Ajax Corporation is a young high-growth company engaged in
the manufacture and distribution of automotive parts. Its common stock has
doubled in value since the company was listed on the NASDAQ exchange about two
years ago. Ajax currently has a high debt/ equity ratio due to the issuance of
debt to finance its capital expansion needs. Despite rapid growth in assets and
profitability, Ajax has severe cash flow problems and a poor working capital
ratio. The company urgently needs co attract new executives to the organization
and to provide financial incentives to existing top management because of
recent turnover and high growth. Approximately 55 % of the common stock is
owned by Andrew Ajax, who is the CEO, and his immediate family. None of the
other officers own stock in the company.
You are a tax consultant for the company who has been asked
to prepare suggestions after reviewing the compensation system. Your
discussions with several top management individuals reveal the following
aspects of corporate strategy and philosophy:
• The company needs to expand the equity capital base
because of its concern for the high risk caused by large amounts of debt.
• Improvement in cash flow and liquidity would enhance its
stock price and enable the company co continue its high growth rate.
• Top management feels that employee loyalty and
productivity would be improved if all employees owned some stock in the
company. The company currently offers a qualified pension plan to its employees
and executives chat provides only minimal pension benefits. No other deferred
compensation or bonus arrangements are currently being offered.
• Andrew Ajax feels chat the top management group should own
a substantial amount of Ajax stock to ensure that the interests of management
correspond with the share – holder interests (i.e., the maximization of
shareholder wealth). The following four types of executive compensation
arrangements have been discussed:
• Sec. 401(k) and ESOP plans for employees.
• Encourage all employees and executives co independently
fund their retirement needs beyond any Social Security benefits by establishing
IRA plans.
• Provide restricted property arrangements (using Ajax
stock) co attract new top level executives and co retain existing executives.
• Offer nonqualified or incentive stock options to existing
and new executives.
Required: Prepare a client memo chat recommends revisions to
Ajax Corporation ‘s existing compensation system for both its employee and
executive groups. Your recommendations should discuss the pros and cons of
different deferred compensation arrangements and should consider both tax and
nontax factors.
Steve is part owner and manager of a small manufacturing
company that makes keypads for alarm systems. The keypads are sold to several
different alarm companies throughout the country. Steve must travel to several
cities each year to meet with current customers and to attract new business.
When you meet with Steve to obtain information to prepare his current year tax
return, he tells you that he has spent about $5,000 during the current year on
airfare and taking his customers out to dinner to discuss business. Because he
took most of his trips in the summer and fall, and it is now April of the
following year, Steve cannot remember the exact time and places of the business
dinners and did not retain any receipts for the cash used to pay the bills.
However, he remembers the names of the customers he went to see, the business
topics that were discussed, and the restaurants where he had his meals. As
Steve’s tax consultant, what is your responsibility regarding the treatment of
the travel and entertainment expenses under the mandates of the AICPA’s
Statements on Standards for Tax Services? Prepare a client letter explaining to
Steve the requirements under Sec. 274(d) for sufficient substantiation of
travel and entertainment expenses. (See the Statements on Standards for Tax
Services section in Chapter 1:15 for a discussion of these issues and Appendix
£.)
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