Tax 2-1 Identify characteristics, advantages and disadvantages of the cash or accrual method of accounting.

Question 1

Question 1 of 30

Which one of the following is not an advantage of the cash basis method of accounting?

a. Income is not reported until it is received.
b. Taxpayers can keep simple records.
c. Taxpayers have more control over each year’s income and expenses.
d. Constructive receipt serves to defer income.

(LO 2-1)

Answer 1

d. Constructive receipt serves to defer income.

Constructive receipt, which serves to accelerate income, is not considered to be an advantage of the cash method of accounting.

Items of income over which the taxpayer has an unrestricted right to receive are considered to be constructively received. For example, the interest on a savings account, although not withdrawn by the taxpayer and actually received, is under the control of the taxpayer and therefore must be included in income for the year in which it was earned.

Question 2

Question 2 of 30

Under which one of the following circumstances may the long-term contract method of accounting be used?

a. The manufacture of an item of inventory, which consistently takes longer than one year to complete.
b. The manufacture of a unique item for which the contract is not completed in the year in which it is entered into.
c. The construction of property for which payments will be received over more than one taxable year.

(LO 2-1)

Answer 2

b. The manufacture of a unique item for which the contract is not completed in the year in which it is entered into.

Manufacturing a unique item for which the contract is not completed within the current year qualifies for the long-term contract method.

Question 3

Question 16 of 30

With respect to services, economic performance occurs when

a. the services are contracted for.
b. the services are provided.
c. the services are paid for.

(LO 2-1, pg 10)

Answer 3

b. the services are provided.

In the case of services, economic performance occurs when the services are actually provided to the taxpayer.

Question 4

Question 17 of 30

Which one of the following is the main advantage of using the accrual basis of accounting?

a. A deduction may be taken for an expense not yet paid.
b. Income is recognized before it is received.
c. Total income recognized is generally less than under the cash method.

(LO 2-1, pg 10)

Answer 4

a. A deduction may be taken for an expense not yet paid.

The accrual basis allows deductions to be taken for expenses that are incurred but not yet paid. Of course, income may be recognized that has not yet been received.

Question 5

Question 18 of 30

Which one of the following is true with respect to accounting methods?

a. Under the cash method, certain items may not be required to be capitalized as under the accrual method.
b. The books and records need not be formally kept as long as the final returns are accurate.
c. The method of accounting must treat items consistently and must clearly reflect the taxpayer’s income for the year.

(LO 2-1)

Answer 5

c. The method of accounting must treat items consistently and must clearly reflect the taxpayer’s income for the year.

One of the requirements for a proper accounting method is that items are treated consistently and clearly reflect income.

Question 6

Question 19 of 30

Which one of the following is a change in accounting method requiring consent from the IRS?

a. a correction of posting errors to the taxpayer’s accounting records
b. a change in the method of valuing ending inventory
c. an adjustment of deduction amounts that were improperly claimed in the previous year

(LO 2-1, pg 15)

Answer 6

b. a change in the method of valuing ending inventory

A change in the method of inventory valuation is an accounting method change requiring IRS consent.

Question 7

Question 25 of 30

Which one of the following is correct regarding the hybrid method of accounting?

a. Purchases and sales are generally accounted for using the accrual method of accounting.
b. The service side of the business typically uses the accrual method of accounting.
c. The inventory side of the business typically will use the cash method of accounting.

(LO 2-1, pg 13)

Answer 7

a. Purchases and sales are generally accounted for using the accrual method of accounting.

Sales of goods and purchases of inventory are generally accounted for under the accrual method when the taxpayer uses a hybrid method of accounting.

Under the hybrid method of accounting, the taxpayer uses the accrual basis method of accounting for sales and purchases and the cash basis method of accounting for all other items of income and expense.

Question 8

3. Which one of the following is considered to be the correction of an error and, thus, does not require consent to change accounting methods from the IRS?
   a. a change in the treatment of any material item of income or expense
   b. a change from the long-term contract method to the accrual method
   c. adjustment of the useful life of a depreciable asset
   d. a change in the method used in valuing inventories

(LO 2-1)

Answer 8

c. adjustment of the useful life of a depreciable asset

An adjustment of the useful life of a depreciable asset is an example of the correction of an error.