Deck 6: Taxable Income From Business Operations

Question 1

Poole Company, a calendar year taxpayer, incurred $589 of long-distance telephone charges in December 2020 and mailed a check to the telephone company on January 4, 2021. If Poole is a cash basis taxpayer, it reports a $589 tax deduction in 2021.

Answer 1

True

Question 2

The after-tax cost of a dollar of business meal expense is 79 cents for a taxpayer with a 21% marginal tax rate.

Answer 2

False

Question 3

On November 30, 2020, Laine Services, a calendar year taxpayer, billed a client $8,450 for services rendered during 2020. Laine received a check in full payment from the client on January 12, 2021. If Laine is an accrual basis taxpayer, it reports $8,450 taxable income in 2020.

Answer 3

True

Question 4

PPQ Inc. wants to change from a hybrid method of accounting to the accrual method of accounting for tax purposes. PPQ can't make this change without receiving permission from the IRS.

Question 5

Taxable income is defined as gross income minus allowable deductions and credits.

Question 6

Taxpayers that sell merchandise to their customers must use the accrual method as their overall method of accounting.

Question 7

A firm's choice of taxable year is usually dictated by the annual operating cycle of the firm's business.

Question 8

Poole Services, a calendar year taxpayer, billed a client for $1,675 of services on November 30, 2020, and received a check in full payment from the client on January 12, 2021. If Poole is a cash basis taxpayer, it reports $1,675 taxable income in 2020.

Question 9

Elcox Company, a calendar year, cash basis taxpayer, paid $950 to purchase eight months' worth of office supplies on December 12. Elcox can deduct $950 in the year of payment.

Question 10

A cash basis taxpayer must account for any prepayment of interest expense under the accrual method.

Question 11

Mr. Stern, a cash basis taxpayer, was notified by his bank that he earned $1,193 of interest on his savings account in 2020. Mr. Stern has not withdrawn any funds from this account for eight years and did not receive the notification until January 26, 2021. Mr. Stern does not recognize the interest as income in 2020.

Question 12

A taxpayer that operates more than one business may use a different method of accounting for each business.

Question 13

When an individual taxpayer begins a new business as a sole proprietorship and wants to keep records on a fiscal year basis, permission to change taxable years is not required because this is a new business.

Question 14

Elcox Company, a calendar year, cash basis taxpayer, paid a $6,340 premium to purchase a casualty insurance policy with a 36-month term. Elcox can deduct $6,340 in the year of payment.

Question 15

All taxpayers that sell merchandise to their customers must use the accrual method to account for purchases and sales of merchandise.

Question 16

Accurate measurement of taxable income is the only objective of the federal income tax laws.

Question 17

A taxpayer that wants to change its taxable year from a fiscal year to a calendar year is not required to receive permission from the IRS to make the change.

Question 18

Political lobbying expenses are nondeductible.

Question 19

Marz Services Inc. is a personal service corporation with $60 million average annual gross receipts. Marz must use the accrual method of accounting for tax purposes.

Question 20

Any taxpayers may adopt the cash receipts and disbursements method, the accrual method, or a hybrid method of accounting for tax purposes.

Question 21

At the end of the current taxable year, Gong Company accrued an expense for an account payable to Mexance Inc. Even if Gong and Mexance are related parties, Gong can deduct the accrued expense in the current year if Mexance also uses the accrual method of accounting for tax purposes.

Question 22

An unfavorable temporary book/tax difference generates a deferred tax asset.

Question 23

Bolton Inc., a calendar year taxpayer, generated a $296,400 net operating loss in 2021. Bolton can carry the loss back five years and forward 20 years for tax purposes.

Question 24

For tax purposes, income is recognized when all events have occurred that fix the taxpayer's right to receive the income and the amount of income can be determined with reasonable accuracy.

Question 25

Bolton Inc., a calendar year taxpayer, generated a $296,400 net operating loss this year. Bolton can carry the loss back five years and forward 20 years for tax purposes.

Question 26

A corporation can't have an increase in deferred tax assets and an increase in deferred tax liabilities in the same year.

Question 27

If an accrual basis taxpayer receives a prepayment of rent income, the receipt results in an unfavorable temporary book/tax difference.

Question 28

The principle of conservatism reflected by GAAP is identical to the principle of conservatism reflected in the tax law.

Question 29

Keagan Company, a calendar year taxpayer, incurred $1,490 of long-distance telephone charges in December 2020 and mailed a check to the telephone company on January 4, 2021. If Keagan is an accrual basis taxpayer, it reports a $1,490 tax deduction in 2021.

