Tax 503 Chapter 9

The allowance method of recognizing bad debt expense is used for ____ reporting, while the direct write-off method is used for ___ reporting.

financial tax

The allowance method of recognizing bad debt expense is used for _____ reporting, while the direct write-off method is used for ______ reporting.

financial , tax

A business may have a tax year that is shorter than a full 12 months during its ____ year in business or its ___ year in business.

first, last

Alex purchased a personal lawn mower to use for mowing his lawn and the lawns at his rental properties. The depreciation expense for the mower was $300. At the end of the season, he documents that he used the mower 70% for his rental properties and 30% for personal purposes. How much can he deduct as a business expense?

The business portion is deductible ($300 x .70 = $210). $210

Which of the following criteria is NOT required for a business expense to be considered ordinary and necessary?

Repetitive in nature

On December 1 of the current year, Jonathon pays $2,400 for a 12-month advertising contract that begins immediately. Jonathon uses the cash method of accounting for his business. How much will he be able to deduct in the current year?

2400

The ______ -method of tax reporting provides a better matching of revenues and expenses.

Accrual

Which of the following statements is INCORRECT regarding the requirements to meet the economic performance test under the various ways a liability can arise?

Certain liabilities, such as rebates, refunds, and workers compensation payments, can be deducted when incurred regardless of when payment is made.

Larger businesses that generate a material portion of their income by selling products they acquire for resale or products they manufacture generally must account for gross profit using the_____ method, regardless of the method used for tax reporting.

accrual

The tax laws do not allow a(n) ____ -method business to deduct accrued expenses for a liability owed to a related party using the ____ -method until the related party recognizes the related income from the transaction.

accrual cash

In order to meet the _____ ____ test for deducting an expense, everything necessary to establish the liability giving rise to the deduction must have occurred, and the business must be able to determine the___ of the liability with reasonable accuracy.

*all-events *amount

The ____ ____ test specifies that businesses may NOT recognize a deduction for an expense until the underlying activity generating the associated liability has occurred.

*economic performance

Which of the following business expenses are deductible for tax purposes? (Check all that apply.)

- Advertising cost for ads placed in the local newspaper - Depreciation expense on a building used to store company vehicles - Legal fees incurred to defend the business in a lawsuit

Which of the following choices are advantages to the taxpayer of choosing the cash-method of tax reporting rather than the accrual-method? (Check all that apply.)

- Bookkeeping is easier. - There is more flexibility to time the recognition of income and deductions.

Which of the following business expenses are disallowed or limited for tax purposes? (Check all that apply.)

- Entertainment expense - Lobbying expenses - Bribes and kickbacks - Political contributions - Interest expense paid on loans to purchase tax-exempt securities

Under what circumstances may a cash-method business be allowed to use the cash method to account for gross profit (select all that apply)?

- It is primarily a retail business and average gross receipts for the past three years have NOT exceeded $26 million annually. - It is primarily a service business and average gross receipts for the past three years have NOT exceeded $26 million annually.

Lesa drives her car approximately 18,000 miles per year. During the most recent year, she drove 7,000 miles commuting to and from work, 4,500 miles for business-related conferences and client visits, and 6,500 miles for personal trips. How many miles are considered business miles and can be used to determine the tax deduction for transportation expenses?

4,500

What are the rules concerning reporting periods for tax purposes?

Business must report their income and deductions for a full 12 month year, unless special circumstances apply.

Which of the following statements is correct when describing the accounting methods used for tax versus financial reporting?

Businesses have an incentive to maximize financial reporting income, but minimize taxable income.

Which of the following criteria is NOT required for a meal to be considered a tax-deductible business meal?

The meal must be eaten on the business premises.

How does the accrual method for tax reporting differ from the accrual method for financial reporting?

The reporting rules tend to be structured to recognize income earlier for tax purposes than financial accounting.

How does the accrual method for tax reporting differ from the accrual method for financial reporting?

The reporting rules tend to be structured to recognize less accrued expenses for tax purposes than for financial accounting purposes.

