XYZ Manufacturing, Inc., located in Centervale, uses the calendar year and the cash method of accounting.
On December 31, 2010, XYZ made the following cash payments:
•$100,000 for a two-year office lease beginning on February 1, 2011
•$58,000 of inventory items held for sale to customers
•$21,800 to purchase new manufacturing equipment, which was delivered and set up on January 15, 2011
•$10,000 compensation to the company's auditors who spent three weeks in January 2011 analyzing XYZ's internal control system, as a part of the annual audit
•$30,500 property tax paid to the local government for the first six months of 2011
To determine the deductible expenses for XYZ Manufacturing, Inc. for the year 2010, we need to consider the principles of accrual accounting and the specific rules for each type of expense.
1. $100,000 for a two-year office lease beginning on February 1, 2011:
Since the lease will start in the following year, it should not be considered a deductible expense for the year 2010. Instead, it will be recorded as an expense over the period it covers, starting from February 1, 2011.
2. $58,000 of inventory items held for sale to customers:
Inventory purchases are generally deductible expenses in the year they are sold. However, since XYZ Manufacturing, Inc. uses the cash method of accounting, expenses are deductible when cash payments are made. Therefore, the $58,000 payment for inventory is a deductible expense for 2010.
3. $21,800 to purchase new manufacturing equipment, delivered and set up on January 15, 2011:
Similar to the lease expense, the purchase of new manufacturing equipment is not deductible in the year of payment for cash basis taxpayers. For XYZ Manufacturing, Inc., the $21,800 payment will be considered an expense in 2011 when the equipment is placed in service.
4. $10,000 compensation to the company's auditors who spent three weeks in January 2011 analyzing XYZ's internal control system, as part of the annual audit:
Since the auditors' services were performed in 2011, this payment is not deductible in the year 2010.
5. $30,500 property tax paid to the local government for the first six months of 2011:
Property taxes are generally deductible in the year they are paid. XYZ Manufacturing, Inc. paid the $30,500 property tax in 2010, so it is a deductible expense for that year.
In summary, the deductible expenses for XYZ Manufacturing, Inc. for the year 2010 are the $58,000 inventory purchase and the $30,500 property tax payment, totaling $88,500. The expenses related to the lease, new manufacturing equipment, and auditors' compensation will be deductible in the following year when they are incurred or placed in service.