Question 30

The tax law does not allow deductions for estimated expenses that result in an allowance or reserve for financial statement purposes.

Question 31

Murray Inc., a calendar year, accrual basis corporation, accrued $946,000 salary and wage expense at the end of 2020. Murray paid the entire amount of the accrued liability on January 13, 2021. Murray can deduct the entire $946,000 accrued expense in 2020.

Question 32

Huml Inc. could not deduct an accrued expense because of the all-events test. As a result, Huml has a permanent unfavorable book/tax difference.

Question 33

A permanent difference between book income and taxable income affects only one taxable year.

Question 34

Income tax expense per books is based on book income adjusted for all book/tax differences.

Question 35

Molton Inc., which operates a chain of retail toy stores, prepares GAAP based financial statements. Molton must use the allowance method to account for business bad debts for both book and tax purposes.

Question 36

If an accrual basis taxpayer prepays interest expense, the payment results in an unfavorable temporary book/tax difference.

Question 37

According to the GAAP principle of conservatism, firms should delay the realization of uncertain revenues and gains and accelerate the realization of uncertain expenses and losses.

Question 38

A temporary difference between book income and taxable income results when an item of income reflected on the books is never included in taxable income.

Question 39

An accrual basis taxpayer that accrues a liability at year-end for unpaid state income tax can deduct the accrued tax expense in the computation of federal taxable income.

Question 40

An accrual basis taxpayer must account for the expense of a legal settlement resulting from a tort under the cash method.

Question 41

On December 12, 2020, Hook Company, a calendar year, cash basis business, mailed a $5,600 bill to Mrs. Gilder for professional services rendered during the month of November. Mrs. Gilder dropped off her $5,600 check at Hook's office on December 28, but the company secretary did not deposit the check in Hook's bank account until January 3. Which of the following statements is true?

A) According to the constructive receipt doctrine, Hook must recognize $5,600 income in 2020.
B) According to the substance over form doctrine, Hook does not recognize $5,600 income until 2021.
C) As a cash basis taxpayer, Hook does not recognize $5,600 income until 2021.
D) As a cash basis taxpayer, Hook can elect to recognize $5,600 income in either 2020 or 2021.

Question 42

Welch Inc. has used a fiscal year ending September 30 as its taxable year since its incorporation in 1988. The shareholders have decided to shut down Welch's business and dissolve the corporation on March 31. Which of the following statements is false?

A) Welch's final tax return will be a short-period return.
B) Welch's final tax return will include its income from October 1 to March 31.
C) Welch's final tax return will include its income from January 1 to March 31.
D) None of these choices are false.

Question 43

Village Inc. has average gross receipts of $100 million annually. This year, Village incurred $25 million of net business interest and has adjusted taxable income of $42 million. Village's current deduction for business interest is:

A) $0
B) $7.5 million
C) $12.6 million
D) $25 million

Question 44

Toro Inc. has average gross receipts of $30 million annually. In 2019, Toro incurred $7 million of net business interest and has adjusted taxable income of $12 million. Toro's current deduction for business interest is:

A) $2.1 million
B) $3.6 million
C) $6 million
D) $0

Question 45

Toro Inc. has average gross receipts of $30 million annually. This year, Toro incurred $5 million of net business interest and has adjusted taxable income of $12 million. Toro's current deduction for business interest is:

A) $1.5 million
B) $3.6 million
C) $5 million
D) $0

Question 46

Which of the following statements about tax policy objectives regarding business expenses is false?

A) Lobbying expenses are not deductible because Congress does not want to subsidize political activities.
B) By disallowing a tax deduction, Congress increases the after-tax cost of undesirable expenditures.
C) The tax treatment of meals and entertainment expenses is intended to make the law more equitable.
D) The business interest expense limitation increases the disparity between the tax treatment of debt and equity financing.

Question 47

Which of the following statements about the cash method of accounting is false?

A) Under the cash method, annual taxable income equals annual net cash inflow.
B) The revenue from a sale of goods is recognized when payment is received.
C) An expense isgenerally recognized when the expense is paid.
D) None of these choices are false.

Question 48

Tonto Inc. has used a calendar year as its taxable year since its incorporation in 1990. Tonto has an excellent business reason for changing to a fiscal year ending May 31. Which of the following statements is true?

A) Because it has a good business reason, Tonto can change to a fiscal year ending May 31 without IRS permission.
B) If Tonto changes to a fiscal year ending May 31, it must file a short-period return for the seven-month period from June 1 to December 31 of the year of change.
C) If Tonto changes to a fiscal year ending May 31, it must file a short-period return for the five-month period from January 1 to May 31 of the year of change.
D) Because it has a good business reason, Tonto can change to a fiscal year ending May 31 without IRS permission and if Tonto changes to a fiscal year ending May 31, it must file a short-period return for the seven-month period from June 1 to December 31 of the year of change.

