Question 1

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 2012, 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 2013. Also, in January 2013, claims for $8,000 were filed for deliveries made in 2012, and $6,000 was paid on these claims by March 15, 2013.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 2012:
A)$68,000.
B)$66,000.
C)$60,000.
D)$50,000.
E)None of the above.

Accepted Answer

Under the all-events and economic performance tests, Ivory can only accrue expenses that have been paid or for which economic performance has occurred. For 2012, Ivory can accrue the $50,000 that was paid in 2012. The remaining amounts either were not paid in 2012 or did not meet the economic performance requirement by the end of 2012.

Question 2

Which of the following statements regarding the matching principle is correct?
A)The matching principle is never relevant to tax accounting.
B)The matching principle of financial accounting is an important component of the cash method of accounting.
C)The matching principle of financial accounting is the cornerstone of accrual basis tax accounting.
D)The matching principle of financial accounting is sometimes relevant to timing deductions for an accrual basis taxpayer's recurring items.
E)None of the above.

Accepted Answer

The matching principle of financial accounting is sometimes relevant to timing deductions for an accrual basis taxpayer's recurring items. This means that expenses should be matched with the revenue they helped generate in the same accounting period. While tax accounting does not always follow the same rules as financial accounting, there may be situations where timing deductions correctly based on the matching principle can benefit the taxpayer. Choices A, B, and C are all incorrect statements.

Question 3

Pink Corporation is an accrual basis taxpayer that uses the recurring item exception to the economic performance test for all relevant years.For 2012, the corporation's income subject to state income tax was $500,000 and the state corporate tax rate was 6%.During 2012, the corporation paid $24,000 on its estimated state income tax liability for that year.The remaining $6,000 of 2012 state income tax was paid in April 2013.In June 2012, the corporation paid $9,000 on its year 2011 state income tax liability, as a result of an audit of the 2011 return that was conducted in 2012. The company has elected to use the recurring item exception to economic performance. As a result of the above, the corporation should deduct in 2012 on its Federal income tax return state income taxes of:
A)$24,000.
B)$30,000.
C)$33,000.
D)$39,000.
E)None of the above.

Accepted Answer

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

Question 4

The installment method can be used for which of the following sales with payments being made in the year following the year of sale?
A)A department store's credit card sales.
B)An individual's sale of common stock in a family owned business.
C)An individual's sale of General Electric common.
D)Depreciable equipment sold for less than its original cost.
E)All of the above.

Accepted Answer

The installment method is typically used for sales of property, such as a sale of common stock in a family owned business. It is not typically used for credit card sales or sales of publicly traded securities. The sale of depreciable equipment sold for less than its original cost may also qualify for the installment method, but this is not a clear-cut answer and would depend on the specific circumstances of the sale. Therefore, the best choice is option B.

Question 5

When the IRS requires a taxpayer to change accounting methods:
A)The taxpayer may be subject to penalties and interest.
B)The taxpayer generally is required to make the change as of the beginning of the earliest open year.
C)The adjustments due to the change cannot be spread over subsequent years.
D)Only a.and b.are correct.
E)a., b., and c.are correct.

Accepted Answer

When the IRS requires a taxpayer to change accounting methods, the taxpayer may be subject to penalties and interest. The taxpayer generally is required to make the change as of the beginning of the earliest open year. The adjustments due to the change cannot be spread over subsequent years. Therefore, all of the options a., b., and c. are correct.

Question 6

In 2012, 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 2011 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.
A)The company should amend its 2011 tax return and reduce its income by $240,000.
B)The company should change its accounting method in 2012, with a $60,000 negative § 481 adjustment which decreases its 2012 taxable income.
C)The company should change its accounting method in 2012, and increase its 2012 income by $60,000, the amount of the positive § 481 adjustment to income.
D)The company should change its accounting method in 2012 and recognize a $60,000 negative § 481 adjustment that will be spread equally over 2012-15.
E)None of the above.

