ACNT 1373

Chapter 1

If a company uses a cash method of accounting, which of the following statements will be true?
(Check all that apply.)
Prepaying expenses other than interest can result in an immediate tax deduction if the
prepayment will be used up within 12 months.
Revenue is recognized when cash is received no matter when the sale actually took place.

On December 1 of the current year, Rhianna pays $2,400 for a 12-month advertising contract
that will begin on March 1 of next year. Rhianna uses the cash method of accounting for her
business. How much will Rhianna be able to deduct in the current year?
 $0 Reason: Since the contract extends beyond the end of the following year and the
effective date doesn't start until March, she can't deduct anything in the current year.

Under what circumstances may a cash-method business be allowed to use the cash method to
account for inventory? (Check all that apply.)
 It is primarily a retail business and average gross receipts for the past three years have
NOT exceeded the statutory limitation adjusted for inflation, $29 million in 2023.
 It is primarily a service business and average annual gross receipts for the past three years
have NOT exceeded the statutory limitation adjusted for inflation, $29 million in 2023.

What two events must have occurred to meet the all-events test? (Check all that apply.)
 When the amount of the income can be determined with reasonable accuracy
 When all events have occurred that determine or fix the business's right to receive the
income

The all-events test generally requires businesses receiving advance payments for services to
recognize the income when they receive the payment, rather than when they perform the service.
Which of the following statements is INCORRECT regarding this rule?
 The tax authorities give the business the option to report the income in the current year or
defer it to the period in which the revenue is earned.

Danielle's Diamonds is a jewelry store that is owned and operated as a sole proprietorship by
Danielle Dawkins that averages $40 million in gross receipts. Danielle uses the cash method of
accounting for tax reporting. Which of the following statements is correct for Danielle's
business?
 Danielle must use the accrual method for reporting gross profit even though she uses the
cash method of accounting for everything else. Reason: Businesses who generate income
by selling products as a material income-producing factor must use the accrual method
for reporting gross income.

Although there are exceptions, a taxpayer or business using the cash method of accounting
recognizes revenue when property or services are actually or Constructively received and
recognizes deductions when the expense is paid.
ACNT 1373
Chapter 1

Which of the following statements is INCORRECT concerning the uniform cost capitalization
(UNICAP) rules?
 Under the UNICAP rules, only costs incurred inside the production facility are allocated
to inventory. Reason: Under GAAP, businesses generally include in inventory only those
costs incurred within their production facility, while the UNICAP rules require
businesses to allocate to inventory the costs they incur inside the production facility and
the costs they incur outside the facility to support production activities.

Under which of the following conditions may a taxpayer use the cash method to account for
inventory?
 Annual gross receipts for the three-year period prior to the current year do not exceed the
statutory limitation $29 million for 2023.

Businesses using the accrual method of accounting generally recognize income when they meet
the All events test.

In order to meet the All test for deducting an expense, everything necessary to establish the
liability giving rise to the deduction must have occurred, and the business must be able to
determine the amount of the liability with reasonable accuracy.

For financial reporting purposes, an advance payment for services is NOT recorded as a revenue,
but rather recorded as a(n) Liability. It will be recognized as a revenue when it is earned. For tax
reporting purposes, an advance payment is taxed immediately because the payment meets the all-
events test. However, there is an exception which allows the prepaid income to be recognized in
the Year following the receipt if certain conditions are met.

Larger businesses that generate a material portion of their income by selling products they
acquire for resale or products they manufacture generally must account for gross profit using the
Accrual method, regardless of the method used for tax reporting.

Which of the following choices are tests that need to be met in order to deduct an expense under
the accrual method? (Check all that apply.)
 All-events test
 Economic performance test

In addition to finished goods, under the Uniform Cost Capitalization rules, inventory costs include
the purchase price of any raw materials, shipping costs, and any indirect costs the business
allocates to inventory.

True or false: The economic performance test generally requires that underlying activity
generating the liability has occurred in order for the associated expense to be deductible.
ACNT 1373
Chapter 1

 True Reason: The economic performance rule often prevents the use of the 12 month
exception to the all events test because the underlying activity must have occurred in
order to deduct the expense. There are some exceptions.

In addition to the all-events test, an accrual-basis business must meet a(n) economic Performance
test with respect to a liability before the corresponding expense can be deducted for tax purposes.

Which of the following statements are correct regarding the requirements to meet the economic
performance test under the various ways a liability can arise? (Check all that apply.)
 Certain liabilities, such as rebates, refunds, and workers compensation payments, must be
deducted when paid regardless of when the liability arises.
 When a business agrees to pay another party for services, the deduction is taken as the
other party provides the services.

The allowance method of recognizing bad debt expense is used for Financial reporting, while the
direct write-off method is used for tax reporting.

Business bad debts can only be deducted when the business uses the Accrual method of
accounting for tax purposes. Only debts determined to be uncollectible under the direct Write -Off
method are able to be deducted for tax purposes.

The accrual-method of tax reporting provides a better matching of revenues and expenses.

The economic performance test specifies that businesses may NOT recognize a deduction for an
expense until the underlying activity generating the associated liability has occurred.

