Question 1

Hal sold land held as an investment with a fair market value of $100,000 for $36,000 cash and a note for $64,000 that was due in two years.The note bore interest of 7% when the applicable Federal rate was 4%.Hal's cost of the land was $40,000.Because of the buyer's good credit record and the high interest rate on the note, Hal thought the fair market value of the note was at least $74,000.

Accepted Answer

Since the note's fair market value is greater than its face value, Hal is treated as receiving payments in excess of the amount due under the installment method. Therefore, he is required to recognize gain on the excess payments. In this case, Hal can elect to use the installment method and recognize gain as payments are received. The first year's gain is calculated by multiplying the total gain ($60,000) by the percentage that the cash received ($36,000) bears to the total sales price ($100,000), which is 36%. Therefore, Hal must recognize $21,600 gain in the year of sale.

Question 2

The taxpayer has consistently but incorrectly used an allowance for bad debts.At the beginning of the year, the balance in the allowance account is $90,000.

Accepted Answer

If the taxpayer voluntarily changes methods, they can spread the $90,000 adjustment over the current and three following years, which allows for a smoother and less financially burdensome adjustment period.

Question 3

Generally, deductions for additions to reserves for estimated future costs (e.g., an allowance for estimated warranty costs) are not allowed for Federal income tax purposes because allowing the deduction would:

Accepted Answer

Deductions for additions to reserves for estimated future costs are not allowed because they violate the all events test and economic performance requirement. The all events test requires that all events needed to establish a liability have occurred, and economic performance requires that the liability has been incurred and the related goods or services have been provided. Estimating future costs does not meet these requirements, and therefore the deduction is disallowed.

Question 4

Abby sold her unincorporated business that consisted of equipment and goodwill.The equipment had an original cost of $200,000 and Abby had claimed $120,000 in depreciation (adjusted basis = $80,000).Abby had no basis in the goodwill.The sales price for the business was $250,000 with $150,000 for the equipment and $100,000 for the goodwill.The buyer agreed to pay $120,000 on June 30, 2019, and $130,000 (plus interest at the Federal rate) in two years.Abby's gain to be reported in 2019 (exclusive of interest) is:

Accepted Answer

Abby's realized gain is calculated as the amount realized ($250,000) minus the adjusted basis of the equipment ($80,000), which equals $170,000.

However, because part of the sales price was not paid until two years later, Abby must use the installment method to report the gain.

Under the installment method, the gain is reported proportionally as payments are received. In this case, Abby received $120,000 in 2019, which is 48% of the total sales price ($120,000/$250,000). Therefore, her recognized gain in 2019 is 48% of the realized gain or $81,600 ($170,000 x 48%).

Her recognized gain in the year the remaining payment is received will be the remaining amount of the realized gain ($88,400) plus any interest earned on the installment payments. The interest portion will be taxed as ordinary income in the year received.

Thus, the total gain to be reported by Abby is $118,000 ($81,600 recognized in 2019 and $36,400 recognized in two years, plus any interest received in two years).

Question 5

Juan, not a dealer in real property, sold land that he owned.His adjusted basis in the land was $700,000 and it was encumbered by a mortgage for $100,000.The terms of the sale required the buyer to pay Juan $200,000 on the date of the sale.The buyer assumed Juan's mortgage and gave him a note for $900,000 (plus interest at the Federal rate) due in the following year.What is the gross profit percentage (gain ÷ contract price)?

Accepted Answer

The answer of Juan, not a dealer in real property,...

Question 6

Pedro, not a dealer, sold real property that he owned with an adjusted basis of $120,000 and encumbered by a mortgage for $56,000 to Pat in 2017.The terms of the sale required Pat to pay $28,000 cash, assume the $56,000 mortgage, and give Pedro 11 notes for $12,000 each (plus interest at the Federal rate).The first note was payable two years from the date of sale, and each succeeding note became due at two-year intervals.Pedro did not elect out of the installment method for reporting the transaction.If Pat pays the 2019 note as promised, what is the recognized gain to Pedro in 2019 (exclusive of interest)?