Accepted Answer

The company should change its accounting method starting in 2012 to properly classify the expenses as administrative expenses. The $60,000 included in ending inventory should be treated as a current year expense, resulting in a negative § 481 adjustment. This adjustment will decrease the company's taxable income in 2012. The other options are incorrect because the 2011 tax return cannot be amended at this time, there is no positive § 481 adjustment, and spreading the adjustment over multiple years is not necessary or appropriate.

Question 7

Juan, not a dealer in real property, sold land that he owned.His adjusted basis in the land was $500,000 and it was encumbered by a mortgage for $200,000.The terms of the sale required the buyer to pay Juan $100,000 on the date of the sale.The buyer assumed Juan's mortgage and gave Juan a note for $600,000 (plus interest at the Federal rate) due in the following year.What is the gross profit percentage (gain ¸ contract price)?
A)300/900 = 33.3%.
B)400/700 = 57.14%.
C)400/600 = 66.67%.
D)500/900 = 55.55%.
E)None of the above.

Accepted Answer

The gross profit is calculated as the selling price minus the adjusted basis. The selling price is $100,000 (cash) + $200,000 (mortgage assumed) + $600,000 (note) = $900,000. The gross profit is $900,000 - $500,000 = $400,000. The contract price is $700,000 ($100,000 cash + $600,000 note). Therefore, the gross profit percentage is $400,000 / $700,000 = 57.14%.

Question 8

Color, Inc., is an accrual basis taxpayer.In December 2013, the company received from a customer a $500 claim for defective merchandise.Color paid the customer in January 2014. Also, in December 2013, the company received a bill of $800 for office supplies that had been purchased and used in November 2013.The bill was not paid until January 2014. In January 2014, the company received a claim for $600 for defective merchandise purchased in 2013.Color paid the customer the $600 in February 2014.Assuming Color uses the recurring item exception to economic performance, the company's deductions for 2013 as a result of the above are:
A)$500.
B)$600.
C)$800.
D)$1,300.
E)$1,900.

Accepted Answer

Under the recurring item exception, Color, Inc. can deduct the $500 claim paid in January 2014 and the $800 bill for office supplies used in 2013, totaling $1,300 for 2013.

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, 2012, and $130,000 (plus interest at the Federal rate) in two years.Abby's gain to be reported in 2012 (exclusive of interest) is:
A)$40,000.
B)$51,000.
C)$102,000.
D)$118,000.
E)$170,000.

Accepted Answer

Abby's total gain is calculated as the sales price minus the adjusted basis. The sales price is $250,000, and the adjusted basis is $80,000 for a total gain of $170,000.

However, only a portion of the gain is recognized in 2012 because part of the sales price is paid in two years. The recognized gain in 2012 is calculated by multiplying the total gain by the percentage of the sales price received in 2012:

$120,000 / $250,000 = 0.48

So, the recognized gain in 2012 is:

$170,000 x 0.48 = $81,600

However, the gain is limited to the amount of cash received in 2012, which is $120,000. Therefore, the recognized gain in 2012 is $118,000 ($120,000 - $2,000 of unallowed gain).

The interest received in 2014 will be reported as interest income on Abby's tax return for that year.

Question 10

In 2012, 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 2013.Beth's recognized installment sale gain in 2013 is:
A)$0.
B)$50,000.
C)$100,000.
D)$200,000.
E)None of the above.

Accepted Answer

Beth's realized gain on the sale is $100,000 ($400,000 selling price - $300,000 basis). However, since she is using the installment method and only received $100,000 in 2012, she only recognizes a proportionate amount of the gain based on the ratio of the down payment to the total selling price. 
The down payment of $100,000 represents 25% ($100,000/$400,000) of the total selling price, so Beth recognizes 25% of the realized gain, which is $25,000 ($100,000 x 0.25), in 2012. 
The remaining gain of $75,000 ($100,000 - $25,000) will be recognized in 2013 when the larger payment is received. Therefore, Beth's recognized installment sale gain in 2013 is $100,000 ($75,000 gain + $25,000 recognized in 2012).

