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(1) No details are given on provisions for depreciation, capital and revenue expenditures, etc.

(2) Collection expenses are assumed to have been actually expended and not included in part in the bad-debt reserve.

(3) By adding the year's provision for bad debts to the reserve at the beginning of the period and deducting the balance at the end the excess of bad debts collected over bad debts charged off is ascertained.

(4) The capital-stock tax is deductible (see art. 132).

(5) Special assessments for local benefits are not deductible unless for repairs.

(6) Premiums on life insurance policies are deductible only when the taxpayer is not a beneficiary thereunder. The principal, when paid, constitutes tax-free income to the individual, but taxable income to the corporation, in spite of the non-deductibility of premiums (art. 294, revised).

(7) Contributions to charitable and other corporations not subject to income tax are not deductible. However, donations to a pension fund controlled by employees or expended for the benefit of employees during the year is regarded as additional compensation to such employees and is deductible.

(8) Dividends from domestic corporations and from foreign corporations subject to United States income taxes are included in gross income and also in allowable deductions, and are therefore not subject to tax. Dividends from other foreign corporations are taxable. It is assumed that the foreign dividends here fall into the latter class.

(9) Bond discount written off is deductible if computed in accordance with standard accounting practice.

(10) Expenses connected with the issuance of capital stock are regarded as capital expenditures and therefore not deductible, no matter what procedure is followed on the corporation's books.

(11) Federal income and excess-profits taxes or provisions therefor are regarded as distributions of profits rather than expenses.

(12) The addition to the inventory reserve is deductible if it represents the difference between cost and market. On the balance-sheet, however, the $500,000.00 provision for 1920 has been added to a similar provision existing at the end of 1919, and has all the appearance of a contingent reserve rather than a valuation account. (b) Invested capital:

Capital stock, surplus and reserves:
Capital stock:


2,500,000.00 $4,000,000.00 Earned surplus

2,150,000.00 Appropriated surplus and non-deductible

reserves :

Contingent reserve
Inventory reserve
Bad-debt reserves
Provision for federal taxes..
Preferred stock redemption fund..


$ 250,000.00


1,700,000.00 $7,850,000.00

Less deduction on account of goodwill:

Goodwill acquired in 1910 for stock..... $1,500,000.00
Less limitation to 25% of par value of

stock outstanding March 3, 1917 (i. e.,
25%, $4,150,000.00)..

1,037,500.00 462,500.00 Balance

$7,387,500.00 Changes in invested capital during year:

Additions--Common stock sold:

Aug. 31: 123/365 of $500,000... $ 168,493.15
Oct. 31: 62/365 of $500,000.

84,931.51 253,424.66

$7,640,924.66 Deductions:

Federal taxes 42.260274% of $800,000. $ 338,082.19
Dividends :
Jan. 31: 335/365 of $20,000.00...

Feb. 28: 307/365 of $250,000.00.

The remaining dividends paid during

1920, as well as the retirement of
preferred stock, are amply covered
by profits earned during year...


$7,074,212.34 Deduction on account of inadmissible asset: Percentage as shown below (2,096%)...

148,275-49 Balance-invested capital for tax purposes

$6,925,936.85 Federal taxes are regarded as being paid from the surplus of the prior year; the fraction for 1920 is 42.144809%. The difference between this rate and the 42.260274% under “deductions" above is caused by the fact that 1920 had 366 days. This computation is, of course, based on the exact number of days.

Average inadmissibles held..

$250,000.00 Average all assets held

-1920 Particulars

January 1 December 31 Total per balance-sheet...,

$11,450,000.00 $15,530,000.00 Less—Depreciation reserve.

$ 500,000.00 $ 700,000.00 Reduction of goodwill...

462,500.00 462,500.00 Capital surplus (revaluation)...

500,000.00 500,000.00

$ 1,462,500.00 $ 1,662,500.00 Balance-admissible and inadmissible assets. $ 9,987,500.00 $13,867,500.00

Average for year (1/2 sum).....


Ratio of average inadmissibles to average

all assets



(1) It may be noted here that reasonable commissions on the sale of stock are an admissible asset, inasmuch as they may not be deducted from gross income (T. B. R. 40).

(2) The portion of the capital surplus account which represents realized appreciation (i. e., the excess of allowable depreciation deductions based on 1913 valuations over similar computations based on cost) may be included in invested capital. However, the entire amount has been excluded, since the problem is silent on depreciation provisions.

