Repond 4

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Question 1

Many individuals have property that increases in value over time. Examples are homes, stocks and bonds, and artwork. Explain why the increase in these items, from year to year, is not considered gross income.

What do you think would happen if these increases were required to be included in gross income? (Consider actions of taxpayers and administrative issues the IRS might face.)

Consider discussing the tax concept of income, administrative convenience, and wherewithal to pay in your responses.

Respond to this…The increase in value on property is not considered gross income because it is not realized income. According to the text, the objective inscreases administrative conveneince. The taxpayer would understate the value increase on their taxes to reduce their tax liabilities. This could create a lot of arguments between taxpayers and the IRS. If the IRS decided that the value of said item was higher than the taxpayer, then there would be an argument about how much needs to be paid. The wherewithal to pay states that a taxpayer is in better stance to pay taxes once they sell their homes, than every year that the value increases. If these types of increases were to be included in gross income, I think there would be a lot more upset taxpayers than there are now. No one truly enjoys paying taxes, and if they had another thing to add to that it could become pretty complicated. The most difficult thing about having to include increase in value in gross income, is that there wouldn't be anyone to truly determine the amount of tax on the increase in value.

Pope, Thomas R. (2016.) Chapter 3: Gross Income: Inclusions. Prentice Hall's Federal Taxation 2016. Prentice Hall. Pg. 13-3 & 13-4.

Question 2

The importance of the Income Statement lends itself in explaining the success of a company in the current period, and how they will perform in the future. Whenever there is a financial crisis, accurate financial statements are a major concern.

What are the effects of accounting errors on the income statement? In addition, are there specific ways to ensure the validity of income statement accounts in your perspective? Support your answer with at least one example.

Respond to this… The income statement starts the process of the financial statements, any mistakes here and it throws off the rest of the numbers. The numbers that are put on this statement end up on the retained earnings, which lead to the balance sheet; they also are part of the Cash Flow Statement. Mistakes that happen here throw off final readings and do not give a proper accounting of the company. Ensuring that proper reporting is being done on the income statement is crucial to the end result that is presented to the SEC and for public viewing. To ensure that proper reporting is being done comes from two places, one is strong internal controls and two is an independent auditor looking over the statements. Expanding on the internal controls would include having limited access for the portion that a person works on, cross-training so that people can double check work and forced vacations. These policies make sure that other people are doing and looking at the work ensuring that proper reporting is being done. Having one person doing the job is not a good idea and is proven to lead to fraudulent behavior. The second part of an external auditor is fairly self-explanatory, but to expand on this I feel that external auditors should be rotated on a regular basis. Long term relationships can lead to cooperation amongst conspirators. Also the accountant or controller that is in charge of picking the auditor should not have the final say as to who that auditor will be. Multiple people need to do independent research to make a proper final decision. The picking of the auditor is part of the strong internal control process. With the insurance of a proper income statement, it can save the company millions is restatement fees, fines, law suits, and the confidence of the investing public.

Question 3

Introduce and explain the Capital Asset Pricing Model. What is it intended to calculate, and why is it useful in finance?

Respond to this… “The capital asset pricing model (CAPM) is a model that describes the relationship between risk and expected return and that is used in the pricing of risky securities” (Capital Asset Pricing Model - CAPM, n.d.).

CAPM calculates investment risk and what the return on the investment should be expected (McClure, n.d.).

Advantages (Zucchi, n.d.)

· “Ease-of-use: CAPM is a simplistic calculation that can be easily stress-tested to derive a range of possible outcomes to provide confidence around the required rates of return.

· Diversified Portfolio: The assumption that investors hold a diversified portfolio, similar to the market portfolio, eliminates unsystematic (specific) risk.

· Systematic Risk (beta): CAPM takes into account systematic risk, which is left out of other return models, such as the dividend discount model. Systematic or market risk is an important variable because it is unforeseen and often cannot be completely mitigated because it is often not fully expected.

· Business and Financial Risk Variability: When businesses investigate opportunities, if the business mix and financing differ from the current business, then other required return calculations, like weighted average cost of capital cannot be used. However, CAPM can.”

Capital Asset Pricing Model - CAPM. (n.d.). Retrieved April 24, 2016, from Investopedia: http://www.investopedia.com/terms/c/capm.asp

McClure, B. (n.d.). The Capital Asset Pricing Model: An Overview. Retrieved April 24, 2016, from Investopedia: http://www.investopedia.com/articles/06/capm.asp

Zucchi, K. (n.d.). The Advantages And Disadvantages Of The CAPM Model. Retrieved April 24, 2016, from Investopedia: http://www.investopedia.com/articles/investing/021015/advantages-and-disadvantages-capm-model.asp