Cool-a-House, an accrual basis calendar year taxpayer, sells air conditioning units.With each sale, the corporation also sells a one-, two-, or three-year contract to turn the units on and off and do routine maintenance.In determining its reporting options, the taxpayer wants to postpone recognition of income for as long as possible.Assuming the corporation sold a three-year contract on November 1 at a price $240, it will recognize income as it is earned, reporting $20 of income this year, $120 next year and $100 in the final year.

Question

Quizplus · Accepted Answer

Under the accrual basis of accounting, income is recognized when earned, regardless of when payment is received. However, for multi-year contracts like the one described, the IRS requires that income be allocated evenly over the term of the contract unless there is evidence that the services are provided unevenly over the contract period. Therefore, for a three-year contract worth $240, the corporation should recognize $80 of income each year ($240 total contract price divided by 3 years), not $20 the first year, $120 the second year, and $100 the third year as stated.

Cool-A-House, an Accrual Basis Calendar Year Taxpayer, Sells Air Conditioning