Deck 5: Gross Income

Question 1

Economists recognize income once it has been realized: (1) the earnings process is complete, and (2) an exchange or transaction has taken place.

Answer 1

False

Question 2

G was injured in a car wreck.He sued the driver of the other automobile and was awarded $10,000 for personal injury.In addition, he was awarded $3,000 as punitive damages.G must report $3,000 as income.

Answer 2

True

Question 3

Upon graduation, T signed a contract to play professional football.The contract contains the team's unsecured promise to pay T $500,000, $200,000 to be paid in his rookie year, with the remaining $300,000 deferred over the next three years.Assuming all other requirements are satisfied, the constructive receipt doctrine would require inclusion of the full $500,000 in income this year, since T was able to control the timing of receipt through a contractual arrangement.

Answer 3

False

Question 4

Crash Corporation manufactures hard disk drives for computers.Its gross receipts for the past several years have averaged less than $2 million.The corporation may use the cash method to account for all of its receipts and disbursements.

Question 5

Several years ago, T started an automotive repair business.His small operation did not warrant a sophisticated accounting system.Consequently, he simply kept track of all his receipts and disbursements in a checkbook for the business.When he filed his return, he indicated that he used the cash method of accounting.This year he wants to change to the accrual method of accounting.J may change to the accrual method without consent because he is changing to an accounting method that more clearly reflects income.

Question 6

Under the cash equivalent doctrine, the taxpayer reports income from credit sales.

Question 7

Clean Wheels, Inc., a calendar year taxpayer, operates a car wash that is located two blocks from six car dealerships that use the facility regularly.Clean has set up credit arrangements with each of the dealerships to allow them to use the car wash and be billed for the services at the end of the month.During the month of December, Clean billed the dealerships $3,000 for the car wash services.These bills were paid in January.Clean must accrue and report the $3,000 as income in December.

Question 8

T owns a series EE savings bond.In previous years, he elected to report the interest income from the bond (i.e., the annual increase in redemption value) when he redeemed the bond rather than currently.This year, T decided that he would be better off to report the income annually rather than defer it.To accomplish this objective, T must seek the approval of the IRS.

Question 9

Healthy Pools Incorporated, an S corporation, operates a swimming pool business.It has successfully acquired many of the hotels and motels in the area as customers.It bills monthly for its services.Assuming the corporation wishes to use the accrual method to account for its billings, it must also use the accrual method to account for all other receipts and disbursements.

Question 10

Last year, J started his own men's clothing store business.His small operation did not warrant a sophisticated accounting system.Consequently, he simply kept track of all his receipts and disbursements in a checkbook for the business.When he files his return, he indicated that he used the cash method of accounting.This year he wants to change to the accrual method of accounting in order to more clearly reflect income.J may change to the accrual method without consent because he is changing from an erroneous method to a correct method.

Question 11

MNO Corporation sued XYZ Incorporated for patent infringement and was awarded $100,000 damages.The $100,000 is taxable.

Question 12

A taxpayer who reports in conformity with generally accepted accounting principles (GAAP) satisfies the tax requirement that income must be clearly reflected.For these taxpayers, book income and taxable income will not vary.

Question 13

The economist's definition of income is expressed mathematically as the sum of one's consumption during a period plus the change in one's net worth between the beginning and end of the period.Consumption and the change in net worth are measured using market values on an accrual basis.

Question 14

An S corporation is similar to a partnership in that shareholders, like partners, are not taxed on the income of the entity until it is distributed to them.

Question 15

There are no special tax consequences arising from a change in accounting method as long as the taxpayer is switching from one permissible method to another.

Question 16

B was recently fired from her position as newscaster for NBS, a national television network.She sued the network for lost wages on the grounds that she was improperly fired.Ms.B won the case and was awarded $25,000.She must treat the $25,000 as taxable income.

Question 17

As a general rule, all income is taxable unless you can locate authority to exclude it from gross income.