Question 49

Stack Inc. owns a $1 million insurance policy on the life of Mary Stack, the corporate CEO. The corporation is the policy beneficiary. Stack's annual premium on the policy is $3,160. Which of the following statements is true?

A) Stack Inc. can deduct the annual premium as a business expense. If Stack ever collects the $1 million death benefit, the benefit is excluded from gross income.
B) Stack Inc. can deduct the annual premium as a business expense. If Stack ever collects the $1 million death benefit, the benefit is included in gross income.
C) Stack Inc. can't deduct the annual premium as a business expense. If Stack ever collects the $1 million death benefit, the benefit is included in gross income.
D) Stack Inc. can't deduct the annual premium as a business expense. If Stack ever collects the $1 million death benefit, the benefit is excluded from gross income.

Question 50

JKL Inc. and Matthew Inc. enter into a business transaction. The two corporations are related parties for tax purposes. Which of the following statements is true?

A) JKL and Matthew must account for the transaction using the same method of accounting.
B) The IRS has the right to reallocate income from the transaction to prevent distortion.
C) The cash method of accounting must be used to account for such transactions.
D) JKL and Matthew must request permission from the IRS to engage in the related party transaction.

Question 51

Lawes Company, a cash basis business, mailed a $24,500 invoice to MWQ Partnership for professional services rendered. MWQ offered to pay the invoice by transferring 250 shares of ConAgri common stock to Lawes. The shares are selling on the NYSE at $98 per share. If Lawes accepts the shares in payment, it recognizes:

A) No taxable income.
B) No taxable income until it sells the ConAgri shares for cash.
C) $24,500 taxable income.
D) It is illegal for a cash basis taxpayer to accept a noncash payment.

Question 52

Which of the following statements about methods of accounting is false?

A) The IRS has the right to determine if a taxpayer's method of accounting clearly reflects the taxpayer's income.
B) A taxpayer must request permission from the IRS to change its method of accounting for tax purposes.
C) A taxpayer engaged in more than one business can use a different method of accounting for each business.
D) Taxpayers must use the same method of accounting to compute taxable income as they use to compute financial statement income.

Question 53

Jethro Company, an accrual basis taxpayer, had a $10,000 overdue account payable to a major supplier. The supplier agreed to settle the account for $9,000 cash from Jethro. Which of the following statements is true?

A) Jethro recognizes $1,000 income because of the settlement.
B) Jethro recognizes no income because of the settlement.
C) Jethro can deduct the $9,000 payment.
D) Jethro can deduct a $1,000 bad debt expense.

Question 54

Why does the federal tax law disallow a business deduction for political contributions?

A) A deduction for the payment of a political contribution would be a subsidy for bad behavior.
B) A deduction for the payment of a political contribution would subsidize partisan political activities.
C) The payment of a political contribution is not an expense for financial reporting purposes.
D) A deduction for the payment of a fine or penalty would distort the measurement of taxable income.

Question 55

Village Inc. has average gross receipts of $100 million annually. In 2019, Village incurred $25 million of net business interest and has adjusted taxable income of $42 million. Village's current deduction for business interest is:

A) $0
B) $12.6 million
C) $21 million
D) $25 million

Question 56

Which of the following business expenses always results in a difference between taxable income and book income?

A) Rent expense
B) Interest expense
C) Client entertainment
D) Salary expense

Question 57

Pim Inc. operates a business with a natural annual operating cycle ending August 31. Which of the following can Pim adopt as its taxable year?

A) A calendar year.
B) Fiscal year ending June 30.
C) Fiscal year ending August 31.
D) Pim can adopt a calendar year or any fiscal year as its taxable year.

Question 58

Which of the following methods of accounting is never permissible for computing taxable income?

A) Cash receipts and disbursements method
B) Accrual method
C) Hybrid method that combines the cash and accrual methods
D) All of the above are permissible methods of accounting.

Question 59

Why does the federal tax law disallow a business deduction for a fine or penalty paid to any government?

A) A deduction for the payment of a fine or penalty would be a subsidy for bad behavior and also against public policy.
B) The payment of a fine or penalty is not an ordinary business expense.
C) The payment of a fine or penalty is not an expense for financial reporting purposes.
D) A deduction for the payment of a fine or penalty would distort the measurement of taxable income.

