Netting of Long term and Short term Capital Gains and Losses

Netting of Long term and Short term Capital Gains and Losses

These groups of capital gains are netted against one another according to the following rules in § 1221.

1. Long-term capital gains are netted against long-term loses.
2. Short-term capital gains are netted against short-term losses.
3. If the results of the first two netting procedures have the same sign (that is, both are losses or both are gains for the taxpayer), then the taxpayer has that amount of each type of net gain or loss, and each is treated accordingly by the Internal Revenue Code and the Internal Revenue Service. 
1. However, if the results of the first two netting procedures have opposite signs (that is, if one is a net gain and the other a net loss), those two outcomes are netted against each other.
2. This final result of this netting has the character of whatever type of gain or loss “sticks out” after the netting procedures regarding capital gains are finished 

What are Business Entertainment Deductions?

The Definition of Business Entertainment Deductions in Tax Accounting

§ 274 of the Internal Revenue Code authorizes no deductions, it limits conditions or prohibits certain deductions that § 162 or 212 would otherwise permit.

BUSINESS ENTERTAINMENT DEDUCTIONS

§ 274(a) If an activity is “of a type generally considered to constitute entertainment, amusement, or recreation its expenses may be deducted if

1. Activity is directly related to the taxpayer’s business OR
2. Activity is associated with the conduct of the taxpayer’s business and it immediately precedes for follows a substantial business discussion

STANDARD: There must be a substantial and bona fide business deduction and a minimal nexus between business and the activity. This is required for a taxpayer claiming a business entertainment deduction.

What is Reasonable Compensation for the IRS?

Definition of Reasonable Compensation

§ 162(a)(1) of the Internal Revenue Code allows for “a reasonable allowance for salaries or other compensation for personal services actually rendered."

The reasonable compensation section of the tax code often comes into play because the double taxation of corporations. If the officers and executives of a corporation are substantially identical with its major shareholders, a temptation may arise to distribute some of the earnings of the corporation under the label of additional compensation for services, rather than under the dividend label to save on taxes.

The reduction in dividend tax lessens that tax advantage of compensation over dividends, but in many situations a significant tax advantage for compensation remains. There are still many  controversies between businesses and the IRS over what is considered reasonable compensation for a corporate officer.

What are Shareholders?

Shareholders:  They are the owners of the corporation.

The Shareholders possess the right to 1) Elect directors 2) Vote on fundamental transactions like mergers, sale of assets, dissolutions, and amendments of articles of incorporation.

• They have residual claim on corporations assets if it is dissolved (“liquidation right”). Once creditors have been paid in a liquidation, the shareholders can get the remaining assets.
• They have a right to receive a pro rata share of corporate profits (dividends) if authorized by board of directors. This is not absolute, they have to bargain for this right. Preferred Shares get dividends first.
• Control rights are weighted by the size of your investment. This is different than a general partnership where all partners vote equally. 
• Other than electing the board, they have no management of conduct rights. Shareholder do not have rights to act on behalf of the corporation. They are passive investors.

What is a company's authorized stock?

A company's authorized stock is the number of shares that it may legally issue. The amount of authorized stock will appear in the articles of incorporation that a company files with the secretary of state during the beginning of its existence.

A corporation cannot issue more stock, or stock of a different class, that the articles of incorporation authorize. This is why it is important for a company to anticipate its future financing needs when preparing its articles of incorporation.

However, with approval of the board of directors or shareholders, the articles of incorporation may be amended to increase the number of shares authorized, or to create an entirely new class of stock for selling to investors.

Preferred Shares –Bargain for Rights

 Preferred Shares –Bargain for Rights

• Have preference or priority in payment over common shares Terms are set out in articles or in separate document called “certificate of designations. 
• They get dividends paid out first. The dividends could accumulate and then preferred shares must get paid out first before holders of other classes of stock outstanding.
• Initially, they did not have voting rights
• Liquidation Preference- Might get right to sell shares back to the company at a certain price 
• Preemptive rights – a right to buy shares ahead of other shareholders from the corporation This is an Anti-Dilution Device and normally something that preferred shareholders pay for and bargain to receive.

Capitalization and Depreciation

Capitalization and Depreciation- Matching Expenses with the Income that those expenses help produce

§168 of the Internal Revenue Code provides various cost recovery schedules. Under the accelerated cost recovery system ACRS, the cost recovery of an asset depends on three things:

1. The total amount of cost to be recovered
2. The number of years over which the cost is to be recovered
3. The rate at which the cost is to be recovered over those year.

