Tax Accounting

Question 1

Accounting periods

Answer 1

• tax year : calendar year or fiscal year
• calendar year: 12 months ending Dec 31
• fiscal year : 12 months ending last day of any month besides dec. or 52-53 week tax year
• new taxpayer can adopt calendar or fiscal year for first return

Question 2

Accounting methods

Answer 2

• after assigning tax year
• assign items of income and deductions to method of accounting

Question 3

Cash receipts and disbursements

Answer 3

• cash method of accounting: realize revenue in year payment is received, regardless of when service is performed
• then match expenses against revenue in year expense is paid, regardless of when liability occurred
• most businesses with less than 29 M in average revenue will use this method
• easiest method to maintain

Question 4

Accrual method

Answer 4

• realize revenue when the earnings process with goods or services they provide is complete, regardless of when payment is received
• firms match expenses against revenues in year firm incurs liability, regardless of when its paid
• if averaging over 29 M during past 3 years and have inventory - mandatory

Question 5

Hybrid method

Answer 5

• can use combination of cash, accrual, and specifically permitted methods if combination clearly reflects income and need

Question 6

Change of accounting method

Answer 6

• cannot change method without advance permission from IRS

Question 7

Long term contracts

Answer 7

• any contract for the manufacture, building, installation, or construction of property if not completed in tax year it started
• use percentage of completion method of accounting
  Eg. bridge, highway, skyscraper

Question 8

Installment sales

Answer 8

• when amount realized on sale of property consists of buyers note (debt to pay at future), the seller can use unique method of accounting
• method permits capital gain recognized to be spread over life of the note rather than recognized all in year of sale

Question 9

Installment sale - exceptions

Answer 9

• all payments received are in year of sale
• property is publicly traded securities
• property sold at loss
• property sold to related party who in turn sells property within two years of original purchase date

Question 10

Installment sale - Calculation of gain

Answer 10

• seller determines gain recognized in year of sale and each subsequent year by multiplying cash received each year by gross profit percentage
• percentage = gain realized on sale / total contract price

Question 11

Inventory valuation and flow methods

Answer 11

• FIFO and LIFO
• during rising prices, LIFO is better

FIFO: increases earnings, greater taxes, current cost inventory

LIFO: reduced earnings, deferral of taxes, understated inventory

Question 12

Net operating loss (NOL)

Answer 12

• excess of deductible expenses over gross income generates NOL
• NOL can be used to reduce taxes in future years
• limit to amount used each year but indefinite carryforward. no carrybacks