(c) Computation of tax payable:

The tax payable may be computed according to the formula applicable to cases in which the invested capital exceeds $71,428.57 and the net taxable income is more than 20% of the invested capital, as follows:

Formula : 46% income — 5.04% invested capital — $740.

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Question 2:

A company was incorporated as of January 1, 1920, to take over certain mines. The properties had been operated for some time by a receiver, the bondholders having bid in the properties at a foreclosure sale through a committee which turned over the properties to the new company.

The plan of reorganization provided for the issuance to the bondholders of the old company of $1,000,000.00 preferred stock and 10,000 shares of common stock of no par value of the new company, being its entire capitalization. An arrangement was made whereby the stockholders receiving such securities returned to the treasury of the new company as a donation 2,500 shares of common stock, with the understanding that such shares should be issued to the president for services to be rendered during the next five years, delivery of such stock to be made to him 1/5 at the end of each year.

The properties and assets acquired by the new company were as follows:

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(1) Prepare an opening entry to record the acquisition of the properties and capitalization.

(2) How would you treat the 2,5000 shares donated by the stockholders?

(3) How would the accounts of the next five years be affected by delivery to the manager of 1/5 of such donated stock at the close of each year?

Solution, Question 2:
(1) Opening entry :
Mines and fixed properties.

Current assets

300,000.00 Current liabilities

$ 200,000.00 Capital stock preferred.

1,000,000.00 Capital stock common-no par value.

900,000.00 To record acquisition of assets and

assumption of liabilities of the
Company in receivership and the
issuing to the bondholders in con-
trol of said company the following

stock for the net assets :
10,000 shares preferred-par 100

10,000 shares common-no par
(2) Treatment of donations :
Treasury stock-common

$225,000.00 Capital surplus ....

$225,000.00 To record donation of 2,500 shares of

no par value stock to be paid to
president for services, at the rate

of 500 shares a year for 5 years. (3) An entry should be made at the close of each year charging salaries and crediting treasury stock $45,000.00.

The charge should be made to salaries and not to capital surplus, because the president's salary is an operating expense—the fact that it is paid in assets which have been donated is immaterial. The two transactions are distinct. The gift is an extraneous affair not related to operations. The salary is an operating charge affecting the operating surplus.

It might seem that the entry each year should be made at the value of the stock on the various dates instead of at $45,000.00. Suppose, for instance, that earnings of $150,000.00 have been credited to the capital stock common account at the end of the first year. The value of the outstanding common stock would be (assuming that preferred dividends have been paid):

Capital stock common:

Paid in

Less treasury stock
Add capital surplus
Value of 7,500 shares outstanding..
Value per share of outstanding stock.

$ 900,000.00

150,000.00 $1,050,000.00

225,000.00 825,000.00

225,000.00 $1,050,000.00


If an attempt were made to make the entry for $140.00 x 500, or $70,000.00, the debit to salaries would be offset by a credit to treasury stock of $45,000.00 and a credit to surplus of $25,000.00. The extra charge to salaries and credit to surplus would offset each other without accomplishing anything. While the president would receive securities worth more than $45,000.00, the extra value is not paid by the corporation, but is the result of, or rather results in, a reduction of the book value of all common shares to an amount less than $140.00.


On pages 231 to 234 of the September, 1920, issue of The Journal of ACCOUNTANCY there appears a letter from a reader of the Students' Department explaining a short method of computing the amount of a bonus to be paid to an employee of a corporation when the federal income and excess profits taxes are to be considered an expense before arriving at the basis of the tax. One sentence of this letter is misleading and should be corrected. This sentence is on page 233, and reads as follows:

"When the bonus comes out of the 40% bracket the amount of the bonus before figuring taxes plus 4.8217813% of itself will give the final bonus.”

The sentence should read as follows:

“When the bonus comes out of the 40% bracket, the amount of the bonus after figuring taxes as though the bonus were not an allowable deduction, plus 4.8217813% of itself will give the final bonus."

Pace & Pace, New York, announce that Charles T. Bryan has been admitted to the firm.

August J. Saxer announces the removal of his office to suite 802 La Salle building, St. Louis.

Edward Clifton Smith announces the removal of his New York office to 15 Park Row.

Charles Frost announces the opening of an office at 1482 Broadway, New York.

George K. Hyslop announces the opening of an office at 42 Broadway, New York.

William Topper announces the removal of his office to 29 Broadway, New York.

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