[Hussainsajwani]

I am pretty sure I am having a tough time understanding the question. From what I read the company pays the CEO a bonus based on the income after taxes .. if the income according to the question is 1.2 mil and tax rate is 30% then income after taxes is 840k and the 15% bonus should be 126k but thats not the right answer. Below are both the question and the answer

The CEO’s compensation contract includes a provision for a bonus of 15% of income before the bonus but after income taxes (30% rate). Income before bonus and income tax is $1.2 million for the current year. The bonus is computed and paid at year-end to obtain the tax deduction for the bonus in the current year. Prepare the journal entry to record the bonus only.

Let B = bonus and T = income tax

B = .15(1.2 million – T)

T = .30(1.2 million – B)

B = .15(1.2 million – [.30(1.2 million – B)])

B = .15(1.2 million – [.30(1.2 million) – .30B])

B = .15(1.2 million – .36 million + .30B)

B = .15(.84 million + .30B)

B = .126 million + .045B

.955B = .126 million

B = .126 million/.955 = 131,937

Since the bonus is paid before year end, the entry would be:

Salary expense 131,937

Cash 131,937

[SeattleAccountant]

The key here is to understand that taxes are paid on the amount AFTER bonus b/c bonus is business expense, tax-deductible. This is why .30 x 1.2mil = 360,000 Taxes is wrong. It has to be .30 x (1.2 – Bonus) = Taxes

By setting up two equations and solving them by substitution, you should get the amount of bonus and also, amount of taxes.

.30 x (1.2-Bonus) = Taxes

.15 x (1.2 – Taxes) = Bonus

Combine them into one equation to solve for Bonus = .15 x (1.2 – [.30 x (1.2 – Bonus)]

Bonus = 131,937

Taxes = 320,418

Becker Class of Jan - Aug 2013: FARB DONE!!!!
CPA license pending 🙂

[Author]

Replies