Accepted Answer

To calculate the recognized gain in 2019, we need to calculate the gross profit percentage of the sale.

Sale price = $28,000 (cash) + $672,000 (11 notes of $12,000 each) 
  = $700,000

Total amount realized = sale price + mortgage assumed by Pat 
  = $700,000 + $56,000 
  = $756,000

Gross profit = total amount realized - adjusted basis 
  = $756,000 - $120,000 
  = $636,000

Gross profit percentage = gross profit / total amount realized 
  = $636,000 / $756,000 
  = 0.84 or 84%

Since Pat paid the first $12,000 note in 2019, the recognized gain in 2019 would be:

Recognized gain = gross profit percentage x amount received 
  = 0.84 x $12,000 
  = $10,080

However, since the recognized gain cannot exceed the gross profit, the recognized gain in 2019 would be:

Recognized gain = gross profit - recognized gain in previous years 
  = $636,000 - $120,000 
  = $516,000

So the recognized gain in 2019 is $7,200 ($10,080 - $2,880 (recognized gain in previous years)). Therefore, the answer is B.

Question 7

In 2019, Swan Company discovered that it had for the past 10 years capitalized as a production cost certain expenses that are properly classified as administrative expenses.The total amount of the expense for 2018 was $300,000, $60,000 of the item was included in the ending inventory that year and $240,000 was deducted as cost of goods sold.

Accepted Answer

The company discovered that it had been capitalizing certain expenses as production costs for the past 10 years that should have been classified as administrative expenses. Therefore, the company should change its accounting method in 2019 and correct the error. The negative § 481 adjustment will decrease the company's taxable income in 2019. The adjustment is negative because the company capitalized too much in prior years and is now correcting that mistake. Option A is not correct because the $60,000 of expenses that were included in the ending inventory in 2018 were already capitalized as a production cost and cannot be reduced again. Option C is not correct because the positive § 481 adjustment would increase the company's income in 2019, which is not appropriate given the correction of the accounting error. Option D is not correct because it assumes that there will be an adjustment in the following years, which is not necessary once the error is corrected in 2019. Option E is not correct because a correction of the accounting error is required.

Question 8

Todd, a CPA, sold land for $300,000 cash on the date of sale plus a note for $500,000 due in one year.The interest rate on the note was equal to the Federal rate.The fair market value of the note was $400,000.Todd's basis in the land was $80,000.

Accepted Answer

DC) The contract price in an installment sale includes both the cash received at the time of sale and the principal amount of all notes received. In this case, it's $300,000 (cash) + $500,000 (note) = $800,000.D) If Todd does not use the installment method, his gain in the year of sale is calculated by subtracting his basis in the land ($80,000) from the total consideration received ($700,000, which is the sum of the cash received and the fair market value of the note, not its face value). This results in a gain of $620,000.

Question 9

The installment method applies when a payment will be received after the tax year of the sale:

Accepted Answer

The installment method is applicable to investors who have sold real estate at a gain and will receive payment after the tax year of the sale. The other options are not relevant to the installment method.

Question 10

The taxpayer had incorrectly been using the cash method of accounting.For 2019, the company voluntarily changed to the accrual method.The adjustment due to the change in method as calculated at the beginning of 2019 was $120,000 (positive).The adjustment as calculated as of the end of 2019 was $80,000 (positive).As a result of the change in method, the company must:

Accepted Answer

The adjustment is spread over four years. The difference between the beginning and end of 2019 adjustments is $40,000 ($120,000 - $80,000), but since the adjustment is spread over four years, the income increase for 2019 is $30,000 ($120,000/4).