Question 60

Pozzi Company, a cash basis business, received $16,930 cash as payment on a loan Pozzi made to a business associate two years ago. The payment consisted of a $15,000 principal payment and $1,930 interest. On receipt of the cash, Pozzi recognizes:

A) No taxable income.
B) $1,930 taxable income.
C) $15,000 taxable income.
D) $16,930 taxable income.

Question 61

Tax expense per books is based on:

A) Before-tax book income
B) Before-tax book income adjusted for permanent differences
C) Before-tax book income adjusted for temporary differences
D) Before-tax book income adjusted for both permanent and temporary differences

Question 62

Which of the following statements about the accrual method of accounting is false?

A) The accrual method is the required method of accounting under GAAP.
B) Every publicly held corporation must use the accrual method of accounting to prepare financial statements.
C) The accrual method of accounting under GAAP and the accrual method of accounting for computing taxable income are identical.
D) Corporations with more than $25 million average annual gross receipts are required to use the accrual method to compute taxable income.

Question 63

Which of the following statements regarding book/tax differences is false?

A) A permanent book/tax difference affects only the year in which it occurs.
B) A temporary book/tax difference affects two or more tax years.
C) Temporary book/tax differences arising in the current tax year will reverse in one or more future tax years.
D) The tax cost or benefit of a permanent book/tax difference is recouped over time.

Question 64

Which of the following statements concerning the cash method of accounting is true?

A) A cash basis taxpayer who is in constructive receipt of an income item must recognize that income, even if the item is not in the taxpayer's actual possession.
B) A cash basis taxpayer can deduct the purchase cost of business equipment.
C) A cash basis taxpayer does not recognize gross income on receipt of an economic benefit unless that benefit consists of money.
D) A cash basis taxpayer can deduct interest when it is paid, regardless of the time period for which the interest is charged.

Question 65

B&B Inc.'s taxable income is computed as follows: $\begin{array}{lr}\text { Book income before tax }&\$9,882,590\\\text { Net permanent differences}&447,600\\\text {Net temporary differences }&(802,100)\\\text { Taxable income }&\$9,528,090\end{array}$
B&B's tax rate is 21%. Which of the following statements is true?

A) The temporary differences caused a $168,441 net decrease in B&B's deferred tax liabilities.
B) The permanent differences caused a $93,996 net increase in B&B's deferred tax assets.
C) The permanent differences caused a $93,996 net decrease in B&B's deferred tax assets.
D) The temporary differences caused a $168,441 net increase in B&B's deferred tax liabilities.

Question 66

Which of the following statements concerning the principle of accounting conservatism is true?

A) According to the GAAP principle of conservatism, financial statements should report expenses and losses in the earliest reasonable year.
B) The GAAP principle of conservatism tries to prevent the overstatement of book income and the understatement of taxable income.
C) According to the tax law principle of conservatism, taxpayers should deduct expenses and losses in the earliest reasonable year.
D) According to the tax law principle of conservatism, taxpayers should deduct expenses and losses in the same year as they are reported on the taxpayers' financial statements.

Question 67

Southlawn Inc.'s taxable income is computed as follows: $\begin{array}{llr} \text { Book income before tax} &\$2,405,600\\ \text {Net permanent differences } &(512,000)\\ \text { Net temporary differences} &(189,000)\\ \text { Taxable income} &\$1,704,600\end{array}$

Southlawn's tax rate is 21%. Which of the following statements is true?

A) The permanent differences caused a $107,520 net increase in Southlawn's deferred tax liabilities.
B) The permanent differences caused a $107,520 net decrease in Southlawn's deferred tax liabilities.
C) The temporary differences caused a $39,690 net increase in Southlawn's deferred tax liabilities.
D) The temporary differences caused a $39,690 net decrease in Southlawn's deferred tax liabilities.

Question 68

According to your textbook, business managers prefer to:

A) Report as much income as possible for book and tax purposes.
B) Report as much income as possible for book purposes and as little income as possible for tax purposes.
C) Report as little income as possible for book and tax purposes.
D) Report the same amount of income for book and tax purposes.

Question 69

Goff Inc.'s taxable income is computed as follows: $\begin{array}{lr}\text { Book income before tax } & \text { 1, 016,200 } \\\text { Net permanent differences } & 77,930 \\\text { Net temporary differences } & 475,200 \\\text { Taxable income } & \$ 1,569,330\end{array}$
Using a 21% rate, compute Goff's tax expense per books and tax payable.

A) Tax expense per books $229,767; tax payable $229,767.
B) Tax expense per books $329,559; tax payable $329,559.
C) Tax expense per books $213,402; tax payable $229,767.
D) Tax expense per books $229,767; tax payable $329,559.

