Exam 2 study guide - Exam 2 Study Guide (Chapters 6, 7, 8,...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
1 Exam 2 Study Guide (Chapters 6, 7, 8, 9) Chapter 6: Taxable Income from Business Operations Taxable income is equal to gross income minus any allowable deductions. Gross income includes “all income from whatever source derived” (unless specifically excluded). Taxpayers must measure their taxable income and pay tax on an annual basis, which may be the calendar year or a fiscal year that corresponds to the business cycle. Firms choose their taxable year and must receive permission from the IRS to change that taxable year. If the IRS grants permission for the change, the company must file a short-period return and annualize the income on the return. This annualization is only required when a firm changes its taxable year, not when a firm files its first (or last) tax return. A firm can use one of three methods of accounting to determine when income and deductions are recognized for tax purposes (must clearly reflect income as determined by the IRS): 1. Cash Receipts and Disbursements Method – report revenue in the year payment is received and deduct expenses in the year the expense is paid Doctrine of constructive receipt : if the taxpayer has unrestricted access to and control of income, it is considered to be received whether or not he actually has possession of it. Prepaid Expenses: can prepay expenses to accelerate the deduction if the benefit has a useful life of 12 months or less and does not extend beyond the end of the following tax year Prepaid interest must be capitalized and deducted in the year(s) in which the interest is actually charged to the firm. 2. Accrual Method – report revenue when earned and deduct expenses when all-events occur Deduct expenses only when they meet the all-events test : all events that established the liability have already occurred; and the amount of the liability can be determined with reasonable accuracy. A third (economic performance) requirement exists for certain expenses, basically making them deductible only in the year of payment. 3. Hybrid Method – generally account for purchases and sales of inventory using the accrual method but account for other transactions using the cash method Sometimes revenues and expenses are treated differently for financial statement (book) purposes than they are for tax purposes. These book-tax differences can be either permanent differences or temporary differences . A permanent difference occurs when income is realized for book purposes but never recognized for taxable purposes or when expenses are realized for book purposes but never recognized for tax purposes. Another cause of a permanent difference is when the tax law allows a deduction that never corresponds to a book loss or expense. Income tax expense for the financial statements is based on book income adjusted for these permanent differences. Temporary differences
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 02/01/2009 for the course ACTG 6610 taught by Professor Ward during the Spring '09 term at Middle Tennessee State University.

Page1 / 5

Exam 2 study guide - Exam 2 Study Guide (Chapters 6, 7, 8,...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online