Differences between cash method and accrual method

Taxpayers have two primary choices that they must stick to when completing accounting records for tax returns. What are the main differences between the cash method of accounting and the accrual method of accounting for tax purposes?

The Cash Method

The cash method of accounting has a focus on money our and money in. For example, a taxpayer has income when she receives a payment from a buyer. The taxpayer has a deduction when they make payment.

The Accrual Method

Oppositely, the accrual method of accounting focuses more on legal rights and obligations: An item is considered income when the right to receive it is earned. An item is deductible when the taxpayer becomes liable to pay the item.

It is important to note that individual taxpayers are generally required to use the cash method of accounting. Certain taxpayers must use the same method of accounting for tax purposes as they use to keep their books.

Section 197 Intangibles- Amortization

What are IRS Section 197 Intangibles- Amortization?

Normally the goodwill of a business is a non-depreciable asset. However, congress made an exception.

§ 197 : Taxpayers are allowed to recover the cost of a wide range of purchased intangibles, including goodwill and other “customer based intangibles,” on a straight line basis over 15 years, without regard to the actual useful life of the asset.

1. § 197 usually does not apply to intangibles created by the taxpayer itself.
2. Little practical significance because taxpayers can deduct the majority of costs used to create goodwill under § 162
3. § 197 only comes into effect when goodwill is purchased

Work Clothing Tax Deduction

What types of tax deductions are available for individual taxpayers regarding work clothing?

The generally accepted rule governing the deductibility of clothing expenses is that the cost of clothing is deductible as a business expense only if:

1. The clothing is of a type required as a condition of employment
2. It is not adaptable to general usage as ordinary clothing, and
3. It is not so worn as ordinary/daily clothing. 

A taxpayer must satisfy all these requirements in order to pass an audit by the IRS concerning a work clothing tax deduction. 

Fixed Costs and Variable Costs Examples

The following are examples of fixed costs and variable costs:

• Indirect labor- fixed costs could be variable under certain circumstances
• Indirect materials- variable costs
• Insurance on building- fixed costs
• Depreciation on building (straight-line)- fixed costs
• Overtime premium pay- variable costs
• Property taxes- fixed costs
• Polishing compounds- variable costs
• Depreciation on machinary (based on machine hours used)- variable costs
• Employer's payroll taxes- variable costs
• Machine lubricants- variable costs
• Employees' hospital insurance (paid by employer)- fixed costs
• Labor for machine repairs- variable costs
• Vacation pay- variable costs
• Patent amortization- fixed costs
• Janitor's wages- fixed costs
• Rent- fixed costs
• Factory electricity- fixed costs
• Plant manager's salary- fixed costs

Additional Accounting Examples:

Variable Cost Ratio Example

Difference between Fixed Cost and Variable Cost

Relationship between Variable and Absorption Costing
Applying Manufacturing Overhead

Accounting Income Statement

The main purpose of the accounting income statement is to report the net income earned by a company during a specified period. Most company's issue annual and quarterly income statements.

The income statement is generally considered the best representation of a company's financial health. A well prepared should answer the following questions:

1. What is the company's current financial status (profit/loss) ?
2. What were the company's operating results for the period?
3. What did the company use its cash for during the period.

Additional Links to Accounting Problems and Examples:

Accumulated Depreciation Balance Sheet
How to Calculate Net Income
Accounting Financial Statements
Credit Sales and Purchases Accounting Problems

What is default risk?

In relation to financial and managerial accounting, default risk is the probability that a company or customer will not be able to make timely debt or interest payments when they are required.

When the amount of debt in a company's capital structure increases, the likelihood of default increases significantly because the principal and required interest payments become much larger.

Additional Accounting Examples:

Purpose of Higher Leverage

What is Financial Leverage?

Ratio Analysis for Financial Control

Operating Expense to Sales Ratio

Calculate Gross Financial Margin

Degree of Financial Leverage

Purpose of Higher Leverage

What is the purpose of higher leverage?

There are many important reasons why a company might make use of high leverage in its borrowing practices. One reason is that higher leverage allows a company to expand without requiring additional stockholder investments but also will make repayment to creditors less certain.

It is important to check a company's financial statements with financial ratios to ensure that they will be able to meet future liabilities.

Additional Accounting Examples:

Ratio Analysis for Financial Control

Operating Expense to Sales Ratio

Calculate Gross Financial Margin

Degree of Financial Leverage

What is default risk?

