ACCT 4300: Chapter 9- Business Income, Deductions, and Accounting Methods

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.

1. all 2. events 3. amount or value

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

1. cash or cash basis 2. accrual 3. hybrid or mixed

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 __________.

1. constructively 2. paid

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.

1. first 2. last

Income is taxed at the entity level rather than flowing through to the owner(s).

C corporation

Entity files a tax return but the profit or loss flows through to owners' individual income tax returns.

Partnership

Match the business entity with the tax form used to report taxable income.

Schedule C --> Sole proprietorship Form 1065 --> Partnership Form 1120S --> S corporation Form 1120 --> C corporation

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

True The economic performance rule often prevents the use of the 12 month exception to the all events test because the underlying activity must have occurred in order to deduct the expense. There are some exceptions.

Under which of the following conditions may a taxpayer use the cash method to account for inventory? a. Annual gross receipts for the three-year period prior to the current year do not exceed $27 million. b. Primary business activity must be to provide services to customers with sales of products being a secondary source of income. c. Primary business activity must be selling products that were acquired for resale or manufactured by the business. d. Total assets of the business may not exceed $27 million.

a. Annual gross receipts for the three-year period prior to the current year do not exceed $27 million.

Which one of the following terms does the Internal Revenue Code use to describe deductible business expenses? a. Necessary b. Crucial c. Important d. Relevant

a. Necessary

When is a business expense deemed to be reasonable in amount? a. When it is not illegal b. When it is not extravagant c. When it is paid to a person or entity that is not related to the taxpayer

b. When it is not extravagant

For 2022, taxpayers with average annual gross __________ during the prior 3 years of ______ million dollars are not subject to the business interest deduction limitation.

income; 27

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

ordinary

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

reasonable

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 -Accrual method test -Uniform cost capitalization test -Economic performance test

-All-events test -Economic performance test

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.) -The cash method provides a better matching of revenues and expenses. -Bookkeeping is easier. -It is required for C corporations and partnerships with corporate partners unless they meet certain size requirements. -There is more flexibility to time the recognition of income and deductions.

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

Which of the following business expenses are deductible for tax purposes? (Check all that apply.) -Depreciation expense on a building used to store company vehicles -Contributions to the governor's reelection campaign -Advertising cost for ads placed in the local newspaper -Legal fees incurred to defend the business in a lawsuit -Traffic fines incurred by an over-the-road truck driver -Interest expense paid on loans to purchase tax-exempt securities

-Depreciation expense on a building used to store company vehicles -Advertising cost for ads placed in the local newspaper -Legal fees incurred to defend the business in a lawsuit Legal fees are deductible, but fines and penalties are generally not deductible

Which of the following choices constitutes gross income from a business? (Check all that apply.) Multiple select question. -Gross profit from inventory sales -Income from services provided -Income from renting property -Revenue less business expenses

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

Under what circumstances may a cash-method business be allowed to use the cash method to account for inventory? -It is primarily a retail business and average gross receipts for the past three years HAVE exceeded $27 million annually. -It is primarily a service business and average gross receipts for the past three years HAVE exceeded $27 million annually. -It is primarily a retail business and average gross receipts for the past three years have NOT exceeded $27 million annually. -A cash-method business can always use the cash method to account for gross profit. -It is primarily a service business and average gross receipts for the past three years have NOT exceeded $27 million annually.

-It is primarily a retail business and average gross receipts for the past three years have NOT exceeded $27 million annually. -It is primarily a service business and average gross receipts for the past three years have NOT exceeded $27 million annually.

If a company uses a cash method of accounting, which of the following statements will be true? (Check all that apply.) -Prepaying expenses other than interest can result in an immediate tax deduction if the prepayment will be used up within 12 months. -Revenue is recognized when cash is received no matter when the sale actually took place. -Payments received in a noncash form (such as property or services) are NOT included in gross income. -Expenditures for prepaid interest expense are deducted when paid.

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

Which of the following statements are CORRECT when requesting permission to change accounting methods? (Check all that apply.) -The business may have to pay a fee and provide a good business reason for making the change. -The SEC must grant approval for the accounting change. -It is NOT necessary to request permission to change from an impermissible method to a permissible method. -The IRS automatically approves certain types of accounting method changes.

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

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 provide services to another party, the expenses incurred for those services cannot be deducted until the payment is made. incorrect -When a business agrees to pay another party for services, the deduction is taken as the other party provides the services. correct -When a business prepays on a lease or rental agreement, the deduction is taken when the payment is made. incorrect -Certain liabilities, such as rebates, refunds, and workers compensation payments, must be deducted when paid regardless of when the liability arises.

-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 workers 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 the amount of the income can be determined with reasonable accuracy -When the work is over 50 percent completed on a job -When the terms and conditions of a job or project have been negotiated and a contract has been signed -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 -When all events have occurred that determine or fix the business's right to receive the income

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

1. financial 2. tax

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 ___________.

1. income 2. deductions 3. deductions 4. income

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.

1. liability 2. all 3. events 4. year

Taxpayers with substantial gross receipts are generally limited to deducting no more than ____ percent of their adjusted taxable income, plus their business interest income, as a business interest deduction.

