Corporate Income Tax Return (Form 1120)
Tx 8120 Project
For two years, you have worked for a CPA firm, Weil, Duit, Wright, & Company (EIN 331201885), 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.”
•
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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
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Pre-Closing Trial Balance per Books (December 31, 2005)
Accounts
Debit
Cash
$ 126,342
Accounts receivable
61,159
Trade receivable
11,100
Inventories (closing)a
333,894
Corporate bondsb
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 retirementc
50,000
Goodwill
1
Cash surrender value of insurance on
officers’ lives
8,150
Prepaid insurance expensesd
2,215
Unamortized bond premium
1,265
Unamortized bond issue expense
8,875
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Credit
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
8,000
1,048
Withheld payroll taxes
3,062
520
393
135
Bonds payable (long-term)
225,000
Accumulated depreciation
311,500
Capital stock:
50,000
435,000
7% Preferred
Common
Paid-in surplus
20,000
Unappropriated retained earnings
182,379
Treasury stock
2,544
Appropriated retained earningsf
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 inventoryh
166,171
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Insurance
8,795
Depreciationi
8,704
Advertising
19,901
Bad debts
3,923
Insurance premiums on officers’ livesj
2,573
Office salariesk
32,392
Sales force compensation
91,703
Officers’ compensationl
76,000
Pensions
10,000
Heating and lightingm
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 expensesn
6,850
Health plan costs
20,700
Taxes:
520
393
8,000
25,491
4,320
58,000
Capital stock (state)
Franchise (state)
Property (state)
Employment
Income (state)
Income (federal)o
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Interest income:
Corporate bondsp
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 premiumr
142
Rental income
15,000
Sales of scraps
411
Net securities salest
1,758
Real estate and equipment salesu
7,288
Worthless stockv
2,500
Fire lossw
1,002
Contributionsx
2,250
Cash dividends paid on:
Preferred
Common
3,500
26,000
$2,747,678
Totals
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$2,747,678
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
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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 296-407222), 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
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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.
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