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Exam 18: Accounting Periods and Methods

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Question 51

Multiple Choice

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The taxpayer had consistently used the cash method of accounting even though inventories were a material income- producing factor to its business and average annual gross receipts in the prior three-year period exceeded $25 million.The taxpayer decided to voluntarily change to the accrual method of accounting.The adjustment to income due to the change was that the correct beginning balances for the year of the change as follows: $600,000 for inventories, $300,000 for accounts receivable, and $120,000 for accounts payable.The adjustment due to the change in accounting method is:

A) A positive adjustment for $1,020,000.
B) A positive adjustment for $900,000.
C) A positive adjustment for $780,000.
D) A positive adjustment for $600,000.
E) None of these.

F) A) and B)
G) A) and C)

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Question 52

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Which of the following statements regarding a 52-53 week tax year is not correct?

A) Some tax years will include more than 366 calendar days.
B) Whether the particular tax year includes 52 weeks or 53 weeks is not elective.
C) The year-end must be the same day of the week in all years.
D) All of these are correct.
E) None of these is correct.

F) A) and B)
G) C) and D)

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Question 53

Multiple Choice

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

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 $23 million, and the farm is not considered a tax shelter.

In 2019, Godfrey received a $50,000 sales commission on a long-term contract.But in 2020, the customer filed for bankruptcy and his 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 2019 but he is in the 24% marginal tax bracket in 2020.

Father sold land to Son for $500,000 in 2019.Father's basis in the land was $100,000.Son paid Father $50,000 and gave Father a note for $450,000 due in 2022.In 2020, Son sold the land for $600,000 cash.The note bore interest at the appropriate Federal rate and both Father and Son held the land as an investment.

In 2019, Cashmere Construction Company, a small business, enters into a contract to build a beach cottage for Martha and Rob for a total price of $500,000.Cashmere estimates the total cost to complete the cottage to be $400,000.In 2019, Cashmere incurred $300,000 of costs on the contract, and in 2020 the contract was completed at a total cost of $425,000.Cashmere is not required to recognize any income from the contract until 2020.

Pink Corporation is an accrual basis taxpayer that uses the recurring item exception to the economic performance test for all relevant years.For 2019, the corporation's income subject to state income tax was $500,000 and the state corporate tax rate was 6%.During 2019, the corporation paid $24,000 on its estimated state income tax liability for that year.The remaining $6,000 of 2019 state income tax was paid in April 2020.In June 2019, the corporation paid $9,000 on its year 2018 state income tax liability as a result of an audit of the 2018 return that was conducted in 2019.The company has elected to use the recurring item exception to economic performance.As a result of these facts, The corporation should deduct in 2019 on its Federal income tax return state income taxes of:

Ted, a cash basis taxpayer, received a $150,000 bonus in 2019 when he was in the 35% marginal tax bracket.In 2020, when Ted was in the 24% marginal tax bracket, it was discovered that the bonus was incorrectly computed, and Ted was required to refund $40,000 to his employer.As a result of the refund, Ted can reduce his 2020 tax liability by $14,000 (.35 × $40,000).

The buyer and seller have tentatively agreed to a contract for the sale of a building that the buyer will use in its business.The buyer will pay the seller $100,000 (principal and interest) each year for five years.The seller's cost of the asset is $200,000, and he will report the capital gain using the installment method.The buyer and seller are now negotiating the interest rate that will be used to compute the interest included in each $100,000 payment.The relevant Federal rate is 5%, but the market rate on similar contracts is in the area is 7%. a.Why would the seller bargain for a 5% interest rate for the contract rather than a 7% interest rate? b.How does the interest rate affect the buyer's future taxable income?