Test Bank Taxable Income from Business Operations Chapter 6 - Taxation Principles 23e Complete Test Bank by Sally Jones. DOCX document preview.
Principles of Taxation for Business and Investment Planning, 23e (Jones)
Chapter 6 Taxable Income from Business Operations
1) For federal tax purposes, gross income from the sale of tangible goods is reduced by the seller's cost of goods sold.
Difficulty: 1 Easy
Topic: Business Profit as Taxable Income
Learning Objective: 06-01 Define gross income and taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
2) Taxable income is defined as gross income minus allowable deductions and credits.
Difficulty: 1 Easy
Topic: Business Profit as Taxable Income
Learning Objective: 06-01 Define gross income and taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
3) A taxpayer that wants to change its taxable year from a fiscal year to a calendar year is not required to receive permission from the IRS to make the change.
Difficulty: 1 Easy
Topic: The Taxable Year
Learning Objective: 06-02 Describe the relationship between business operating cycle and taxable year.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
4) A firm's choice of taxable year is usually dictated by the annual operating cycle of the firm's business.
Difficulty: 1 Easy
Topic: The Taxable Year
Learning Objective: 06-02 Describe the relationship between business operating cycle and taxable year.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
5) When an individual taxpayer begins a new business as a sole proprietorship and wants to keep records on a fiscal year basis, permission to change taxable years is not required because this is a new business.
Difficulty: 2 Medium
Topic: The Taxable Year
Learning Objective: 06-02 Describe the relationship between business operating cycle and taxable year.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
6) A taxpayer that operates more than one business may use a different method of accounting for each business.
Difficulty: 1 Easy
Topic: Methods of Accounting
Learning Objective: 06-03 Identify the permissible methods of accounting for tax purposes.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
7) PPQ Inc. wants to change from a hybrid method of accounting to the accrual method of accounting for tax purposes. PPQ can't make this change without receiving permission from the IRS.
Difficulty: 1 Easy
Topic: Methods of Accounting
Learning Objective: 06-03 Identify the permissible methods of accounting for tax purposes.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
8) Taxpayers may adopt the cash receipts and disbursements method, the accrual method, or a hybrid method of accounting for tax purposes.
Explanation: Many large corporations are prohibited from using the cash method for tax purposes.
Difficulty: 2 Medium
Topic: Methods of Accounting; The Cash Method
Learning Objective: 06-03 Identify the permissible methods of accounting for tax purposes.; 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
9) Accurate measurement of taxable income is the only objective of the federal income tax laws.
Difficulty: 1 Easy
Topic: Tax Policy Objectives
Learning Objective: 06-04 Explain why tax policy objectives affect the taxable income computation.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
10) Political lobbying expenses are nondeductible.
Difficulty: 1 Easy
Topic: Tax Policy Objectives
Learning Objective: 06-04 Explain why tax policy objectives affect the taxable income computation.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
11) The after-tax cost of a dollar of business meal expense is 79 cents for a taxpayer with a 21% marginal tax rate.
Explanation: Only 50 cents of the expense is deductible, so the tax savings at a 21% rate is only 10.5 cents.
Difficulty: 2 Medium
Topic: Tax Policy Objectives
Learning Objective: 06-04 Explain why tax policy objectives affect the taxable income computation.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
12) Poole Services, a calendar year taxpayer, billed a client for $1,675 of services on November 30, 2019, and received a check in full payment from the client on January 12, 2020. If Poole is a cash basis taxpayer, it reports $1,675 taxable income in 2019.
Difficulty: 1 Easy
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
13) Poole Company, a calendar year taxpayer, incurred $589 of long-distance telephone charges in December 2019 and mailed a check to the telephone company on January 4, 2020. If Poole is a cash basis taxpayer, it reports a $589 tax deduction in 2020.
Difficulty: 1 Easy
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
14) Mr. Stern, a cash basis taxpayer, was notified by his bank that he earned $1,193 of interest on his savings account in 2019. Mr. Stern has not withdrawn any funds from this account for eight years and did not receive the notification until January 26, 2020. Mr. Stern does not recognize the interest as income in 2019.
Explanation: He must recognize the interest as income in 2019 under the doctrine of constructive receipt.
