Accounting Methods, Inventory Valuations, Depreciation, Section 179 Flashcards
Specific identification
Can only be used when the firm is able to differentiate inventory by purchase lot. The major advantage is that both inventory valuation and the amount charged to cost of good sold are accurate.
Cash method
Recognizes expenses when they are actually paid and revenue when they are actually or constructively received. Tax return is always cash basis.
In a rising price environment will profit be higher under FIFO or LIFO
FIFO
In a falling price environment will profit be higher under FIFO or LIFO
LIFO
Accrual method; revenue
Revenue is recognized when the right to receive it exist (for example accounts receivable) not when the payment is received
Accrual method; expenses
Recognized when liability can be established not when payment is made
Three prong test for expenses under accrual method
- Determine liability exists - contingent expenses, not allowed.
- Amount estimated with reasonable accuracy.
- Economic performance (work done.)
Two prong test for revenue under accrual method
- Right to receive income is established and not contingent upon a future event.
- Amount can be estimated with reasonable accuracy.
Constructive receipt
Occurs when funds are available without restriction
When must accrual method be used?
Corporations must use use the accrual method if average annual gross receipts for the three taxable years ending with the prior taxable year exceeds 30 million and when inventory is necessary to account for income, then accrual method must be used for purchases and sales.
When must accrual method be used?
Corporations must use use the accrual method if average annual gross receipts for the three taxable years enfing with the prior taxable year exceeds 30 million and when inventory is necessary to account for income, then accrual method must be used for purchases and sales.
Hybrid method
Taxpayer would prefer to use the cash method, but have inventory as a component of their business. Accrual method will be used for inventory business and sales of inventory, cash method may still be used for service portion of business
What requirements must property meet to be depreciable?
- It must be property owned by the taxpayer
- It must be used in business or income producing activity
- It must have a determinable useful life.
- It must be expected to last more than one year
Useful life for common depreciable assets
- Auto 5 years
- Computer 5 years
- Heavy machinery 7 years
- Office furniture 7 years
- Residential real estate 27.5 years
- Non-residential real estate 39 years
When does depreciation start and stop?
Depreciation starts when the property is placed in service for use in trade or business or to produce income. Depreciation stops when the cost has been fully recovered or when it’s retired from service, which ever happens first.
Accelerated depreciation
Enables taxpayer to have more depreciation in the early years and less at the end of the assets useful life. This increases cash flow. MACRS stands for modified accelerated cost recovery system.
Straight line depreciation
Purchase price of an asset - salvage value / by useful life of an asset
Half or midyear convention
Only half of the full amount of the depreciation can be taken in the yea the asset was put into service. Another half is taken in the last year.
Section 179 overview
Allows businesses to deduct the full cost of qualifying capital assets immediately. The deduction limit is up to 1.2 million of the acquisition cost, which can be deducted as an ordinary expense in the year of purchase.
Non-qualifying property for section 179
- Real property: land, buildings, and land improvements
- Air-conditioning and heating
- Property used outside the US
- Property used to furnish lodging
- Property acquired by gift or inheritance - Property purchased from related parties
Qualifying property for section 179
- Equipment purchase for business use
- Tangible personal property used in business
- Computers and off the shelf software
- Office furniture and equipment
- Certain business vehicles
Section 179 phase out limit
The 1.2 million max deduction is reduced dollar dollar if capital spending exceeds 3.05 million
Limitations on section 179 deduction
Limited to the firms net profit excluding 179 expense, any excess 179 expense can be carried over to the next year’s taxes
Section 179 in sole prop
A sole proprietor can aggregate net business profit with unrelated W-2 wages for the purpose of calculating 179 expense deduction
In a liquidation of a C Corp the event is taxable to
The corporation and the shareholders
In a liquidation of a C Corp. the event is taxable to
The corporation and the shareholders
In liquidation of an S Corp. the event is taxable to
The shareholders as S corpse are pass-through entities
LLC members and self-employment tax
Members of an LLC are subject to the self-employment tax if the LLC is taxed as a partnership and the members are actively involved in the business. If the LLC elects to be tax as an a corporation members may not be subject to self-employment tax on distributions, but they would still owe payroll taxes on wages received as employees. This does not apply to passive members who are only investors.
