Corporate Income Tax Return (Form 1120) Tx 8120 Project For two years, you have worked for a CPA firm, Weil, Duit, Wright, & Company (EIN 33-1201885), located at 1840 Peachtree Street, Atlanta, GA 30314 (telephone 404-389-7724). The firm assigned you primary responsibility to prepare the 2005 income tax return and schedules for Sharpe Supplies Corporation. You can obtain an electronic copy of Form 1120 and related instructions from www.irs.gov. This project does not require the completion of Form 4562, Form 4684, Form 4797, or Form 6251 (but you may do so if you wish). Instead of completing these forms, simply report the summary figures on the appropriate lines of Form 1120. However, please compose and provide any schedule when the detail is available and Form 1120 requests it. Even when not required, provide a supporting schedule for items on the return if such a schedule would facilitate the return s review. At a minimum, you should provide supporting schedules for interest income, taxes and licenses, and other deductions on page 1 of Form 1120; current assets, other investments, buildings and other depreciable assets, other assets, and other current liabilities in Schedule L; and other decreases of unappropriated retained earnings in Schedule M-2. The Sharpe Supplies Corporation (located at 3114 West Hamilton Road, Nashville, TN 37233) uses the accrual method and the calendar year. It manufactures office supplies (business activity code 3998). Its employer identification number is 35-0817903, and it was incorporated on July 1, 1940. During the taxable year, Sharpe Supplies neither owned 20 percent or more of another corporation s voting stock or stock value, nor did any person own 20 percent or more of its voting stock or stock value. Sharpe Supplies is neither a personal holding company nor a member of a controlled group of corporations. Also, Sharpe Supplies owns no interest in foreign banks, securities, or financial accounts, nor has it had any dealings with foreign trusts. Further, all manufacturing and sales occur within the United States, and Sharpe can deduct $5,914 for its domestic production activities. The corporation has a $100 capital loss carryover from the prior year. Sharpe Supplies filed all required information returns related to the dividends it paid this year (e.g., Form 1099-DIV). General Approach to Completing Form 1120 Start with page 1 of Form 1120, completing Schedules A, C, E, and J as needed. Taxable income before special deductions (line 28 in 2005) carries over to Schedule M-1 as the amount with which the preparer must reconcile net income. If page 1 of Form 1120 shows an overpayment of federal income tax (line 35 in 2005), the necessary adjusting entry: Increases prepaid federal income tax (current asset) on Schedule L, Increases net income (via decrease in federal income tax expense) on Schedules M-1 and M-2, and Decreases federal income tax on Schedule M-1. The effect on Schedule M-1 washes out. But, the increase in net income on Schedule M-2 increases unappropriated retained earnings, which carries over to Schedule L and causes the balance sheet to balance. If page 1 of Form 1120 shows an underpayment of federal income tax (line 34 in 2005), the necessary adjusting entry: Increases accrued federal income tax (current liability) on Schedule L,
Decreases net income (via increase in federal income tax expense) on Schedules M-1 and M-2, and Increases federal income tax on Schedule M-1. The effect on Schedule M-1 washes out. But, the decrease in net income on Schedule M-2 decreases unappropriated retained earnings, which carries over to Schedule L and causes the balance sheet to balance. 2
Balance Sheet (December 31, 2004) Assets Cash $ 118,515 Notes and accounts receivable 63,115 Inventories 355,240 Investments in U.S. government obligations 30,000 Tax-exempt securities 10,000 Other investments 96,700 Buildings and other fixed depreciable assets $627,096 Less accumulated depreciation 251,146 375,950 Land 17,500 Other assets 61,225 Total assets $1,128,245 Liabilities and Capital Accounts payable $ 39,456 Mortgages, notes, and bonds payable due in less than one year 40,000 Other current liabilities 71,410 Mortgages, notes, and bonds payable due in one year or more 225,000 Capital stock: Preferred Common $ 50,000 435, 000 485,000 Paid-in or capital surplus 20,000 Retained earnings Appropriated 54,544 Retained earnings Unappropriated 195,379 Less cost of treasury stock (2,544) Total liabilities and capital $1,128,245 3
Pre-Closing Trial Balance per Books (December 31, 2005) Accounts Debit Credit Cash $ 126,342 Accounts receivable 61,159 Trade receivable 11,100 Inventories (closing) a 333,894 Corporate bonds b 22,400 State and municipal bonds 30,000 Treasury bonds 48,000 Stock in domestic corporations 105,500 Land 25,500 Buildings 456,500 Machinery and equipment 149,892 Office furniture 21,440 Trucks 45,264 Sinking fund for bond retirement c 50,000 Goodwill 1 Cash surrender value of insurance on officers lives 8,150 Prepaid insurance expenses d 2,215 Unamortized bond premium 1,265 Unamortized bond issue expense 8,875 4
