3. Accounting Periods and Methods

Question 1

1. Which of the following date ranges would be considered a fiscal tax year?

A. January 1, 2012 to December 31, 2012.
B. February 15, 2012 to February 15, 2013.
C. July 1, 2012 to June 30, 2013.
D. May 1, 2012 to May 31, 2013.

Answer 1

The answer is C. A fiscal tax year is any tax year that is 12 consecutive months and ends on the last day of any month except December. Answer A is incorrect because this is a calendar year, not a fiscal year. Answer B is incorrect because a fiscal year must end on the last day of the month. Answer D is incorrect because it is more than 12 consecutive months.

Question 2

2. Which of the following date would not be considered the end of an acceptable tax year?

A. January 31.
B. April 15.
C. December 31.
D. The last Friday in February.

Answer 2

The answer is B. April 15 is the IRS due date for individual tax returns, not the end of a tax year. Answer A is incorrect because January 31 is the last day of the month, which qualifies as a fiscal tax year-end. Answer C is incorrect because December 31 is a calendar year-end. Answer D is incorrect because a tax year that ends on the same day of the week every year is 52/53-week tax year, which is a legitimate type of fiscal year.

Question 3

3. What is the definition of the calendar year?

A. A calendar year is always from January 1 to December 31.
B. A calendar year is always a 12-month period ending on the last day of any month.
C. A calendar year can end on any day of the month, so long as the period spans 12 months.
D. A calendar year starts on April 15 and ends on April 15 the following year.

Answer 3

The answer is A. A calendar year is always from January 1 to December 31.

Question 4

4. A business must adopt its first tax year by what date?

A. The due date (including extensions) for filing a return.
B. The due date (not including extensions) for filing a return.
C. The date the EIN is established.
D. The first time the business pays estimated payments.

Answer 4

The answer is B. A business must adopt its first tax year by the due date (not including extensions) for filing a return for that year. A business adopts a tax year when it files its first income tax return.

Question 5

5. Vargas Cellular Corporation was organized on April 1, 2012. It elected the calendar year as its tax year. When is the first tax return due for Vargas Cellular for this short tax year?

A. April 15, 2013.
B. April 15, 2012.
C. March 15, 2013.
D. May 15, 2013.

Answer 5

The answer is C. Since the corporation chose a calendar year, its first tax return is due March 15, 2013. This short period return will cover April 15, 2012 through December 15, 2012. Corporate tax returns are due the fifteenth day of the third month after the end of the corporation’s taxable year.

Question 6

6. Which of the following entities may use the cash method of accounting?

A. A family farming corporation with average gross receipts of $22 million.
B. A C corporation with average gross receipts of $50 million.
C. A tax shelter with $50,000 in average gross receipts.
D. A corporation with long-term contracts and average gross receipts of $900,000.

Answer 6

The answer is A. A family farming corporation may use the cash method of accounting if its average annual gross reciopts are $25 million or less. A tax shelter must always use the accrual method, regardless of its gross receipts. A corporation with long-term contracts must always use the accrual method A C corporation with gross receipts exceeding $5 million is required to use the accrual method.

Question 7

7. Which of the following changes in accounting method does not require prior approval from the IRS?

A. A change from FIFO to LIFO inventory valuation.
B. A change from the cash method to the accrual method.
C. A change in the overall method of figuring depreciation.
D. A correction of a math error in depreciating an asset.

Answer 7

The answer is D. The correction of a math error does not require prior approval from the IRS. Consent from the IRS is not required for the following changes”

• Correction of a math error for computing tax liability or other mathematical error.
• A correction in depreciable life or correction of a depreciation error.
• An adjustment to an asset’s useful life.

Question 8

8. A company can choose to compute taxable income under which of the following methods?

A. Hybrid method.
B. accrual method.
C. Cash method.
D. All of the above.

Answer 8

The answer is D. Unless specifically prohibited by the IRC or income tax regulations, a company can choose to compute its taxable income under any of the listed methods. Any accounting method may be acceptable if it clearly reflects income and is applied consistently from year to year.

Question 9

9. Helen Banner is the owner of Banner’s Custom Lamps, Inc., a calendar year, accrual-basis S corporation. She sells five lamps to Sonny’s Interior Design on December 21, 2012, billing Sonny’s for $2,500. Sonny’s Interior Design pays the invoice on January 15, 2013. Banner’s Custom Lamps would include this income in which tax year?

A. 2012.
B. 2013.
C. 2014.
D. None of the above.

Answer 9

The answer is A. The income would be included in Banner’s 2012 tax return, because Banner is using accrual method of accounting for income and expenses. Under the accrual method, income is reported in the year earned and expenses are deducted in the year incurred. Since Banner sold the lamps in 2012, the income would be reported in 2012, regardless of when payment is actually received.

