CHAPTER 16 ACCOUNTING PERIODS AND METHODS

1. Purple Corporation, a personal service corporation (PSC), adopted a fiscal year ending September 30th. The sole shareholder of the corporation is a calendar year taxpayer. During the fiscal year ending September 30, 2014, the shareholder-employee received $120,000 salary. The corporation paid the shareholder-employee a salary of $15,000 during the period beginning October 1, 2014 through December 31, 2014.

a. The corporation salary expense for the fiscal year ending September 30, 2015 is limited to $120,000.

b. The corporation salary expense for the fiscal year ending September 30, 2015 is limited to $135,000.

c. The corporation salary expense for the fiscal year ending September 30, 2015 is limited to $60,000.

d. The corporation must switch to a calendar year.

e. None of the above.

2. A C corporation is required to annualize its income:

a. The first year the corporation is in existence, if the first tax return includes less than 12 months.

b. The last year the corporation is in existence.

c. The year the corporation changes its tax year.

d. When there has been a greater than 50% change in the ownership of the stock.

e. All of the above.

3. In 2014, Godfrey received a $50,000 sales commission on a long-term contract. But in 2015, the customer filed bankruptcy and Godfrey’s employer was not able to collect from the customer. Under the bonus agreement, Godfrey was required to repay the employer $20,000 of the bonus. Godfrey was in the 35% marginal tax bracket in 2014 but he is in the 25% marginal tax bracket in 2015.

a. Godfrey can amend his 2014 tax return and reduce his taxable income by $20,000.

b. Godfrey should deduct the $20,000 paid in 2015 and thus his tax savings will be $5,000.

c. Godfrey can reduce his 2015 tax liability by 35% × $20,000 = $7,000.

d. Godfrey should not have reported the income in 2014 because of the contingencies.

e. None of the above.

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4. Which of the following taxpayers is required to use the accrual method of accounting?

a. A retail business with average annual gross receipts of $800,000.

b. A medical doctor with average annual gross receipts of $2 million.

c. An insurance agency with average annual gross receipts of $2 million.

d. All of the above are required to use the accrual method.

e. None of the above is required to use the accrual method.

5. Karen, an accrual basis taxpayer, sold goods in December 2014 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 2015. The note bore interest at the Federal rate. The fair market value of the note at the end of 2014 was $18,000. Karen collected $20,500 from the customer in April 2014, $20,000 principal plus $500 interest. Under the accrual method, Karen must recognize income of:

a. $20,500 in 2015.

b. $18,000 in 2014 and $2,500 in 2015.

c. $20,000 in 2014 and $500 in 2015.

d. $20,500 in 2015.

e. None of the above.

6. The accrual method generally is required to report income for which of the following types of businesses:

a. From long-term construction contracts.

b. Earned by an incorporated public accounting firm with gross receipts in excess of $5 million.

c. Earned by a partnership that has a partner that is an S corporation.

d. A grocery store with average annual gross receipts of $800,000.

e. None of the above.

7. Which of the following must use the accrual method of accounting?

I. An incorporated property management company with average annual gross receipts of $50 million.

II. An incorporated law firm with average annual gross receipts of $6 million.

III. An unincorporated grocery store with average annual gross receipts of $1,200,000.

a. All of the above must use the accrual method.

b. None of the above must use the accrual method.

c. Only I and II must use the accrual method.

d. Only I and III must use the accrual method.

e. Only III must use the accrual method.

8. Andrew owns 100% of the stock of Crow’s Farm Inc., an S corporation, that raises cattle and corn. The farm’s annual gross receipts have never exceeded $3 million and the farm is not considered a tax shelter.

a. The farm must report its sales and cost of goods sold by the accrual method because inventories are material to the business.

b. The income from the farm may be reported by the cash method.

c. The income from the sales of cattle may be reported by the cash method, but the income from the sales of corn must be reported by the accrual method.

d. The income from the sales of corn may be reported by the cash method, but the income from cattle sales must be reported by the accrual method.

e. None of the above.

