Karen, an accrual basis taxpayer, sold goods in December 2014 for $20,000. The customer was unable to pay cash. So the customer gave Karen a note for $20,000 that was payable in April 2015. The note bore interest at the Federal rate. The fair market value of the note at the end of 2014 was $18,000. Karen collected $20,500 from the customer in April 2014, $20,000 principal plus $500 interest. Under the accrual method, Karen must recognize income of:

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Karen must recognize the income for the sale in the year it occurred, which is 2014. The fair market value of the note, $18,000, is considered as the selling price. Therefore, Karen will recognize $18,000 of income in 2014. When Karen collected $20,500 in April 2015, $20,000 of which is a principal payment, she will recognize that $20,000 as a reduction of accounts receivable in 2015, and the remaining $500 as interest income in 2015.

Karen, an Accrual Basis Taxpayer, Sold Goods in December 2014