Difficulty: 2 Medium
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
15) A cash basis taxpayer must account for any prepayment of interest expense under the accrual method.
Difficulty: 2 Medium
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
16) Elcox Company, a calendar year, cash basis taxpayer, paid $950 to purchase eight months' worth of office supplies on December 12. Elcox can deduct $950 in the year of payment.
Difficulty: 2 Medium
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
17) Elcox Company, a calendar year, cash basis taxpayer, paid a $6,340 premium to purchase a casualty insurance policy with a 36-month term. Elcox can deduct $6,340 in the year of payment.
Explanation: Under the 12-month rule, Elcox must deduct the $6,340 expense over the 36-month term of the payment.
Difficulty: 2 Medium
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
18) Taxpayers that sell merchandise to their customers must use the accrual method to account for purchases and sales of merchandise.
Difficulty: 1 Easy
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
19) Taxpayers that sell merchandise to their customers must use the accrual method as their overall method of accounting.
Explanation: They must use the accrual method only for purchases and sales of merchandise.
Difficulty: 2 Medium
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
20) Marz Services Inc. is a personal service corporation with $60 million average annual gross receipts. Marz must use the accrual method of accounting for tax purposes.
Explanation: Personal service corporations can use the cash method regardless of the amount of their gross receipts.
Difficulty: 2 Medium
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
21) Laine Services, a calendar year taxpayer, billed a client for $8,450 of services on November 30, 2019, and received a check in full payment from the client on January 12, 2020. If Poole is an accrual basis taxpayer, it reports $8,450 taxable income in 2019.
Difficulty: 1 Easy
Topic: The Accrual Method
Learning Objective: 06-06 Apply the accrual method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
22) Keagan Company, a calendar year taxpayer, incurred $1,490 of long-distance telephone charges in December 2019 and mailed a check to the telephone company on January 4, 2020. If Poole is an accrual basis taxpayer, it reports a $1,490 tax deduction in 2020.
Difficulty: 1 Easy
Topic: The Accrual Method
Learning Objective: 06-06 Apply the accrual method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
23) According to the GAAP principle of conservatism, firms should delay the realization of uncertain revenues and gains and accelerate the realization of uncertain expenses and losses.
Difficulty: 1 Easy
Topic: The Accrual Method
Learning Objective: 06-06 Apply the accrual method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
24) The principle of conservatism reflected by GAAP is identical to the principle of conservatism reflected in the tax law.
Difficulty: 1 Easy
Topic: The Accrual Method
Learning Objective: 06-06 Apply the accrual method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
25) A permanent difference between book income and taxable income affects only one taxable year.
Difficulty: 1 Easy
Topic: Permanent versus Temporary Differences
Learning Objective: 06-07 Differentiate between a permanent and a temporary book/tax difference.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
26) A temporary difference between book income and taxable income results when an item of income reflected on the books is never included in taxable income.
Difficulty: 1 Easy
Topic: Permanent versus Temporary Differences
Learning Objective: 06-07 Differentiate between a permanent and a temporary book/tax difference.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
27) Income tax expense per books is based on book income adjusted for all book/tax differences.
Explanation: Income tax expense per books is based on book income adjusted for all permanent book/tax differences.
Difficulty: 2 Medium
Topic: Tax Expense versus Tax Payable
Learning Objective: 06-08 Explain the difference between tax expense per books and tax payable.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
28) An unfavorable temporary book/tax difference generates a deferred tax asset.
Difficulty: 1 Easy
Topic: Tax Expense versus Tax Payable
Learning Objective: 06-08 Explain the difference between tax expense per books and tax payable.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
29) A corporation can't have an increase in deferred tax assets and an increase in deferred tax liabilities in the same year.
Explanation: Changes in deferred tax assets and deferred tax liabilities are determined on a transaction-by-transaction basis. Consequently, a corporation could engage in transactions affecting deferred tax assets and other transactions affecting deferred tax liabilities in the same year.
Difficulty: 3 Hard
Topic: Tax Expense versus Tax Payable
Learning Objective: 06-08 Explain the difference between tax expense per books and tax payable.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
30) If an accrual basis taxpayer receives a prepayment of rent income, the receipt results in an unfavorable temporary book/tax difference.
