SolutionsCh3 - Chapter 3 Determining Gross Income 39...

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Chapter 3: Determining Gross Income 39 Solutions to Chapter 3 Problem Assignments Check Your Understanding 1. Choice of Tax Year Michelle (a calendar year individual) begins a new business as a sole proprietorship. She would like to use an October 31 fiscal year end for her business because the calendar year ends during her busy season. Can Michelle use a fiscal tax year? Solution: The sole proprietorship’s operating results will all be reported on Michelle’s tax return. As a result, it will have to be on a calendar-year basis unless Michelle applies for and receives permission to change her tax year to October 31. 2. Accounting Methods Jabba Company uses the cash method of accounting. Jabba received a computer from a customer as payment for a $2,000 bill. Can Jabba avoid recognizing income because it received payment in a noncash form? Explain. Solution: Jabba must recognize the fair market value of the computer (assumed to be approximately $2,000) as income in payment of the bill. Cash basis taxpayers must recognize income when cash or cash equivalents are received as payment. The computer constitutes a cash equivalent. 3. Accounting Methods Murphy Company, a cash-basis, calendar-year taxpayer, received a call on December 28, year 1, from a client stating that a check for $9,000 as payment in full for their services could be picked up at their offices, two blocks away, any weekday afternoon between 1:00 and 6:00 P.M. Murphy does not pick up the check until January 3, year 2. In which year does Murphy recognize the income? Solution: Murphy should recognize the income in year 1. The check was readily available several days before the end of the year and, as a cash basis taxpayer, Murphy cannot turn its back on the income by failing to pick up the check. 4. Accounting Methods Are there any restrictions on which businesses can use the cash method of accounting? Explain. Solution: There are several restrictions on the use of the cash method. If inventory is a material factor in the determination of income, an otherwise cash-basis taxpayer must use the accrual method for determining sales and purchases. They may use the cash method for all other income and expense items, however. Businesses with average annual gross receipts of $10 million or less may use a variation of the cash method under which they account for the cost of merchandise inventory as an asset, but their sales on the cash basis. Finally, a C corporation with average annual gross receipts of more than $5 million (except personal service corporations) is prohibited from using the cash method.
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40 Solutions Manual for Taxation for Decision Makers 5. Tax vs. Financial Accounting Explain why accrual-method taxpayers treat prepaid income differently for GAAP and tax purposes.
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SolutionsCh3 - Chapter 3 Determining Gross Income 39...

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