In reporting financial statement income, businesses have incentives to select accounting methods that accelerate ____ and defer_____ . In reporting taxable income, businesses have incentives to select accounting methods that accelerate _____ and defer ____

accelerate income and defer deductions. defer income and accelerate deductions.

In addition to the all-events test, an accrual-basis business must meet a(n) _____ _____ test with respect to a liability before the corresponding expense can be deducted for tax purposes.

economic performance

When an accrual-method business receives an advance payment for goods it will provide to customers in the future, the business may account for the prepayment under the____ - ____ method or the ____ method.

full-inclusion, deferral method

Montgomery & Company are accounting for their bad debts. The company uses the accrual method of accounting. During the current year, M&C has $42,000 in accounts receivable. The estimated bad debts for the period is $2,000 using the allowance method of accounting for uncollectible accounts. The amount of accounts actually written off during the period is $1,700. What is the amount of bad debt expense that can be deducted for tax purposes?

$1,700 - M&C must use the direct write-off method for tax purposes.

Which of the following choices constitutes gross income from a business? (Check all that apply.)

- Income from renting property - Gross profit from inventory sales - Income from services provided

Which of the following statements are correct regarding the requirements to meet the economic performance test under the various ways a liability can arise? (Check all that apply.)

- When a business agrees to pay another party for services, the deduction is taken as the other party provides the services. - Certain liabilities, such as rebates, refunds, and worker's compensation payments, must be deducted when paid regardless of when the liability arises.

What two events must have occurred to meet the all-events test? (Check all that apply.)

- When all events have occurred that determine or fix the business's right to receive the income - When the amount of the income can be determined with reasonable accuracy

Which of the following statements are CORRECT when requesting permission to change accounting methods? (Check all that apply.)

- the IRS automatically approves certain type of accounting method changes - the business may have to pay a fee and provide a good business reason for making the change

If a company uses a cash method of accounting, which of the following statements will be true? (Check all that apply.)

-Paying expenses other than interest can result in an immediate tax deduction if the prepayment will be used up to 12 months - Revenue is recognized when cash is received no matter when the sale actually took place.

On December 1 of the current year, Rhianna pays $2,400 for a 12-month advertising contract that will begin on March 1 of next year. Rhianna uses the cash method of accounting for her business. How much will Rhianna be able to deduct in the current year?

0

Which of the following statements is correct regarding the recognition of the cumulative difference in taxable income due to a change in accounting method?

1. if the adjustment decreases taxable income, it is recognized-in its entirety in the year of the change. 2. if the adjustment increases taxable income , it is recognized over 4 years by adding 25% of the increase each year

Leonard's Lofts rents townhouses to tenants. When a tenant moves in, they are required to pay the first month's rent of $525 and prepay the last month's rent of $525. In addition, the tenant must pay a refundable security deposit of $600. Leonard's Lofts uses the accrual method for tax reporting. Upon receipt of the $1,650, Leonard's initial Lofts must recognize $____ in rental revenue.

1050, since the security deposit is refundable it is not considered income.

When is a business deemed to have adopted an impermissible accounting method?

After it has used the method for two consecutive years

Which of the following conditions must be met for a cash-method business to possibly be able to use the cash method to account for gross profit?

Annual gross receipts for the three-year period prior to the current year do not exceed $26 million.

Which of the following expenses is NOT included with deductible business travel expenses?

Charlie paid $50 to attend a play during his 3-day business trip.

Which of the following accounting methods are NOT acceptable for tax reporting?

Credit method

An accrual-method business receiving an advance payment for goods that it will provide to customers in the future must account for the prepayment for tax purposes under the deferral method, meaning that the income recognition is deferred until the period the goods are delivered.

False

Which of the following choices is INCORRECT when defining the gross income of a business?

Gross income for a business may be calculated as sales less returns and discounts.

When a business wants to change an accounting method for tax reporting, such as the cost-flow method used for inventory, what body must give permission for the change?

