Business Taxation in Canada: Analysis of Eldridge Asset Sales Inc. Financial Statements

This article provides an analysis of Eldridge Asset Sales Inc. financial statements for business taxation in Canada. It includes deductions and adjustments made for tax purposes, such as inventory reserves, warranty expenses, charitable donations, and golf club membership fees. The article also covers the capital cost allowance schedule and opening balances for each class of EASI's assets.

Running head: BUSINESS TAXATION IN CANADA 1
Topic: Business Taxation in Canada
By (Name of Student)
(Institutional Affiliation)
(Course Code)
(Date of Submission)

BUSINESS TAXATION IN CANADA 2
The following information is taken from the financial statements and audit working papers of Eldridge
Asset Sales Inc. ("EASI") for its fiscal year ended December 31, 2018.
Eldridge Asset Sales Inc.
Condensed Unaudited Income Statement
For the Year Ended December 31, 2013
Sales $16,650,000
Cost of goods sold (14,050,000)
Gross profit $ 2,600,000
Selling expenses $975,000
General and administrative expenses 195,000 (1,170,000)
Net income before provision for income taxes $ 1,430,000
Provision for income taxes — current $220,000
— future 310,000 (530,000)
Net income after tax $ 900,000
Net income for accounting purposes: $900,000
Add back tax expenses: $530,000
TOTALS $1430,000
The following items were deducted in arriving at the above net income:

BUSINESS TAXATION IN CANADA 3
1. Included in sales for the year is a deposit of $28,200 received from a customer for goods
that will be delivered next year
Reason/process
20 (1)(m), deferred revenue is allowed, TAX = GAAP
NIL
2. During the year, a warehouse worker managed to remove valuable inventory worth $18,000
during the night shift by taking it out in his lunch box.
Reason/process
Pass three tests, deductible
NIL
3. Late in the year, it became apparent that during the next year new competitive products
would come on the market which would drive the price of their products down. They expect
this decline to take place in about six months. As a result, they decided to set up a reserve
for a decline in the inventory value in the amount of $23,000. They have never set up this
kind of reserve before.
Reason/process
Does not meet LCM, reverse accounting treatment
+$23,000

BUSINESS TAXATION IN CANADA 4
4. Because their products come back for repair under their warranty program, they set up a
reserve for this expense on their financial statements. Last year the reserve was $56,000.
This year they decreased the reserve to $44,000. The warranty was not insured. The actual
cost was $5,000.
Reason/process
Not extended warranty, not deductible
+$56,000
5. Charitable donations were made in the amount of $12,000. The company expensed the
donations as promotional expense.
Reason/process
Donation was not for the business, thus not deductible
+$12,000
6. Golf club membership fees in the amount of $16,000 were paid for the sales manager who
used the club regularly to close sales. The sales manager incurred expenses related to meals
and entertainment at the golf club in the amount of $12,300.
Reason/process
Membership fee in golf club; not deductible
+$16,000
Also, for the sales manager,
Not business related, not deductible
+$12,300

BUSINESS TAXATION IN CANADA 5
7. Management bonuses of $92,000 were accrued at December 31, 2017 ($27,000 was not
paid until June 30, 2018 due to lack of sufficient funds).
Reason/process
The total amount is paid within 180 days after fiscal year end, deductible in 2018
NIL
8. The December holiday banquet for the employees cost $10,000.
Reason/process
Deductible under 67.1 (2)(f)
NIL
9. EASI had a dispute with one of its major suppliers over the use of the supplier's product. As
a result of a court decision, the supplier was awarded damages for breach of contract in the
amount of $18,000. The company booked a contingent liability of $35,000 last year.
Reason/process
Pass three tests, deductible
NIL
10. In order to raise money for expansion, the company mortgaged the real estate it used in the
business. It incurred accounting fees of $5,000 and appraisal fees of $2,000 related to this
financing. The mortgage has a 10-year term and a 30-year amortization period.
Reason/process/calculation
20(1)(e), business related, deduct 20% over 5 years
$7000/5 = $1400, $7000 - $1,400 = $5,600