Question 18

Video Games Unlimited Inc.allows its game designers to use, without charge, company cars for their personal vacations.The employer's motive for providing the cars is to ensure that these valuable assets (i.e., the employees) of the business are retained.Because this is a reasonable business purpose, the employees will recognize no income from their use of the cars.

Question 19

A public accounting firm that operates as a professional corporation and has $10 million in gross receipts may use the cash method.

Question 20

Near year-end, FGH Construction Corporation mailed E, a plumbing contractor, a $10,000 check for services that he had performed on one of the corporation's projects.On December 27 of this year, the controller of FGH called E and asked E not to cash the check until after the first of the year, because there were insufficient funds in the bank to cover it.E must include the $10,000 as income this year.

Question 21

L currently reports income from Series EE savings bonds annually.He is considering switching to the alternative method.L may change methods without consent from the IRS.

Question 22

Cool-a-House, an accrual basis calendar year taxpayer, sells air conditioning units.With each sale, the corporation also sells a one-, two-, or three-year contract to turn the units on and off and do routine maintenance.In determining its reporting options, the taxpayer wants to postpone recognition of income for as long as possible.Assuming the corporation sold a three-year contract on November 1 at a price $240, it will recognize income as it is earned, reporting $20 of income this year, $120 next year and $100 in the final year.

Question 23

T Corporation signed an agreement with the city of St.Lansberg to manufacture 50,000 seats for the city's new baseball stadium.T does not carry this type of seat in inventory but will custom make the unique seat to the city's specifications.Assuming manufacture of the seats is not complete at the close of T's taxable year, the contract will be considered a long-term contract.

Question 24

This year, G Corporation contracted to build a hotel that it anticipates completing in 10 months.G Corporation's annual gross receipts have historically exceeded $15 million.Assuming construction is not complete at the end of its taxable year, the corporation must use the percentage of completion method to account for the income from the contract.

Question 25

Income arising from Series EE U.S.Savings Bonds need not be reported on an annual basis.

Question 26

R currently operates a hardware store and uses the cash method of accounting for all income and expenses.Under the general rules, R may use the cash method.

Question 27

Heat-a-Home, an accrual basis calendar year taxpayer, sells furnaces.With each sale, the corporation also sells a one-, two-, or three-year contract to turn the furnaces on and off and do routine maintenance.Assuming the corporation sold a two-year contract on November 1 at a price of $240, it may report income for this year of $20.

Question 28

H signed a contract on October 1 to manufacture 35,000 folding chairs; the manufacturer currently has 5,000 in stock and estimates that the contract will take 14 months to complete.The contract is a long-term contract.

Question 29

On May 3 of this year, R called his broker and told him to sell all of R's AZ bonds.R had purchased the bonds for $9,500 several years ago.The bonds have a $10,000 par value, and pay interest at a rate of 10 percent semiannually on June 30 and December 31.Ten days after his call R received a check for $11,000.R should report a capital gain on the sale of $1,500.

Question 30

Embezzlement proceeds are not taxable because the embezzler has an obligation to repay the funds.

Question 31

An accrual basis taxpayer reports prepaid rent (e.g., payments received in advance for the use of property where the lessor provides no services) when it is earned.

Question 32

Absent any special tax treatment, the claim of right doctrine could be applied to make the following income taxable in 2012:
Payments received during October 2012 by a skiing corporation for season passes (November, 2012 through April, 2012).The corporation is on the accrual basis, and its tax year is the calendar year.

Question 33

Airco is a manufacturer of airplanes, specializing in jumbo jets.This year it signed a contract with Pan World Airlines to supply it with 20 jumbo jets.Each jet takes 15 months to build.The contract is a long-term contract.

Question 34

Warm-a-Home, an accrual basis calendar year taxpayer, sells furnaces.With each sale, the corporation also sells a one-, two-, or three-year contract to turn the furnaces on and off and do routine maintenance.Assuming the corporation sold a one-year contract on November 1 at a price of $120, it will report income for this year of $20.

