Accounting methods and book differences

Question 1

Unfavorable vs Favorable

Answer 1

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:

Question 2

When tax depreciation > book depreciation, then?

Answer 2

Favorable (because it decreases taxable income), which creates a temporary TAXABLE difference, which results in a DTL.

Question 3

When book depreciation > tax depreciation?

Answer 3

Unfavorable (because it increases taxable income), which creates a temporary DEDUCTIBLE difference, which results in a DTA

Question 4

Permissible methods of accounting

Answer 4

a taxpayer may compute taxable income under any of the following methods of accounting: accrual, cash, and any combination of methods permitted by regulations

Question 5

Limitations of cash method

Answer 5

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

Question 6

companies with inventory must use the blank method

Answer 6

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.

Question 7

Income Tax- General rule

Answer 7

amount of any item of gross income must be included in gross income for the taxable year in which received

Question 8

Cash method- income

Answer 8

income is taxable when actually or constructively (credited to account, or made available) received

Question 9

Cash method- expense

Answer 9

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”

Question 10

12 month rule

Answer 10

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

Question 11

Accrual method - Income

Answer 11

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…..

Question 12

Accrual method- advance payments

Answer 12

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)

Question 13

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.

Answer 13

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

Question 14

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

Answer 14

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.

Question 15

Items that do not apply to the deferral method. They are taxable when received - cash method applies

Answer 15

deferred rent, deferred insurance, and deferred interest

Question 16

Accrual method - Expenses

Answer 16

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

Question 17

Accrual method - Expenses

Answer 17

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

Question 18

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

Answer 18

D

Question 19

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

Answer 19

B

Question 20

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

Answer 20

D

unfavorable is when accrued >

favorable is when tax > book and when something is > accrued

Question 21

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

Answer 21

A

Question 22

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

Answer 22

C

Question 23

tax depreciation > book depreciation

Answer 23

Favorable - Temp. - Taxable - DTL

Question 24

Bad debt Expense > Write-offs

Answer 24

Unfavorable - Temp. - Deductible - DTA

Question 25

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.

Answer 25

Favorable- Temp. Taxable - DTL

Y1 - 0
Y2 - 11,000
Y3- 1,000

Question 26

Warranty Reserves Accrued exceeds Warranty Claims paid

Answer 26

Unfavorable - Temp Deductible - DTA

Question 27

Taxpayer receives dividends eligible for the Dividends Received Deduction

Answer 27

Favorable

because DRD will decrease taxable income

Question 28

ABC Inc. sells investments resulting in a net capital loss

Answer 28

Unfavorable - Temp. Deductible - DTA

Question 29

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.

Answer 29

Unfavorable - Deductible - DTA