30

Due to the personal enjoyment element involved with business meals not purchased from a restaurant, taxpayers may only deduct ____% of the actual cost.

50

T/F: Taxpayers that report average gross receipts of $27 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 These taxpayers can generally treat purchases of goods for sale as either non-incidental materials or use an accounting method that conforms to the taxpayer's financial accounting treatment of inventory.

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

IRS, Commissioner, or Internal Revenue Service

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.

Sole proprietorship

Which of the following statements is correct when describing the accounting methods used for tax versus financial reporting? a. Businesses have an incentive to maximize financial reporting income, but minimize taxable income. b. Taxable income and financial reporting income should equal the same amount. c. All reporting requirements for GAAP are permissible methods of reporting for tax purposes. d. Businesses must use the same accounting method for tax purposes that they use for financial reporting purposes.

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

Which of the following choices is INCORRECT when defining the gross income of a business? a. Gross income for a business may be calculated as sales less returns and discounts. b. Revenues from renting property is included in gross profit for rental businesses. c. Gross income for a service business can be calculated as income from services provided. d. Gross income from a business includes gross profit from inventory sales.

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

Which one of the following terms does the Internal Revenue Code use to describe deductible business expenses? a. Ordinary b. Crucial c. Relevant d. Important

a. Ordinary

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? a. The course or courses qualify Evan for a new trade or business. b. The course or courses meet the requirements necessary to keep his job. c. The course or courses only improve Evan's skills in his existing business.

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

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? a. 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. b. The IRS provides an exception that allows the recognition of the advance payment of services to be deferred to the tax year following the prepayment. c. This rule holds for prepayment of interest or rent. d. For financial accounting, the prepayment is recorded as a liability and not recognized as income until the service is performed.

a. 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? a. The taxpayer can deduct the business portion of the vehicle operating costs, plus depreciation, plus a standard mileage rate based on business miles. b. The taxpayer can deduct the business portion of the actual costs of operating the vehicle plus depreciation. c. The taxpayer can deduct a standard mileage rate based on business miles driven. d. The taxpayer can NOT deduct the costs of commuting from her home to her regular place of business.

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

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

accrual

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

all events

Which of the following accounting methods is NOT acceptable for tax reporting? a. Cash method b. Credit method c. Hybrid method d. Accrual method

b. Credit method

Which of the following statements is INCORRECT when requesting permission to change accounting methods? a. A Form 3115 must be filed with the IRS. b. It is NOT necessary to request permission to change from an impermissible method to a permissible method. c. The IRS automatically approves certain types of accounting method changes. d. The business may have to pay a fee and provide a good business reason for making the change.

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

Which of the following statements is INCORRECT regarding the requirements to meet the economic performance test under the various ways a liability can arise? a. When a business prepays on a lease or rental agreement, the deduction is allocated over the rental period. b. When a business agrees to provide services to another party, the expenses incurred are deducted as the service is provided or costs incurred. c. Certain liabilities, such as rebates, refunds, and workers compensation payments, can be deducted when incurred regardless of when payment is made. d. When a business agrees to pay another party for services, the deduction is taken as the other party provides the services.

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

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? a. Tax court b. Congress c. Internal Revenue Service d. Financial Accounting Standards Board

c. Internal Revenue Service

Which of the following criteria is NOT required for a business expense to be considered ordinary and necessary? a. Appropriate under the circumstances b. Conducive to the business activities c. Repetitive in nature d. Helpful to the business

c. Repetitive in nature

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? a. The equipment should NOT be deducted until the year Allison sells or disposes of it. b. The equipment should be deducted in the year that it is purchased. c. The equipment should be capitalized and depreciated according to the tax code.

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

For accrual-method businesses, bad debt expense is recognized using the ______ method for financial accounting and is deducted using the ______ method for tax purposes. a. allowance; allowance b. direct write-off; direct write-off c. allowance; direct write-off d. direct write-off; allowance

c. allowance; direct write-off

What are the rules concerning reporting periods for tax purposes? a. Businesses must file tax returns reporting income and deductions on a quarterly basis. b. A business tax year can NOT consist of a period less than 12 months. c. Businesses can file tax returns as often as they want, but must report at least once per year. d. Business must report their income and deductions for a full 12 month year, unless special circumstances apply.

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

Which of the following choices is NOT considered deductible transportation expenses? a. The cost of driving to a client's place of business to deliver a final report b. The cost of driving a pizza delivery vehicle to deliver pizzas c. The cost of airfare to attend a business conference in another state d. The cost of driving from home to work

d. The cost of driving from home to work

Which of the following criteria is NOT required for a meal to be considered a tax-deductible business meal? a. The meal must be directly associated with the active conduct of the business. b. The taxpayer or an employee of the taxpayer must be present for the meal. c. The amount must be reasonable under the circumstances. d. The meal must be eaten on the business premises.

d. The meal must be eaten on the business premises.

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? a. tuition and clothing b. none are deductible c. khaki pants and blue shirt d. Tuition for the marketing course e. groceries for his lunches while at work

d. Tuition for the marketing course

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

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