Question 11

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:
A)A positive adjustment for $102,000.
B)A positive adjustment for $90,000.
C)A positive adjustment for $78,000.
D)A positive adjustment for $60,000.
E)None of the above.

Accepted Answer

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

Question 12

The taxpayer had incorrectly been using the cash method of accounting. For 2012, the company voluntarily changed to the accrual method. The adjustment due to the change in method as calculated at the beginning of 2012 was $120,000 (positive). The adjustment as calculated as of the end of 2012 was $80,000 (positive).As a result of the change in method, the company must:
A)Increase its income for 2012 by $120,000.
B)Increase its income for 2012 by $80,000.
C)Increase its income for 2012 by $30,000.
D)Increase its income for 2012 by $40,000.
E)None of the above.

Accepted Answer

The adjustment is spread over four years. The difference between the beginning and end of 2012 is $40,000 ($120,000 - $80,000), and one-fourth of this amount, $30,000, is recognized in 2012.

Question 13

The accrual basis taxpayer sold land for $100,000 on December 31, 2012.He did not collect the $100,000 until January 2, 2013.The land was held as an investment.
A)If the accrual basis taxpayer's basis in the land was $110,000, the loss would be recognized in 2013.
B)If the accrual basis taxpayer's basis in the land was $60,000, the gain must be reported in 2012.
C)If the accrual basis taxpayer's basis in the land was $60,000, the gain must be reported in 2013, unless the taxpayer elects to not use the installment method.
D)The accrual basis taxpayer must recognize the gain or loss in the year of sale.
E)None of the above.

Accepted Answer

The accrual basis taxpayer must recognize the gain in the year of sale, which is 2012. However, since the taxpayer did not collect the proceeds until 2013, the gain can be reported using the installment method, allowing for reporting of a portion of the gain in 2013. If the taxpayer elects not to use the installment method, the entire gain must be recognized in 2012. The basis in the land is not relevant to the timing of recognition in this case.

Question 14

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.
A)If the IRS examines the taxpayer's return and requires the taxpayer to change accounting methods, the taxpayer will be required to recognize an additional $90,000 of income (one-half in the current year and one-half in the following year) as the adjustment due to the change in accounting methods.
B)If the taxpayer voluntarily changes methods, the $90,000 adjustment can be spread over the current and three following years.
C)If the taxpayer voluntarily changes methods, the $90,000 reserve can be used to absorb bad debts until the account balance is zero.
D)If the IRS examines the taxpayer's return, no adjustment to the reserve account will be required if the balance is consistent with prior bad debt experience.
E)None of the above.

Accepted Answer

If the taxpayer voluntarily changes methods, the adjustment can be spread over the current and three following years, per the IRS guidance on changes in accounting methods. Option A is incorrect because the full $90,000 adjustment would only be recognized in the current and following year if it is a required change by the IRS. Option C is incorrect because the $90,000 reserve cannot be used to absorb bad debts if it was never properly established in the first place. Option D is incorrect because a consistent balance in the allowance account does not necessarily mean it was appropriately calculated using proper methods.

Question 15

In the case of an accrual basis taxpayer, an item of income:
A)Is not recognized until cash is received.
B)From services is never recognized until the services are performed.
C)Is not recognized if the customer can return the goods.
D)Is recognized 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.
E)None of the above.

Accepted Answer

An accrual basis taxpayer recognizes income when all events have occurred to fix the taxpayer's right to receive income and the amount can be determined with reasonable accuracy. This means that income is recognized when the taxpayer has earned it, even if payment has not yet been received.

Question 16

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 11% when the applicable Federal rate was 7%.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.
A)Hal can elect to treat the $36,000 as a recovery of capital.
B)Hal must recognize $60,000 gain in the year of sale.
C)Hal must recognize $36,000 gain in the year of sale.
D)Unless Hal elects not to use the installment method, Hal must recognize $21,600 gain in the year of sale.
E)None of the above.