Question 35

During the year, R Corporation entered into a long-term contract to build a nuclear power plant.The plant will take four years to build.At the close of the current taxable year, the corporation estimated that it had completed 8 percent of the contract.The corporation must use the percentage of completion method and must report 8 percent of the estimated contract price as income this year.

Question 36

On October 1 of this year, SBX Construction contracted to build the new Fourth National Bank office tower.The company began work on October 15 and is expected to finish construction in 30 months.The company must use the percentage of completion method in accounting for the contract.

Question 37

C is the controller of XYZ Corporation.As C prepared this year's tax return, she noted that several errors had been made in posting the accounts in the prior year and were reflected on last year's tax return.To correct the errors in the prior year's return C should seek approval from the IRS since this is a change in accounting method.

Question 38

This year, F Corporation contracted to build an office building that it anticipates completing in six months.Assuming construction is not complete at the end of its taxable year, the corporation must use the percentage of completion method to account for the income from the contract.

Question 39

G's accountant recently determined that G should be capitalizing certain costs that he has traditionally expensed.According to the accountant, G is using a clearly erroneous method of accounting.A change to the proper method would result in substantial income in the year of the change.G should consider voluntarily making the change to the proper method because the treatment is more favorable than if the IRS requires the change.

Question 40

S, a cash basis taxpayer, received a $10,000 prepayment for services that he contracted to perform in the following year.S may report the income in the following year when he earns it.

Question 41

Which of the following businesses must use the accrual method of accounting to account for all or a part of its operations?

A)F Gas Corporation, a chain of 10 gas stations owned and operated by F.The corporation has gross receipts of $3 million annually.
B)The Clinic.This corporation is owned and operated by 80 physicians who provide a variety of health care services to the citizens of Houston.Annual billings to insurance companies and patients monthly exceed $20 million.
C)Whitewater Rafting of Idaho is a partnership owned by B and T.Gross receipts for the past several years have averaged $100,000.
D)D Drilling, a partnership owned by J and A.The partnership operates oil drilling rigs all over the world.Annual gross receipts consistently exceed $8 million.
E)More than one of the above and these are__________.

Question 42

Fast-Heat, an accrual basis calendar year taxpayer, sells furnaces.With each sale, the corporation also sells a one-, two-, or three-year contract to service the furnace.On November 1 of this year, the corporation sold a one-year contract for $120 and a two-year contract for $240.The taxpayer wants to postpone income for as long as possible.Due to these sales, the corporation will report income for the current year of

A)$360
B)$140
C)$260
D)$40
E)some other amount

Question 43

Interest-free loans of less than $10,000 can be used without restriction to shift income.

Question 44

T Corporation manufactures the Banana, a clone of a popular computer.Its gross receipts for the last several years have averaged $4 million.Indicate which of the following statements is true with respect to the method of accounting that T can adopt.

A)The corporation may use the cash method to account for all receipts and disbursements.
B)The corporation must use the accrual method to account for all receipts and disbursements.
C)The corporation may use the cash method for some items and the accrual method for other items as it desires.
D)The corporation may use the cash method for some items but is required to use the accrual method for other items.

Question 45

The accountant's concept of income is distinguished from the economist's by

A)The principle of accrual
B)The principle of relativity
C)The principle of realization
D)None of the above

Question 46

Which of the following does not cause a difference between economic income and income for tax purposes?

A)The realization concept
B)The treatment of benefits derived in kind from consumer durables
C)The convenience of the employer theory
D)The return of capital doctrine

Question 47

M operates a lawn maintenance business.In the past, the business has used the cash method of accounting.This year, M decided to switch to the accrual method.At the beginning of the year, M had accounts receivable of $50,000 and accounts payable of $20,000.Assuming M requests a change from the cash to the accrual method, the IRS will require a

A)Net negative adjustment of $30,000
B)Net positive adjustment of $30,000
C)Net negative adjustment of $50,000
D)Net positive adjustment of $50,000
E)None of the above

Question 48

H and W have one child, S.Several years ago, S's grandparents indicated to H and W that they would like to help pay for their grandson's college education.To this end, the grandparents purchased Series EE savings bonds for their grandson in 2012.In 2012, G enrolled at City University in his hometown.G derives virtually all of his support from his parents.However, his grandparents cashed in some of the bonds and paid for G's tuition, $500.Grandma and grandpa are retired and have income of $40,000 for the year.A portion of the interest on the bonds should be nontaxable.

