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Chapter 16 Accounting Periods And Methods
Discussion Questions
1. LO.1 Would a tax year ending December 31 be appropriate for a Ski lodge? Why or why not?
2. LO.1 Assume that a partnership is profitable and that its tax year ends on December
31 but one of the partners’ tax year ends on September 30. Does the partner enjoy a tax benefit or detriment from the partnership’s use of a December
31 tax year-end? Explain.
3. LO.1 A law practice was incorporated on January 1, 2016, and expects to earn $25,000 per month before deducting the lawyer’s salary. The lawyer owns
100% of the stock. The corporation and the lawyer both use the cash method of accounting. The corporation does not need to retain any of the earnings in the business; thus, the salary of the lawyer (a calendar year taxpayer) will equal the corporation’s net income before salary expense. If the corporation could choose any tax year and pay the lawyer’s salary at the time that would be most tax efficient (but at least once every 12 months), what tax year should the corporation choose? When should the salary be paid each year?
4. LO.1 Fred, a cash basis taxpayer, received a $15,000 bonus from his employer in
2016. The bonus was based on the company’s profits for 2015. In 2017, the company discovered that its 2015 profits were incorrectly computed. As a result,
Fred received an additional $10,000 with respect to 2015 profits. Fred’s marginal tax rate in 2016 was 15%, and it was 35% in 2017. Sue, also a cash basis taxpayer, received a $35,000 bonus in 2017 that was based on 2016 profits. In 2017, the company discovered that it had overstated its profits in 2016. As a result, Sue was required to repay $10,000 of her bonus in 2017. Sue was in the 35% marginal tax bracket in 2016 and in the 15% marginal bracket in 2017. What special tax treatment is available to Fred and Sue as a result of their employer’s errors?
5. LO.2 Under what conditions would the cash method of accounting be advantageous as compared with the accrual basis?
6. LO.2 In December 2016, Nell, Inc., an accrual basis taxpayer, paid $12,000 for insurance premiums for her business for the 2017 calendar year. How much of the premiums can Nell, Inc., deduct in 2016?
7. LO.2 In 2015, the taxpayer became ineligible to use the cash method of accounting.
At the beginning of the year, accounts receivable totaled $240,000, accounts payable for merchandise totaled $80,000, and the inventory on hand totaled $320,000. What is the amount of the adjustment due to the change in accounting method?
8. LO.2 Compare the cash and accrual methods of accounting for the following events:
a. Purchased new equipment, paying $50,000 cash and giving a note payable for $30,000 due next year.
b. Paid $3,600 for a three-year service contract on the new equipment.
c. Collected $1,800 for services to be provided over the current and following years.
d. Received a $3,000 note from a customer for services provided in the current year. The market value of the note was only $2,400.
9. LO.2 Edgar uses the cash method to report the income from his software consulting business. A large publicly held corporation has offered to invest in Edgar’s business as a limited partner. What tax accounting complications would be created if Edgar and the corporation became partners?
10. LO.2 Samantha, an accrual basis taxpayer, subscribes to a service that updates a database used in her business. In December 2016, Samantha paid the $120,000 subscription for the period January 2016 through December 2017. What is
Samantha’s deduction for 2016?
11. LO.2 Emerald Motors is an automobile dealer. The controller consults with you about the type of accounting used for a special offer to its new car customers.
Emerald has offered to provide at no charge to the customer the first four recommended service visits (i.e., at 3,000, 6,000, 9,000, and 12,000 miles). It is a virtual certainty that all customers will exercise their rights to the service, and the cost of the services can be accurately estimated. The controller reasons that the estimated cost should be accrued when the sale of an automobile is made so that all of the costs of the sale can be matched with the revenue. How would you respond to the controller?
12. LO.4, 6 Irene has made Sara an offer on the purchase of a capital asset. Irene will pay (1) $200,000 cash or (2) $50,000 cash and a 6% installment note for $150,000 guaranteed by City Bank of New York. If Sara sells for $200,000 cash, she will invest the after-tax proceeds in certificates of deposit yielding 6% interest. Sara’s cost of the asset is $25,000. Why would Sara prefer the installment sale?
13. LO.4 Arnold gave land to his son, Bruce. Arnold’s basis in the land was $100,000, and its fair market value at the date of the gift was $150,000. Bruce borrowed $130,000 from a bank that he used to improve the property. He sold the property to
Della for $360,000. Della paid Bruce $90,000 in cash, assumed his $120,000 mortgage, and agreed to pay $150,000 in two years. Bruce’s selling expenses were $10,000. Della is going to pay adequate interest. What is Bruce’s installment sale gain in the year of sale?
14. LO.4, 6 On June 1, 2014, Father sold land to Son for $300,000. Father reported the gain by the installment method, with the gain to be spread over five years.
In May 2016, Son received an offer of $400,000 for the land, to be paid over three years. What would be the tax consequences of Son’s sale? How could the tax consequences be improved?
15. LO.4, 6 In December 2016, Carl Corporation sold land it held as an investment.
The corporation received $50,000 in 2016 and a note payable (with adequate interest) for $150,000 to be paid in 2018. Carl Corporation’s cost of the land was $80,000. The corporation has a $90,000 net capital loss carryover that will expire in 2016. Should Carl Corporation report the sale in 2016 or use the installment method to report the income as payments are received?
16. LO.2, 5 What are the similarities between the crop method used for farming and the completed contract method used for long-term construction?
17. LO.5 The Hawk Corporation builds yachts. The vessels it currently produces are practically identical and are completed in approximately 8 months. A customer has approached Hawk about constructing a larger yacht that would take approximately 15 months to complete. What are the tax implications of accepting the contract proposal?