Accounts payable 36,075 Notes payable (short-term) 30,000 Accrued interest on notes payable 2,925 Accrued payroll 3,328 Accrued vacation pay 18,910 Accrued taxes: Capital stock (state) Franchise (state) Income (state) Income (federal) e Property (state) Employment 520 393 135 8,000 1,048 Withheld payroll taxes 3,062 Bonds payable (long-term) 225,000 Accumulated depreciation 311,500 Capital stock: 7% Preferred Common 50,000 435,000 Paid-in surplus 20,000 Unappropriated retained earnings 182,379 Treasury stock 2,544 Appropriated retained earnings f 67,544 Sales 1,306,023 Sales returns and allowances 6,395 Net purchases 422,133 Inventory variations (decrease) g 21,346 Factory wages 149,613 Costs attributable to inventory h 166,171 5
Insurance 8,795 Depreciation i 8,704 Advertising 19,901 Bad debts 3,923 Insurance premiums on officers lives j 2,573 Office salaries k 32,392 Sales force compensation 91,703 Officers compensation l 76,000 Pensions 10,000 Heating and lighting m 9,720 Service guarantees 8,285 Printing and mailing 5,257 Amortized bond issue expense 700 Interest expense 22,000 Legal and accounting fees 12,500 Travel expenses n 6,850 Health plan costs 20,700 Taxes: Capital stock (state) Franchise (state) Property (state) Employment Income (state) Income (federal) o 520 393 8,000 25,491 4,320 58,000 6
Interest income: Corporate bonds p State and municipal bonds Treasury bonds Certificates of deposit Trade accounts 1,568 788 7,125 2,300 770 Dividends received (domestic) q 8,970 Amortized bond premium r 142 Rental income 15,000 Sales of scrap s 411 Net securities sales t 1,758 Real estate and equipment sales u 7,288 Worthless stock v 2,500 Fire loss w 1,002 Contributions x 2,250 Cash dividends paid on: Preferred Common 3,500 26,000 Totals $2,747,678 $2,747,678 7
Notes for Trial Balance a The company measures inventory at cost and uses FIFO. b Show corporate bonds and shares held in domestic and foreign corporations as other investments on Schedule L. Remember to attach the required schedule. c List sinking funds, goodwill, cash surrender value of insurance on officers lives, unamortized bond premium, and unamortized bond issue expense as other assets on Schedule L. Remember to attach the required schedule. d Prepaid insurance expenses appear as other current assets on Schedule L. If estimated prepayments of federal income tax exceed the actual federal income tax liability appearing on page 1 of Form 1120, the overpayment also appears as other current assets. Remember to attach the required schedule. e Completing Form 1120 allows one to determine the accrued federal income tax for the taxable year (i.e., tax due) or the prepaid federal income tax (i.e., tax overpaid). The tax due or overpaid requires an adjusting entry and, thus, affects the federal income tax appearing in Schedule M-1. Specifically, if tax is due, you must debit federal income tax expense and credit accrued federal income tax on the Sharpe s books. Conversely, if tax is overpaid, you must debit prepaid federal income tax and credit federal income tax expense. Through this entry, tax due (overpaid) increases other current liabilities ( other current assets ) on Schedule L. f The total includes $50,000 appropriations for bond sinking fund retirements, $15,000 for contingencies, and $2,544 for the cost of treasury stock. During the taxable year, the company increased appropriations $10,000 for the sinking fund and $3,000 for contingencies. g This amount equals the difference between aggregate inventories at the taxable year s beginning and ending; it does not appear separately on Form 1120. h The costs include $8,795 insurance expenses, $3,600 office salaries, $8,444 officers salaries, $10,000 pension costs, $20,700 health plan costs, $8,000 property taxes, $25,491 employment taxes, $53,513 depreciation, $20,849 plant utility expenses, and $6,779 repair costs. Though some of these amounts may appear to duplicate expenses listed elsewhere in the trial balance, they do not. The company simply allocated half of some costs to inventory. i Since the SEC does not require registration, Sharpe Supplies chooses not to have its financial statements audited. For convenience, the company depreciates all assets using methods the federal income tax law allows. However, Sharpe has never elected 179 immediate expensing or additional first year bonus depreciation or used the mid-quarter convention. Assume Form 4562 (not required for this project) shows total depreciation of $62,217. Company records show the following details: Bought machinery (7-year recovery property) in August 2005 for $15,000 and elected straight-line depreciation Completed construction of a new factory building (39-year recovery property) in June 2005 at $36,000 cost Purchased machinery (7-year recovery property) during July 2004 for $134,892 and depreciated using prescribed MACRS 7-year recovery period Bought furniture and fixtures (7-year recovery property) in 2003 for $21,440 and depreciated using prescribed MACRS 7-year recovery period Acquired trucks in 2004 for $45,264 and used the prescribed MACRS 5-year recovery 8
