Problem 13 - Accounting Principles

Question

During 2017, Talon Inc. had sales revenue \(\$ 376,000\), gross profit \(\$ 176,000\), operating expenses \(\$ 66,000\), cash dividends \(\$ 30,000\), other expenses and losses \(\$ 20,000\). Its corporate tax rate is \(30 \%\). What was Talon's income tax expense for the year? (a) \(\$ 18,000\). (c) \(\$ 112,800\). (b) \(\$ 52,800\). (d) \(\$ 27,000\).

Step-by-Step Solution

Answer

The income tax expense is $27,000.

Step 1: Calculate Gross Profit

Gross profit is given as $176,000 from sales revenue.

Step 2: Calculate Operating Income

Subtract operating expenses from gross profit: Operating Income = Gross Profit - Operating Expenses. This gives us: \[176,000 - 66,000 = 110,000.\]

Step 3: Calculate Income Before Tax

Income before tax is calculated by subtracting other expenses and losses from operating income: Income Before Tax = Operating Income - Other Expenses and Losses. This gives: \[110,000 - 20,000 = 90,000.\]

Step 4: Calculate Income Tax Expense

Apply the corporate tax rate (30%) to the income before tax:\[Income Tax Expense = Income Before Tax \times Tax Rate.\]Substitute in the known values:\[90,000 \times 0.30 = 27,000.\]

Key Concepts

Gross Profit

When we talk about gross profit, we refer to the amount of money a company makes after deducting the costs associated with making and selling its products, also known as the cost of goods sold (COGS). It's important to note that gross profit focuses only on the direct costs of production and excludes other expenses such as administrative or marketing costs.
Gross profit is crucial because it serves as the preliminary insight into how a company's core activity is performing. For instance, in the case of Talon Inc., the gross profit was \(176,000\).

• This results from subtracting the total cost of goods sold from the sales revenue.
• This figure helps in understanding how effectively a company manages its production costs in relation to its sales.

Remember that gross profit does not account for other expenses like administrative costs, taxes, or debts. It's the first step in evaluating a company's profitability.

Operating Expenses

Operating expenses, often abbreviated as 'OPEX', are the ongoing costs incurred in the normal day-to-day operation of a business. In the case of Talon Inc., they amounted to \(66,000\). These expenses can include things like rent, utilities, salaries, and other miscellaneous costs necessary for running the daily operations.

• Operating expenses are crucial for determining the operating income, an important measure of a company's financial performance.
• Unlike gross profit, operating income takes into consideration the direct costs (COGS) and these operating expenses.

When you subtract operating expenses from the gross profit, you obtain the operating income. This step is fundamental as it gives a clearer picture of how profitably a company is managing its normal business operations.
Some companies aim to minimize operating expenses to improve their operating income and overall profitability.

Corporate Tax Rate

The corporate tax rate is a percentage that businesses must pay on their profits to the government. In this exercise, Talon Inc. has a corporate tax rate of 30%. This means for every dollar of taxable income, 30 cents go to the government as tax. This rate can vary from year to year and differs by country or region.

• Understanding the corporate tax rate is important for determining the company's net income after taxes.
• Corporations need to plan for these taxes as they form a significant part of business expenses.

For Talon Inc., once they calculate their income before tax, the tax rate is applied to find out how much tax they owe. This impacts the overall earnings available for shareholders and future reinvestments. Therefore, managing and planning for corporate tax is a crucial aspect of financial strategy.

Income Before Tax

Income before tax, also known as 'pre-tax income' or 'earnings before tax', is the total earnings of a company before any income tax charges have been accounted for. It reflects both operational and non-operational components of a business and gives a clear picture of total revenues minus expenses, excluding taxes.
In the case of Talon Inc., their income before tax was calculated to be \(90,000\), resulting from subtracting other expenses and losses from their operating income.

• This measure is critical because it determines the base upon which taxes are calculated.
• Businesses keep track of this figure to forecast future earnings and manage their tax liabilities.

The income before tax number is a strong indicator to assess the pre-tax performance of a company, showing how much profit is made from all business operations without the influence of tax costs.