Accepted Answer

Since Hal received a note as part of the payment, he can use the installment method for reporting his gains. To calculate the gain to be reported in the year of sale, we need to find the gross profit ratio which is calculated as follows:
Gross Profit Ratio = (Selling Price - Cost) / Selling Price 
= (36,000 + 64,000 - 40,000) / 100,000 
= 0.6 or 60%
Using the gross profit ratio, Hal can calculate the gain to be reported in the year of sale as follows:
Gain in Year of Sale = Installment Payment Received x Gross Profit Ratio 
= 36,000 x 60% 
= $21,600
Therefore, unless Hal elects not to use the installment method, he must recognize $21,600 gain in the year of sale.

Question 17

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:
A)Result in a mismatching of revenues and expenses.
B)Violate established public policy.
C)Violate the economic performance requirement.
D)Violate the tax benefit rule.
E)None of the above.

Accepted Answer

The economic performance requirement states that a deduction cannot be taken until all events necessary to establish the liability have occurred and the liability can be determined with reasonable accuracy. For reserves for estimated future costs, the liability has not yet been incurred, and therefore, the deduction cannot be taken until the future cost is actually incurred and paid for. Allowing the deduction would violate the economic performance requirement. Reserves for estimated future costs do not violate public policy, and the tax benefit rule and matching principle are not relevant to this issue.

Question 18

Gray Company, a calendar year taxpayer, allows customers to return defective merchandise for a full refund within 30 days of the purchase.In 2012, the company refunded $400,000 for claims involving sales.The $400,000 consisted of $350,000 in refunds from 2012 sales and $50,000 in refunds from 2011 sales.All of the refunds from 2011 sales were for claims filed in 2011 and were paid in January and February 2012.At the end of 2012, the company had $12,000 in refund claims for sales in 2012 for which payment had been approved.These claims were paid in January 2013.Also in January 2013, the company received an additional $30,000 in claims for sales in 2012.This $30,000 was paid by Gray in February 2013.With respect to the above, Gray can deduct:
A)$350,000 in 2012.
B)$362,000 in 2012.
C)$392,000 in 2012.
D)$442,000 in 2012.
E)None of the above.

Accepted Answer

Gray Company can deduct $362,000 in 2012, which includes $350,000 in refunds from 2012 sales and $12,000 in approved refund claims for 2012 sales paid in January 2013.

Question 19

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.
A)If Todd uses the cash basis to report the income from his practice, he cannot use the installment method to report the gain on the sale of the land.
B)If Todd uses the accrual basis to report the income from his practice, he cannot use the installment method to report the gain from the sale of the land.
C)If Todd uses the installment method to report the gain, the contract price is $800,000.
D)If Todd does not use the installment method, his gain in the year of sale is $620,000 ($700,000 - $80,000).
E)None of the above.

Accepted Answer

Todd can use the installment method to report the gain on the sale of the land since he received a note with a one-year maturity date. In this case, the total contract price is $800,000 ($300,000 cash + $500,000 note). The fair market value of the note is not relevant when using the installment method.

Question 20

The installment method applies where a payment will be received after the tax year of the sale:
A)By an investor who sold real estate at a gain.
B)By an investor who sold real estate at a loss.
C)By an appliance dealer who sold inventory at a gain.
D)By an investor who sold IBM Corporation common stock at a gain.
E)None of the above.

Accepted Answer

The installment method is allowed for taxpayers who sell property at a gain and receive payment for the sale over a period of time that extends beyond the tax year of the sale. This allows the taxpayer to defer recognition of the gain until the payments are actually received. Therefore, choice A is the correct answer. The other choices either do not involve the sale of property or do not meet the criteria for using the installment method.

Quiz 16: Accounting Periods and Methods

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

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

When the IRS requires a taxpayer to change accounting methods:

The accrual basis taxpayer sold land for $100,000 on December 31, 2012.He did not collect the $100,000 until January 2, 2013.The land was held as an investment.

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.

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

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:

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.

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