Question 49

In which of the following situations would the taxpayer not be considered in constructive receipt of income in 2012? Assume that all of the taxpayers use the cash method of accounting.

A)Al is a self-employed accountant.On December 27, 2012, he received a check for $2,000 for preparing the November financial statements of one of his clients.Due to illness, he was unable to deposit the check until January 5, 2012.
B)Ben entered into a contract to sell his rental property on December 3, 2012.On that date, the down payment, a check for $1,000, was placed in an escrow account.Ben received the check when the transaction closed on January 20, 2012.
C)Sugar Ray fought Rocky on December 25, 2012, a Christmas fight shown on television all over the world.On December 28, the fight promoters gave Sugar Ray's agent, Leo Luciani, a check for $5 million representing his prize money for the fight.Leo delivered the check to Sugar Ray on January 12, 2012.
D)On December 20, 2012, Mr.Big received stock worth $10,000 as a bonus from the corporation for which he worked.He did not sell the stock until January 5, 2012.
E)All of the taxpayers above are in constructive receipt of the income items.

Question 50

In using the percentage of completion method, annual income to be reported from a contract is determined in part by comparing actual costs incurred to total estimated costs.If total actual costs are less than that which were originally estimated, the taxpayer is required to pay the IRS interest.

Question 51

Taxpayers must use special accounting methods for inventories if they are an income producing factor.Which of the following statements is true?

A)The taxpayer is required to accrue the cost of the inventory but may report sales when receivables are collected.
B)The taxpayer is required to accrue the cost of the inventory and accrue the income from sales of the inventory.
C)The taxpayer is required to expense the cost of the inventory and accrue the income from sales of the inventory.
D)None of the above are correct.

Question 52

Arguably, free parking places provided to employees by their employers might be excluded from taxable income on the grounds that

A)Such items neither satisfy the economic definition of income nor fall within the definition of the income for tax purposes.
B)Any gain obtained by the employee is secondary or incidental to the employer's business purpose that is served by granting such benefit.
C)The value of the benefit obtained by the employee is not determinable.
D)The benefit obtained by the employee is not in the form of cash.

Question 53

The following entities are not involved in the farming or timber business; which of them may not use the cash method of accounting?

A)An S corporation with average annual gross receipts of $8 million
B)A partnership with average annual gross receipts of $12 million
C)A regular C corporation with average annual gross receipts of $10 million
D)A regular C corporation with average annual gross receipts of $4 million
E)More than one of the above.

Question 54

Ralph, a cash basis taxpayer, owns a five-story office building that he leases to various tenants.During the year, he signed a three-year lease with a tenant and received a check of $6,000 for the following: Rent for November 1,2012 to October 1,2012 $\quad$$\$ 5,000$
Advance rent for last three months of lease $\quad$ 600
Security deposit (refundable) $\quad$$\quad$ 400 For the current year, 2012, Ralph must report income of

A)$6,000
B)$5,600
C)$5,000
D)$832
E)some other amount

Question 55

Which of the following statements is true regarding changes in accounting methods?

A)The treatment of a change in accounting method differs depending on who initiates the change.
B)Adjustments arising from a voluntary change in accounting method are generally accounted for in the year of the change.
C)Taxpayers who change from an incorrect method of accounting to a correct method of accounting are not required to obtain the consent of the IRS.
D)Corrections due to errors are treated the same as changes in accounting methods.

Question 56

T is switching accounting methods this year.Which of the following statements is true?