Dividend Preferences

It is important to consider Dividend Preferences in companies that have both common stock and preferred stock. The manner in which the dividends are divided is based on the rights of preffered stock holders.

Additional Accounting Examples and Explanations:

Four Significant Dividend Dates

Cost of Preferred Stock

Prepaid Rent and Unearned Rent

What is the different between Prepaid Rent and Unearned Rent?

The following is an accounting example explaining the different between prepaid rent and unearned rent. Prepaid rent is a type of payment made by a tenant in advance of its due date and is an asset to the receiving company. For example, if the apartment's tenant had paid $240 in January for the entire year rent ($20 a month), it would show as of 1/31/xx $240 as prepaid rent. 240/12=20, 240-20=220.

The landlord in this situation would show $220 as unearned rent as of 1/31/xx a liability on the balance sheet, because they have received money for rent in which they have not provided service February through December, therefore the title unearned rent. This is the matching principle in accounting, primarily the major underlying principal of generally accepted accounting principles (GAAP).

Additional Accounting Examples:

Advance Payments and Unearned Rent

Credit Sales and Purchases

Accounting Cost Principle

Revenue Recognition Principle

Seasonal Change in Inventory

Many firms have inventories that are highly seasonal and change greatly throughout their business year. Therefore, calculating the inventory turnover from end of year inventories will not produce the most accurate results for different firms. Companies with large seasonal changes in inventories are better to calculate the firm's average inventory over the past year and use that to calculate inventory turnover than other less accurate methods.

Additional Accounting Tutorials and Accounting Examples:

FIFO Method and Weighted Average Inventory Method
Perpetual Inventory System
Basic Equation for Inventory Accounts
Inventory Cost Flow Assumptions
Accounting Inventory Shrinkage Example Problem
Merchandising Accounting Journal Entry

What is Fair Value Accounting?

What is fair value accounting and how is it related to the accounting for trading securities?

In accounting we have to rationalize relevance and reliability, as outlined in the FASB's conceptual framework. In financial reporting this means fair value vs. historical costs. On many physical assets, GAAP is recording at historical costs. However, on trading securities and many intangible assets, its irrelevant to record them at historical costs.

Companies follow a fair value hierarchy, when reporting costs. There are three levels, based on reliability.

Calculate Account Receivable Turnover

A receivable turnover ratio measures how long it takes for a company to collect on credit sales. This turnover ration tells an accountant how many times receivables are turned over. The average collection period will indicate the average length of time that a firm must wait after making a sale before it receives cash.

Receivables Turnover = Sales/ Accounts Receivable

What drives “convergence” for international firms?

Convergence is the increasing similarity of management practices in firms.  It is more apparent in transnational firms than multinational firms.

Globalization is pushing convergence for multiple reasons including global customers, growing levels of economic development, and global competition. In order for firms to remain competitive, it is an advantage to be aware of what people are doing in other foreign countries.

Transnational firms must seek to take advantage of their foreign domestic situations by assimilating into their culture.

For further information about international business, check these links: 

Advantages and Disadvantages of Globalization
Multi-Domestic Strategy and Transnational Strategy

Fiscal Year Definition and Explanation

The following is the accounting definition and explanation of a fiscal year:

The year long accounting period used by a company is known as its fiscal year. The maximum length of this accounting period is generally twelve months which includes all transactions that have taken place in the accounting cycle or fiscal year

A year-long accounting period that ends when its business activities are at their lowest point in the annual operating cycle is called a natural business year. It is possible to see the long-term financial history of a company by reviewing balance sheets that are prepared every year. The history of operations for each fiscal year is shown in the income statement.

Additional Accounting Examples and Explanations:

Information on the Accounting Cycle
What is a Trial Balance?
Common Trial Balance Errors

No Inequality in Trial Balance

The following four types of errors will not cause an inequality in the trial balance of an account.

1. Recording a transaction more than once
2. Posting part of a specific transaction correctly as a debit or credit yet doing it in the wrong account.
3. Failing to record a transaction or to post a transaction in the appropriate account
4. Accidentally recording the exact same erroneous amount for both debit and credit parts of a transaction.

Additional Accounting Examples and Explanations:

Information on the Accounting Cycle
What is a Trial Balance?
Common Trial Balance Errors

Normal Balances of Accounts

What is a Normal Balance

The sum of increases to the account is equal to or greater than the decreases to the account. Hence, the account is considered to have a normal balance.

What is Accounting Business Transaction?