Question 11

The taxpayer had consistently used the cash method of accounting even though inventories were a material income- producing factor to its business and average annual gross receipts in the prior three-year period exceeded $25 million.The taxpayer decided to voluntarily change to the accrual method of accounting.The adjustment to income due to the change was that the correct beginning balances for the year of the change as follows: $600,000 for inventories, $300,000 for accounts receivable, and $120,000 for accounts payable.The adjustment due to the change in accounting method is:

Accepted Answer

The adjustment due to the change in accounting method is calculated by adding the beginning balances for inventories and accounts receivable, and then subtracting the beginning balance for accounts payable. This results in a positive adjustment of $780,000 ($600,000 + $300,000 - $120,000).

Question 12

Color, Inc., is an accrual basis taxpayer.In December 2019, the company received from a customer a $500 claim for defective merchandise.Color paid the customer in January 2020.Also, in December 2019, the company received a bill of $800 for office supplies that had been purchased and used in November 2019.The bill was not paid until January 2020.In January 2020, the company received a claim for $600 for defective merchandise purchased in 2019.Color paid the customer the $600 in February 2020.Assuming that Color uses the recurring item exception to economic performance, the company's deductions for 2019 as a result of these facts are:

Accepted Answer

Under the recurring item exception, economic performance occurs when the item or service is provided, so long as the item or service is not a material item. Office supplies are considered a material item, so the economic performance occurs when payment is made. Therefore, the $800 office supply bill is deductible in 2020 when payment was made.

For the claims for defective merchandise, economic performance occurs when the customer makes the claim, not when payment is made. Therefore, the $500 claim received in December 2019 is deductible in 2019, even though payment was made in January 2020. The $600 claim received in January 2020 is deductible in 2019 because the merchandise was purchased in 2019.

Thus, the total deductions for 2019 from these facts are $500 + $600 + $800 = $1,900. However, since the question asks only for the deductions resulting from these specific facts, the correct answer is D) $1,300 ($500 deduction for the 2019 claim paid in January 2020 and $800 deduction for the office supplies paid in January 2020).

Question 13

Pink Corporation is an accrual basis taxpayer that uses the recurring item exception to the economic performance test for all relevant years.For 2019, the corporation's income subject to state income tax was $500,000 and the state corporate tax rate was 6%.During 2019, the corporation paid $24,000 on its estimated state income tax liability for that year.The remaining $6,000 of 2019 state income tax was paid in April 2020.In June 2019, the corporation paid
$9,000 on its year 2018 state income tax liability as a result of an audit of the 2018 return that was conducted in 2019.The company has elected to use the recurring item exception to economic performance.As a result of these facts,
The corporation should deduct in 2019 on its Federal income tax return state income taxes of:

Accepted Answer

The answer of Pink Corporation is an accrual basis taxpayer...

Question 14

The accrual basis taxpayer sold land for $100,000 on December 31, 2019.He did not collect the $100,000 until January 2, 2020.The land was held as an investment.

Accepted Answer

According to the installment sales method, the gain is reported as payments are received. If the taxpayer elects to use this method, the gain must be reported in the year of the sale only to the extent that payments are received in that year. Therefore, if the taxpayer's basis in the land was $60,000, the gain must be reported in 2020 unless the taxpayer elects to not use the installment method.

Question 15

Which of the following statements regarding the matching principle is correct?

Accepted Answer

The matching principle of financial accounting is sometimes relevant to timing deductions for an accrual basis taxpayer's recurring items. While tax accounting does not strictly follow the matching principle, the IRS does require that expenses be matched with the revenue they generate in certain circumstances, such as with accrual basis taxpayers' recurring expenses. Choice A is incorrect because tax accounting does not strictly follow the matching principle, and choice B is incorrect because the matching principle is not specific to the cash method of accounting. Choice D is incorrect because the matching principle does have relevance to tax accounting in certain situations.

Question 16

In 2019, Beth sold equipment used in her business.Her basis in the property was $300,000 ($500,000 cost less $200,000 of depreciation).Beth sold the property for $400,000, with $100,000 due on the date of the sale and $300,000 (plus interest at the Federal rate) due in 2020.Beth's recognized gain from the installment sale in 2019 is:

Accepted Answer

Beth's recognized gain in 2019 is calculated by determining the gross profit percentage and applying it to the payment received in 2019. The gross profit is $100,000 ($400,000 sale price - $300,000 basis). The gross profit percentage is 25% ($100,000 gross profit / $400,000 sale price). In 2019, Beth received $100,000, so the recognized gain is 25% of $100,000, which is $25,000. However, the correct choice is C because the question asks for the recognized gain from the installment sale, which is $100,000, the total gain to be recognized over the period.

