FOR THE YEAR ENDED DECEMBER 31, 2012

You have been assigned to the audit team for B.B. JAMS Ltd., one of your significant clients. Below is the income statement prepared by the company's accountant for the December 31, 2012 year end.

B.B. JAMS LIMITED

INCOME STATEMENT

Sales………………………………………………………… $147,840,000

Cost of sales (Note (1)) …….……………………………… (119,859,000)

Gross profit…………………………………………………… $ 27,981,000

General and administrative expenses (notes (2)-(7)) ………… (12,374,000)

Selling expenses (Note (8)) …………………………………… (9,311,000)

Income from operations…………………………………..…… $ 6,296,000

Other income (Notes (9)-(10)) ………………………………………16,000

Net income before income taxes………………………………… $ 6,312,000

Provision for income taxes……………………………………… (2,528,000)

Net income……………………………………………………… $ 3,784,000

Notes:

Through various discussions with the accountant, you have been able to determine that the following information has been recorded in the financial statements:

(1) JAMS had a number of items of inventory that did not sell well in the current year. For accounting purposes, the accountant has recorded a reserve for inventory obsolescence. The reserve was calculated based on the carrying value of any inventory item that had not had a sale in the last 180 days. The reserve at year-end was $1,285,000.

(2) JAMS provides insurance for employees and paid the following amounts to Nat Insurance Company during the year:

$2,000,000 insurance policy on the life of the president included in insurance

expense ($300 per month)…………………………………………….$ 3,600

$1,000,000 insurance policy on the life of the vice-president — marketing

included in insurance expense…………………………………………..2,000

Group term life insurance for employees included in salaries and benefits

($37,000 X 12 months)…………………………………………… 444,000

Total……………………………………………………………… $449,600

JAMS is the beneficiary of the policies on the president and vice-president. On June 1, 2012, JAMS renegotiated its bank debt, and due to the ever increasing responsibilities of the president, the bank required the insurance policy on the life of the president as part of the collateral for the loan. The premiums on the policy are equal to the net cost of pure insurance for the policy.

(3) An analysis of the professional fees for 2012 revealed the following expenses:

Legal and accounting fees related to the issuance of shares………………$29,300

Legal fees related to amending the articles of incorporation…………………2,300

Costs incurred regarding the renegotiating of the bank loans ………………..46,100

Costs incurred to defend the company against a wrongful dismissal charge…59,600

Costs related to the structuring of an agreement for the purchase of equipment from

a foreign company……………………………………………………………..38,700

Appraisal costs to determine value of the equipment for the bank……………..5,100

(4) During the year, there were substantial repairs completed to the outside of the building. After the repairs some of the landscaping had to be redone. The total costs were $139,000. Of this, $23,500 relates to the landscaping costs. The entire $139,000 was included in general and administrative expenses.

(5) A review of the other expense accounts included in general and administrative expenses showed the following:

Amortization……………………………………………………. $4,560,000

Interest on late payment of municipal taxes …………………………….900

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Severance payments to four managers ……………………………..245,000

Loss from theft by accounting clerk …………………………………. 4,500

Donations to various registered charities……………………………..57,000

All of the amounts were paid in the year.

(6) The salaries and benefits account shows contributions for certain employees to the company's registered pension plan. The contributions were not actually made until March 31, 2013. The pension plan is a defined contribution (money purchase) plan. The company matches the employees' contributions on a dollar for dollar basis.

(7) In early November 2012, JAMS announced an early retirement package that was made available to employees over the age of 60. In order to provide employees with the time required to assess the offer, the deadline for accepting the package has been set at February 15, 2013. While no formal replies were received as of December 31, 2012, the personnel manager anticipates a high acceptance rate. She expects that the costs associated with the packages will be $672,000. This cost has been accrued in the 2012 financial statements.

(8) The following information was taken from the various selling expense accounts:

Cost of sponsoring presentations at a local theatre company …………..$15,000

Hockey game tickets given to customers…………………………………8,000

Meals and entertainment costs of salespeople…………………………109,500

Staff Christmas party and summer barbecue……………………………43,800

Cost of sponsoring local little league teams………………………………5,000

Memberships for salespeople at local golf courses ……………………. 12,700

(9) The other income includes a loss on the sale of various fixed assets of $35,900.

(10) During the year, the company had cash on hand for a short period of time due to the timing of certain contract payments. The funds earned interest income of $10,400 while they were held.

Other Information:

(11) The accountant has calculated that JAMS is entitled to claim capital cost allowance and CECA of $5,835,000 in 2012. You have confirmed that this calculation is correct.

