Students' Department EDITED BY H. A. FINNEY The examination questions of the American Institute of Accountants are now used by thirty-two state C. P. A. boards as well as by the institute. Readers of THE JOURNAL OF ACCOUNTANCY who were candidates in the November examinations conducted by these boards or by the institute are, therefore, already familiar with the problems. These solutions, it should be understood, merely represent the opinion of the editor of this department and are not official solutions by the institute. EXAMINATION IN ACCOUNTING THEORY AND PRACTICE PART I-Continued Question 4: Mr. Richard Roe, a married man, requests you to prepare his federal income-tax return for the ten months ended December 31, 1919, from the following information which he has submitted to you: Loss of a dwelling house, from which he had received rents, by fire, no insurance being carried 1,200.00 Judgment rendered against him in his suit to collect the past due note of Harry Hanson State the resultant tax. The rates for individual taxes for 1919 were: First $4,000.00-4%, thereafter 8% 150.00 $2,470.00 Taxable income: A married man is entitled to an exemption of $2,000.00. Solution, Question 4 (by Eric L. Kohler): -Subject toNormal tax Surtax only $ 5,000.00 105.00 7,596.54 Salary .... Directors' fees Rent of property (net).. Total gross income Allowable deductions : Interest Taxes (including bank stock tax).... (1) Loss by fire (less depreciation already re 2,150.00 $ 7,850.00 $ 7,999.86 14,000.00 $21,999.86 1,666.67 Net income subject to normal tax. $ 7,999.86 Less normal tax credit: $ 6,333.19 $ 160.00 186.66 $ 710.00 9% of $1,999.86... Total tax payable $ 346.66 Notes: (1) Loss of an individual's own residence through fire may be deducted to the full extent of its cost or fair market value at March 1, 1913, if purchased prior to that date, without allowance for accrued depreciation. In this case, the house having been rented, depreciation thereon has been an allowable deduction during each taxable year. (2) If accrued interest of $320.00 has been reported as income in this return or in a prior return, the amount thereof uncollected may also be deducted. (3) The return being on the basis of 10 months, only 5/6 of the personal exemption may be deducted. A return for less than a year may be made only in case the taxpayer is changing, with the consent of the commissioner, from a fiscal to calendar year. (4) The rule for calculating surtaxes on income not exceeding $100,000.00, follows: Ascertain the highest even number of thousands contained in the net income (in the above, 20), divide by 2, and (a) subtract 1 and (b) subtract 2; multiply a x b x 10, and subtract 10 (9 x 8 x 10 10), the result being the surtax on the highest even thousand. The balance of the income (which will be less than $2,000.00) is subject to a surtax equal to a (the a above) percent thereof. Question 5: The balance-sheet of the Rozinante Company at June 30, 1920, was as follows: A and B buy the entire stock, new certificates being made out to them in equal proportions. The price agreed upon is $20,000.00, of which $15,000.00 is paid in cash, the balance being represented by a joint and several note for $5,000.00 signed by A and B. In addition, the former stockholders, X and Y, as part of a contract, are allowed to withdraw the $1,000.00 cash shown in the above balance-sheet. Without consulting an accountant, A and B open a new set of books, but are uncertain how much to credit capital stock. They therefore ask the former stockholders what their $25,000.00 credit to capital stock represents, and are informed that "it was the amount we paid for the stock of the corporation when it was organized." Acting on this information they credit capital stock with the price they agreed to pay for it, opening new books by the following journal entry: As the corporation is in need of funds an attempt is made to borrow $1,500.00. The bank will not accept the corporation's note, but offers to lend $750.00 to A and the same amount to B on their personal notes. The notes are issued and the cash is deposited in bank to the credit of the corporation. A and B agree that this $1,500.00 shall be considered “an additional investment," and an entry is made debiting cash and crediting capital stock, $1,500.00. When the notes mature a cheque for $1,500.00 is drawn on the corporation's bank account, but the bookkeeper does not know what account to charge and asks for your advice. Upon investigation you find the facts as set forth above. Comment on the propriety of the transactions and the entries and state what entries you would advise the bookkeeper to make. Solution, Question 5: This problem illustrates the confusion which exists in the minds of a good many people who fail to recognize the distinction between a corporation and a partnership. The sale of all the stock to A and B should have had no effect on the corporation's books except to the extent of the $1,000.00 of cash withdrawn by the former stockholders and the change of stockholders shown in the stock ledger. The withdrawal of the cash increased the deficit to $9,000.00, and an entry should have been made debiting deficit and crediting cash $1,000.00. It is probable that A and B could be held liable to creditors for the amount of this $1,000.00 if the corporation became incapable of paying its debts. Their consent to the withdrawal in conjunction with the purchase of the stock would probably be interpreted by a court as equivalent to a withdrawal of $1,000.00 by them at a time when there was no surplus. The payment of $15,000.00 in cash and the issuing of notes for $5,000.00 is a private matter between A and B on the one hand and X and Y on the other, and no entry for the transaction should have been made on the corporation's general books. The $9,000.00 charge to goodwill is also wrong. A corporation does not acquire goodwill when a portion or all of its stock changes hands, even though the price paid is greater than the book value of the stock. The $9,000.00 should appear in deficit account. It was not necessary to open new books, but there is nothing improper in doing so, provided the entries are correct. The entries as made were wrong and should be reversed. An entry should then be made reopening the books correctly. After making an entry on the old books charging deficit and crediting cash $1,000.00, the proper entry on the new books would be: To transfer balances from old to new ledger. These entries have the following results: The goodwill is eliminated and the deficit shown; $15,000.00 3,000.00 9,000.00 $25,000.00 2,000.00 The capital stock account shows the par of the stock outstanding; The notes payable account is eliminated, since the notes are personal and not corporate. The entry for the issue of the two notes totaling $1,500.00 should be reversed: Capital stock $1,500.00 $1,500.00 To reverse entry crediting capital stock with proceeds of two notes of $750,000 each, issued by A and B. No entry should be made for the notes themselves, as they are not a liability of the corporation, but since the cash proceeds are to be treated as additional investments reducing the deficit, the following entry should be made: Cash Deficit Cash donation by A and B; $750.00 each. $1,500.00 $1,500.00 When the notes mature, they should be paid by A and B individually. If they are paid from the corporation's cash, the cash payment should be regarded as a loan to A and B, and should be recorded as follows: A loan B loan Cash $750.00 $1,500.00 Cash lent to A and B with which to pay their notes. Question 6: The following letter is received by a practising accountant from a man not previously known to the former: "I am contemplating the purchase of a business, the proposal of the present owner being that I pay him a flat price of $500,000.00 He states that the plant and real estate are worth $200,00.00, the inventories and accounts receivable $250,000.00 and the cash $30,000.00. The liabilities of the business which would be assumed by the purchaser amount to $120,000.00. The profits are said to be good and stable. "The nature of the business appeals to me and I am much interested in the proposition, but I have never had any experience in such matters and cannot make up my mind. I do not know how to determine what the business is worth or what dangers are involved in taking over a business in this way. My lawyer has suggested to me that public accountants are generally em |