Accounting methods and book differences Flashcards
Unfavorable vs Favorable
Favorable- decrease taxable payable income
Unfavorable - increases taxable payable income.
Temporary DEDUCTIBLE difference: create DTA: Unfavorable to Favorable
Temporary TAXABLE differences: DTL: Favorable to Unfavorable:
When tax depreciation > book depreciation, then?
Favorable (because it decreases taxable income), which creates a temporary TAXABLE difference, which results in a DTL.
When book depreciation > tax depreciation?
Unfavorable (because it increases taxable income), which creates a temporary DEDUCTIBLE difference, which results in a DTA
Permissible methods of accounting
a taxpayer may compute taxable income under any of the following methods of accounting: accrual, cash, and any combination of methods permitted by regulations
Limitations of cash method
Cannot use cash method: C-corp, partnerships with a partner that is a C-corp, or tax shelter
Exceptions/CAN use it: farming, PSC personal service corporations (this includes fields of health, law, engineering owned by employees or former employees), entities with average annual gross receipts not exceeding 30M for the prior 3 years
companies with inventory must use the blank method
accrual method for purchases and sales
Unless taxpayer with average annual gross receipts is less than or equal to 30M. Then, in that case, they are not required to.
Income Tax- General rule
amount of any item of gross income must be included in gross income for the taxable year in which received
Cash method- income
income is taxable when actually or constructively (credited to account, or made available) received
Cash method- expense
deductions are taken into account when cash is paid except when it creates an asset (like prepaid expense). Then, you would capitalize.
prepaid expenses: paid in advance are deductible only in the year to which it applies, unless it qualifies for the “12 month rule”
12 month rule
Taxpayer is not required to capitalize prepaid expenses if:
1) the benefit realized by the taxpayer will be consumed within 12 months
AND
2) the benefit does not extend beyond the taxable year
This rule DOES NOT APPLY to prepaid interest
Accrual method - Income
includable when it meets the “all events test”:
1. all the events have occurred which fix the right to receive such income, and
2. the amount can be determined with reasonable accuracy
amount is includable on the EARLIEST of dates: when earned, payment is due, payment received…..
Accrual method- advance payments
Full inclusion method: include in taxable income in year of receipt
Deferral method: include in taxable income any amounts included in AFS (when earned). All others are included in next year (only up to two years)
On 11/1/20X1, ABC receives an advance payment of $4,800 for 1 year contract to provide 48 one-hour dance lessons. ABC provides 8 lessons in 20X1 and 40 lessons in 20X2. ABC recognizes $800 (8 out of 48 lessons) of the revenue in 20X1 onits financial statement (book) income.
Accrual - recognize $800 In YR 1 and 4,000 in YR2. Income is includable in the year of receipt
Cash method - recognize all $4,800 in YR1 because income is includable when actually or constructively received
ABC receives an advance payment of $9,600 for a 3-year contract to provide 96 one-hour dance lessons. ABC provides 8 lessons in 20X1; 48 lessons in 20X2; 40 lessons in 20X3. For financial statement (book) purposes ABC recognizes:
Book Purposes
8/96 $ 800 in 20X1
48/96 $4,800 in 20X2
40/96 $4,000 in 20X3
Deferral accrual method - Include income earned in YR1, then all other income included in year 2
YR1 - 800
YR2 - 8,800
We are Increasing taxable income (went from 4,800 to 8,800) so this is an unfavorable temporary deductible difference, creating a DTA.
Items that do not apply to the deferral method. They are taxable when received - cash method applies
deferred rent, deferred insurance, and deferred interest
Accrual method - Expenses
deduction takin in the year which:
1) the all events test has been met
2) economic performance has occurred: as property or service is provided to or by taxpayer
Accrual method - Expenses
estimates that fail the “all events test” and are only deductible when written off (bad debt) or when paid/service performed (warranty)
also the 12 month rule applies to accrual method and they may not deduct prepaid interest or rent. Those are required to be capitalized
Which of the following items is not a temporary book-tax basis difference?
a. Warranty reserve accruals
b. Accelerated depreciation
c. IRC §263A capitalized inventory costs
d. State of Florida bond interest
D
Which of the following items is not a permanent book-tax difference?
a. Dividends received deduction
b. U.S. Treasury Bond interest income
c. Political contributions
d. Meals and entertainment
B
Which of the following book-tax differences does not result in a favorable temporary difference in the current period?
a. Tax depreciation in the current period exceeds book depreciation in the current period
b. Bad debt write-offs in the current period exceeding bad debts accrued in the current period
c. Vacation paid in the current period exceeds vacation accrued in the current period
d. Warranty estimates accrued in the current period exceed warranty claims paid in the current period
D
unfavorable is when accrued >
favorable is when tax > book and when something is > accrued
Which of the following book-tax differences results in a taxable temporary difference?
a. Tax depreciation in the current period exceeds book depreciation
b. Bad debt estimates in the current period exceed bad debt write-offs in the
current period
c. Vacation pay accrued in the current period exceeds vacation paid in the
current period
d. Warranty reserves accrued in the current period exceed warranty claims
paid in the current period
A
Which of the following book-tax differences results in creating a deferred tax asset?
a. Municipal bond interest
b. Tax depreciation exceeding book depreciation
c. Bad debt estimates in the current period exceed bad debt write-offs in the current period
d. Gain on the sale of a building in the current period recorded as an
installment sale for tax
C
tax depreciation > book depreciation
Favorable - Temp. - Taxable - DTL
Bad debt Expense > Write-offs
Unfavorable - Temp. - Deductible - DTA
ABC Inc., an accrual method taxpayer, paid $12,000 in November 20X1 for a 12-month insurance policy that begins January 20X2 and ends December 20X2.
Favorable- Temp. Taxable - DTL
Y1 - 0
Y2 - 11,000
Y3- 1,000
Warranty Reserves Accrued exceeds Warranty Claims paid
Unfavorable - Temp Deductible - DTA
Taxpayer receives dividends eligible for the Dividends Received Deduction
Favorable
because DRD will decrease taxable income
ABC Inc. sells investments resulting in a net capital loss
Unfavorable - Temp. Deductible - DTA
ABC Inc., an accrual method taxpayer, received in November 20X1, $10,000 in rent payments from its tenants, including first month of $5,000 for January 20X2 and last month of $5,000 for December 20X2.
Unfavorable - Deductible - DTA
