns the largest percentage of stock, and is the only owner who works in the business. The other three investors brought money to the table, but never planned on working in the sporting goods store. Therefore, no one questioned Mike when he suggested naming the corporation Mike’s Sporting Goods, Inc. In addition, Mike has always had a strong desire to be known as the big guy on campus even after graduation. See Appendix A for more corporate data on Mike’s Sporting Goods, Inc.

Location As the old saying goes, Location, location, location. Luckily, Juan is a commercial real estate broker with a reputation for finding the perfect location for small businesses. After showing the location to the other investors, everyone agreed it would attract their target market of young athletic enthusiasts. As corporate officers, Mike and Juan signed a ten-year lease that required $9,200 per year in rent.

The building was built just a few years ago, so minimal expense was projected for maintenance and repairs. In 20Y5 (read as Year 5), Mike kept repairs expense down to $800, which really pleased Juan, Elroy, and Scott.

Corporate investments During 20Y5, Mike’s Sporting Goods, Inc. received the following investment incomes:

! Interest from its own Accounts Receivables = $1,500 ! Interest from corporate bonds = $4,000 ! Interest from tax-exempt state bonds = $5,000 ! Dividends from various U.S. corporations = $10,000

o All of which qualifies for the 80% dividends-received deduction because Mike’s Sporting Goods, Inc. is a 20%-or-more owner.

Since Mike’s Sporting Goods, Inc. did not have a net operating loss, its only entry on line 29 is the dividends-received deduction of $8,000 from Schedule C, page two.

Year-end 20Y5, includes a $3,600 capital losses from the sale of securities.

Revenue from Sales The corporation, which uses an accrual basis of accounting on a calendar year, brought in $2,010,000 in gross sales in 20Y5. Just less than 1% of gross sales were returned, thus bringing net sales to $1,990,000. Thanks to Mike’s purchasing savvy, cost of goods sold was $1,520,000, which is less than the industry standard of 80% of sales. Gross margin or gross profit as some refer to it was $470,000.

Expenses:

Advertising While the stockholder’s had intended on spending more on advertising, Mike only spent $8,700 and most of it was in Website development.

Bad debt expense The corporation uses the specific account write off method for uncollectible accounts receivable. A total of $1,600 in accounts receivable were written off in 20Y5.

Charitable contributions During the year, Mike’s Sporting Goods, Inc. contributed $11,400 to the UMUC Traveling Athletes Fund and $12,600 to the UMUC Athletic Scholarship Fund.

Depreciation

Mike’s Sporting Goods, Inc. reports $1,620 on line 8a. This is the difference between the depreciation claimed on the tax return and the depreciation shown on the corporation's books, which is $3,580.

Depreciation from Form 4562 (not illustrated) is $17,600. Enter it on line 20. Reduce this amount by the depreciation ($12,400) included in the amount claimed on line 5 of Schedule A and enter it on line 21a. Deduct the balance of $5,200 on line 21b since it is the depreciation on the assets used in the indirect operations of the business.

This includes all deductions claimed for tax purposes but not recorded in the corporation's books.

Interest expense: Mike’s Sporting Goods, Inc. incurs interest expense on debt to finance operations and to buy investments when a deal is just too good to pass up. Elroy is a securities broker with a national brokerage firm, therefore he handles all corporate investments. In 20Y5, the corporation accrued $27,200 in interest expense plus $850 in interest on notes used to carry tax-exempt state bonds.

Salaries When the corporation was first formed, the four corporate officers agreed to keep their salaries low for the first five years to allow the business to grow. Thus, they agreed to pay Mike $55,000 per year, since he will manage the store, and $5,000 per year to the other stockholders.

Thereby, total officers salaries will be $70,000 per year for the first five years. Hint: use Schedule E.

Since Mike will be handling the ordering, inventory management, and other administrative tasks, all employees will be in sales. Given the nature of sporting goods stores, everyone agreed the staff should be college students currently attending UMUC. Their goal was to keep wages below $50,000 per year. In 20Y5, Mike managed to keep total wages at $44,000.

Rent on the retail facility was $9,200 per year.

The company paid $15,000 in deductible taxes this year.

All other operating expenses All other operating expenses of Mike’s Sporting Goods, Inc. total $78,300. These expenses include the following:

Other operating expenses: Legal & professional services 5,000 Office supplies & other office expenses 8,100 Sales commissions 65,200 Total other expenses $78,300

To review a Partial Trial Balance, the company’s Income Statement per Book, and Balance Sheet per Book, see Appendices B, C, & D. All transactions affecting Retained Earnings are depicted in T-account format in Appendix E.

Taxes and credits Taxes:

At December 31, 20Y5, the corporation had $55,387 in accrued federal income taxes.

Mike’s Sporting Goods, Inc. made four estimated tax payments totaling $69,117 as follows:

! $17,280 on 4/15/20Y5 ! $17,280 on 6/15/20Y5 ! $17,280 on 9/15/20Y5 ! $17,277 on 1/15/20Y6

See photocopies of the cancelled checks in Appendix F.

Tax Credits:

The work opportunity credit is an incentive to hire persons from groups with a particularly high unemployment rate or other special employment needs. Given the high unemployment rate of college students, Mike’s Sporting Goods, Inc. is eligible for a $6,000 work opportunity credit. Hint: use Form 5884.

Reconciling Book to Return:

Mike’s Sporting Goods, Inc. has the following non-deductible expenses on its Income Statement Per Books:

Premiums paid on term life insurance on corporate officers $9,500 Interest paid to purchase tax-exempt state bonds 850 Nondeductible contributions 500 Reduction of salaries by work opportunity credit 6,000 Total $16,850

Deductible taxes totaled $15,000.

