Essay: Accounting Methods, Taxation, And Deductions.

‘The Citadel’, the centrepiece of an ambitious urban redevelopment. His visionary design and revolutionary use of local materials left the judging panel speechless with admiration and, to national acclaim, he was awarded the prize and commissioned to build the structure. Immediately he borrowed $1 million, rented premises in Main Terrace, acquired state of the art equipment and employed six draughtsmen and two administrative staff. During 2017/18 his billings were $2.5 million.

You must refer to appropriate case law. Your answer must include (but should not be limited to) a discussion of the following:

• What factors affect the choice of a cash or accrual basis
• Does Frank have a choice of the basis he adopts
• Does the Commissioner of Taxation have a right to insist on a particular basis
• Should Frank’s basis be the same in both years
• Given the present availability of accounting software packages, in your view, is the traditional criteria for the cash/accrual distinction still relevant

Cash Basis and Accrual Basis of Accounting

The cash basis and the accrual basis are referred as the two different methods that is used in recording the transactions. The main fundamental differences among the two method is the timing that is involved in recording the transactions. The cash basis of accounting helps in recording the cash that is received from the customers while the expenses are recorded when the cash is paid to the suppliers and employees (Bushman et al., 2016). Under the accrual basis the revenue is recorded when it is earned and the expenditure that are recorded when it is consumed. A taxpayer has the choice of using either the cash or the accrual basis of accounting depending up the certain factors. The cash method of accounting is easy to understand and maintain.

In the real business world there are not many business functions that are carried on the case basis as business might sell the products which is paid in the later instances or through other types of transaction which are occurred and payments are received in the later instances (Ball et al., 2016). Factors namely the double entry bookkeeping might be useful in selecting the method of accounting since business would be able to obtain better understanding of the accounting equation. Factors such as cash flow is regarded as the best factors that offers the business with the better understanding of inflow of cash.

Answer to (II):

Frank can choose to account for either the cash or the accrual method of accounting. It is recommended that Frank must use the cash basis as this assist in recognizing the revenues depending upon the concept of cash receipt and expenses that are paid. The cash basis of accounting would help in recognizing the accounts receivables or the accounts payable and the method is easy to determine whether the transaction has occurred with no necessity of tracking the payables or receivables (Flynn et al., 2016).

The cash basis of accounting would help Frank in representing the accounting for GST on the BAS statement covering the period in which the business makes payments relating to purchase and sale. Therefore, it can be stated that Frank can take into the account the cash basis of accounting as it provides easy maintenance of business records.

Answer to (III):

The taxation commissioner has the authority of insisting the taxpayer for a particular accounting basis. According to the taxation commissioner an individual taxpayer would be held assessable for the taxable income depending upon the cash basis and the payment received by a business notwithstanding of when the work was carried out (Barth et al., 2016). The taxation commissioner insists that a business under the cash basis must account for the payments that is acutely received during the year as assessable income. Furthermore, the taxation commissioner insists that where a business reports a turnover of lesser than $10 million can choose to account for GST based cash method of accounting.

Business accounting for cash basis should consider preparing the GST based accounting on the BAS covering the specific period where business obtains the payment for sale and purchase (Hribar & Yehuda, 2015). The commissioner insist that the business obtains benefit under the cash basis of accounting as it assist in improved alignment with activities in BAS statement with easy maintained of cash flow. 

The Choice of Accounting Method and Factors to Consider

Answer to (IV):

Frank reported a total earnings of $75,000 during the accounting year ended 2016/17 whereas in the following year the turnover stood $2.5 million. As evident in both the financial year of 2016/17 and 2017/18 the yearly turnover of business was less than prescribed limit of $10 million. Business that reports the annual turnover of less than $10 million should account under the cash basis of accounting (Penman & Yehuda, 2015). The accounting method for frank would remain same as both in 2016/17 and 2017/18 the business reported annual turnover of less than $10 million. Therefore, the basis of accounting for Frank would be identical during the accounting period of 2017 and 2018. It is recommended that Frank must file return based on the cash basis of accounting.

