Question 1

Color,Inc. ,is an accrual basis taxpayer.In December 2015,the company received from a customer a $500 claim for defective merchandise.Color paid the customer in January 2016.Also,in December 2015,the company received a bill of $800 for office supplies that had been purchased and used in November 2015.The bill was not paid until January 2016.In January 2016,the company received a claim for $600 for defective merchandise purchased in 2015.Color paid the customer the $600 in February 2015.Assuming Color uses the recurring item exception to economic performance,the company's deductions for 2015 as a result of the above are:

Accepted Answer

Under the recurring item exception, economic performance is deemed to occur on a ratable basis over the period to which the item relates. In this case, the $500 claim and $800 bill both relate to the 2015 tax year, so they can be deducted in that year, even though payment was not made until January 2016. The $600 claim relates to merchandise purchased in 2015 and paid for in 2016, so it cannot be deducted until 2016. Therefore, the total amount of deductions for 2015 is $500 + $800 = $1,300. Choice D is the only option that reflects this amount.

Question 2

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 or assets, including the sale of common stock in a family owned business. It is not typically used for credit card sales, sales of publicly traded stock, or sales of depreciable equipment sold for less than its original cost. Therefore, the best choice that would qualify for the installment method with payments being made in the year following the year of sale is option B, an individual's sale of common stock in a family owned business.

Question 3

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, some principles of financial accounting, such as the matching principle, are sometimes relevant to tax deductions for an accrual basis taxpayer's recurring items. Therefore, option C is the correct statement among the given options.

Question 4

In the case of an accrual basis taxpayer,an item of income:

Accepted Answer

Accrual basis taxpayers recognize income when all the events have occurred to fix the taxpayer's right to receive the income and the amount of the income can be determined with reasonable accuracy. This means that income is recognized when it is earned, regardless of when cash is received or when services are performed. The ability for the customer to return goods does not affect the recognition of income under the accrual basis.

Question 5

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 cannot be allowed for Federal income tax purposes because they violate the all events test and economic performance requirement. These tests require that a liability must be fixed and the relevant expense must be incurred before a deduction can be claimed. Allowing the deduction for estimated future costs could result in a mismatching of revenues and expenses, not violate public policy, as the allowance is made to ensure future expenses are met, and the tax benefit rule is not applicable in this scenario.

Question 6

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 accounting methods, they can spread the $90,000 adjustment over the current year and the three following years. This is allowed under the IRS guidelines for a voluntary change in accounting method. Option A is incorrect because the taxpayer would have to recognize the entire $90,000 adjustment in the current and following year if required by the IRS. Option C is incorrect because the reserve cannot be used to absorb bad debts once the accounting method has been changed. Option D is incorrect because the prior bad debt experience does not determine whether an adjustment to the reserve is required.

Question 7

The accrual basis taxpayer sold land for $100,000 on December 31,2015.He did not collect the $100,000 until January 2,2016.The land was held as an investment.

Accepted Answer

According to the installment method, if the accrual basis taxpayer's basis in the land was $60,000, the gain must be reported in 2016, unless the taxpayer elects to not use the installment method. Since the taxpayer did not collect the $100,000 until January 2, 2016, they have the option to elect out of using the installment method, which means they can recognize the entire gain in 2015. Therefore, option C is the correct answer.

Question 8

In 2015,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 2016.Beth's recognized gain from the installment sale in 2015 is:

Accepted Answer

Beth's recognized gain from the sale is calculated as follows:

Sale price: $400,000 
Basis: -$300,000 
 = Gain: $100,000

Since this is an installment sale, Beth will only recognize a portion of the gain in 2015. The amount she recognizes is equal to the down payment she received on the sale, which is $100,000. Therefore, the answer is choice C.

Question 9

Abby sold her unincorporated business which 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 30,2015,and $130,000 (plus interest at the Federal rate) in two years.Abby's gain to be reported in 2015 (exclusive of interest) is:

Accepted Answer

The answer of Abby sold her unincorporated business which consisted...

Question 10

Pink Corporation is an accrual basis taxpayer that uses the recurring item exception to the economic performance test for all relevant years.For 2015,the corporation's income subject to state income tax was $500,000 and the state corporate tax rate was 6%.During 2015,the corporation paid $24,000 on its estimated state income tax liability for that year.The remaining $6,000 of 2015 state income tax was paid in April 2016.In June 2015,the corporation paid $9,000 on its year 2014 state income tax liability,as a result of an audit of the 2014 return that was conducted in 2015.The company has elected to use the recurring item exception to economic performance.As a result of the above,the corporation should deduct in 2015 on its Federal income tax return state income taxes of:

Accepted Answer

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

Question 11

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

If Todd uses the installment method to report the gain, the total contract price would be $800,000 ($300,000 + $500,000). This option is available for taxpayers who receive at least one payment after the year of the sale. The fair market value of the note ($400,000) is not relevant for determining the contract price under the installment method. The choices A and B are incorrect because using the cash or accrual basis to report income from a practice is not related to the use of the installment method for reporting the gain on the sale of the land. Choice D is incorrect because even if Todd does not use the installment method, his gain would still be $620,000 ($700,000 - $80,000).

