Tax 2-2 Evaluate a situation to select the most appropriate method of tax accounting to use. Flashcards
Accounting Methods
The taxpayer is typically required to use the _____ when the use of another method would result in a distortion of income.
cash method
hybrid method
accrual method
long-term contract
(2-2, pg 87)
accrual method
Accounting Methods
Businesses that have contracts that extend over 12 months or longer or contracts to produce items that are not normally carried in finished goods inventory are permitted to use a _____ method of accounting.
cash method
hybrid method
accrual method
long-term contract
(2-2, pg 87)
long-term contract
Accounting Methods
A business may use the _____ of accounting if a significant portion of its operations involves both inventory and service. Thus, the accrual method would be used for purchases and sales, and the cash method for non-inventory items.
cash method
hybrid method
accrual method
long-term contract
(2-2, pg 87)
hybrid method
Accounting Methods
For each of the following situations, consider whether the cash, accrual, or hybrid accounting method should be used.
Eva Candles operates an exclusive art gallery. She has had average annual sales of $2 million per year. She operates the business as a sole proprietor. Her taxable income from the business in the current year will be approximately $165,000. Select the most appropriate accounting method for Eva to use.
(2-2, pg 88)
Because inventory constitutes a significant part of her business, the accrual method may be used to account for purchases and sales. It does not appear that services are significant, so the hybrid method does not seem appropriate. Eva may not use the cash method of accounting, since she has average annual gross receipts of more than $1 million and her business involves retail trade.
Accounting Methods
For each of the following situations, consider whether the cash, accrual, or hybrid accounting method should be used.
Dom Giovanni operates a restaurant that has net sales of approximately $230,000 per year. He serves lunch and dinner six days a week. He serves alcoholic beverages, but only with meals. He operates the business as a corporation. His costs are broken down as follows: 20% food and beverage, 16% overhead, and 64% labor. Select the most appropriate accounting method for Dom to use.
(2-2, pg 88)
Dom may use the cash method of accounting, since he has average annual gross receipts of $1 million or less. This would likely be the easiest to use. Because inventory and service (labor) constitute a significant portion of the operation, the hybrid method would also be appropriate. The accrual method may also be used.
Accounting Methods
For each of the following situations, consider whether the cash, accrual, or hybrid accounting method should be used.
Gene Prince operates an appliance distributorship for a six-state area. The business is operated as a partnership. The annual sales average $12 million and the average net income of the partnership is $2.75 million. Select the most appropriate accounting method for Gene to use.
(2-2, pg 88)
The accrual method must be used. The average annual gross receipts are too high to qualify for one of the small business exclusions that would allow the use of the cash method of accounting.
Accounting Methods
For each of the following situations, consider whether the cash, accrual, or hybrid accounting method should be used.
Ron Martin is an accountant in private practice. He prepares reports and tax returns, and advises clients on the consequences of various actions. He receives retainers from over 10% of his clients, and he bills the rest of them on a monthly basis. Select the most appropriate accounting method for Ron to use.
(2-2, pg 88)
Because Ron’s business is service oriented, the cash method is appropriate.
Accounting Methods
Identify situations in which a taxpayer is required to use the accrual method of accounting.
2-2
The taxpayer is typically required to use the accrual method when the use of another method would result in a distortion of income. If inventories are necessary to show income accurately, then the accrual method generally must be used to account for purchases and sales. However, there are two exceptions to this rule: (1) any business with average annual gross receipts of $1 million or less for the three prior tax years, or (2) a business with average annual gross receipts of more than $1 million but less than $10 million (whose principal business is not mining, manufacturing, wholesale trade, retail trade, or information industries). These businesses can use the cash method of accounting and can account for inventories in much the same way as materials and supplies. In other words, take a deduction for the inventory actually sold during the year—the cost of goods sold. Note that most C corporations with average gross receipts over $5 million in the three prior years (or the period of its existence, if less) are barred from using the cash method.
Accounting Methods
Identify the types of businesses that are permitted to use a long-term contract method of accounting.
2-2
Businesses that have contracts that extend over 12 months or longer or contracts to produce items that are not normally carried in finished goods inventory are permitted to use these methods.
Accounting Methods
Identify the types of businesses that are permitted to use the hybrid method of accounting.
2-2
A business may use the hybrid method of accounting if a significant portion of its operations involves both inventory and service. Thus, the accrual method would be used for purchases and sales, and the cash method for noninventory items.
Accounting Methods
Eva Candles operates an exclusive art gallery. She has had average annual sales of $2 million per year. She operates the business as a sole proprietor. Her taxable income from the business in the current year will be approximately $165,000. Select the most appropriate accounting method for Eva to use. Justify your selection.
2-2
Because inventory constitutes a significant part of her business, the accrual method may be used to account for purchases and sales. It does not appear that services are significant, so the hybrid method does not seem appropriate. Eva may not use the cash method of accounting, since she has average annual gross receipts of more than $1 million and her business involves retail trade.
Accounting Methods
Dom Giovanni operates a restaurant that has net sales of approximately $230,000 per year. He serves lunch and dinner six days a week. He serves alcoholic beverages, but only with meals. He operates the business as a corporation. His costs are broken down as follows: 20% food and beverage, 16% overhead, and 64% labor. Select the most appropriate accounting method for Dom to use. Justify your selection.
2-2
Dom may use the cash method of accounting, since he has average annual gross receipts of $1 million or less. This would likely be the easiest to use. Because inventory and service (labor) constitute a significant portion of the operation, the hybrid method would also be appropriate. The accrual method may also be used.
Accounting Methods
Gene Prince operates an appliance distributorship for a six-state area. The business is operated as a partnership. The annual sales average $12 million and the average net income of the partnership is $2.75 million. Select the most appropriate accounting method for Gene to use. Justify your selection.
2-2
The accrual method must be used. The average annual gross receipts are too high to qualify for one of the small business exclusions that would allow the use of the cash method of accounting.
Accounting Methods
Ron Martin is an accountant in private practice. He prepares reports and tax returns, and advises clients on the consequences of various actions. He receives retainers from over 10% of his clients, and he bills the rest of them on a monthly basis. Select the most appropriate accounting method for Ron to use. Justify your selection.
2-2
Because Ron’s business is service oriented, the cash method is appropriate.
Accounting Methods
Using the _____ method, the taxpayer compares the amount of tax paid in previous years with the amount of tax that would have been paid had actual costs—not estimates—been used. Interest is computed using the IRS overpayment rate, compounded daily, applied to the overpayment or underpayment amount.
2-2
lookback
The lookback method does not apply to any contract that satisfies both of the following requirements:
- The gross receipts of the contract cannot exceed the lesser of $1 million or 1% of the average annual gross receipts of the taxpayer for the three taxable years preceding the taxable year in which the contract was completed.
- The contract must be completed within two years of the contract commencement date.