Difficulty: 2 Medium
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
31) If an accrual basis taxpayer prepays interest expense, the payment results in an unfavorable temporary book/tax difference.
Explanation: The accounting treatment of prepaid interest expense is the same for book and tax purposes.
Difficulty: 3 Hard
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
32) For tax purposes, income is recognized when all events have occurred that fix the taxpayer's right to receive the income and the amount of income can be determined with reasonable accuracy.
Difficulty: 2 Medium
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
33) An accrual basis taxpayer must account for the expense of a legal settlement resulting from a tort under the cash method.
Difficulty: 3 Hard
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
34) An accrual basis taxpayer that accrues a liability at year-end for unpaid state income tax can deduct the accrued tax expense in the computation of federal taxable income.
Explanation: Under the general rule, accrued state income taxes are a payment liability deductible in the year in which payment is made.
Difficulty: 3 Hard
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
35) Huml Inc. could not deduct an accrued expense because of the all-events test. As a result, Huml has a permanent unfavorable book/tax difference.
Explanation: As a result, Huml has a temporary unfavorable book/tax difference. The all-events test affects the timing, not the fact, of a deduction.
Difficulty: 2 Medium
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
36) At the end of its taxable year, Gong Company accrued an expense for an account payable to Mexance Inc. Even if Gong and Mexance are related parties, Gong can deduct the accrued expense if Mexance also uses the accrual method of accounting for tax purposes.
Explanation: Gong's deduction is deferred only if Mexance used the cash method of accounting.
Difficulty: 3 Hard
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
37) The tax law does not allows deductions based on estimated expenses that result in an allowance or reserve for financial statement purposes.
Difficulty: 2 Medium
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
38) Murray Inc., a calendar year, accrual basis corporation, accrued $946,000 salary and wage expense at the end of 2019. Murray paid the entire amount of the accrued liability on January 13, 2020. Murray can deduct the entire $946,000 accrued expense in 2019.
Difficulty: 1 Easy
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
39) Molton Inc., which operates a chain of retail toy stores, prepares GAAP based financial statements. Molton must use the allowance method to account for business bad debts for both book and tax purposes.
Explanation: Molton must use the direct-write off method for tax purposes.
Difficulty: 2 Medium
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
40) Bolton Inc., a calendar year taxpayer, generated a $296,400 net operating loss this year. Bolton can carry the loss back five years and forward 20 years for tax purposes.
Explanation: For tax years after 2017, net operating losses can only be carried forward, for an indefinite period.
Difficulty: 1 Easy
Topic: Net Operating Losses
Learning Objective: 06-10 Explain how the NOL deduction smooths taxable income over time.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
41) For its first taxable year, UY Products Inc. generated a $124,950 net operating loss. The loss resulted in a deferred tax liability that will reverse over future years in which UY is allowed an NOL carryforward deduction.
Explanation: The NOL resulted in a deferred tax asset that will reverse in the future.
Difficulty: 3 Hard
Topic: Net Operating Losses
Learning Objective: 06-10 Explain how the NOL deduction smooths taxable income over time.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
42) Which of the following statements most accurately defines taxable income from business operations?
A) Gross income from the sales of goods or performance of services less allowable deductions.
B) Gross income from whatever source derived less allowable deductions.
C) Revenues from business transactions less expenses.
D) Gross income from whatever source derived less expenses.
Difficulty: 2 Medium
Topic: Business Profit as Taxable Income
Learning Objective: 06-01 Define gross income and taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
43) Jethro Company, an accrual basis taxpayer, had a $10,000 overdue account payable to a major supplier. The supplier agreed to settle the account for $9,000 cash from Jethro. Which of the following statements is true?
A) Jethro recognizes $1,000 income because of the settlement.
B) Jethro recognizes no income because of the settlement.
C) Jethro can deduct the $9,000 payment.
D) Jethro can deduct a $1,000 bad debt expense.
Difficulty: 1 Easy
Topic: Business Profit as Taxable Income
Learning Objective: 06-01 Define gross income and taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
44) Pim Inc. operates a business with a natural annual operating cycle ending August 31. Which of the following can Pim adopt as its taxable year?
A) A calendar year.
B) Fiscal year ending June 30.
C) Fiscal year ending August 31.
D) Pim can adopt a calendar year or any fiscal year as its taxable year.