There are two important criteria for an action to be considered an Accounting Business Transaction

1. The business transaction must be recorded
   
2. Transactions that are not related directly to outsiders are sometimes referred to as internal transactions.
   

Maturity Value Definition

What is the accounting definition of Maturity Value?

Bond Maturity Value is the amount of an obligation to be collected or paid at maturity by the bond issuer that is equal to the principal plus any interest.

Plantwide Overhead Rate

The Plant-wide overhead rate is used by companies as a single overhead rate that is used throughout all production departments in a specific plant. It is popular for companies to use multiple overhead rates rather than plantwide overhead rates to more accurately distribute overhead costs among produced products.

It is a good idea to use multiple overhead rates in manufacturing situations when one department is machine intensive and another department is more labor intensive in its production techniques.

What is an example of a globalization driver?

Globalization drivers are conditions in an industry that favor transnational/international strategies over multi-local/regional strategies. These factors generally fall into four categories such as markets, costs, governments, and competition. 

An example of a cost factor would include the search for cheaper local labor and procuring cheaper raw materials in foreign countries.

For further information about international business practices, check these links: 

Advantages and Disadvantages of Globalization
Multi-Domestic Strategy and Transnational Strategy

What is Accounting Work Sheet?

A work sheet is a preparation tool used by accountants to help them produce financial statements. They are normally only used within the company and will not be shown to outsiders. In todays computer economy, many are prepared on computer spreadsheet programs such as Excel.

What is Retained Earnings?

Calculate Internal Rate of Return

The internal rate of return (IRR) is defined as the rate of return an investment project creates over its entire life. It is computed by finding that discount rate that results in a zero net present value for the project.


Additional Accounting Links:
Calculate Accounting Average


Useful External Links:

Online NPV Calculator
Calculate IRR using Excel

Purchase Raw Materials Journal Entry

Use the following information to record the purchase raw materials in the accounting ledger.
When you receive the ship, you are obligated to pay cash or a agree on paying at a later date

Both transactions require these accounting journal entries to keep the ledger in check.

1. Increase raw materials inventory with credit
   
2. Decrease cash account with debit
   
3. Increase accounts payable with credit
   

Additional Accounting Tutorials and Accounting Examples:

What are Direct Materials?
What are Indirect Materials?
FIFO Method and Weighted Average Inventory Method
Perpetual Inventory System
Basic Equation for Inventory Accounts
Inventory Cost Flow Assumptions
Accounting Inventory Shrinkage Example Problem
Merchandising Accounting Journal Entry

Prepaid Expenses and Unearned Revenues

In accounting, prepaid expenses and unearned revenues are considered prepayments by accountants. That is defined as money has exchanged hands but the expense or revenue is not recorded due to the expense has not been incurred yet or the revenue has not been earned yet by the company.

Examples of prepaid expenses and unearned revenues

• Prepaid Expense - A year long insurance contract a company paid $12,000 for at the beginning of the year. Since the insurance company owes the company service, the expense prepayment is recorded as an asset (Journal Entries: debit Prepaid Insurance and credit Cash).

• Unearned Revenue - A year long subscription of $12,000 is received in advance by a magazine company. Because the company owes something, the unearned revenue is recorded as a liability (Journal Entries: debit Cash and credit Unearned Revenue).

Advantages and Disadvantages of Globalization

What is globalization and what are some of its advantages and disadvantages?

In recent decades, globalization has been defined as an economic force driving worldwide economic integration and the expanding of businesses beyond their domestic borders. The worldwide trend of diminishing trade barriers, increased technology, and reduced shipping costs have promoted a prosperous era of world trade. Companies are no longer limited to their domestic boundaries and may conduct business anywhere in the world. Some benefits of globalization include lower prices and job creation.

Manufacturing activities can be performed where labor and supplies are cheapest leading to reduced consumer costs. Jobs can be created in poorer economies that eventually lead to prosperous economic growth. Yet the effects of job creation and globalization are like a double edged sword. Jobs often are eliminated in countries with higher costs and out-sourced to countries with lower cost structures.

This has been viewed as one of the main disadvantages of globalization and a point of contention between employees of multinational companies. However, many of these benefits continue to outweigh its disadvantages therefore the world will continue to see globalization rise as a powerful global economic force.

What is Working Capital Management

Working capital management relates to the short-term management of a firm's short term assets and liabilities. For example, inventory is considered a short-term asset and accounts payable is categorized as a short-term liability that shows what the firm owes to other entities.