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Exam 16: Accounting Periods and Methods

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Question 51

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In 2018, Godfrey received a $50,000 sales commission on a long-term contract. But in 2019, 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 2018 but he is in the 24% marginal tax bracket in 2019.

A) Godfrey can amend his 2018 tax return and reduce his taxable income by $20,000.
B) Godfrey should deduct the $20,000 paid in 2019 and thus his tax savings will be $4,800.
C) Godfrey can reduce his 2019 tax liability by 35% × $20,000 = $7,000.
D) Godfrey should not have reported the income in 2018 because of the contingencies.
E) None of the above.

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

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Question 52

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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 5 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?

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a. The total payments the seller will re...

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Question 53

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The taxpayer has consistently, but incorrectly, used an allowance for bad debts. At the beginning of the year, the balance in the allowance account is $90,000.

Under the percentage of completion method, if the actual costs are the estimated costs, the taxpayer must pay interest on the underpayment of prior years' taxes.

Color, Inc., is an accrual basis taxpayer. In December 2018, the company received from a customer a $500 claim for defective merchandise. Color paid the customer in January 2019. Also, in December 2018, the company received a bill of $800 for office supplies that had been purchased and used in November 2018. The bill was not paid until January 2019. In January 2019, the company received a claim for $600 for defective merchandise purchased in 2018. Color paid the customer the $600 in February 2018. Assuming Color uses the recurring item exception to economic performance, the company's deductions for 2018 as a result of the above are:

Sandstone, Inc., has consistently included some factory overhead as a current expense, rather than as a cost of producing goods. As a result, the beginning inventory for 2018 is understated by $10,000. If Sandstone voluntarily changes accounting methods effective January 1, 2018, the positive adjustment to the inventory is a § 481 adjustment and $2,500 must be added to taxable income for each year 2018, 2019, 2020, and 2021.

Generally, an advantage to using the cash method of accounting, as compared to the accrual method, is that under the cash method income is not recognized until it is collected, rather than being taxed as soon as the taxpayer has the right to collect the income.

The tax year of one of the principal partners may determine the partnership's tax year.