Explanation: A corporate taxpayer can adopt a calendar year or any fiscal year.
Difficulty: 2 Medium
Topic: The Taxable Year
Learning Objective: 06-02 Describe the relationship between business operating cycle and taxable year.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
45) Tonto Inc. has used a calendar year as its taxable year since its incorporation in 1990. Tonto has an excellent business reason for changing to a fiscal year ending May 31. Which of the following statements is true?
A) Because it has a good business reason, Tonto can change to a fiscal year ending May 31 without IRS permission.
B) If Tonto changes to a fiscal year ending May 31, it must file a short-period return for the seven-month period from June 1 to December 31 of the year of change.
C) If Tonto changes to a fiscal year ending May 31, it must file a short-period return for the five-month period from January 1 to May 31 of the year of change.
D) Because it has a good business reason, Tonto can change to a fiscal year ending May 31 without IRS permission and if Tonto changes to a fiscal year ending May 31, it must file a short-period return for the seven-month period from June 1 to December 31 of the year of change.
Difficulty: 2 Medium
Topic: The Taxable Year
Learning Objective: 06-02 Describe the relationship between business operating cycle and taxable year.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
46) Welch Inc. has used a fiscal ending September 30 as its taxable year since its incorporation in 1988. The shareholders have decided to shut down Welch's business and dissolve the corporation on March 31. Which of the following statements is false?
A) Welch's final tax return will be a short-period return.
B) Welch's final tax return will include its income from October 1 to March 31.
C) Welch's final tax return will include its income from January 1 to March 31.
D) None of the above is false.
Difficulty: 1 Easy
Topic: The Taxable Year
Learning Objective: 06-02 Describe the relationship between business operating cycle and taxable year.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
47) Toro Inc. has average gross receipts of $30 million annually. This year, Toro incurred $5 million of net business interest and has adjusted taxable income of $12 million. Toro's current deduction for business interest is:
A) $1.5 million
B) $3.6 million
C) $5 million
D) $0
Explanation: Toro's deduction for business interest is limited to 30% of adjusted taxable income ($12 million × 30% = $3.6 million).
Difficulty: 2 Medium
Topic: Tax Policy Objectives
Learning Objective: 06-04 Explain why tax policy objectives affect the taxable income computation.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
48) Village Inc. has average gross receipts of $100 million annually. This year, Village incurred $25 million of net business interest and has adjusted taxable income of $42 million. Village's current deduction for business interest is:
A) $0
B) $7.5 million
C) $12.6 million
D) $25 million
Explanation: Village's deduction for business interest is limited to 30% of adjusted taxable income ($42 million × 30% = $12.6 million).
Difficulty: 2 Medium
Topic: Tax Policy Objectives
Learning Objective: 06-04 Explain why tax policy objectives affect the taxable income computation.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
49) Which of the following statements about tax policy objectives regarding business expenses is false?
A) Lobbying expenses are not deductible because Congress does not want to subsidize political activities.
B) By disallowing a tax deduction, Congress increases the after-tax cost of undesirable expenditures.
C) The tax treatment of meals and entertainment expenses is intended to make the law more equitable.
D) The business interest expense limitation increases the disparity between the tax treatment of debt and equity financing.
Difficulty: 2 Medium
Topic: Tax Policy Objectives
Learning Objective: 06-02 Describe the relationship between business operating cycle and taxable year.; 06-04 Explain why tax policy objectives affect the taxable income computation.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
50) Which of the following statements about methods of accounting is false?
A) The IRS has the right to determine if a taxpayer's method of accounting clearly reflects the taxpayer's income.
B) A taxpayer must request permission from the IRS to change its method of accounting for tax purposes.
C) A taxpayer engaged in more than one business can use a different method of accounting for each business.
D) Taxpayers must use the same method of accounting to compute taxable income as they use to compute financial statement income.
Difficulty: 1 Easy
Topic: Methods of Accounting
Learning Objective: 06-03 Identify the permissible methods of accounting for tax purposes.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
51) Which of the following methods of accounting is never permissible for computing taxable income?
A) Cash receipts and disbursements method
B) Accrual method
C) Hybrid method that combines the cash and accrual methods
D) All of the above are permissible methods of accounting.