period (not subject to 280F) Purchased a shed for $5,000 in 1994 and deducted $1,830 in prior years and $33 this year before a fire destroyed it (fire insurance proceeds $2,135) At the beginning of 2005, records show the total cost of pre-1971 buildings (kept in a single account) as $420,500 with current depreciation of $9,344 (i.e., unadjusted basis times straight-line class life rate of 2.22 percent for 45-year class life) j Sharpe Supplies is the beneficiary under these policies. k Include office salaries and sales force compensation as salaries and wages on Form 1120. These amounts do not relate to manufacturing. l The president, B. Spikert (social security 252-67-8315), receives $34,000 compensation and owns 15 percent of the common stock. The vice president, R. Spearman (social security 296-40- 7222), receives $26,500 compensation and owns ten percent of the common stock. The secretarytreasurer, T. Thornbury (social security 307-31-3433), receives $23,944 compensation and owns ten percent of the common stock. All three officers work full-time for Sharpe Supplies. Per an earlier note, inventory costs include $8,444 of officers salaries. The corporation has 12 common shareholders other than these three officers and three equal owners of the nonvoting preferred stock. All shareholders are unrelated. m Treat insurance, heat and lighting expenses, service guarantees, printing and mailing, amortized bond issue expenses, legal and accounting fees, and travel expenses as other deductions. n Section 274 does not limit travel deductions. o This total is the estimated federal income tax paid during the taxable year. The corporation paid four $14,500 quarterly installments on time. The company is not a large corporation. Sharpe Supplies requests you to credit the overpayment (if any) to next year s federal income tax. Sharpe Supplies must make one last entry on its books to adjust the $58,000 federal income tax expense to the actual federal income tax appearing as total tax on page 1 of the Form 1120. p Sharpe Supplies bought these corporate bonds on July 1, 2004, for $23,875. The bonds mature on December 31, 2011, show a face value of $22,400, pay interest at seven percent, and yield an expected effective rate of return of six percent (three percent every six months for 17 periods). Sharpe Supplies elected to amortize the bond premium. The amortization for the taxable year equals $142, which offsets the interest income reported on page 1 of Form 1120. At the beginning of 2005, the bonds carrying value totaled $23,807. q The dividend amount includes the fair market value of noncash property ($6,850) that Slyce Steel, Inc. (a domestic corporation) distributed to Sharpe Supplies. Slyce had purchased this property for $1,850 (its adjusted basis when distributed), but Sharpe Supplies recorded the property at the higher fair market value, which is reflected as such in the trial balance. Sharpe received all other dividends in cash. r Net amortization with interest income on page 1 of Form 1120. s Show gain from the sale of inventory scrap as other income on Form 1120. t On May 28, 2005, Sharpe Supplies sold 100 shares of Glasser Services, Inc. for $20,500, which it bought for $18,487 on July 15, 2004. On April 14, 2005, Sharpe sold 200 shares of Kniffen, Ltd. (a foreign corporation not engaged in a U.S. business) for $4,400, which it purchased for $4,755 on July 28, 2004. On April 12, 2005, Sharpe sold Treasury bonds for $15,100, which it 9
bought for $15,000 on June 9, 1994. u On July 5, 2005, Sharpe Supplies sold vacant land that it had used in its business for $20,000, which it purchased for $12,712 on June 1, 1970. The corporation received Form 1099-S, showing sale proceeds of $20,000. Form 4797, which this project does not require, reports the gain from this sale and then transfers the gain for further netting to Schedule D (Form 1120). v Cutter Corporation stock became worthless during the taxable year. Sharpe paid $2,500 for the stock on January 30, 1981, which was the stock s basis when it became worthless. w In February 2005, a fire destroyed a shed that Sharpe Supplies used in its manufacturing operations. The company acquired the shed in 1994 for $5,000. Since its acquisition, depreciation amounted to $1,863. Prior to the fire, the shed s fair market value was $5,000. Form 4684, which this project does not require, reports the loss from this casualty and then transfers the loss to Form 4797. x Sharpe Supplies gave cash to the following qualified organizations: $750 to United Charities, $500 to the Boy Scouts of America, $250 to the Red Cross, and $750 to the Community Fund. 10