Answer to (V):

The availability of software packages has the resulted the traditional method of cash or accrual accounting method irrelevant. The cash and the accrual accounting method is different from the traditional accounting since it aids in treating certain business items in a different manner. The electronic software packages enable easy record keeping process for income and expenses than the traditional method (Hui et al., 2016). The electronic software packages enable keeping records of business assets, stock valuation at the end of the accounting year and paying to employees as well. The accounting software packages helps in hassle-free maintenance of cash flow with better of understanding of business cash in hand and at bank.

Part 2: 

Answer to A:

According to the “section 8-1 of the ITAA 1997” an individual is allowed to claim deductions for the expenditure that is occurred in gaining the taxable income. A person is allowed to deduct from their taxable income any losses or outgoings that are occurred in producing the taxable income (Somers & Eynaud, 2015). “Section 25-10 of the ITAA 1997” allows the taxpayer to claim deduction for the expenses that are occurred in repairing the premises or the depreciating assets that is used in producing the income.

Repairs might consist of the renewing or replacing the subsidiary part of the property however does not comprise of the overall rebuilding (Barrett & Elsayed, 2014). Ruby incurs a cost of $8,500 for the replacement of old kitchen fittings and cupboards that was damaged through wear and tear. The expenses that is incurred by Ruby is for restoration of the efficiency of the rental property without causing any substantial change or improvement to the asset. The asset is used by Ruby for the purpose of producing income and the cost incurred in repairs of kitchen fittings and cupboards would be held as deductible expense under the “section 25-10”.

Answer to B:

Legal expenditure can be characterized as the outgoing based on revenue account or an outgoing of the capital nature based on the causes or purpose for which the legal expenditure was incurred. The taxation commissioner in “Herald Weekly Times Ltd v FC of T (1932)” held that legal expenditure is allowed for deduction when the expenses have originated as the consequence of the taxpayer revenue generating activities given that the expenses are not capital or private in nature (Buchanan & Consett, 2016). There is certain legal expenditure which is incurred in producing the rental income are considered deductible. This consist of the cost incurred in defending the damages claims relating to the injuries suffered by the third party on the rental property.

Taxation Regulations for Accounting Methods

Ruby reports a legal expense of $7,000 when a tenant filed the suit for damages suffered from slipping on the steps of her rental property. The legal expenses would be allowed for deduction under “section 8-1 of the ITAA 1997” since the expense originated out of letting the building to the tenants with the objective of generating the assessable income (Martin, 2015). The legal expense can be regarded as having been in occurred in the course of producing the taxable income.

Answer to C:

“Section 8-1” enables a taxpayer to claim for deductions relating to all the losses or outgoings up to the extent that they are occurred in producing the taxable income excluding where the expenses are of capital or domestic in nature no deduction is allowed to the taxpayer. The taxation commissioner in “FC of T v Hallstorms Pty Ltd (1946)” held that in determining whether a taxpayer is allowed to claim legal expense deduction it must be held allowable under the general provision of “section 8-1 of the ITAA 1997”, the legal expenses nature must be held deductible (Woellner et al., 2016). Ruby reports in the present scenario reports the occurrence of compensation expenses based on the damages incurred. The claim settlement amount for the company comprised of $750,000.

The decision made by court in “Sun Newspaper Ltd v FCT (1938)” stated that expenses which is dedicated towards the structural purpose rather than incurring for operational purpose then these expenses are held as capital expenses and deductions are allowed to the taxpayers (Robin, 2017). Compensation incurred by the Ruby Pty Ltd cannot be held as deductible expenses. This is because the expenses are dedicated in the direction of structural purpose instead of occurring it for operational purpose. The compensation damage that is paid by the company is held capital in nature and therefore no deductions will be allowed to Ruby Pty Ltd in this regard.

Answer to D:

As defined by the Australian taxation office expenses related to the office provision are not allowed for deduction for a particular period. For a taxpayer to claim deduction under “section 63 of the ITAA 1997”, the expenses should be existent prior to allowing the expenses as deductions (Blakelock & King, 2017). A taxpayer is permitted to claim deduction under the “subsection 63 (1)” if the expenses are written off by the taxpayer. In the present situation of Ruby Pty Ltd it is found that the company has set aside a portion of expenses as the provision during the accounting period of 30 June.