Question 70

Which of the following businesses is prohibited from using the cash receipts and disbursement method of accounting for tax purposes?

A) Partnership with two individual partners with $9 million average annual gross receipts
B) Personal service corporation with $8 million average annual gross receipts
C) Corporation with $3 million average annual gross receipts
D) None of the businesses are prohibited from using the cash method

Question 71

Goff Inc.'s taxable income is computed as follows: $$\begin{array} { l c } \text { Book income before tax } & \$ 1,016,200 \\\text { Net permanent differences } & 77,530 \\\text { Net temporary differences } & 475,200 \\\text { Taxable income } & \$ 1,569,330\end{array}$$ Goff's tax rate is 21%. Which of the following statements is true?

A) The permanent differences caused a $16,365 net increase in Goff's deferred tax liabilities.
B) The permanent differences caused a $16,365 net increase in Goff's deferred tax assets.
C) The temporary differences caused a $99,792 net increase in Goff's deferred tax assets.
D) The temporary differences caused a $99,792 net increase in Goff's deferred tax liabilities.

Question 72

B&B Inc.'s taxable income is computed as follows: $\begin{array}{llr} \text { Book income betore tax} &\$9,882,590\\ \text { Net permanent differences} &447,600\\ \text { Net temporary differences} &(802,100)\\ \text { Taxable income} &\$9,528,090\end{array}$
Using a 21% rate, compute B&B's tax expense per books and tax payable.

A) Tax expense per books $2,000,899; tax payable $2,169,340.
B) Tax expense per books $2,169,340; tax payable $2,000,899.
C) Tax expense per books $2,169,340; tax payable $2,169,340.
D) Tax expense per books $2,000,899; tax payable $2,000,899.

Question 73

Eaton Inc. is a calendar year, cash basis taxpayer. On October 1, 2020, Eaton paid $4,800 to a security firm for night-time and weekend security services for the 24-month period beginning with October. Which of the following is true?

A) As a cash basis taxpayer, Eaton can deduct the $4,800 expense in 2020.
B) Eaton can deduct $600 in 2020, and the remaining $4,200 in 2021.
C) Eaton can deduct $600 in 2020, $2,400 in 2021, and $1,800 in 2022.
D) None of these choices are true.

Question 74

Which of the following does not result in a permanent book/tax difference?

A) Tax-exempt interest on state and local bonds
B) NOL carryforwards
C) Business entertainment expenses
D) Lobbying expenses

Question 75

Which of the following businesses can't use the cash receipts and disbursement method of accounting for tax purposes?

A) Sole proprietorship with $8 million average annual gross receipts
B) Corporation with $50 million average annual gross receipts
C) Partnership of individuals with $20 million average annual gross receipts
D) Personal service corporation with $50 million average annual gross receipts

Question 76

Which of the following statements about the constructive receipt doctrine is false?

A) The doctrine applies to cash basis taxpayers.
B) The doctrine relates to the time period variable in tax planning.
C) Application of the doctrine by the IRS is subjective and depends on the facts and circumstances of each case.
D) None of these choices are false.

Question 77

Southlawn Inc.'s taxable income is computed as follows: $\begin{array}{llr} \text { Book income before tax} &\$2,405,600\\ \text {Net permanent differences } &(512,000)\\ \text { Net temporary differences} &(189,000)\\ \text { Taxable income} &\$1,704,600\end{array}$
Using a 21% rate, compute Southlawn's tax expense per books and tax payable.

A) Tax expense per books $397,656; tax payable $357,966.
B) Tax expense per books $357,966; tax payable $397,656.
C) Tax expense per books $612,570; tax payable $357,966.
D) None of these choices are correct

Question 78

Which of the following does not result in a permanent book/tax difference?

A) Business meal and entertainment expense
B) Nondedutible fines and penalties
C) Premiums paid on key-person life insurance policies
D) All of the above result in a permanent book/tax difference.

Question 79

Addis Company operates a large retail men's clothing store that has annual gross receipts of $30 million. Because Addis has merchandise inventory, it must use:

A) The accrual method as its overall method of accounting.
B) The accrual method to account only for sales of merchandise.
C) The accrual method to account only for purchases of merchandise.
D) The accrual method to account for both sales and purchases of merchandise.

Question 80

Which of the following statements describes a permanent book/tax difference?

A) An expense reported on the current income statement but deducted on next year's tax return
B) A revenue item included in current taxable income but not reported on the income statement until next year
C) An expense (or loss) is realized for book purposes but never recognized for tax purposes
D) A revenue item reported on the current income statement but not included in taxable income until an indefinite future year