If Mike’s Sporting Goods, Inc. owes income tax, the corporation will mail a check; if, otherwise, credit any overpayment to next years estimated taxes.

III. Steps to Completion:

Prepare IRS Form 1120

1. Prepare Schedules M-1: Reconciliation of Income (Loss) per Books with Income per Return using financial data in the Appendices.

2. Prepare Schedule M-2: Analysis of Unappropriated Retained Earnings per Books using financial data in the Appendices.

IV. Deliverables:

Form 1120 with the following schedules:

! M-1 ! M-2

List of Appendices:

! Appendix A: Basic corporate information

! Appendix B: Partial Trial Balance

! Appendix C: Income Statement (per Books)

! Appendix D: Balance Sheet (per Books)

! Appendix E: Statement of Retained Earnings (per Books)

! Appendix F: Cancelled checks

! Appendix G: Supplemental disclosures

Appendix A: Mike’s Sporting Goods, Inc. Basic corporate information Corporate Name Mike’s Sporting Goods, Inc.

Corporate Address 422 Bruce Lane

Annapolis, MD 21401

Federal Tax ID 52-9746858

IRS Business Activity Code

451110

Corporate officers:

President/CEO Michael S. Duke 19% ownership

Vice President Juan Delaross 10% ownership

Treasurer Elroy Mulcane 10% ownership

Secretary Scott Barnett 10% ownership

Other stockholders

Marsha Duke (Michael’s mother) 15% ownership

Samantha Duke (Michael’s wife) 9% ownership

Tara Delaross (Juan’s wife) 9% ownership

Niesha Mulcane (Elroy’s wife) 9% ownership

Niki Barnett (Scott’s wife) 9% ownership

Total 100% ownership

Appendix B: Mike’s Sporting Goods, Inc. Partial Trial Balance

Partial Trial Balance

Account Debit Credit

Advertising 8,700

Bad debts 1,600

Charitable Contributions to Not-for-Profit organizations 24,000

Charitable Contributions to political campaigns 500

Compensation of officers 70,000

Cost of goods sold 1,520,000

Depreciation--indirect 3,580

Dividends received 10,000

Federal income tax accrued 55,387

Interest expense on note to buy tax-exempt state bonds 850

Interest expense on note to buy corporate bonds 27,200

Interest income on tax exempt state bonds 5,000

Interest income on taxable corporate bonds 5,500

Loss on securities 3,600

Maintenance and Repairs 800

Net income per books after tax 147,783

Other expenses of operations 78,300

Premiums on life insurance 9,500

Proceeds from life insurance 9,500

Equipment rental expense 9,200

Salaries and wages--indirect 44,000

Sales - gross $2,010,000

Sales returns and allowances 20,000

Taxes 15,000

Total $2,040,000 $2,040,000

Appendix C: Mike’s Sporting Goods, Inc. Income Statement (per Books)

Mike’s Sporting Goods, Inc. Income Statement (per Books)

Year ending 20Y5 Revenue: Gross sales $ 2,010,000 Less: Returns & allowances $ 20,000 Net sales 1,990,000 Cost of goods sold 1,520,000 Gross Margin 470,000 Operating expenses: Advertising 8,700 Bad debt 1,600 Charitable contributions: Deductible $ 24,000 Non-deductible 500 24,500 Depreciation 3,580 Equipment rental 9,200 Life insurance 9,500 Maintenance & repairs 800 Officers compensation 70,000 Salaries and wages 44,000 Total operating expenses 171,880 Operating Income $298,120 Other revenue and gains: Dividend income $ 10,000 Interest income: Maryland bonds 5,000 Interest income: All other bonds 5,500 Proceeds from life insurance 9,500 Total other revenue and gains 30,000 Other expenses and losses: Accrued federal income taxes $ 55,387 Other operating expenses 78,300 Loss on investments 3,600 Total other expenses and losses 137,287 Total income before interest & taxes $ 190,833 Interest expense on note to purchase tax-exempt bonds

$ 850

Interest expense on all other notes 27,200 $ 28,050 Income before tax $ 162,783 Less: Income tax 15,000 Net income per books after tax $ 147,783

Appendix D: Mike’s Sporting Goods, Inc. Comparative Balance Sheet per Books

Mike’s Sporting Goods, Inc. Balance Sheet per Books

December 31, 20Y5

Year Ending 20Y4 Year ending 20Y5 Assets Cash $ 14,700 $ 28,331 Accounts receivable (net) 98,400 103,700 Inventory 126,000 298,400 Tax-exempt securities 100,000 120,000 Other current assets 26,300 17,266 Other investments 100,000 80,000 Buildings $ 272,400 $ 296,700 Accumulated depreciation 88,300 184,100 104,280 192,420 Land 20,000 20,000 Other assets 14,800 19,300 Total assets $ 684,300 $ 879,417 Liabilities & Stockholder’s Equity Accounts payable $ 28,500 $ 34,834 Notes payable (short term) 4,300 4,300 Other current liabilities 6,800 7,400 Notes payable (long term) 176,700 $ 264,100 Total Liabilities $216,300 $310,634 Stockholder’s Equity Common stock $ 200,000 $ 200,000 Retained earnings: Appropriated 30,000 40,000 Retained earnings: Unappropriated 238,000 328,783 Total Stockholder’s Equity $ 468,000 $ 568,783 Total liabilities & Stockholder’s Equity $ 684,300 $ 879,417

Appendix E: General ledger Retained Earnings account in T-account format

Appendix F: Canceled checks

Appendix G: Supplemental Disclosures

• The company uses the accrual method of accounting • The company uses the Lower of Cost or Market when valuing inventories. • Inventory acquired for resale is subject to the rules of section 263A. • There were no changes in determining inventory quantities, cost, or

valuation between the opening and closing inventory. • The corporation was not a subsidiary of any other corporation.