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+$5,600
11. A number of years ago, the company issued a bond at a discount. They have been
amortizing this discount at the rate of $7,000 per year ever since, including this year. The
accumulated amortization is $28,000. The bond was issued at a 2.5% discount. The yield
to market at that time was 8% and the coupon rate is 11%. The bond matures in the 2018
tax year.
Reason/process
Fully deductible
NIL
12. During the year, the company bought the shares of another company. In completing this
transaction, legal fees of $7,500 were incurred.
Reason/process
Capital in nature, not deductible
+$7,500
13. Instead of borrowing money at the bank, the company decided to pay their income tax
instalments late. This resulted in an interest charge from the Canada Revenue Agency in the
amount of $900. The amount was expensed in the provision for income taxes.
Reason/process
Interest on late payment on the income tax is not deductible
+$900

BUSINESS TAXATION IN CANADA 7
14. Business interruption insurance premiums of $3,100 were paid to protect the company in
the event a fire forced them to close for a period of time.
Reason/process
Not deductible until it is incurred
+$3,100
15. Computer software costing $750 related to word processing was expensed because they
always bought the upgrades each year.
Reason/process
Capital in nature is not deductible, we take CCA instead
+$750
16. Depreciation expense on the fixed assets was $66,000.
Reason/process
Not deductible
+$66,000
TOTAL = $ 197,550
An examination of the capital cost allowance schedule for 2018 provided the following opening
balances for the undepreciated capital cost for each class of EASI's assets:
Class 3 — building....................................... $220,000
Class 8 — office furniture and equipment.... 60,000
Class 10 — trucks for transportation of goods 80,000

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Class 10.1 — passenger vehicle (BMW i8)....... 55,000
Class 13 — leasehold improvements.............. 150,000
Class 43 — manufacturing equipment........... 90,000
The following additional information was found in the 2018 fixed asset schedules working paper files.
1. The Class 3 building which cost $250,000 was sold for $195,000 (equal to its accounting carrying
amount). It was the only building in Class 3 at the time of its sale. A new building was purchased in
April 2018 for $750,000. Also, in February 2018 a land adjacent to the new building was purchased
for $100,000 for use as a parking lot by employees and visitors. This lot was paved at a cost of
$25,000. A fence was erected around an outside storage area near the new building at a cost of
$40,000.
2. New office furniture was purchased for $20,000. This purchase replaced old assets which were sold
for $5,000. None of the old assets was sold for more than capital cost.
3. Class 10 assets consisted of 3 delivery trucks and all these trucks were sold during the year for
$56,000 (total) as the company decided to hire a third party delivery service. Also, the company
purchased a Ford GT for the company’s president to be used as to carry out her employment duties
at a cost of $120,000 to replace BMW i8 which was purchased 3 years ago. The BMW i8 cost
$170,000 and sold for $125,000.
4. Leasehold improvements had been made to a leased warehouse at a cost of $225,000 in 2013. The
remaining length of the lease in that year was six years with two successive renewal options of
three years each. Further leasehold improvements were made to this warehouse in 2017 at a cost of
$21,000.

BUSINESS TAXATION IN CANADA 9
REQUIRED:
Compute the minimum Net Income for Tax Purposes for Eldridge Asset Sales Inc. for the year-ended
December 31, 2018, under the provisions of the Income Tax Act. Please provide a clear working paper
trial so that I can allow you part marks (if any). Assume all expenses are reasonable in the
circumstances.
Solution
NET INCOME FOR TAX PURPOSES (If required, please use the following
page to show additional work).
Subtotal Total
Net income for accounting purposes
Add back provision for income tax
The following items were deducted in arriving at the above net income:
$900,000
$530,000
$1,430,000
1. Included in sales for the year is a deposit of $28,200 received from a
customer for goods that will be delivered next year
Reserve allowed under 20(1)(m) (28,200)
2. During the year, a warehouse worker managed to remove valuable
inventory worth $18,000 during the night shift by taking it out in his
lunch box.

BUSINESS TAXATION IN CANADA 10
Amount is deductible for tax purposes – no adjustment as tax and accounting
treatment are the same
NIL
3. Late in the year, it became apparent that during the next year new
competitive products would come on the market which would drive the
price of their products down. They expect this decline to take place in
about six months. As a result, they decided to set up a reserve for a
decline in the inventory value in the amount of $23,000. They have never
set up this kind of reserve before.
Inventory reserve is not allowed for tax purposes – add back $23,000
4. Because their products come back for repair under their warranty
program, they set up a reserve for this expense on their financial
statements. Last year the reserve was $56,000. This year they decreased
the reserve to $44,000. The warranty was not insured. The actual cost
was $5,000.
Warranty is not allowed for tax purposes – 20(1)(m.1) not applicable as the
warranty must be insured by third party
Accounting treatment – add back last year 56,000, expense this year 44,000
So net expense for accounting purposes is (11,000).
Need to add this back for tax purposes and adjust with actual cost (5,000).
(12,000) + (5,000) = (17,000). ($17,000)

