Question 1

The financial accounting principle of conservatism is not well suited to the task of measuring taxable income.

Accepted Answer

The principle of conservatism is focused on minimizing the possibility of overstating assets and income, and understating liabilities and expenses. Taxable income, on the other hand, is determined by specific tax laws and regulations, and may not align with the conservatism principle. Therefore, conservatism may not be the most appropriate approach for measuring taxable income.

Question 2

A sole proprietor purchased an asset for $1,000 in 2019.Its value was $1,500 at the end of 2019.In 2020, the taxpayer sold the asset for $1,400.In 2020, the proprietor realized a taxable gain of $400 but an economic loss of
$100.

Accepted Answer

The taxable gain is calculated based on the difference between the selling price ($1,400) and the purchase price ($1,000), which equals $400. However, considering the asset's value at the end of 2019 was $1,500, selling it for $1,400 in 2020 represents an economic loss of $100, as the selling price is lower than the asset's value at the end of the previous year.

Question 3

The constructive receipt doctrine requires that income be recognized when it is made available to the cash basis taxpayer, although it has not been actually received.The constructive receipt doctrine does not apply to accrual basis taxpayers.

Accepted Answer

The statement is true. The constructive receipt doctrine applies only to cash basis taxpayers and requires them to recognize income when it is made available, even if it has not been actually received. However, this doctrine does not apply to accrual basis taxpayers who recognize income when it is earned, regardless of when it is received.

Question 4

In 2019, Juan, a cash basis taxpayer, was offered $3 million for signing a professional baseball contract.He counteroffered that he would receive $900,000 per year for four years beginning in 2020.The team accepted the counteroffer.Juan constructively received $3 million in 2019.

Accepted Answer

Although Juan negotiated and agreed to receive $900,000 per year for four years, the actual payments did not begin until 2020. Therefore, he did not constructively receive the $3 million in 2019.

Question 5

The realization requirement gives an incentive to own assets that have increased in value and to sell assets whose value has decreased.

Accepted Answer

The realization requirement refers to the concept that gains on an asset are not taxed until the asset is sold, or "realized." This gives an incentive for individuals to hold onto assets that have increased in value, as they can continue to defer taxes on those gains. On the other hand, selling assets whose value has decreased allows individuals to "realize" losses and potentially offset gains on other assets. Therefore, the realization requirement does provide an incentive to own assets that have increased in value and sell assets whose value has decreased.

Question 6

Judy is a cash basis attorney.This year, she performed services in connection with the formation of a corporation and received stock with a value of $4,000 for her services.By the end of the year, the value of the stock had decreased to $2,000.She continued to hold the stock.Judy must recognize $4,000 of gross income from the stock for the current year.

Accepted Answer

Even though the value of the stock decreased by the end of the year, under cash basis accounting, Judy must recognize the full value of the stock ($4,000) as gross income in the year she received it in exchange for her services. The fluctuation in value after that point is irrelevant for tax purposes.

Question 7

Fred is a full-time teacher.He has written a book and receives royalties from it.Fred's mother, Mabel, is age 65 and lives on her Social Security benefits and gifts from her son.This year Fred directed the publisher to make the royalty check payable to Mabel because she needs the money for support.Fred must include the amount of the royalty check in his gross income.

Accepted Answer

Even though the royalty check was made payable to Mabel, the income still belongs to Fred since he is the author and the source of the income. Therefore, he must include the amount of the royalty check in his gross income.

Question 8

On December 1, 2019, Daniel, an accrual basis taxpayer, collects $12,000 rent for December 2019 and $12,000 for
January 2020.Daniel must include the $24,000 in 2019 gross income.

Accepted Answer

An accrual basis taxpayer must include income when it is earned, regardless of when it is received. In this case, the rent for December 2019 and January 2020 is considered earned income for December 2019, so Daniel must include the $24,000 in 2019 gross income.

Question 9

Jessica is a cash basis taxpayer.When she failed to repay a loan, the bank garnished her salary.Each week $60 was withheld from Jessica's salary and paid to the bank.Jessica is required to include the $60 each week in her gross income even though it is the creditor that benefits from the income.

Accepted Answer

As a cash basis taxpayer, Jessica is required to include the $60 each week in her gross income, even though it is being paid directly to the bank as part of the garnishment. The fact that the creditor (the bank) benefits from the income does not change the fact that it is income to Jessica.

Question 10

An advance payment received in June 2019 by an accrual basis and calendar year taxpayer for services to be provided over a 36-month period can be spread over four tax years.

Accepted Answer

Under the accrual basis accounting, income is recognized when earned, not when received. However, for tax purposes, the IRS allows taxpayers to defer income received for services to be performed by the end of the next tax year. Since the services are to be performed over a 36-month period starting from June 2019, the income can only be spread over three tax years (2019, 2020, and 2021), not four.