(12) In reviewing the income tax assessments, you noted that JAMS had been charged interest of $4,900 on the late payment of instalments. You discussed this with the accountant and determined that the interest was recorded in the income tax expense account.

REQUIRED

Based on the information that you have obtained, calculate the income from business for tax purposes for JAMS for December 31, 2012. Show all calculations whether or not they seem relevant to the final answer. Comment on all items omitted from the calculation.

SOLUTION

Reference to Schedule 1 of the T2 corporate tax return may be helpful in completing reconciliation problems.

Net income per financial statements ........................................................................	Net income per financial statements ........................................................................	$ 3,784,000	Sec. 9
Add:
Provision for income taxes.......................................................................	$2,528,000		Par. 18(1)(e)
Charitable donations ................................................................................	57,000		Par. 18(1)(a)
Over contributions to company pension plan(1)........................................	4,500		Ssec. 147.2(1)
Loss on disposable of depreciable assets .................................................	35,900		Par. 18(1)(b)
Depreciation and amortization .................................................................	4,560,000		Par. 18(1)(b)
Club dues .................................................................................................	12,700		Par. 18(1)(l)
Meals and entertainment ($109,500 50%) ............................................	54,750		Sec. 67.1
Hockey tickets ($8,000 50%)................................................................	4,000		Sec. 67.1
Non-deductible life insurance — Vice-president..............................	2,000		Par. 18(1)(a)
— President ($300 5 months)........	1,500		Par. 18(1)(a)
Legal and accounting expenses re issuance of shares (80% $29,300)...	23,440		Par. 20(1)(e)
Legal expenses re articles of incorporation..............................................	2,300		Par. 18(1)(b)
Costs re bank loan (80% $46,100) ........................................................	36,880		Par. 20(1)(e)
Costs re equipment purchase....................................................................	38,700		Par. 18(1)(b)
Appraisal cost for bank (80% $5,100) ..................................................	4,080		Par. 20(1)(e)
Accrued early retirement payments(2) ......................................................	672,000		Par. 18(1)(e)
Total additions .........................................................................................		8,037,750
Subtotal ............................................................................................		$11,823,750
Deduct:
Capital cost allowance .............................................................................		5,835,000	Par. 18(1)(b)
Income from business ..................................................................................		$ 5,988,750

Items Not Included in Computation:

1. The reserve for inventory obsolescence, although called a “reserve,” is deductible since the amount is determined by identifying specific items that are obsolete and, therefore, is not a reserve or contingent liability.

2. Group term life insurance is deductible as part of the remuneration provided to employees and meets the “incurred to earn income test” in paragraph 18(1)(a).

3. The life insurance premiums on the president are deductible after June 1, 2009 since the insurance was held as collateral by the bank.

4. The costs related to the wrongful dismissal charge are deductible as a cost of doing business.

5. The repairs to the outside of the building are deductible as a cost of doing business as long as they are not enhancing the value of the building and the costs of landscaping are specifically allowed.

6. The interest on the municipal taxes is a cost of doing business.

7. The severance payments are deductible as a cost of doing business.

8. Theft by an employee is an inherent risk for most businesses and as such the theft usually is a deductible business expense.

9. Sponsoring of the local theatre company and sponsoring of the little league teams are deductible as a cost of doing business as long as they are reasonable in the circumstances.

10. The costs of the staff Christmas party and summer barbeque is exempt from the 50% limitation for meals and entertainment, to the extent that these occasional events do not exceed six times in a year.

11. The interest earned on the cash on hand is considered business income if the income is incidental to the business. The funds were only held for a short time and related to payments on contracts.

12. The interest and penalties on the income tax instalments is not a deductible expense [par. 18(1)(t)]. However, the expense has been recorded as part of income tax expense. Therefore, it has already been added back to income as part of the income tax expense addback. No further adjustment is required.

(1)

Least of:	President	Vice-President	Accountant
(a) Employer plus employee RPP contributions ........................	$ 26,500	$ 20,500	$ 10,800
(b) Money-purchase limit for 2010 .........	22,450	22,450	22,450
(c) 18% of compensation ..............	45,000	27,000	12,600
Least amount..............................................................................	22,450	20,500	10,800
Less: employee and employer contributions .......	26,950	20,500	10,800
Amount to be added back (excess of actual over deductible)	4,500	Nil	Nil
(2)	Generally accepted accounting principles require the accrual of the expected payments under the early retirement package if the probability of the payment is likely and the amount can reasonably be estimated. A reserve for a contingent liability is disallowed for tax purposes. The deduction will be allowed for tax purposes when there is a legal obligation to pay the amount under the package.