13.4 - Accounting Methods

Question 1

What is a tax year?

Answer 1

• Annual accounting period used to keep a person’s books and records

Question 2

Tax Year

Provide 2 examples of a tax year

Answer 2

• Calendar year (ending December 31^st)
• Fiscal year (any 12-month period ending on the last day of the month)

Question 3

Tax Year

True or False >>>

a 52 / 53 week tax year must always end on a Friday

Answer 3

False -

• Must always end on the same day of the week

Question 4

Tax Year

When is the short tax year acceptable?

Answer 4

• Must annualize income
• Year of startup / dissolution

Question 5

Tax Year

What must an entity do to change their tax year?

Answer 5

• Can change tax year after gaining IRS consent

Question 6

Tax Year

What type of tax return must an entity file when changing their tax year after gaining IRS consent?

Answer 6

• Short tax year return required

Question 7

Accounting Method

What is an accounting method?

Answer 7

• Method of accounting regularly used to compute income in keeping books and records

Question 8

Accounting Method

What are the two types of accounting methods?

Answer 8

• Cash method and accrual method

Question 9

Accounting Method

Does the change in accounting method require IRS consent?

Answer 9

Yes

Question 10

Identify 5 accounting changes that can be made without IRS consent

Answer 10

• Adopting LIFO inventory valuation
• Switching from declining-balance to straight line depreciation
• Making adjustments in useful lives of certain assets
• Correcting an error in computing tax
• Changing from accrual method to the installment method of reporting income

Question 11

Cash Method:

When is income accounted for under the cash method?

Answer 11

• Accounts for income when:
  
  • Cash is actually received
  • Cash equivalent is actually received
  • Cash or equivalent is constructively received

Question 12

Cash Method:

How is the value of noncash property / services accounted for under the cash method?

Answer 12

• FMV of noncash property / services is included in GI

Question 13

Cash Method:

Define the proper cash method accounting treatment when the value of property received cannot be determined

Answer 13

• FMV of property given up will be treated as the amount of income to recognize

Question 14

Doctrine of Constructive Receipt:

Does deferring deposit of a check defer income?

Answer 14

No

Question 15

Doctrine of Constructive Receipt:

When are items included in GI under the “doctrine of constructive receipt”?

Answer 15

• when a person has an unqualified right to immediate possession
• Constructively receives in tax year during which it is credited to his/her account, set apart for him/her or otherwise made available so that he/she may draw upon it at anytime

Question 16

Doctrine of Economic Benefit

Define gross income according to the doctrine of economic benefit

Answer 16

• GI includes any economic or financial benefit conferred on an employee as compensation

Question 17

Doctrine of Economic Benefit

Does the doctrine of economic benefit still apply when the taxpayer cannot choose to take the equivalent value of the income in cash?

Answer 17

Yes

Question 18

Accrual Method

Identify the types of entities that are required to use the accrual accounting method

Answer 18

• C Corporations,
• partnerships with a C corporation as a partners, and
• tax shelters

Question 19

Accrual Method

Identify the exceptions available to corporations who must normally use the accrual method of accounting

Answer 19

• Exceptions:
  
  • Qualified personal service corporations
  • Entities with < $5 million in average gross receipts in the 3 preceding years
  • Farming or tree-raising businesses

Question 20

Accrual Method

True or False >>>

• Taxpayer that maintains inventory must use the accrual method for purchases and sales, with exceptions for qualifying taxpayers that have minimum gross receipts from sale of that inventory

Answer 20

True

Question 21

Accrual Method

What accounting method must an entity use to report income if they use accrual for expenses?

Answer 21

the same accounting method used to report income must also be used to report expenses and vice versa.

Question 22

Accrual Method

When does the accrual method account for income?

Answer 22

• Accounts for income in the period it is actually earned

Question 23

Define the “All Events Test”

Answer 23

• Income is included when:
  
  • All the events have occurred that fix the right to receive it and
  • The amount can be determined with reasonable accuracy

Question 24

Right Not Fixed

What is the right not fixed contingent on?

Answer 24

future events

Question 25

# Right Not Fixed When must prepaid income be included in income under "right not fixed"?

Answer 25

* Prepaid income must be included in income when received * For both cash and accrual methods

Question 26

When are deductions allowed under both the cash and accrual accounting methods?

Answer 26

When the amount can be determined with reasonable accuracy

Question 27

# Inventory True or False \>\>\> Gross income includes receipts reduced by COGS for both manufacturing and purchasing entities

Answer 27

True

Question 28

# Inventory When can LIFO be used for tax purposes?

Answer 28

If it is also used for financial reporting

Question 29

# Long-Term Contracts: What is a long-term contract?

Answer 29

* Contract completed in a tax year subsequent to the one in which it was entered into

Question 30

# Long-Term Contracts: What method must be used to account for all long-term contracts?

Answer 30

* Must use the same method to account for all long-term contracts * Percentage of completion * Completed contract method

Question 31

# Long-Term Contracts: What is the completed contract method?

Answer 31

* Receipts accounted for in tax year in which contract is completed

Question 32

# Long-Term Contracts: When is the completed contract method allowed?

Answer 32

* Only allowed for home construction projects or small businesses with average annual gross receipts not greater than $10 million for 3 preceding tax years’ subject to additional restrictions

Question 33

# Long-Term Contracts: Define the % of completion method for long-term contracts

Answer 33

* Reports as income that portion of the total contract price that represents the % of total work completed in the year

Question 34

# Long-Term Contracts: What is the formula to calculate the percentage of completion?

Answer 34

## Footnote (cost for tax year) / (total expected cost)

Question 35

# Installment Method: When is the installment method required?

Answer 35

* Required for installment sales by both cash-method and accrual method taxpayers

Question 36

# Installment Method: Do the election exist to not apply the installment method?

Answer 36

Yes

Question 37

# Installment Method: What is an installment sale?

Answer 37

* Disposition of property in which at least one payment received after year of sale

Question 38

# Installment Method: Does the installment apply to both losses and gains?

Answer 38

No - only gains

Question 39

# Installment Method: When are losses recognized under the installment method?

Answer 39

* Loss fully recognized in year realized

Question 40

# Installment Method: Provide 5 situations where the installment method is not applied

Answer 40

* Generally, not applied to: * Inventory personal property sales * Revolving credit sales * Dealer disposition * Publicly traded securities * Sales by manufacturers of tangible personal property

Question 41

# Installment Method: When must depreciation recapture be recongized under the installment method?

Answer 41

* Depreciation recapture must be recognized in year of sale regardless of payments received

Question 42

# Installment Method: Identify the 3 step process in calculating installment sale income

Answer 42

* Step # 1: Calculate gross profit: * Step # 2: Calculate gross profit % * Step # 3: Calculate current year IS Income

Question 43

# Installment Method: Calculate gross profit in step # 1 of the 3 step process to calculating installment sale income under the installment method

Answer 43

Contract Price **-** COGS

Question 44

# Installment Method: Calcualte gross profit % in step # 2 of the 3-step process to calculating installment sale income under the installment method

Answer 44

Gross Profit **/** Contract Price

Question 45

# Installment Method: Calculate installment sale income in step # 3 of the 3-step process of calculating installment sale income under the installment method

Answer 45

Current Year Income **\*** Gross Profit %

Question 46

# Tax Year: What is the annualized income calculation?

Answer 46

(12 months / short tax year months) \* short tax year income

Question 47

What is the short tax year calculation?

Answer 47

(short tax year months / 12 months) \* annualized income tax