BUSINESS TAXATION IN CANADA 11
5. Charitable donations were made in the amount of $12,000. The company
expensed the donations as promotional expense.
Not a business expense – not deductible for tax purposes
$12,000
6. Golf club membership fees in the amount of $16000 were paid for the
sales manager who used the club regularly to close sales.
Golf membership fees are not deductible under 18(1)(l) – add back $16,000
7. The sales manager incurred expenses related to meals and entertainment
at the golf club in the amount of $12,300.
50% of M&E is not deductible under 67.1 – add back 50% x 12,300 $6,150
8. Management bonuses of $92,000 were accrued at December 31, 2016
($27,000 was not paid until June 30, 2017 due to lack of sufficient funds).
27,000 was not paid within 180 days of year-end for Fiscal Year 2016 and was

BUSINESS TAXATION IN CANADA 12
not included in computing 2016 Taxable Income. This amount is to be accounted
for in computing 2017 Taxable Income. ($27,000)
9. The December holiday banquet for the employees cost $10,000.
Business related expense and 67.1(1) does not apply - - fully deductible – no
adjustment necessary
NIL
10. EASI had a dispute with one of its major suppliers over the use of the
supplier's product. As a result of a court decision, the supplier was
awarded damages for breach of contract in the amount of $18,000.
Damages was paid – therefore, deductible – no adjustment as tax = accounting NIL
11. In order to raise money for expansion, the company mortgaged the real
estate it used in the business. It incurred accounting fees of $5,000 and
appraisal fees of $2,000 related to this financing. The mortgage has a 10-
year term and a 30-year amortization period.
Cost incurred in the course of borrowing money – 20(1)(e) allows cost be the
deducted over 5 years (e.g. 1,400 is deductible in 2008). Add back the amount
not deductible this year
$7,000 – $1,400 = $5,600 $5,600
12. A number of years ago, the company issued a bond at a discount. They
have been amortizing this discount at the rate of $7,000 per year ever
since, including this year. The accumulated amortization is $28,000. The
bond qualifies as a “shallow discount” under s. 20(1)(f). The bond
matures in the 2018 tax year.

BUSINESS TAXATION IN CANADA 13
Bond has not been settled yet... discount not deductible – add back $7,000
13. During the year, the company bought the shares of another company. In
completing this transaction, legal fees of $7,500 were incurred.
Legal fees incurred to purchase shares is included in the cost of buying the shares
– not deductible for tax purposes – add back – 18(1)(b)
$7,500
14. Instead of borrowing money at the bank, the company decided to pay
their income tax instalments late. This resulted in an interest charge from
the Canada Revenue Agency in the amount of $900. The amount was
expensed in the provision for income taxes.
Interest mandated by the Income Tax Act is not deductible under 18(1)(t) – since
the amount is not part of pre-tax accounting income, no adjustment required
NIL
15. Business interruption insurance premiums of $3,100 were paid to protect
the company in the event a fire forced them to close for a period of time.
Normal cost of doing business – deductible – no adjustment NIL
16. Computer software costing $750 related to word processing was
expensed because they always bought the upgrades each year.
Software is capital in nature, not deductible under 18(1)(b) – need to add back –
should be included in CCA (e.g. Sch 8)
$750

BUSINESS TAXATION IN CANADA 14
17. Depreciation expense on the fixed assets was $66,000.
Not deductible under 18(1)(b) – take corresponding CCA. $66,000
CAPITAL COST ALLOWANCE AND CUMULATIVE ELIGIBLE
AMOUNT–
MAXIMUM CCA
TERMINAL LOSS
RECAPTURE
(127,225)
(25,000)
$1,512,650

BUSINESS TAXATION IN CANADA 15
Working Paper for CLASS 13
2011 improvements = $225,000 / (6+3) = 25,000
2017 improvements =
Lesser of:
i) 21,000/5 = 4,200
ii) 21,000/(0+3) = 7,000
Total CCA for class 13= 25,000 + (1/2 x 4,200) = 27,100
1,250

BUSINESS TAXATION IN CANADA 16
MINIMUM NET INCOME FOR TAX PURPOSES $1,360,425
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