Question

Michael Smith has provided you with the current year’s income statement for Palo Alto, Inc. Reconcile book income to taxable income.

	Palo Alto, Inc.
	Income Statement
	Current Year
			Book - Tax Adjustments
	Book Income/(Loss)		(DR)	Cr	Taxable Income
Revenue from sales	$64,800,000
Cost of Goods Sold	-45,600,000
Gross profit	$19,200,000
Other income:
Interest income	75,000	(1)
Miscellaneous income	80,000
Gross Income	$19,355,000
Expenses:
Compensation	-9,630,000	(2)
Stock option compensation	-350,000	(3)
Advertising	-1,950,000
Repairs and Maintenance	-658,000
Rent	-857,000
Bad debt expense	-50,000	(4)
Depreciation	-1,750,000	(5)
Warranty expenses	-95,000	(6)
Meals and entertainment	-60,000
Life insurance premiums	-25,000	(7)
Federal income tax expense	-1,250,000
Other expenses	-350,000	(8)
Total Expenses	-17,025,000
Net Income	2,330,000
Notes
(1)	Of the $75,000 interest income, $25,000 is from California State municipal bond.
(2)	This includes total officer compensaiton of $2,950,000 (no one officer received more than $1,000,000 compensation).
(3)	This amount is the portion of incenctive stock option compensation that was expensed during the year (recepiants are officers).
(4)	Palo Alto wrote off $35,000 of its accounts receivable as uncollectible.
(5)	Tax depreciation for the year was $2,300,000.
(6)	In the current year, Palo Alto did not make any actual payments on warranties it provided to customers.
(7)	Premiums on key employee life insurance policies
(8)	This includes $10,000 of Politial Contributions.

Answer 1

Palo Alto, Inc.
	Income Statement
	Current Year
			Book - Tax Adjustments
	Book Income/(Loss)		(DR)	Cr	Taxable Income
Revenue from sales	$ 6,48,00,000				$ 6,48,00,000
Cost of Goods Sold	$-4,56,00,000				$-4,56,00,000
Gross profit	$ 1,92,00,000				$ 1,92,00,000
Other income:					$                 -
Interest income	$         75,000	1	$        25,000		$         50,000	see note
Miscellaneous income	$         80,000				$         80,000
Gross Income	$ 1,93,55,000				$ 1,93,30,000
Expenses:					$                 -
Compensation	$   -96,30,000	2	$                -	$              -	$   -96,30,000	See note
Stock option compensation	$     -3,50,000	3		$ 3,50,000	$                 -	See Note
Advertising	$   -19,50,000				$   -19,50,000
Repairs and Maintenance	$     -6,58,000				$     -6,58,000
Rent	$     -8,57,000				$     -8,57,000
Bad debt expense	$        -50,000	4	$                -	$              -	$        -50,000	See note
Depreciation	$   -17,50,000	5	$     5,50,000		$   -23,00,000
Warranty expenses	$        -95,000	6		$     95,000	$                 -	See note
Meals and entertainment	$        -60,000				$        -60,000
Life insurance premiums	$        -25,000	7		$     25,000	$                 -	See Note
Federal income tax expense	$   -12,50,000	9		$ 12,50,000	$                 -	See Note 9
Other expenses	$     -3,50,000	8		$     10,000	$     -3,40,000	See note
Total Expenses	$-1,70,25,000				$-1,58,45,000
Net Income	$    23,30,000				$    34,85,000
Notes
1	Of the $75,000 interest income, $25,000 is from California State municipal bond.: Considered Tax exempt
2	This includes total officer compensaiton of $2,950,000 (no one officer received more than $1,000,000 compensation).: Considered Reasonable payment and hence deductible
3	This amount is the portion of incenctive stock option compensation that was expensed during the year (recepiants are officers): Considered as not allowable expenses since it is assumed that employees have not exercised yet
4	Palo Alto wrote off $35,000 of its accounts receivable as uncollectible.: Considered worthless and hence considered as expenses under specific charge method
5	Tax depreciation for the year was $2,300,000. : The tax depreciation is considered for Tax Calculation
6	In the current year, Palo Alto did not make any actual payments on warranties it provided to customers. :Since the liability cannot be reasonibly calculated, the expenses are not deductible under accrual method of accounting
7.	Premiums on key employee life insurance policies :: Considered non-deductible expenses since these employees have financial interest in the business and considered that the beneficiary of the insurance will be Paulo INC
8	This includes $10,000 of Politial Contributions. : and hence not deductible expenses
9	Federal Income Tax payment is not deductible