13.4 - Accounting Methods Flashcards
What is a tax year?
- Annual accounting period used to keep a person’s books and records
Tax Year
Provide 2 examples of a tax year
- Calendar year (ending December 31st)
- Fiscal year (any 12-month period ending on the last day of the month)
Tax Year
True or False >>>
a 52 / 53 week tax year must always end on a Friday
False -
- Must always end on the same day of the week
Tax Year
When is the short tax year acceptable?
- Must annualize income
- Year of startup / dissolution
Tax Year
What must an entity do to change their tax year?
- Can change tax year after gaining IRS consent
Tax Year
What type of tax return must an entity file when changing their tax year after gaining IRS consent?
- Short tax year return required
Accounting Method
What is an accounting method?
- Method of accounting regularly used to compute income in keeping books and records
Accounting Method
What are the two types of accounting methods?
- Cash method and accrual method
Accounting Method
Does the change in accounting method require IRS consent?
Yes
Identify 5 accounting changes that can be made without IRS consent
- 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
Cash Method:
When is income accounted for under the cash method?
- Accounts for income when:
- Cash is actually received
- Cash equivalent is actually received
- Cash or equivalent is constructively received
Cash Method:
How is the value of noncash property / services accounted for under the cash method?
- FMV of noncash property / services is included in GI
Cash Method:
Define the proper cash method accounting treatment when the value of property received cannot be determined
- FMV of property given up will be treated as the amount of income to recognize
Doctrine of Constructive Receipt:
Does deferring deposit of a check defer income?
No
Doctrine of Constructive Receipt:
When are items included in GI under the “doctrine of constructive receipt”?
- 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
Doctrine of Economic Benefit
Define gross income according to the doctrine of economic benefit
- GI includes any economic or financial benefit conferred on an employee as compensation
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?
Yes
Accrual Method
Identify the types of entities that are required to use the accrual accounting method
- C Corporations,
- partnerships with a C corporation as a partners, and
- tax shelters
Accrual Method
Identify the exceptions available to corporations who must normally use the accrual method of accounting
- Exceptions:
- Qualified personal service corporations
- Entities with < $5 million in average gross receipts in the 3 preceding years
- Farming or tree-raising businesses
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
True
Accrual Method
What accounting method must an entity use to report income if they use accrual for expenses?
the same accounting method used to report income must also be used to report expenses and vice versa.
Accrual Method
When does the accrual method account for income?
- Accounts for income in the period it is actually earned
Define the “All Events Test”
- 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
Right Not Fixed
What is the right not fixed contingent on?
future events
Right Not Fixed
When must prepaid income be included in income under “right not fixed”?
- Prepaid income must be included in income when received
- For both cash and accrual methods
When are deductions allowed under both the cash and accrual accounting methods?
When the amount can be determined with reasonable accuracy
Inventory
True or False >>>
Gross income includes receipts reduced by COGS for both manufacturing and purchasing entities
True
Inventory
When can LIFO be used for tax purposes?
If it is also used for financial reporting
Long-Term Contracts:
What is a long-term contract?
- Contract completed in a tax year subsequent to the one in which it was entered into
Long-Term Contracts:
What method must be used to account for all long-term contracts?
- Must use the same method to account for all long-term contracts
- Percentage of completion
- Completed contract method
Long-Term Contracts:
What is the completed contract method?
- Receipts accounted for in tax year in which contract is completed
Long-Term Contracts:
When is the completed contract method allowed?
- 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
Long-Term Contracts:
Define the % of completion method for long-term contracts
- Reports as income that portion of the total contract price that represents the % of total work completed in the year
Long-Term Contracts:
What is the formula to calculate the percentage of completion?
(cost for tax year) / (total expected cost)
Installment Method:
When is the installment method required?
- Required for installment sales by both cash-method and accrual method taxpayers
Installment Method:
Do the election exist to not apply the installment method?
Yes
Installment Method:
What is an installment sale?
- Disposition of property in which at least one payment received after year of sale
Installment Method:
Does the installment apply to both losses and gains?
No - only gains
Installment Method:
When are losses recognized under the installment method?
- Loss fully recognized in year realized
Installment Method:
Provide 5 situations where the installment method is not applied
- Generally, not applied to:
- Inventory personal property sales
- Revolving credit sales
- Dealer disposition
- Publicly traded securities
- Sales by manufacturers of tangible personal property
Installment Method:
When must depreciation recapture be recongized under the installment method?
- Depreciation recapture must be recognized in year of sale regardless of payments received
Installment Method:
Identify the 3 step process in calculating installment sale income
- Step # 1: Calculate gross profit:
- Step # 2: Calculate gross profit %
- Step # 3: Calculate current year IS Income
Installment Method:
Calculate gross profit in step # 1 of the 3 step process to calculating installment sale income under the installment method
Contract Price - COGS
Installment Method:
Calcualte gross profit % in step # 2 of the 3-step process to calculating installment sale income under the installment method
Gross Profit / Contract Price
Installment Method:
Calculate installment sale income in step # 3 of the 3-step process of calculating installment sale income under the installment method
Current Year Income * Gross Profit %
Tax Year:
What is the annualized income calculation?
(12 months / short tax year months) * short tax year income
What is the short tax year calculation?
(short tax year months / 12 months) * annualized income tax