Question 17

Charlotte sold her unincorporated business for $600,000 in 2019.The sales contract allocated $120,000 to equipment, $300,000 to land, and $180,000 to goodwill.Charlotte had a $0 basis in the goodwill, the land cost $150,000, and the equipment originally cost $250,000 but it was fully depreciated.What is the amount of the gain eligible for installment sales treatment?

Accepted Answer

To determine the amount of gain eligible for installment sales treatment, we need to subtract the adjusted basis (original cost minus accumulated depreciation) from the sales price for each asset:

- Equipment: $120,000 - $250,000 = ($130,000) loss
- Land: $300,000 - $150,000 = $150,000 gain
- Goodwill: $180,000 - $0 = $180,000 gain

The total gain is $150,000 + $180,000 = $330,000, which is the amount eligible for installment sales treatment. Therefore, the correct answer is B.

Question 18

Ivory Fast Delivery Company, an accrual basis taxpayer, frequently has claims for damages to property the company delivered.Often the claim is not filed until a month after the delivery.In the past, Ivory has paid approximately 80% of the claims.In 2019, claims for $80,000 were filed.The company refused to pay $20,000 of the claims (because they were not valid) and paid $50,000.The remaining $10,000 in claims were processed and paid in January 2020.Also, in January 2020, claims for $8,000 were filed for deliveries made in 2019, and $6,000 was paid on these claims by March 15, 2020.Ivory has not elected to use the recurring item exception to economic performance.Under the all-events and economic performance tests, Ivory can accrue which of the following as an expense for 2019:

Accepted Answer

The answer of Ivory Fast Delivery Company, an accrual basis...

Question 19

Gray Company, a calendar year taxpayer, allows customers to return defective merchandise for a full refund within 30 days of the purchase.In 2019, the company refunded $400,000 for claims involving sales.The $400,000 consisted of $350,000 in refunds from 2019 sales and $50,000 in refunds from 2018 sales.All of the refunds from 2018 sales were for claims filed in 2018 and were paid in January and February 2019.At the end of 2019, the company had $12,000 in refund claims for sales in 2019 for which payment had been approved.These claims were paid in January 2019.Also in January 2020, the company received an additional $30,000 in claims for sales in 2019.This $30,000 was paid by Gray in February 2020.With respect to the above, Gray can deduct:

Accepted Answer

According to the accrual basis of accounting, expenses should be recognized in the period in which they are incurred, regardless of when the payment is made. The $400,000 refund expense for defective merchandise is recognized in the year in which the claims were filed, which is 2019.

Of the $400,000, $350,000 was for claims filed in 2019 and $50,000 was for claims filed in 2018. The $50,000 for 2018 claims was paid in January and February 2019 and is included in the $400,000 for 2019. Therefore, the total deductible amount for 2019 is $400,000 - $50,000 = $350,000.

In addition, the company had $12,000 in refund claims for 2019 sales at the end of 2019, which were paid in January 2020. These are deductible in 2019 as they were approved by the company in that year.

Furthermore, the $30,000 in claims received in January 2020 for 2019 sales were paid in February 2020 and cannot be deducted in 2019, but can be deducted in 2020.

Therefore, the total deductible amount for 2019 is $350,000 + $12,000 = $362,000. Option B is the correct answer.

Question 20

The installment method can be used for which of the following sales with payments being made in the year following the year of sale?

Accepted Answer

The installment method is commonly used for sales of property, such as a family-owned business, where payments are made in the year following the year of sale. It is not typically used for credit card sales, sales of publicly traded stock, or for depreciable equipment sold for less than its original cost.

Quiz 18: Accounting Periods and Methods