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9. In the case of an accrual basis taxpayer, an item of income:

a. Is not recognized until cash is received.

b. From services is never recognized until the services are performed.

c. Is not recognized if the customer can return the goods.

d. Is recognized when all the events have occurred to fix the taxpayer’s right to receive the income and the amount of the income can be determined with reasonable accuracy.

e. None of the above.

10.Ivory Fast Delivery Company, an accrual basis taxpayer, frequently has claims for damages to property the company delivered. Often the claim is not filed until a month after the delivery. In the past, approximately 80% of the claims are paid by Ivory. In 2014, claims for $80,000 were filed. The company refused to pay $20,000 of the claims (because they were not valid), and paid $50,000. The remaining $10,000 in claims were processed and paid in January 2015. Also, in January 2015, claims for $8,000 were filed for deliveries made in 2014, and $6,000 was paid on these claims by March 15, 2015. Ivory has not elected to use the recurring item exception to economic performance. Under the all-events and economic performance tests, Ivory can accrue as an expense for 2014:

a. $68,000.

b. $66,000.

c. $60,000.

d. $50,000.

e. None of the above.

11.Color, Inc., is an accrual basis taxpayer. In December 2014, the company received from a customer a $500 claim for defective merchandise. Color paid the customer in January 2015. Also, in December 2014, the company received a bill of $800 for office supplies that had been purchased and used in November 2014. The bill was not paid until January 2015. In January 2015, the company received a claim for $600 for defective merchandise purchased in 2014. Color paid the customer the $600 in February 2014. Assuming Color uses the recurring item exception to economic performance, the company’s deductions for 2014 as a result of the above are:

a. $500.

b. $600.

c. $800.

d. $1,300.

e. $1,900.

12.Pink Corporation is an accrual basis taxpayer that uses the recurring item exception to the economic performance test for all relevant years. For 2014, the corporation’s income subject to state income tax was $500,000 and the state corporate tax rate was 6%. During 2014, the corporation paid $24,000 on its estimated state income tax liability for that year. The remaining $6,000 of 2014 state income tax was paid in April 2015. In June 2014, the corporation paid $9,000 on its year 2013 state income tax liability, as a result of an audit of the 2013 return that was conducted in 2014. The company has elected to use the recurring item exception to economic performance. As a result of the above, the corporation should deduct in 2014 on its Federal income tax return state income taxes of:

a. $24,000.

b. $30,000.

c. $33,000.

d. $39,000.

e. None of the above.

13.Which of the following statements regarding the matching principle is correct?

a. Tax accounting strictly follows the matching principle.

b. The matching principle of financial accounting is an important component of the cash method of accounting.

c. The matching principle of financial accounting is sometimes relevant to timing deductions for an accrual basis taxpayer’s recurring items.

d. The matching principle has no relevance to tax accounting.

e. None of the above.

14. Gray Company, a calendar year taxpayer, allows customers to return defective merchandise for a full refund within 30 days of the purchase. In 2014, the company refunded $400,000 for claims involving sales. The $400,000 consisted of $350,000 in refunds from 2014 sales and $50,000 in refunds from 2013 sales. All of the refunds from 2013 sales were for claims filed in 2013 and were paid in January and February 2014. At the end of 2014, the company had $12,000 in refund claims for sales in 2014 for which payment had been approved. These claims were paid in January 2015. Also in January 2014, the company received an additional $30,000 in claims for sales in 2014. This $30,000 was paid by Gray in February 2015. With respect to the above, Gray can deduct:

a. $350,000 in 2014.

b. $362,000 in 2014.

c. $392,000 in 2013.

d. $442,000 in 2014.

e. None of the above.

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15. Generally, deductions for additions to reserves for estimated future costs (e.g., an allowance for estimated warranty costs) are not allowed for Federal income tax purposes because allowing the deduction would:

a. Result in a mismatching of revenues and expenses.

b. Violate established public policy.

c. Violate the economic performance requirement.

d. Violate the tax benefit rule.

e. None of the above.