Amy borrowed $25,000 for her business from a local bank two years ago.To increase her deductions for 2013,she pays December interest of $400 and prepays January and February interest totaling $800 on December 30,2013.The maturity date of the note is November 30,2014.How much of the interest that she paid in December is deductible in 2013?
I.If she is a cash-basis taxpayer,Amy's interest deduction is $1,200.
II.If she is an accrual-basis taxpayer,Amy's interest deduction is $400.
A)Only statement I is correct.
B)Only statement II is correct.
C)Both statements are correct.
D)Neither statement is correct.

Question

Quizplus · Accepted Answer

The correct statement is II, which says that if Amy is an accrual-basis taxpayer, her interest deduction is $400. This is because under the accrual basis of accounting, expenses are deductible when they are incurred, regardless of when they are paid. Therefore, only the interest that was actually accrued in December ($400) is deductible in 2013, and the prepayment of $800 for January and February interest cannot be deducted until those months are reached. Statement I is incorrect because it assumes that the entire $1,200 in interest paid in December is deductible in 2013, which is not the case under the accrual basis of accounting.

Amy Borrowed $25,000 for Her Business from a Local Bank