Internal Revenue Service

Josh and Michael are related for tax purposes. Josh is self-employed and has an accrual-basis sole proprietorship. Michael is a cash-method taxpayer. Josh hired Michael to help him complete a construction project. At the end of the year, Josh owed Michael $700 for work performed during December. Josh paid Michael the $700 on January 2. When will Josh be able to deduct the wage expense and when will Michael have to include the $700 in gross income?

Josh must wait to deduct the expense until Michael includes it in gross income. Michael will include the $700 in the year he receives it.

Which one of the following terms does the Internal Revenue Code use to describe deductible business expenses?

Ordinary

Match the business entity with the tax form used to report taxable income. Schedule C Form 1065 Form 1120S Form 1120

Sole Proprietorship Partnership S Corporation C Corporation

Evan incurred education-related expenditures related to his self-employment job. Under which of the following circumstances will Evan NOT be allowed to deduct these expenditures as a BUSINESS expense?

The course or courses qualify Evan for a new trade or business.

Which one of the following statements is correct regarding an asset that is used for both business and personal purposes?

The deductible business expense is determined by prorating the expenses based on the percentage of time it is used for business.

Allison purchased equipment that cost $100,000 for use in her business. She expects the equipment to be useful for the business for the next 8 years. Which of the following choices correctly describes the tax treatment of the cost of the equipment?

The equipment should be capitalized and depreciated according to the tax code.

When a business asset is completely destroyed due to a casualty, what is the amount of the deductible loss?

The insurance proceeds minus the adjusted basis (if the basis exceeds the proceeds)

The all-events test generally requires businesses receiving advance payments for services to recognize the income when they receive the payment, rather than when they perform the service. Which of the following statements is INCORRECT regarding this rule?

The tax authorities give the business the option to report the income in the current year or defer it to the period in which the revenue is earned.

Which of the following choices is NOT correct regarding deductible transportation expenses for a taxpayer using her personal vehicle for business purposes?

The taxpayer can deduct the business portion of the vehicle operating costs, plus depreciation, plus a standard mileage rate based on business miles.

In order to deduct travel expenses (as opposed to transportation expenses), the taxpayer must be away from home on a trip of sufficient duration to require sleep or rest.

True

Which of the following statements is INCORRECT concerning the uniform cost capitalization (UNICAP) rules?

Under the UNICAP rules, only costs incurred inside the production facility are allocated to inventory.

In order to defer deductions for manufacturing costs until the finished products are sold, Congress enacted rules specifying that the cost of raw materials, shipping costs, and any other indirect costs of manufacturing must be added to the cost of inventory. What are these rules called?

Uniform cost capitalization rules

For tax purposes, when a business wants to adopt a new accounting method, it must get permission from the _____

irs

A business is deemed to have adopted a permissible accounting method if it has used the method for ___ year(s). It is deemed to have adopted an impermissible accounting method if it has used the method for ___ consecutive years.

one two

The term ___ is used to describe an expense that is normal or appropriate for the business under the circumstances.

ordinary

Sonny incurred the following expenses last month in his self-employment business: Khaki pants and a blue button-down shirt to wear to work; tuition for a course in marketing to improve his current job skills as a fashion designer; and groceries so that he could take his lunch to work. Which of these expenses is/are deductible business expenses?

tuition for the marketing course

In addition to finished goods, under the ____ ____ _____ rules, inventory costs include the purchase price of any raw materials, shipping costs, and any indirect costs the business allocates to inventory.

uniform cost capitalization

For financial reporting purposes, an advance payment for services is NOT recorded as a ____ revenue, but rather recorded as a(n) . It will be recognized as a revenue when it is earned. For tax reporting purposes, an advance payment is taxed immediately because the payment meets the ____ - _____ test. However, there is an exception which allows the prepaid income to be recognized in the _____ following the receipt if certain conditions are met.

liability, all events, year

All ____ and _____ expenses that are reasonable in amount and incurred in carrying on a trade or business are deductible for tax purposes.

ordinary, necessary

____ casualty losses in a presidentially declared disaster area are generally deductible from AGI as itemized deductions, and ____ casualty losses are deductible for AGI.

personal, business

Ordinary and necessary business expenses are deductible only to the extent they are ____ in amount.

reasonable

Despite the use of the accrual method, prepaid ____ and prepaid ____ are taxed immediately upon receipt.

rent, interest

Which of the following statements are correct regarding inventory capitalization rules? (Check all that apply.)

