Exam 18: Accounting Periods and Methods

In 2016, T Corporation changed its tax year from ending each April 30th to ending each December 31st. The corporation earned $60,000 during the period May 1, 2016 through December 31, 2016. The annualized income for the short year is $90,000.

Generally, deductions for additions to reserves for estimated future costs (e.g., an allowance for estimated warranty costs) are not allowed for Federal income tax purposes because allowing the deduction would:

Gold Corporation, Silver Corporation, and Platinum Corporation are equal partners in the GSP Partnership, which was formed on July 1, 2017. Gold and Silver use a calendar tax year, and Platinum's tax year ends June 30th. GSP is not a seasonal business.

The use of the LIFO inventory method for tax purposes:

Franklin Company began business in 2013 and has consistently used the cash method to report income from the sale of inventory in income tax returns filed for 2013 through 2017. As a result of an audit by the IRS, Franklin was required to change to the accrual method of accounting beginning with 2018. The net adjustment due to the change is a positive adjustment to income. The adjustment may be spread equally over 2018 and the three following years.

The LIFO method is beneficial only when prices are rising and the taxpayer is increasing the quantities of inventory items on hand.

The buyer and seller have tentatively agreed to a contract for the sale of a building that the buyer will use in its business. The buyer will pay the seller $100,000 (principal and interest) each year for 5 years. The seller's cost of the asset is $200,000, and he will report the capital gain using the installment method. The buyer and seller are now negotiating the interest rate that will be used to compute the interest included in each $100,000 payment. The relevant Federal rate is 5%, but the market rate on similar contracts is in the area is 7%. a.Why would the seller bargain for a 5% interest rate for the contract rather than a 7% interest rate? b.How does the interest rate affect the buyer's future taxable income?

The company has consistently used the LIFO inventory method and has deferred over $1 million of income from using that method. However, in the last two years, the prices it pays for goods has been decreasing. Therefore, the company is considering changing to the FIFO inventory method. What would be some tax consequences of the change?

The taxpayer had incorrectly been using the cash method of accounting. For 2017, the company voluntarily changed to the accrual method. The adjustment due to the change in method as calculated at the beginning of 2017 was $120,000 (positive). The adjustment as calculated as of the end of 2017 was $80,000 (positive). As a result of the change in method, the company must:

What incentives do the tax accounting rules provide for taxpayers to voluntarily change from an incorrect method of accounting that has reduced the company's tax liability in prior years?

Red Corporation and Green Corporation are equal partners in the R & G Partnership. Red Corporation's tax year ends September 30th, and Green Corporation is a calendar year taxpayer. The greatest aggregate deferral of income would occur if the partnership used a calendar year for tax purposes.

When an accrual basis taxpayer finances the construction of its building by borrowing, the interest is added to the cost of the building.

A C corporation is required to annualize its income:

A manufacturer must capitalize the following costs relative to inventories: I. Maintenance cost for the factory building. II) Health insurance for production workers. III) Storage cost for finished goods.

In the case of a change from the lower-of-cost-or-market FIFO to the LIFO inventory method:

Todd, a CPA, sold land for $300,000 cash on the date of sale plus a note for $500,000 due in one year. The interest rate on the note was equal to the Federal rate. The fair market value of the note was $400,000. Todd's basis in the land was $80,000.

Generally, an advantage to using the cash method of accounting, as compared to the accrual method, is that under the cash method income is not recognized until it is collected, rather than being taxed as soon as the taxpayer has the right to collect the income.

The installment method applies where a payment will be received after the tax year of the sale:

A C corporation that does not have a natural business year must use a calendar year as its tax year.

Gold Corporation sold its 40% of the Ruby Corporation common stock. Gold received $10 million in the year of the sale and a note for $15 million, payable in three years with interest at the Federal rate. Gold's basis in the stock was $5 million. Assume that Gold Corporation will report the gain by the installment method where the method is permitted.