Difficulty: 1 Easy
Topic: Methods of Accounting
Learning Objective: 06-03 Identify the permissible methods of accounting for tax purposes.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
52) JKL Inc. and Matthew Inc. enter into a business transaction. The two corporations are related parties for tax purposes. Which of the following statements is true?
A) JKL and Matthew must account for the transaction using the same method of accounting.
B) The IRS has the right to reallocate income from the transaction to prevent distortion.
C) The cash method of accounting must be used to account for such transactions.
D) JKL and Matthew must request permission from the IRS to engage in the related party transaction.
Difficulty: 2 Medium
Topic: Methods of Accounting
Learning Objective: 06-03 Identify the permissible methods of accounting for tax purposes.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
53) Which of the following business expenses always results in a difference between taxable income and book income?
A) Rent expense
B) Interest expense
C) Client entertainment
D) Salary expense
Explanation: After 2017, client entertainment expense not deductible.
Difficulty: 2 Medium
Topic: Tax Policy Objectives
Learning Objective: 06-04 Explain why tax policy objectives affect the taxable income computation.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
54) Why does the federal tax law disallow a business deduction for a fine or penalty paid to any government?
A) A deduction for the payment of a fine or penalty would be a subsidy for bad behavior and also against public policy.
B) The payment of a fine or penalty is not an ordinary business expense.
C) The payment of a fine or penalty is not an expense for financial reporting purposes.
D) A deduction for the payment of a fine or penalty would distort the measurement of taxable income.
Difficulty: 1 Easy
Topic: Tax Policy Objectives
Learning Objective: 06-04 Explain why tax policy objectives affect the taxable income computation.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
55) Why does the federal tax law disallow a business deduction for political contributions?
A) A deduction for the payment of a political contribution would be a subsidy for bad behavior.
B) A deduction for the payment of a political contribution would subsidize partisan political activities.
C) The payment of a political contribution is not an expense for financial reporting purposes.
D) A deduction for the payment of a fine or penalty would distort the measurement of taxable income.
Difficulty: 1 Easy
Topic: Tax Policy Objectives
Learning Objective: 06-04 Explain why tax policy objectives affect the taxable income computation.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
56) Stack Inc. owns a $1 million insurance policy on the life of Mary Stack, the corporate CEO. The corporation is the policy beneficiary. Stack's annual premium on the policy is $3,160. Which of the following statements is true?
A) Stack Inc. can deduct the annual premium as a business expense. If Stack ever collects the $1 million death benefit, the benefit is excluded from gross income.
B) Stack Inc. can deduct the annual premium as a business expense. If Stack ever collects the $1 million death benefit, the benefit is included in gross income.
C) Stack Inc. can't deduct the annual premium as a business expense. If Stack ever collects the $1 million death benefit, the benefit is included in gross income.
D) Stack Inc. can't deduct the annual premium as a business expense. If Stack ever collects the $1 million death benefit, the benefit is excluded from gross income.
Difficulty: 2 Medium
Topic: Tax Policy Objectives
Learning Objective: 06-04 Explain why tax policy objectives affect the taxable income computation.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
57) Which of the following statements about the cash method of accounting is false?
A) Under the cash method, annual taxable income equals annual net cash inflow.
B) The revenue from a sale of goods is recognized when payment is received.
C) An expense is recognized when the expense is paid.
D) None of the above is false.
Difficulty: 1 Easy
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
58) Pozzi Company, a cash basis business, received $16,930 cash as payment on a loan Pozzi made to a business associate two years ago. The payment consisted of a $15,000 principal payment and $1,930 interest. On receipt of the cash, Pozzi recognizes:
A) No taxable income.
B) $1,930 taxable income.
C) $15,000 taxable income.
D) $16,930 taxable income.
Difficulty: 1 Easy
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
59) Lawes Company, a cash basis business, mailed a $24,500 invoice to MWQ Partnership for professional services rendered. MWQ offered to pay the invoice by transferring 250 shares of ConAgri common stock to Lawes. The shares are selling on the NYSE at $98 per share. If Lawes accepts the shares in payment, it recognizes:
A) No taxable income.
B) No taxable income until it sells the ConAgri shares for cash.
C) $24,500 taxable income.