Question 11

The fact that the accounting method the taxpayer uses to measure income is consistent with GAAP does not ensure that the method will be acceptable for tax purposes.

Accepted Answer

Just because the accounting method is consistent with GAAP (Generally Accepted Accounting Principles) does not mean it conforms to the tax law requirements of the Internal Revenue Code or IRS regulations. The IRS has specific rules for recording income and deductions for tax purposes, which may differ from GAAP standards.

Question 12

A cash basis taxpayer purchased a certificate of deposit for $1,000 on July 1, 2017 that will pay $1,100 upon its maturity on June 30, 2019.The taxpayer must recognize a portion of the income in 2018.

Accepted Answer

The taxpayer must recognize $50 of interest income in 2018 because the certificate of deposit is a cash basis taxpayer and the interest is not taxable until it is received.

Question 13

In December 2018, Mary collected the December 2018 and January 2019 rent from a tenant.Mary is a cash basis taxpayer.The amount collected in December 2018 for the 2019 rent should be included in her 2019 gross income.

Accepted Answer

Since Mary is a cash basis taxpayer, she should only include income in the year that it is received. Therefore, the amount collected in December 2018 for January 2019 rent should be included in her 2018 gross income, not 2019.

Question 14

In 2009, Terry purchased land for $150,000.He also received $10,000 from a local cable television company in exchange for allowing the company to run an underground cable across his property.Terry is not required to recognize income from receiving the $10,000 because it was a return of his capital invested in the land.

Accepted Answer

The payment received by Terry from the cable television company is considered a return of capital, not income, because it represents compensation for the use of his land.

Question 15

On January 1, 2019, an accrual basis taxpayer entered into a contract to provide termite inspection service each month for 24 months.The amount received for the contract was $2,400.The taxpayer reported $1,200 as income on its financial statement for 2019, and should do the same for its tax return.

Accepted Answer

Since the taxpayer is on accrual basis, they must report income when it is earned, not when it is received. The contract is for 24 months, so the taxpayer should recognize $100 of income per month for each month of the contract. Therefore, they correctly reported $1,200 of income on their financial statement for 2019 and should report the same on their tax return.

Question 16

Ralph purchased his first Series EE bond during the year.He paid $709 for a 10-year bond with a $1,000 maturity value.The yield to maturity on the bonds was 3.5%.Ralph is not required to recognize the $291 ($1,000 - $709) original issue discount until the bond matures.However, Ralph can elect to amortize the discount over the 10-year period.

Accepted Answer

Ralph can elect to amortize the discount over the 10-year period, meaning he can spread out the recognition of the discount over the life of the bond.

Question 17

Barney painted his house, which saved him $3,000.According to the realization requirement, Barney must recognize
$3,000 of income.

Accepted Answer

According to the realization requirement, Barney cannot recognize the $3,000 savings as income because he did not receive any actual money or property. Income must be received in a taxable form to be recognized.

Question 18

ABC Corporation declared a dividend for taxpayers of record as of December 24, 2018.The dividend checks were mailed on December 31, 2018.Ed, a cash basis shareholder, received the dividend check on January 2, 2019.Ed cannot delay reporting the income from the dividend until 2019.

Accepted Answer

Ed, being a cash basis taxpayer, must report income when it is actually or constructively received. Since he received the dividend check in 2019, he should report the dividend income in 2019, not 2018.

Question 19

Nicholas owned stock that decreased in value by $20,000 during the year, but he did not sell the stock.He earned $45,000 salary, but received only $34,000 because $11,000 in taxes were withheld.Nicholas saved $10,000 of his salary and used the remainder for personal living expenses.Nicholas's economic income for the year exceeded his gross income for tax purposes.

Accepted Answer

Economic income includes all forms of income, including unrealized gains or losses on investments. Since Nicholas's stock decreased in value, this loss would be considered in his economic income but not in his gross income for tax purposes, as it was an unrealized loss (he did not sell the stock). His gross income for tax purposes would only include the salary earned, not the decrease in stock value or the taxes withheld.

Question 20

At the beginning of 2019, Mary purchased a 3-year certificate of deposit (CD) for $8,760.The maturity value of the certificate was $10,000 and it was to yield 4.5%.She also purchased a Series EE bond for $6,400 with a maturity value in 10 years of $10,000.Mary must recognize $1,240 of income from the certificate of deposit in 2019, and
$3,600 from the Series EE bonds in 2028.

Accepted Answer

Interest on a certificate of deposit (CD) is typically recognized annually as it accrues, not in a lump sum at maturity. For the Series EE bond, the interest is often deferred until redemption, sale, or maturity, but the specific recognition of $3,600 in 2028 cannot be determined without knowing the bond's interest rate or how it compounds.

Quiz 4: Gross Income: Concepts and Inclusions