Using the tests for deductibility discussed in Chapter 5, explain why the follow
ID: 2422241 • Letter: U
Question
Using the tests for deductibility discussed in Chapter 5, explain why the following expenses may not be fully deductible in the current year
a. Janet pays $900 in interest on debt she incurred to purchase municipal bonds. The bonds pay $1,500 of interest in the current year.
b. Andrew owns a retail-clothing store. Andrew has the opportunity to obtain a franchise to operate a discount sporting goods store. He spends $5,000 investigating the possibility of opening a sporting goods store in a neighboring town.
c. Jane owns a fitness center. She employs the star basketball player at Local University as an aerobics instructor. Because of his reputation, she pays him $20 an hour. Jane pays her other aerobics instructors $10 an hour.
d. Alvin makes a vacation trip to Florida, and while there spends two days investigating the feasibility of opening up a new office of his optometry practice.
Explanation / Answer
Answer is as follows:
a. In this situation, Janet pays interest on the debt availed to acquire the capital asset. Normally, the interest cost incurred on a debt to acquire capital asset is to be capitalised, if the asset is not to put to use and not started earning profits. Since here in the given situation bonds started earning income, the interest paid on dets may be deductable against the income of bonds.
b. Investing is like checking the feasibility of a project. These expenses will be grouped under Preliminary expenses which will be generally set off against capital or will deferred over a period of time on the basis of company policy or policy of statue governing the company. Hence expense of $ 5000 incurred towards investing need to be capitalised i.e., has to set off against capital or shall be deferred over a period of time.
c. The amount that is being paid to reputed aerobic instructor can be deductable against the income even though higher amount is paid as premium. If company feels, it can defer the amount paid to famous playes if it feels the benefir will spread over to many financial years.
d. Expense incurred on feasibility of a project will come under Preliminary expenses which will be generally set off against capital or will deferred over a period of time on the basis of company policy or policy of statue governing the company. Hence expense incurred towards feasibility can be capitalised i.e., has to set off against capital or shall be deferred over a period of time.
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