D) It is illegal for a cash basis taxpayer to accept a noncash payment.
Difficulty: 1 Easy
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
60) On December 12, 2019, Hook Company, a calendar year, cash basis business, mailed a $5,600 bill to Mrs. Gilder for professional services rendered during the month of November. Mrs. Gilder dropped off her $5,600 check at Hook's office on December 28, but the company secretary did not deposit the check in Hook's bank account until January 3. Which of the following statements is true?
A) According to the constructive receipt doctrine, Hook must recognize $5,600 income in 2019.
B) According to the substance over form doctrine, Hook does not recognize $5,600 income until 2020.
C) As a cash basis taxpayer, Hook does not recognize $5,600 income until 2020.
D) As a cash basis taxpayer, Hook can elect to recognize $5,600 income in either 2019 or 2020.
Difficulty: 2 Medium
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
61) Which of the following statements about the constructive receipt doctrine is false?
A) The doctrine applies to cash basis taxpayers.
B) The doctrine relates to the time period variable in tax planning.
C) Application of the doctrine by the IRS is subjective and depends on the facts and circumstances of each case.
D) None of the above is false.
Difficulty: 2 Medium
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
62) Which of the following statements concerning the cash method of accounting is true?
A) A cash basis taxpayer who is in constructive receipt of an income item must recognize that income, even if the item is not in the taxpayer's actual possession.
B) A cash basis taxpayer can deduct the purchase cost of business equipment.
C) A cash basis taxpayer does not recognize gross income on receipt of an economic benefit unless that benefit consists of money.
D) A cash basis taxpayer can deduct interest when it is paid, regardless of the time period for which the interest is charged.
Difficulty: 2 Medium
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
63) Eaton Inc. is a calendar year, cash basis taxpayer. On October 1, 2019, Eaton paid $4,800 to a security firm for night-time and weekend security services for the 24-month period beginning with October. Which of the following is true?
A) As a cash basis taxpayer, Eaton can deduct the $4,800 expense in 2019.
B) Eaton can deduct $600 in 2019, and the remaining $4,200 in 2020.
C) Eaton can deduct $600 in 2019, $2,400 in 2020, and $1,800 in 2021.
D) None of the above is true.
Explanation: Because the expense resulted in a benefit extending more than 12 months, Eaton must capitalize it and amortize it over 24 months.
Difficulty: 2 Medium
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
64) Addis Company operates a large retail men's clothing store. Because Addis has merchandise inventory, it must use:
A) The accrual method as its overall method of accounting.
B) The accrual method to account only for sales of merchandise.
C) The accrual method to account only for purchases of merchandise.
D) The accrual method to account for both sales and purchases of merchandise.
Difficulty: 1 Easy
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
65) Which of the following businesses can't use the cash receipts and disbursement method of accounting for tax purposes?
A) Sole proprietorship with $8 million average annual gross receipts
B) Corporation with $50 million average annual gross receipts
C) Partnership of individuals with $20 million average annual gross receipts
D) Personal service corporation with $50 million average annual gross receipts
Difficulty: 2 Medium
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
66) Which of the following businesses is prohibited from using the cash receipts and disbursement method of accounting for tax purposes?
A) Partnership with two individual partners with $9 million average annual gross receipts
B) Personal service corporation with $8 million average annual gross receipts
C) Corporation with $3 million average annual gross receipts
D) None of the businesses are prohibited from using the cash method
Explanation: Corporations with $25 million or less average annual gross receipts are allowed to use the cash method.
Difficulty: 3 Hard
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
67) Which of the following statements about the accrual method of accounting is false?
A) The accrual method is the required method of accounting under GAAP.
B) Every publicly held corporation must use the accrual method of accounting to prepare financial statements.
C) The accrual method of accounting under GAAP and the accrual method of accounting for computing taxable income are identical.
D) Corporations with more than $5 million average annual gross receipts are required to use the accrual method to compute taxable income.
Difficulty: 1 Easy
Topic: The Accrual Method
Learning Objective: 06-06 Apply the accrual method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
68) According to your textbook, business managers prefer to:
A) Report as much income as possible for book and tax purposes.
B) Report as much income as possible for book purposes and as little income as possible for tax purposes.
C) Report as little income as possible for book and tax purposes.