Question 10

10. Ben owns a jewelry store. All of the following transactions are example of constructive receipt of income in 2012 except?

A. Ben receives a check payment on December 31, 2012, but does not deposit the check in the bank until January 2, 2013.
B. Ben receives a direct deposit of funds to his bank account on December 15, 2012, but does not withdraw any of the funds until March 2013.
C. Ben receives a signed IOU from a delinquent account in November 2012. He receives payment on this account on January 10, 2013.
D. An escrow agent receives a payment on Ben’s behalf that is restricted for his use. It is a advance payment for a custom ring, but he cannot access any of the funds until the ring is delivered and inspected. On December 25, 2012, the ring is delivered and the restriction is lifted. Ben picks up the cash on January 9, 2013.

Answer 10

The answer is C. According to the doctrine of constructive receipt, income is included in gross income when a person has an unqualified right to the funds. Constructive receipt must be more than just a billing, an offer, or a mere promise to pay. The amount promised to Ben as an IOU, therefore, does not have to be included in income for 2012.

Question 11

11. Which of the following entities may not use the cash method of accounting?

A. A partnership that produces inventory for sale to customers and has $1.2 million in average annual gross receipts.
B. A C corporation without inventory that has $4.5 million in average annual gross receipts.
C. A qualified family farming corporation with $24 million in average annual gross receipts.
D. A sole proprietor with inventory and $500,000 in average annual gross receipts.

Answer 11

The answer is A. Generally, an entity cannot use the cash method if it has average annual gross receipts exceeding $5 million. However, if a company has inventory, the threshold for gross receipts is $1 million. A qualified family farming corporation may use the cash method if its average annual gross receipts do not exceed $25 million.

Question 12

12. Ray operates a retail store using the accrual method of accounting and reports income on Schedule C, Net Profit and Loss from Business. He also runs a lawn care service that operates only in the summer months. Which of the following statements is true?

A. The lawn care business is required to use the accrual method of accounting because Ray has already elected this method for his other business, and all businesses operated by one individual must use the same method of accounting.
B. The lawn care business may use either the cash or accrual method of accounting, so long as both businesses have separate and distinct records.
C. Ray may keep one set of records for the two businesses and use different methods of accounting for each one.
D. Ray must combine the income for both businesses and keep one set of record books for both.

Answer 12

The answer is B. A taxpayer may use different methods of accounting for the two distinct and separate businesses. Separate accounting books must be kept for each business.

Question 13

13. The following are all acceptable methods of accounting for inventory except:

A. Specific identification.
B. Coupon method.
C. FIFO.
D. LIFO.

Answer 13

The answer is B. FIFO, LIFO, and specific identification are all acceptable inventory methods. The “coupon method” is not.

Question 14

14. Jenny owns a small side business selling makeup door-to-door. She reports her income and loss on Schedule C. Occasionally, she takes items out of inventory for her own personal use. In 2012, she took $250 worth of makeup for her own use. What is the proper tax treatment of this action?

A. Jenny must reduce the amount of her total inventory purchases by $250.
B. Jenny may take an expense of $250 on Schedule C for the personal use items.
C. Jenny must increase the cost of her purchases by the value of her personal use items.
D. Jenny may deduct the $250 on Schedule A as an employee business expense.

Answer 14

The answer is A. Taxpayers are required to subtract the cost of personal use items from total purchases, if they remove items for personal use from business inventory.

Question 15

15. Under the lower of cost or market method of valuing inventory, what is the value of the inventory as a whole, based on the table below?

Item Cost FMV
Shirts $200 $500
Shoes $300 $200
Shorts $225 $150
Total $725 $850

A. $725.
B. $850.
C. $750.
D. $550.

Answer 15

The answer is D. To value inventory using the “lower of cost or market value” method, compare the cost and the fair market value of each of the items in inventory, and choose the lower of the two to obtain the inventory’s value. The answer is calculated as follows:
(shirts $200 + shoes $200 + shorts $150) = $550 inventory valuation.

Question 16

16. Which of the following activities would make a taxpayer subject to the uniform capitalization rules?

A. A taxpayer produces items as a hobby and occasionally sells them at a profit.
B. A taxpayer produces property for sale to wholesale retailers.
C. A taxpayer acquires raw land and holds it for investment.
D. A taxpayer refurbishes multiple automobiles for his own use.

Answer 16

The answer is B. A taxpayer is subject to the uniform capitalization rules if he produces real property or personal property for use in a trade or business. Producing items for personal use or as a hobby does not qualify.