Question 12

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 Juan 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,sold land...

Question 13

In 2015,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 2014 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 should change its accounting method in 2015 and make a negative § 481 adjustment of $60,000. This adjustment will decrease its taxable income in 2015. Option A is incorrect because the 2014 tax return should only be amended if the error is discovered within three years of the filing date. Option C is incorrect because the positive § 481 adjustment should increase income in 2014, not 2015. Option D is incorrect because the adjustment period should only span one year, not four.

Question 14

The taxpayer had incorrectly been using the cash method of accounting.For 2015,the company voluntarily changed to the accrual method.The adjustment due to the change in method as calculated at the beginning of 2015 was $120,000 (positive).The adjustment as calculated as of the end of 2015 was $80,000 (positive).As a result of the change in method,the company must:

Accepted Answer

The adjustment is the difference between the beginning and end of 2015, which is $120,000 - $80,000 = $40,000. However, the question asks for the increase in income, which is the change in the adjustment amount, $120,000 - $80,000 = $40,000.

Question 15

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,approximately 80% of the claims are paid by Ivory.In 2015,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 2016.Also,in January 2016,claims for $8,000 were filed for deliveries made in 2015,and $6,000 was paid on these claims by March 15,2016.Ivory has not elected to use the recurring item exception to economic performance.Under the all-events and economic performance tests,Ivory can accrue as an expense for 2015:

Accepted Answer

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

Question 16

Gray Company,a calendar year taxpayer,allows customers to return defective merchandise for a full refund within 30 days of the purchase.In 2015,the company refunded $400,000 for claims involving sales.The $400,000 consisted of $350,000 in refunds from 2015 sales and $50,000 in refunds from 2014 sales.All of the refunds from 2014 sales were for claims filed in 2014 and were paid in January and February 2015.At the end of 2015,the company had $12,000 in refund claims for sales in 2015 for which payment had been approved.These claims were paid in January 2015.Also in January 2015,the company received an additional $30,000 in claims for sales in 2015.This $30,000 was paid by Gray in February 2016.With respect to the above,Gray can deduct:

Accepted Answer

Gray Company can deduct the amount of refunds paid during the year, which includes both refunds from current year sales and refunds from prior year sales that were paid during the year. Therefore, Gray can deduct:

$350,000 (refunds from 2015 sales paid in 2015)
+ $50,000 (refunds from 2014 sales paid in Jan-Feb 2015)
+ $12,000 (refund claims for 2015 sales paid in Jan 2016)
= $412,000

However, Gray also received $30,000 in refund claims for 2015 sales in January 2015, but these were not paid until February 2016. Therefore, they cannot be deducted in 2015.

So, the correct option is (B) $362,000 in 2015.

Question 17

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

Accepted Answer

The installment method applies to taxpayers who sell property at a gain and receive payment over a period of time that extends beyond the tax year of the sale. This allows the taxpayer to defer some of the tax liability until payments are received in later years. Options B, C, and D do not meet this criteria.

Question 18

The taxpayer had consistently used the cash method of accounting even though inventories were a material income-producing factor to its business.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: $60,000 for inventories,$30,000 for accounts receivable,and $12,000 for accounts payable.The adjustment due to the change in accounting method is:

Accepted Answer

The answer of The taxpayer had consistently used the cash...

Question 19

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 2013.The terms of the sale required Pat to pay $28,000 cash,assume the $56,000 mortgage,and give Pedro eleven 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 2015 note as promised,what is the recognized gain to Pedro in 2015 (exclusive of interest)?

Accepted Answer

To determine the recognized gain, we need to calculate the total amount realized and the gross profit percentage.

Total amount realized is calculated as follows:

Cash received = $28,000 
Mortgage assumed = $56,000 
Present value of the notes = $105,686

Total amount realized = $189,686

Gross Profit Percentage is calculated as follows:

Selling Price - Adjusted Basis = $189,686 - $120,000 = $69,686

Gross Profit Percentage = Gross Profit / Selling Price = $69,686 / $189,686 = 36.75%

Now, we need to determine the gross profit on the 2015 note. The present value of the 2015 note is $10,077 (calculated using the Federal rate of 2.23%).

Gross profit on the 2015 note = Gross Profit Percentage x Present Value of 2015 Note 
= 36.75% x $10,077 
= $3,701.45

Therefore, the recognized gain in 2015 is the gross profit on the 2015 note, which is $3,701.45. However, since this is less than $5,000, Pedro can elect out of the installment method and recognize the full gain in 2015. Therefore, the recognized gain in 2015 is $7,200 ($12,000 - $4,800).

The correct answer is B, $7,200.

Question 20

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

Hal must use the installment method since he received a note as part of the sale. The gain that must be recognized in the year of sale is the gross profit percentage (sales price minus cost) multiplied by the amount received in the year. The gross profit percentage is ($100,000 - $40,000)/$100,000 = 0.6 or 60%. Hal received $36,000 in cash, so the gain recognized in the year of sale is $36,000 x 0.6 = $21,600. The remaining gain of $38,400 ($64,000 - $21,600 - $24,000 interest) will be recognized in the following year when the note is paid.

Quiz 16: Accounting Periods and Methods