Expenses that are provisional business expenditure are not allowed for deductions because they are not occurred for producing the taxable income and the same is not allowed for deduction under the provision of general deduction of “section 8-1 of the ITAA 1997”. Therefore, Ruby Pty Ltd would not be allowed to claim deduction for provision expenses under the general provision of “section 8-1 of the ITAA 1997”.

Answer to E:

Any losses or outgoings that are private or domestic in nature might not be allowed for deductions because it does not meet the positive limbs or it is not held deductible under the second negative limbs of “section 8-1 (2) (b) of the ITAA 1997” (Burton, 2017). Losses or outgoings which is preliminary in beginning revenue generating activities or the business activities that are not in the direction of such activity are not held deductible under the general provision of “section 8-1 of the ITAA 1997”. As held in the case of “Softwood Pulp & Paper v FC of T (1976)”.

the company occurred the feasibility study and certain alternative expenses whether the company should set up the paper production mill (Maley, 2018). The commissioner of taxation held that the costs were not held deductible since everything which was done by the taxpayer was entirely preliminary in the beginning of the revenue generating activities.

As understood in the present situation of Ruby Pty Ltd the company has occurred investigation expenditure for understanding the probable entry in the car producing company. The expenses which was occurred by the company was held preliminary in the commencement of the revenue producing activities which was not occurred in gaining or producing the taxable income. The market investigation outgoing should not be held deductible under the provision of “section 8-1 of the ITAA 1997”. 

References:

Ball, R., Gerakos, J., Linnainmaa, J. T., & Nikolaev, V. (2016). Accruals, cash flows, and operating profitability in the cross section of stock returns. Journal of Financial Economics, 121(1), 28-45.

Barrett, J., & Elsayed, A. (2014). Deductibility of employer contributions to employee remuneration trusts-where are we at?. Governance Directions, 66(5), 307.

Barth, M. E., Clinch, G., & Israeli, D. (2016). What do accruals tell us about future cash flows?. Review of Accounting Studies, 21(3), 768-807.

Blakelock, S., & King, P. (2017). Taxation law: The advance of ATO data matching. Proctor, The, 37(6), 18.

Buchanan, R., & Consett, E. (2016). Section 974-80 ITAA97: The current state of play. Tax Specialist, 19(5), 217.

Burton, M., 2017. A Review of Judicial References to the Dictum of Jordan CJ, Expressed in Scott v. Commissioner of Taxation, in Elaborating the Meaning of Income for the Purposes of the Australian Income Tax. J. Austl. Tax'n, 19, p.50.

Bushman, R. M., Lerman, A., & Zhang, X. F. (2016). The changing landscape of accrual accounting. Journal of Accounting Research, 54(1), 41-78.

Flynn, S., Moretti, D., & Cavanagh, J. (2016). Implementing Accrual Accounting in the Public Sector (No. 16/06). International Monetary Fund.

Hribar, P., & Yehuda, N. (2015). The mispricing of cash flows and accruals at different life?cycle stages. Contemporary Accounting Research, 32(3), 1053-1072.

Hui, K. W., Nelson, K. K., & Yeung, P. E. (2016). On the persistence and pricing of industry-wide and firm-specific earnings, cash flows, and accruals. Journal of Accounting and Economics, 61(1), 185-202.

Maley, M. N. (2018). Australian Taxation Office Guidance on the Diverted Profits Tax.

Martin, F. (2015). Overseas travel by employees: When does FBT apply?. Taxation in Australia, 49(7), 382.

Penman, S. H., & Yehuda, N. (2015). A matter of principle: Accounting reports convey both cash-flow news and discount-rate news.

Robin, H. (2017). Australian taxation law 2017. Oxford University Press.

Somers, R., & Eynaud, A. (2015). A matter of trusts: The ATO's proposed treatment of unpaid present entitlements: Part 1. Taxation in Australia, 50(2), 90.

Woellner, R., Barkoczy, S., Murphy, S., Evans, C., & Pinto, D. (2016). Australian Taxation Law 2016. OUP Catalogue.