Taxation Law

Name

Course

Date

Tutor

Part A

Facts

Lee commenced his dole proprietor business at his residential place garage on 1st July 2013. At the end of the year 2013/14, he has a small client base mainly locals and private referrals. Similarly, his billing was $75,000. On 30th June 2015, he submitted a design for a national competition, which he subsequently won. As a result, he borrowed a $1 million loan, rented a premises, bought equipment, and employed six draughtsmen and two administrative staffs. Due to this investment, his billings increased to $1.5 million.  

Issue

To analyze the most appropriate accounting method for Lee’s business for the period 2013/2014 and 2014/2015.

Rule

The Australian tax law, the income tax law Act, as well as case laws will be used for the purpose of analysis the aforementioned issue.

Analysis

Under the Australian taxation system, business owners must consider two key factors as the file their annual income tax. These factors include; the Accounting Period and the Accounting Method. Accounting period accounts for business activities conducted over a span of 52-53 weeks (12 months). The Australian commercial law recognizes both accounting based on a calendar year (from 1st January to 31st December), or the fiscal year which accounts for any 12 months but do not end on 31st December. In this regard, Lee’s accounting period would be classified under a fiscal tax year starting on 1st July and ending on 30th June every year.  

Whereas the accounting period is inconsequential on the financial reports, the accounting method has major effects on the financial records. The cash accounting method is mainly used by individuals and sole proprietors when calculating their income tax. This is because the sole proprietor is not distinct to the business. The cash method takes into account the fact that little or no records are kept and that the individuals or owners of sole proprietor businesses keep cash method records. The cash system accounts for income actually and consecutively received during the tax year, further, assets fair market value must be reported as income. Similarly, expenses incurred in the tax period are deducted as well as those that the business contests liability. Nonetheless, expenses paid in advance should not be deducted^[1][2].

Accordingly, businesses with an aggregate revenue of less than $ 2 million are allowed in law to use the cash method. The cash accounting method requires the accounting for Goods and Services Tax on the period in which a sale or purchase was made. This is advantageous in that it closely links with money inflow to the liabilities thus making it easier to manage cash flow in the business. Under the Australian tax law, cash accounting method is only allowed for; small business entities whose aggregate turnover is below $ 2 million, dormant business that are not transacting but the turnover is less than $ 2 million, the account for income tax is on a cash basis. It is important to note that a business is eligible to Goods and Service Tax (GST) if its turnover is above $75,000. Accordingly, GST is defined as a broad-based tax of 10% charged on most consumer goods and services in Australia. On the other hand, the accrued system, takes into consideration all incomes earned in the tax year or the capitalized expenses incurred in the same period. The accrual method aims at matching income and expenses to their accurate periods. As such, income under this method only include what is actually received in the tax year this means that amount payables and due are treated as income.

The ATO Taxation Ruling TR 98/1, states that the accounting method used by a business for the purposes of income tax must be the most appropriate for that business^[3]. In this regard, the cash method is most fitting for Lee’s business since it is a small enterprise offering skills and services to clients. Further, according to the GST guidelines businesses whose yearly turnover is below $ 2 million but greater than $75,000 has the liberty to register either the cash or the accrual method as their basis. In reliance to these facts, the commissioner of tax has no right to dictate which accounting basis a business entity applies. Nonetheless, they can give advice since each accounting basis has tax implications on the business. For instance, GST affects a business cash flow given that payables are factored in, thus, the accrual method may injure a small enterprise^[4].

Part B  

Facts

Beta Smash Repairs commenced business as a sole proprietor form of business on 1st July 2013, as a vehicle repair shop. In addition, the business buys wrecked vehicles, rebuilds, and repairs them for resale. In the tax year 2013/14, no sale was made.

On 30th June 2015, the business had six rebuild vehicles;

Stock

6 vehicles@ $12,000 each

Purchases

2----------- Free

3----------- Cost $500 each

1 --------- From customer owned @ the ratio 1:2 --- Non ownership until sale  

Parts------ $50,000 ($5,000 unused)

Overheads---- $80,000

Estimates

70% of costs = repairs, 30% = rebuilding

Selling price per Vehicle= $12000

Accrual method

Year 2014/2015

Closing stock = opening stock + (purchases-sales)

                       = 0 + (3 x 500)

                       = 0 + 1500

                       = $1,500

Cash method

Closing stock= opening stock + (Purchases – sales) 

                       = 0 + (3 x 500) + (12,000 x 1/3)

                       = 0+ 1500 + 4,000

                       = $5500

Implication of income tax to the business

Analysis

Under the Australian business, entities are required to include all earned annual incomes depending on the accounting basis the business assumes. Accordingly, businesses with an aggregate revenue of less than $ 2 million are allowed in law to use the cash method. The cash accounting method requires the accounting for Income Tax on the period in which and income was made or expense was incurred. This is advantageous in that it closely links with money inflow to the liabilities thus making it easier to manage cash flow in the business. Under the Australian tax law, cash accounting method is only allowed for; small business entities whose aggregate turnover is below $ 2 million, dormant business that are not transacting but the turnover is less than $ 2 million, the account for income tax is on a cash basis. Conversely, the accrued system, takes into consideration all incomes earned in the tax year or the capitalized expenses incurred in the same period. The accrual method aims at matching income and expenses to their accurate periods. As such, income under this method only include what is actually received in the tax year this means that amount payables and due are treated as income (Public Sector Accounting Standards Board Australia).