Question 17

17. Which of the following types of property are not exempt from the uniform capitalization rules?

A. Qualified expenses of a writer, photographer, or performing artist.
B. Timber and the underlying land.
C. Services provided to customers.
D. A corporation that produces audio recordings.

Answer 17

The answer is D. A corporation that produces audio recordings or films would be subject to UNICAP. Generally, the uniform capitalization rules apply to a taxpayer that produces property for use or resale in a business. A company that provides only services would not carry an inventory, so it is not subject to UNICAP. Independent (self-employed) authors, writers, and artist are exempt from the rules.

Question 18

18. All of the following activities are exempt from the uniform capitalization rules except:

A. Resellers of personal property with average annual gross receipts of $25 million.
B. intangible drilling and development costs of oil and gas or geothermal wells.
C. Research and experimental expenditures.
D. Property produced under a long-term contract.

Answer 18

The answer is A. Resellers of personal property with average annual gross receipts of $10 million or less are exempt from UNICAP. A reseller with average annual gross receipts of $25 million would be subject to UNICAP.

Question 19

19. Chris is the owner-shareholder of Chris’s Clothing Company, an S corporation. He manufactures clothing items for resale to the general public and also sells them to wholesale distributors. Chris is trying to figure out his inventory calculations in order to file his 2012 tax return. Which of the following items should be included in his year end inventory?

A. 2,000 t-shirts out on consignment for another retailer to sell.
B. The machinery used to manufacture the clothing.
C. An order of fabric that was in transit, FOB destination (the title had not yet passed to Chris).
D. 1,000 shirts that were shipped COD to a retailer that had not arrived at the buyer’s warehouse.

Answer 19

The answer is A. Chris should include the consigned goods in his own inventory, since goods on consignment are not actually sold to the retailer, and title remains with Chris. Merchandise sent COD is included in inventory until it reaches the buyer, because title does not pass to the buyer until the item is delivered and paid for. Machinery and other fixed assets are not included in inventory. They are depreciated separately.

Question 20

20. All of the following practices are acceptable methods of accounting for inventory except:

A. The taxpayer accounts for inventory and includes only direct costs associated with manufacturing the goods.
B. The taxpayer has a theft loss of inventory when a disgruntled employee steals substantial amounts of merchandise. The taxpayer choose to increase his cost of goods sold to account for the stolen items.
C. The taxpayer values his inventory using the lower of cost or market method, using the lowest value for each item in his inventory valuations.
D. The taxpayer has two businesses, and choose to use LIFO for the first business and FIFO for the second one. He keeps a separate set of books for each business.

Answer 20

The answer is A. Taxpayer must include direct and indirect costs in inventory. Taxpayer may claim a casualty or theft loss of inventory through the increase in the cost of goods sold by properly reporting opening and closing inventories. Taxpayers may choose to use different accounting methods for different businesses, so long as the businesses are kept separate and distinct accounting records are maintained for each.

Question 21

21. Tuxedo House, a clothing retailer, had the following expenses in 2012. Based on the information below, what is Tuxedo House’s cost of goods sold for the year?

Tuxedos purchased for resale: $20,000
Freight in $3,000
Freight out to customers $6,000
Beginning inventory $15,600
Ending inventory $12,000

A. $23,000.
B. $26,600.
C. $28,600.
D. $42,500.

Answer 21

The answer is B. The COGS is $26,600 (15,600 beginning inventory + 20,000 purchases + 3,000 freight in, minus 12,000 ending inventory). Freight in and merchandise purchased for resale are part of the COGS, but freight out is not.

Question 22

22. Thomas is a cash-basis sole proprietor who reports income and loss on Schedule C. He purchases a bulk order of watches for his mail order business. The watches cost $5,000, and the related shipping cost is $350. What is the correct treatment of the shipping cost he paid for delivery of the watches?

A. Thomas may elect to deduct the shipping cost on his tax return as a regular expense.
B. Shipping cost paid on the watches must be added to the basis of the inventory.
C. Thomas cannot deduct the shipping cost and cannot capitalize it.
D. Thomas may elect to deduct the shipping cost as an itemized deduction on Schedule A.

Answer 22

The answer is B. The shipping cost increases the asset’s basis. If the property is merchandise bought for resale (such as inventory), the shipping cost is part of the cost of the merchandise and must be capitalized and later recovered as cost of goods sold when the watches are resold.

Question 23

23. All of the following costs must be included in inventory except:

A. Shipping raw materials to the business’s factory.
B. Shipping finished product orders to customers.
C. Raw materials.
D. Direct labor costs.

Answer 23

The answer is B. Shipping finished product orders to customers is not an expense that should be included in inventory. This cost is a current expense and would be deductible as postage, rather than capitalized as a cost of inventory.