# C11-Chp-05-3P-Compute-Earnings-and-Profits

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Tab:Problem                  File:e572505b-8be3-4b62-b9a8-7831da360ca1.xls

Compute Earnings & Profits
Davis Corporation, an accrual method taxpayer,
Davis had accumulated E & P of \$100,000 as of December 31, 2004.
For the 2005 tax year, Davis' books and records reflect the following:
Sales                                                                   \$700,000
Cost of sales                                            \$400,000
Municipal bond interest                                                   2,000
Compensation                                              100,000
Meals and entertainment (Gross)                            20,000
Payroll taxes, and Miscellaneous Expense                  140,000
Subtotal                                                    660,000      702,000
Net Income before taxes                                      42,000
Total                                                      \$702,000     \$702,000
Davis does not have any carryover of losses, deductions or credits to this year.
The company does not qualify for any credits in the current year.
You may ignore the impact of state income taxes.
What is the amount of accumulated E & P as of December 31, 2005?
a. \$134,500 b. \$187,000 c. \$250,000        d. \$313,000 e. None of these
First Compute Taxable Income & Income Tax                   Debit       Credits
Sales                                                                            \$700,000
Cost of sales                                                         \$400,000
Municipal bond interest                                                             2,000
Compensation                                                           100,000
Meals and entertainment (Gross)                                         20,000
Payroll taxes, & Misc. Expense                                         140,000
Subtotal                                                               660,000    702,000
Net Income (GAAP) before taxes
Deduct: municipal bond interest
Taxable income
Income Tax
Compute Earnings & Profits (Similar to Retained Earnings)
Taxable Income
Federal income taxes                                                  Subtract
Nondeductible entertainment                                           Subtract
Equals: Current Earnings and Profits
Add: Accumulated E&P at first of year
Total
Less: Dividends paid
Earnings and Profits at End of Year
Note: E & P is reduced by nondeductible expenses that reduce
dividend paying ability - such as non-deductible entertainment expense.
5-23
Tab:Solution                  File:e572505b-8be3-4b62-b9a8-7831da360ca1.xls

Compute Earnings & Profits
Davis Corporation, an accrual method taxpayer,
Davis had accumulated E & P of \$100,000 as of December 31, 2004.
For the 2005 tax year, Davis' books and records reflect the following:
Sales                                                                  \$700,000
Cost of sales                                            \$400,000
Municipal bond interest                                                  2,000
Compensation                                              100,000
Meals and entertainment (Gross)                            20,000
Payroll taxes, and Miscellaneous Expense                  140,000
Subtotal                                                    660,000     702,000
Net Income before taxes                                      42,000
Total                                                      \$702,000    \$702,000
Davis does not have any carryover of losses, deductions or credits to this year.
The company does not qualify for any credits in the current year.
You may ignore the impact of state income taxes.
What is the amount of accumulated E & P as of December 31, 2005?
a. \$134,500 b. \$187,000 c. \$250,000        d. \$313,000 e. None of these
First Compute Taxable Income & Income Tax                   Debit       Credits
Sales                                                                             \$700,000
Cost of sales                                                         \$400,000
Municipal bond interest                                                              2,000
Compensation                                                           100,000
Meals and entertainment (Gross)                                         20,000
Payroll taxes, & Misc. Expense                                         140,000
Subtotal                                                               660,000     702,000
Net Income (GAAP) before taxes                                          42,000
Add: one half of entertainment                                         10,000
Deduct: municipal bond interest                                        (2,000)
Taxable income                                                           50,000
Income Tax                                                                7,500
Compute Earnings & Profits (Similar to Retained Earnings)
Taxable Income                                                                       50,000
Federal income taxes                                                  Subtract      (7,500)
Nondeductible entertainment                                           Subtract     (10,000)
Equals: Current Earnings and Profits                                                 34,500
Add: Accumulated E&P at first of year                                              100,000
Total                                                                               134,500
Less: Dividends paid
Earnings and Profits at End of Year                                                 134,500
Note: E & P is reduced by nondeductible expenses that reduce
dividend paying ability - such as non-deductible entertainment expense.
Tab: Worksheet                    File:e572505b-8be3-4b62-b9a8-7831da360ca1.xls           Page 3 of 3

Computation of Earnings and Profits
Taxable income
Plus: Income excluded from taxable income but included in E&P
Tax-exempt interest income
Life insurance proceeds where the corporation is the beneficiary
Recoveries of bad debts and other deductions from which the corporation
Federal income tax refunds from prior years
Plus: Deferred Income that is included in E&P in the current year
Deferred gain on installment sales is included in E&P in year of sale
Plus or minus: Income & deduction items that ARE recomputed when
computing E&P
Income on long-term contracts must be based on percentage of completion
method rather than completed contract method
Depreciation on personal and real property must be based on:
The straight-line method for property other than MACRS or ACRS property
Straight-line ACRS calculation with extended recovery period for ACRS property
The alternative depreciation system for MACRS property
Excess of percentage depletion claimed over cost depletion
Plus: Deductions that reduce taxable income but do not affect E&P
Carryovers (NOL, charity, and capital loss) used in current year
Minus: Non-Deductible Expenses and Losses that reduce E&P
Federal income taxes
Life insurance premiums where the corporation is the beneficiary
Excess capital losses that are not deductible in current year
Excess charitable contributions that are not deductible in current year
Expenses related to production of tax-exempt income
Nondeductible losses on sales to related parties
Nondeductible penalties and fines
Nondeductible political contributions and lobbying expenses
Equals: Current Earnings and Profits
Add: Accumulated Earnings & Profits at end of Prior Year
Subtotal
Less: Dividends paid in Current Year
Earning and Profits at end of Current Year

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