The taxpayer has consistently, but incorrectly, used an allowance for bad debts. At the beginning of the year, the balance in the allowance account is $90,000.
A) If the IRS examines the taxpayer's return and requires the taxpayer to change accounting methods, the taxpayer will be required to recognize an additional $90,000 of income (one-half in the current year and one- half in the following year) as the adjustment due to the change in accounting methods.
B) If the taxpayer voluntarily changes methods, the $90,000 adjustment can be spread over the current and three following years.
C) If the taxpayer voluntarily changes methods, the $90,000 reserve can be used to absorb bad debts until the account balance is zero.
D) If the IRS examines the taxpayer's return, no adjustment to the reserve account will be required if the balance is consistent with prior bad debt experience.
E) None of the above.

Question

Quizplus · Accepted Answer

If the taxpayer voluntarily changes methods, the $90,000 adjustment can be spread over the current and three following years. This is known as a Sec. 481(a) adjustment, and it allows for the spreading of the adjustment amount over multiple years. Option A is incorrect because the adjustment would be one-half in the current year and one-half in the following year, not all in the current year. Option C is incorrect because once the accounting method is changed, the reserve cannot be used to absorb bad debts. Option D is incorrect because a consistent balance in the reserve account does not necessarily mean that no adjustment is required.

The Taxpayer Has Consistently, but Incorrectly, Used an Allowance for Bad