Todd operates a business using the cash basis of accounting. At the end of last year, Todd was granted permission to switch his sales on account to the accrual method. Last year, Todd made $420,000 of sales on account, and $64,000 was uncollected at the end of the year. What is Todd's §481 adjustment for this year?
A)Increase income by $420,000
B)Increase income by $16,000
C)Increase expenses by $64,000
D)Increase expenses by $420,000
E)Todd has no §481 adjustment this year.

Question

Quizplus · Accepted Answer

Since Todd switched from cash basis to accrual basis, he will need to make a §481 adjustment to account for the sales on account that were uncollected at the end of the year.

The adjustment will be the difference between the amount of uncollected sales at the end of the year under the cash basis and the amount of accounts receivable for those sales at the end of the year under the accrual basis.

Under the cash basis, Todd did not include the $64,000 of uncollected sales in his income for the year, so his income was understated. Under the accrual basis, Todd would have included those sales in his income, since they were earned during the year, even though they were not collected.

So, the §481 adjustment will increase Todd's income by the amount of the uncollected sales that were not included under the cash basis, which is $64,000. Therefore, the correct answer is B) Increase income by $16,000, since Todd made the change during the year.

Todd Operates a Business Using the Cash Basis of Accounting