When a business wants to change an accounting method for tax reporting, such as the cost-flow
method used for inventory, what body must give permission for the change? Internal Revenue
Service

Which of the following statements is INCORRECT regarding the requirements to meet the
economic performance test under the various ways a liability can arise?
Certain liabilities, such as rebates, refunds, and workers compensation payments, can be
deducted when incurred regardless of when payment is made.

For accrual-method businesses, bad debt expense is recognized using the ______ method for
financial accounting and is deducted using the ______ method for tax purposes. allowance;
direct write-off

When is a business deemed to have adopted an impermissible accounting method?

After it has used the method for one year

Montgomery & Company are accounting for their bad debts. The company uses the accrual method of
accounting. During the current year, M&C has $42,000 in accounts receivable. The estimated bad debts
for the period is $2,000 using the allowance method of accounting for uncollectible accounts. The amount
ACNT 1373
Chapter 1

of accounts actually written off during the period is $1,700. What is the amount of bad debt expense that
can be deducted for tax purposes?

$1,700 - M&C must use the direct write-off method for tax purposes - Reason: M&C must use the
accrual method of accounting and can only deduct the amount that would be deductible under the
direct write-off method.
Which of the following choices are advantages to the taxpayer of choosing the cash-method of
tax reporting rather than the accrual-method? (Check all that apply.)
 There is more flexibility to time the recognition of income and deductions.
 Bookkeeping is easier.

Which of the following statements is INCORRECT when requesting permission to change

accounting methods?
 It is NOT necessary to request permission to change from an impermissible method to a
permissible method.

For tax purposes, when a business wants to adopt a new accounting method, it must get permission from
the IRS.

Which of the following statements are correct regarding the recognition of the cumulative
difference in taxable income due to a change in accounting method? (Check all that apply.)
 If the adjustment increases taxable income, it is recognized over 4 years by adding 25%
of the increase each year.
 If the adjustment decreases taxable income, it is recognized in its entirety in the year of
the change.

A business is deemed to have adopted a permissible accounting method if it has used the method for
one , year(s), but is not deemed to have adopted an impermissible accounting method unless it has used
the method for two consecutive years.

Which of the following statements are CORRECT when requesting permission to change
accounting methods? (Check all that apply.)
 The business may have to pay a fee and provide a good business reason for making the change.
 The IRS automatically approves certain types of accounting method changes.

In the year that a business changes its accounting method, it must make an adjustment to taxable income
that represents the cumulative difference for the amount that would have been taxed or deducted in prior
years. If the adjustment increases taxable income, the taxpayer includes 25 % of the addition in the
current year. If the adjustment decreases taxable income, the taxpayer includes 100% of the deduction in
the current year.

Reasonable in amount means that expenditures cannot be exorbitant even if the amount is
motivated by profit. True
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Chapter 1

Highway speeding fines can be deducted if the speeding was done in the line of business. False

The cost of a business meal is deductible only if an existing client is present at

the meal. False

The deduction for business interest cannot exceed 30 percent of adjusted

taxable income plus allocable interest income. True

Adjusted taxable income is defined as taxable income computed without

regard to income not properly allocable to a trade or business. False

The limitation on the deduction of business interest does not apply to a business that
qualifies as small business under the gross receipts test. True

The gross receipts test is only applied to firms that have complete financial
data for a minimum of 4 years. False

A short tax year can end on any day of any month. True

The "all-events" test for income determines the amount of income that will be included
in taxable income for accrual method taxpayers. True

Taxpayers can always defer recognition of a receipt of payments in advance of sales or

services until the payment is recognized as income for financial reporting purposes.
False

The arm's length transaction test would most likely not apply to which of the following?
Whether an expenditure should be deducted in a later period

Which of the following is a true statement?

The cost of business entertainment is not deductible.

Which of the following is a true statement? The cost of lodging is deductible if the taxpayer is away
from home overnight on business.

Drake operates a trucking business, and one of his trucks was damaged in a traffic accident. The
truck was purchased for $52,000 and the adjusted basis was $22,000 at the time of the accident.
The truck was repaired at a cost of $5,000 and insurance reimbursed Drake $2,000 of this cost.
What is the amount of Drake's casualty loss deduction? $3,000

Which of the following cannot be selected as a valid tax year end? December 15th

Charley Incorporated is a large corporation that reported revenue of $80 million and income of
$620,000 this year. Included in the calculation of income was $10,000 of interest income,
ACNT 1373
Chapter 1

depreciation deductions of $170,000, and interest expense deductions of $420,000. What is the
maximum amount of interest expense deduction this year? 370,000

Steven operates a landscaping service on the accrual method. In September of this year, Steven
received a payment of $18,000 for 24 months of landscape services ($750 per month
commencing on November 1st of this year). When must Steven recognize the income if his
accounting methods are selected to minimize income recognition? $1,500 is recognized in this year,
$16,500 next year.

Which of the following is not a payment liability? Accrued compensation

Which of the following is a true statement? An employer can deduct the full cost of meals provided to
employees as compensation.

Blue Corporation began business on April 1 of last year and reported gross receipts of $21
million. Which of the following is true statement about the gross receipts test as applied to Blue?
Blue will qualify because their average gross receipts is only $28 million.