D) Report the same amount of income for book and tax purposes.
Difficulty: 1 Easy
Topic: The Accrual Method
Learning Objective: 06-06 Apply the accrual method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
69) Which of the following statements concerning the principle of accounting conservatism is true?
A) According to the GAAP principle of conservatism, financial statements should report expenses and losses in the earliest reasonable year.
B) The GAAP principle of conservatism tries to prevent the overstatement of book income and the understatement of taxable income.
C) According to the tax law principle of conservatism, taxpayers should deduct expenses and losses in the earliest reasonable year.
D) According to the tax law principle of conservatism, taxpayers should deduct expenses and losses in the same year as they are reported on the taxpayers' financial statements.
Explanation: GAAP conservatism does not apply to the measurement of taxable income. According to the tax law principle of conservatism, taxpayers should deduct expenses and losses in the latest reasonable year.
Difficulty: 3 Hard
Topic: The Accrual Method
Learning Objective: 06-06 Apply the accrual method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
70) Which of the following statements describes a permanent book/tax difference?
A) An expense reported on the current income statement but deducted on next year's tax return
B) A revenue item included in current taxable income but not reported on the income statement until next year
C) An expense (or loss) is realized for book purposes but never recognized for tax purposes
D) A revenue item reported on the current income statement but not included in taxable income until an indefinite future year
Difficulty: 1 Easy
Topic: Permanent versus Temporary Differences
Learning Objective: 06-07 Differentiate between a permanent and a temporary book/tax difference.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
71) Which of the following does not result in a permanent book/tax difference?
A) Business meal and entertainment expense
B) Domestic production activities deduction
C) Premiums paid on key-person life insurance policies
D) All of the above result in a permanent book/tax difference.
Difficulty: 1 Easy
Topic: Permanent versus Temporary Differences
Learning Objective: 06-07 Differentiate between a permanent and a temporary book/tax difference.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
72) Which of the following does not result in a permanent book/tax difference?
A) Tax-exempt interest on state and local bonds
B) NOL carryforwards
C) Business entertainment expenses
D) Lobbying expenses
Difficulty: 1 Easy
Topic: Permanent versus Temporary Differences
Learning Objective: 06-07 Differentiate between a permanent and a temporary book/tax difference.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
73) Which of the following statements regarding book/tax differences is false?
A) A permanent book/tax difference affects only the year in which it occurs.
B) A temporary book/tax difference affects two or more tax years.
C) Temporary book/tax differences arising in the current tax year will reverse in the future in one or more tax years.
D) The tax cost or benefit of a permanent book/tax difference is recouped over time.
Difficulty: 2 Medium
Topic: Permanent versus Temporary Differences
Learning Objective: 06-07 Differentiate between a permanent and a temporary book/tax difference.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
74) Southlawn Inc.'s taxable income is computed as follows:
Book income before tax | $ 2,405,600 | |||
Net permanent differences | (512,000 | ) | ||
Net temporary differences | (189,000 | ) | ||
Taxable income | $ 1,704,600 |
Using a 21% rate, compute Southlawn's tax expense per books and tax payable.
A) Tax expense per books $397,656; tax payable $357,966.
B) Tax expense per books $357966; tax payable $397,656.
C) Tax expense per books $612,570; tax payable $357,966.
D) None of the above
Explanation: ($2,405,600 − $512,000 permanent differences) × 21% = tax expense per books. Tax payable is always based on taxable income.
Difficulty: 2 Medium
Topic: Tax Expense versus Tax Payable
Learning Objective: 06-08 Explain the difference between tax expense per books and tax payable.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
75) Southlawn Inc.'s taxable income is computed as follows:
Book income before tax | $ 2,405,600 | |||
Net permanent differences | (512,000 | ) | ||
Net temporary differences | (189,000 | ) | ||
Taxable income | $ 1,704,600 |
Southlawn's tax rate is 21%. Which of the following statements is true?
A) The permanent differences caused a $107,520 net increase in Southlawn's deferred tax liabilities.
B) The permanent differences caused a $107,520 net decrease in Southlawn's deferred tax liabilities.
C) The temporary differences caused a $39,690 net increase in Southlawn's deferred tax liabilities.
D) The temporary differences caused a $39,690 net decrease in Southlawn's deferred tax liabilities.
