Karen, an accrual basis taxpayer, sold goods in December 2019 for $20,000.The customer was unable to pay cash. So the customer gave Karen a note for $20,000 that was payable in April 2020.The note bore interest at the Federal rate.The fair market value of the note at the end of 2019 was $18,000.Karen collected $20,500 from the customer in April 2020, $20,000 principal plus $500 interest.Under the accrual method, Karen must recognize income of:

Question

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Under the accrual method of accounting, income should be recognized in the year that it is earned, even if payment is not received until a later year. In this case, Karen earned $20,000 in December 2019 when she sold the goods to the customer. The fact that the customer gave her a note instead of paying cash does not change the fact that she earned the income in 2019.

The fair market value of the note at the end of 2019 was $18,000, which means that Karen could have sold the note for that amount if she wanted to receive payment immediately. However, she chose to hold on to the note and receive payment in April 2020.

When Karen received payment in April 2020, she collected $20,500 - $20,000 in principal and $500 in interest. The $500 interest should be recognized as income in 2020. Therefore, the total income recognized is $20,000 in 2019 and $500 in 2020. The correct answer is choice C.

Karen, an Accrual Basis Taxpayer, Sold Goods in December 2019