SE Machinery Pty Ltd (SEM) Term Paper Example | Topics and Well Written Essays - 2000 words

SE Machinery Pty Ltd (SEM) - Term Paper Example When the customer contributed $500,000 as capital contribution to SEM in May 2011, it appeared in the books as part of the Equity or Capital Account and reported as part of the gross profit by yearend which ended June 2012.. In such a transaction wherein actual cash was received and SEM chose to recognize the cash inflow as capital, the tax law provides that this be considered as ordinary income. Division 6 – Assessable Income and Exempt Income, Section 6.5, states that Australian residents’ ordinary income are assessed whether derived from within Australia or outside, including those derived indirectly or directly â€Å"from all sources† (Australian Parliament 1997, Section 6.5). As Flynn, M.(2009, p.171) had stated, â€Å"The second test is to ask whether the receipt represents a flow produced by an item of capital. If it does, the receipt is revenue.† B. However, the Arthur Murray principle will apply for the prepayment. According to Kater, E. (2009), u nder that principle, income is generally not derived until after services or products have been delivered, except in a situation wherein there may not be a refund of prepayment according to a contract. There was no contract which specifically stated there can be no refund under certain conditions. Income was recognized in June 2012 even though products were yet to be delivered in August 2012. The prepayments were recognized as revenue so that the gross profit includes the value of that prepaid order. But requirements for such a capital contribution to be considered an Income of SEM were not yet completed although prepaid. The goods (Teftoffelex) were delivered only in August 2012. Since there is no contract stipulating that the prepayment was not refundable, the Arthur Murray principle will allow for the delay in payment of Income Tax corresponding to the $ 1,200,000 worth of orders. SEM has received payment and delivered the orders only in August 2012. Thus, this will result in hav ing unearned income as of yearend, June 2012. The Arthur Murray Principle will be applicable because income should be recognized only after the fulfilment of an order and after payment had been received. But this only means that in the next income declaration, income tax would have to be paid for the $1,200,000. The book entries should have been as follows (Appendix 1) It is only after the delivery of goods that the liability account, Unearned Revenues, amounting to a total of $ 1,200,000 should be reversed to consider the entire $ 1,200,000 as Sales. Thus, the proper advice to SEM is to adjust the Sales by $ 1,200,000 because it is in fact still a liability (as Unearned Income) and will remain that way until the goods are delivered. II A. Explanations for Revenue and Expense Accounts 1. Bad Debt Deduction After Write-Off = $8,000 Section 63 paragraphs 34-39 allows for deductions of bad debts only after they have been written off. (AG/ATO 2012, TR 92/18). The Australian Taxation Law under Act No. 55 as amended, in Division 21-5. 2. Interest Expense on Working Capital = $ 25,000 Borrowed @ 8% Interest From February 1, 2012 to end of June 2012 which is 5 months, SEM should recognize the accrued interest expense. This would amount to 25,000 x 0.08 x 5 mos. / 12 months = $ 833. According to the AASB 123 Core Principle (AG/AASB 2009, p. 7 & 9), â€Å"Borrowing Costs that are directly attributable to the acquisition, construction, or production of a qualifying asset form part of the cost of that asset. All other borrowing costs are recognized as an expense.† This should include interest (Section 6a p. 9). Usually, interest expenses are prepaid upon release of borrowed money. And based on the Principle of Profit Determination of the AASB(AAT & Willis, D. 1997, p.7), the expense should be matched with the revenue given a certain period. Thus, upon receipt of the loan, interest expenses should have been treated as Prepaid Interest. And the Prepaid Interest asset account should be reduced by the accrued expense value which would amount