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AC312 – Tax Research Memo #2 You provide tax consulting services for Oh Gnome You Didn’t,...

AC312 – Tax Research Memo #2 You provide tax consulting services for Oh Gnome You Didn’t, Inc. (“Gnome”), a C-corporation that designs and constructs whimsical gnome gardens for its clientele. On May 25th, 2018, Gnome acquired substantially all the business assets of an unrelated company named You Better Duck, Inc. (“Duck”). Duck bathed and groomed pet ducks prior to Gnome’s acquisition of its assets. It is well-known that 75% of duck aficionados own a gnome garden because ducks love to quack up at the funny-looking gnomes, so this was a very strategic business decision for Gnome. The transition was seamless, and no duck was forced to stay unkempt for a moment. Gnome paid $1,725,000 to acquire Duck’s assets, of which $690,000 was allocated to tangible assets and the remaining $1,035,000 of the purchase price related to Duck’s intangible assets. Your friend Millie who also happens to be Gnome’s CFO has provided the following table for you to reference that itemizes the purchase and computes the 2018 GAAP expense associated with the acquired assets: Asset Description Adjusted Basis Cost Allocation Method – GAAP 2018 GAAP Expense Duck bathing and grooming equipment $690,000 Depreciate over 48 months, beginning with June 2018 $690,000/48 months * 7 months in 2018 = 100,625 3-year exclusive supplier agreement with Ducks ‘R Us 93,000 Amortize over 36 months, beginning with June 2018 $93,000/36 months * 7 months in 2018 = 18,083 Patent for the Clean “Bill” of Health bathing process invented by Donald, Duck’s founder (expires in 16 years) 25,000 Amortize over 192 months, beginning with June 2018 $25,000/192 months * 7 months in 2018 = 911 2-year Employment Agreement with the #1 duck whisperer in the known universe 260,000 Amortize over 24 months, beginning with June 2018 $260,000/24 months * 7 months in 2018 = 75,833 Goodwill 657,000 Not amortizable Not Applicable Total Cost of Acquired Assets $1,725,000 2018 GAAP Depreciation & Amortization Expense for Acquired Assets $195,452 Continued next page… AC312 – Tax Research Memo #2 (continued) Millie would like to know the 2018 tax expense amount that will be reported on Gnome’s income tax return with respect to the acquired assets. She has asked you to compute the allowable 2018 tax depreciation and tax amortization expense amounts and would like you to summarize your results using the partially completed table below. Millie believes that Gnome’s 2018 income tax return is likely to be audited by the IRS, so she has requested you document your findings in a professional tax research memo using proper citations to substantiate your cost allocation method conclusions for each type of asset. Asset Description Adjusted Basis Cost Allocation Method – Tax 2018 Tax Expense Duck bathing and grooming equipment $690,000 3-year exclusive supplier agreement with Ducks ‘R Us 93,000 Patent for the Clean “Bill” of Health bathing process invented by Donald, Duck’s founder (expires in 16 years) 25,000 2-year Employment Agreement with the #1 duck whisperer in the known universe 260,000 Goodwill 657,000 Total Cost of Acquired Assets $1,725,000 2018 Tax Depreciation & Amortization Expense for Acquired Assets $??? Expert Answer

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Answer:

A Total cost and depreciation of the acquired assets
Sl No Asset Description Cost ($) Useful Life Depreciation Expense (2018)
1 Duck bathing and grooming equipment 690,000 48 Months 100,625
2 Exclusive supplier agreement with Ducks ‘R Us 93,000 36 Months 18,083
3 Patent for the Clean “Bill” of Health bathing process 25,000 192 Months 911
4 Employment Agreement 260,000 24 Months 75,833
5 Goodwill 657,000 0
Total 1,725,000 195,452
B Computation of allowable 2018 tax depreciation and tax amortization expense
Sl No Asset Description Depreciation/Amortization (2018) Remarks
1 Duck bathing and grooming equipment 100,625 Depreciation can be claimed
2 Exclusive supplier agreement with Ducks ‘R Us 18,083 Allowable amortization expense
3 Patent for the Clean “Bill” of Health bathing process 911 Allowable amortization expense
4 Employement Agreement 75,833 Allowable amortization expense
5 Goodwill 657,000 Entire goodwill has to be charged to income statement in the year of acquisition. Aquired good will can not be capitalized as per GAAP rules.
Total allowable 852,452
C Tax research memo to substantiate the findings
1 Depreciation expense on capitalized equipment can be allowed as tax expense
2 Amortization expense on the intangible assets purchased can be allowed as tax expense
3 Depreciation on acquisition can not be capitalized in books. The same shall be charged off. It can be taken as tax allowance.

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