* Under UNICAP, businesses generally capitalize the inventory costs in one. * UNICAP rules require businesses to capitalize more costs to inventory for tax purposes than they do for financial reporting. * Under UNICAP rules, businesses capitalize in inventory a portion of the compensation paid to employees in production supporting departments.

Which of the following methods are the primary inventory cost-flow methods used for tax purposes? (Check all that apply.)

*First in first out (FIFO) *Last in first out (LIFO) *Specific identification method

Due to the personal enjoyment element involved with meals, taxpayers may only deduct _____% of the actual cost.

50

Businesses are generally not allowed to deduct losses incurred with the sale or disposal of business assets. These losses must be used to offset any gains produced by the sale of other business assets or carried forward to offset future gains.

False

Taxpayers that report average gross receipts of $26 million or less for the three-tax year period ending with the prior tax year must use the accrual method to account for inventory even if they are a cash method taxpayer.

False

Which of the following statements is INCORRECT when requesting permission to change accounting methods?

It is NOT necessary to request permission to change from an impermissible method to a permissible method.

Sydney operates a small business. She sold some equipment used in her business for $7,500. The equipment had an adjusted basis of $8,000. How will this transaction impact Sydney's tax liability?

Sydney will report a deductible loss of $500.

The economic performance test generally requires that underlying activity generating the liability has occurred in order for the associated expense to be deductible.

True

Under the all-events test, in addition to specifying that all events to establish the liability must have occurred, the test also provides that the business must be able to determine the amount of the liability with reasonable accuracy.

True

Which of the following methods is NOT a primary inventory cost-flow method used for tax purposes?

Weighted average cost

Match the entity with the statement that describes the tax treatment of that entity. Sole proprietorship Partnership C corporation

a.) Revenues and expenses are reported directly on the owner's tax return, and the profit (or loss) is subject to both individual income and self employment taxes b.) Entity reports income on tax forms separate tax (information) forms, but the profit or loss flows through to owners' individual income tax returns c.) Income is taxed at the entity level rather than flow through to the owners

Larger businesses that generate a material portion of their income by selling products they acquire for resale or products they manufacture generally must account for gross profit using the ____ method, regardless of the method used for tax reporting.

accrual

Business bad debts can only be deducted when the business uses the ______ method of accounting for tax purposes. Only debts determined to be uncollectible under the ____ ____ - _____ method are able to be deducted for tax purposes.

accrual direct write off

Which of the following choices are tests that need to be met in order to deduct an expense under the accrual method? (Check all that apply.)

all events test, economic performance test

Businesses using the accrual method of accounting generally recognize income when they meet the _____ - _____ test.

all-events

For accrual-method businesses, bad debt expense is recognized using the ______ method for financial accounting and is deducted using the ______ method for tax purposes.

allowance; direct write-off

The accounting methods that can be chosen for tax reporting include the _____ method, the _____ method, and the ____ method.

cash, accrual, hybrid

Although there are exceptions, a taxpayer or business using the cash method of accounting recognizes revenue when property or services are actually____ or received and recognizes deductions when the expense is _____.

constructively, paid

In the year that a business changes its accounting method, it must make an adjustment to taxable income that represents the ____ difference for the amount that would have been taxed or deducted in prior years. If the adjustment increases taxable income, the taxpayer includes ____ % of the addition in the current year. If the adjustment decreases taxable income, the taxpayer includes ____ % of the deduction in the current year.

cumulative, 25%, 100%

When is a business expense deemed to be reasonable in amount?

When it is not extravagant