A)Assuming T initiates the change, any adjustment normally will be accounted for in the year of the change.
B)Assuming the IRS initiates the change, any adjustment normally will be accounted for in the year of the change.
C)There are no special tax consequences arising from a change in accounting method as long as the taxpayer is switching from one permissible method to another.
D)None of the above

Question 57

Corporations using the completed contract method are required to pay interest on the deferred tax upon completion of the contract.

Question 58

Assume that the present tax system and its progressive rate structure are replaced by a so-called flat tax method.Under this system, a single rate would be applied to any type of income regardless of source, and large exemptions would be allowed to each taxpayer to eliminate low-income taxpayers from the tax rolls.One favorable result of such a system is to completely eliminate the motivation for arrangements when the sole purpose is to split or shift income to lower bracket taxpayers.

Question 59

LMN Partnership is owned equally by R and S, calendar year taxpayers.The partnership reports on a fiscal year ending October 31.During the calendar year 2010, the partnership earned $1,000 a month.During the calendar year 2012, the partnership earned $2,000 a month.During 2010 and 2012, R withdrew $300 a month.On his personal return for 2012, R will report income from the partnership of

A)$1,800
B)$3,500
C)$11,000
D)$12,000

Question 60

Dr.Payne Phull is a cash basis taxpayer.Normally, his patients pay his fee on the day they see him in the office.For some customers, his office processes a medical reimbursement claim and bills the insurance company for the visit.In the current year, his records reveal the following: Cash received at time of office visit $\quad \$ 70,000$
Collections on insurance receivables $\quad$ 88,000
Total accounts receivable, January $1 \quad 5,000$
Total accounts receivable, December $31 \quad 15,000$ All of the receivables outstanding at the beginning of the year were collected during the year.What amount should Dr.Phull report as his income this year?

A)$70,000
B)$158,000
C)$168,000
D)$173,000
E)Some other amount

Question 61

L purchased ten REX Corporation bonds on March 5 for $11,120.The bonds have a $1,000 par value and pay interest at an annual rate of 10 percent semiannually on January 1 and July 1.On July 1, L received his first interest check of $1,000.Immediately after he received the interest payment, which of the following is true?

A)His basis in the bonds is $11,120.
B)His interest income is more than $1,000.
C)His interest income is less than $1,000.
D)His basis in the bonds is more than $11,120.

Question 62

Using the following information, decide for which of the following the completed contract method may be used.Assume the taxable year is the calendar year in all cases.

A)A contract to construct a bridge estimated to be completed in 18 months; the contractor has average annual gross receipts of $15 million.
B)A contract signed on October 1 to build the residence of John Smith; it is estimated that it will take six months to complete the job.The contractor has gross receipts of $15 million.
C)A contract to construct a highway estimated to be completed in 36 months; the contractor has average annual gross receipts of $9 million.
D)More than one of the above.

Question 63

RST Corporation is a large construction company with annual gross receipts, averaging $20 million annually.Last year, the corporation signed an agreement to construct a road for $720,000.Total estimated costs are $600,000.Last year, the corporation actually incurred costs of $240,000.This year, the corporation completed the contract and incurred costs of $300,000.For the current year, RST's gross profit on the contract will be

A)$48,000
B)$50,000
C)$99,600
D)$132,000
E)None of the above

Question 64

"Substantial tax benefits await the self-sufficient (e.g., an individual who can repair his own automobile is better off from a tax perspective than someone who cannot)." Select the correct comment on this statement.

A)The above statement is valid, since such an individual may barter his or her services for those of another and pay no tax on the services furnished to him.
B)The above statement is valid because the concept of taxable income would exclude the benefit derived from repairing one's own automobile.
C)The above statement is valid because the form of benefit principle enables a taxpayer to exclude gains received in a certain form.
D)The above statement is false-no tax benefits await the self-sufficient.

Question 65

Several useful techniques permit an individual taxpayer to postpone income recognition.They include all the following, except

A)Like-kind exchanges
B)Installment sales of property
C)Deferred compensation arrangements
D)Income on Treasury bills
E)All of the above permit deferral

Question 66

Prepaid interest income

A)Is recognized as income by cash basis taxpayers when it is earned
B)Is recognized as income by accrual basis taxpayers when it is earned
C)Is recognized by accrual basis taxpayers when received
D)None of the above

Question 67

The famous horticultural metaphor involving the fruit and the tree operates primarily in situations concerning

A)Bunching of income
B)Splitting of income
C)Deferral of income
D)Contested income

Question 68

The application of Code § 7872 to interest-free or below-market loans has certain tax consequences for the lender and borrower.They include

A)The borrower may be allowed an itemized deduction for the interest hypothetically paid to the lender.
B)The lender is not required to report the hypothetical payment as interest income until the loan is repaid.
C)The borrower treats the hypothetical payment as earned income.
D)The lender is deemed to have made a completed gift of the loan amount.

Question 69

Which of the following statements is true?

A)Under the community property system, assets owned before marriage are considered equally owned by each spouse after marriage.
B)Only a few states use the common law property system.
C)Income from separate property is community property in some community property states.
D)The common law property system denies criminals rights in property.

Question 70

Inconsistencies between the tax and financial methods of accounting for advanced payments for goods received by an accrual basis taxpayer normally do not occur because

A)The goods for which the payment is made are normally on hand at year end.
B)The payments received are "substantial" (i.e., they exceed the cost of the goods to be sold).
C)Delivery of the goods normally occurs within a short period after the payments become substantial.
D)According to the Internal Revenue Code, tax methods of accounting for advance payments must be in conformity with financial methods (GAAP).

Question 71

JKL Corporation is a large construction company with annual gross receipts, averaging $20 million annually.This year the corporation signed an agreement to construct a road for $720,000.Total estimated costs are $600,000.This year the corporation actually incurred costs of $240,000.For the year, JKL's gross profit on the contract will be

A)$0
B)$288,000
C)$200,000
D)$48,000
E)None of the above

Question 72

Lynn O'Leeum is an accrual basis calendar year taxpayer.He operates a flooring company.His accounting records for 2012 reveal the following: Collections on accounts receivable $\quad$$\$ 405,000$
Sales on account to customers $\quad$ 521,000
Rent received on November 1, 2012
for use of part of his warehouse
from November 1, 2012 to April 30, $2012 \quad\quad 12,000$
Rent received on February 1, 2012 for use of part of his
warehouse for December 2010 and January $2012 \quad\quad 4,000$ Of the amounts collected on the accounts receivable, $25,000 was for receivables outstanding at the end of 2009.Lynn will include gross income for 2010 of

A)$421,000
B)$533,000
C)$535,000
D)$537,000
E)None of the above

Question 73

Tyler T.Tycoon owns various office buildings and warehouses throughout the city of Dallas.He rents one building to Kate, Saperstein and Sons, a large department store.The lease is for four years and calls for a rental of $12,000 a year.Rent is payable in quarterly installments on March 31, June 30, September 30, and December 31.On May 1, Tyler transferred all the rights under the lease to his son, Tex.At that date, the lease had 44 months to run.This year Tex collected $9,000 of rents.He paid his father the $1,000 rent received for the month of April during which he was not the owner of the lease.For the year, Tyler will report rental income of

A)$1,000
B)$3,000
C)$4,000
D)$12,000
E)some other amount

Question 74

Which of the following contracts would be considered a long-term contract?

A)A contract signed on September 1 with the U.S.Army to manufacture 20 planes estimated to be completed in 15 months (a single plane takes about one month to complete); the contractor currently has 12 planes in inventory.
B)A contract to manufacture a telescope custom-made for space flight.The telescope will be the first of its kind.Estimated time of manufacturing is eight months.
C)A three-year contract signed by JB Systems to provide the design work for the space shuttle.
D)More than one of the above.