Difficulty: 2 Medium
Topic: Tax Expense versus Tax Payable
Learning Objective: 06-08 Explain the difference between tax expense per books and tax payable.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
76) B&B Inc.'s taxable income is computed as follows:
Book income before tax | $ 9,882,590 | |||
Net permanent differences | 447,600 | |||
Net temporary differences | (802,100 | ) | ||
Taxable income | $ 9,528,090 |
Using a 21% rate, compute B&B's tax expense per books and tax payable.
A) Tax expense per books $2,000,899; tax payable $2,169,340.
B) Tax expense per books $2,169,340; tax payable $2,000,899.
C) Tax expense per books $2,169,340; tax payable $2,169,340.
D) Tax expense per books $2,000,899; tax payable $2,000,899.
Explanation: ($9,882,590 + $447,600 permanent differences) × 21% = tax expense per books. Tax payable is always based on taxable income
Difficulty: 2 Medium
Topic: Tax Expense versus Tax Payable
Learning Objective: 06-08 Explain the difference between tax expense per books and tax payable.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
77) B&B Inc.'s taxable income is computed as follows:
Book income before tax | $ 9,882,590 | |||
Net permanent differences | 447,600 | |||
Net temporary differences | (802,100 | ) | ||
Taxable income | $ 9,528,090 |
UB&B's tax rate is 21%. Which of the following statements is true?
A) The temporary differences caused a $168,441 net decrease in B&B's deferred tax liabilities.
B) The permanent differences caused a $93,996 net increase in B&B's deferred tax assets.
C) The permanent differences caused a $93,996 net decrease in B&B's deferred tax assets.
D) The temporary differences caused a $168,441 net increase in B&B's deferred tax liabilities.
Difficulty: 2 Medium
Topic: Tax Expense versus Tax Payable
Learning Objective: 06-08 Explain the difference between tax expense per books and tax payable.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
78) Goff Inc.'s taxable income is computed as follows:
Book income before tax | $ 1,016,200 | |||
Net permanent differences | 77,930 | |||
Net temporary differences | 475,200 | |||
Taxable income | $ 1,569,330 |
Using a 21% rate, compute Goff's tax expense per books and tax payable.
A) Tax expense per books $229,767; tax payable $229,767.
B) Tax expense per books $329,559; tax payable $329,559.
C) Tax expense per books $213,402; tax payable $229,767.
D) Tax expense per books $229,767; tax payable $329,559.
Explanation: ($1,016,200 + $77,930 permanent differences) × 21% = tax expense per books. Tax payable is always based on taxable income.
Difficulty: 2 Medium
Topic: Tax Expense versus Tax Payable
Learning Objective: 06-08 Explain the difference between tax expense per books and tax payable.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
79) Goff Inc.'s taxable income is computed as follows:
Book income before tax | $ 1,016,200 | |||
Net permanent differences | 77,930 | |||
Net temporary differences | 475,200 | |||
Taxable income | $ 1,569,330 |
Goff's tax rate is 21%. Which of the following statements is true?
A) The permanent differences caused a $16,365 net increase in Goff's deferred tax liabilities.
B) The permanent differences caused a $16,365 net increase in Goff's deferred tax assets.
C) The temporary differences caused a $99,792 net increase in Goff's deferred tax assets.
D) The temporary differences caused a $99,792 net increase in Goff's deferred tax liabilities.
Difficulty: 2 Medium
Topic: Tax Expense versus Tax Payable
Learning Objective: 06-08 Explain the difference between tax expense per books and tax payable.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
80) Tax expense per books is based on:
A) Before-tax book income
B) Before-tax book income adjusted for permanent differences
C) Before-tax book income adjusted for temporary differences
D) Before-tax book income adjusted for both permanent and temporary differences
Difficulty: 1 Easy
Topic: Tax Expense versus Tax Payable
Learning Objective: 06-08 Explain the difference between tax expense per books and tax payable.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
81) Which of the following statements about tax expense per books and tax payable is false?
A) If a corporation has no temporary differences between book income and taxable income, tax expense per books equals tax payable.
B) If a corporation has no permanent differences between book income and taxable income, tax expense per books equals tax payable.
C) Tax expense per books and tax payable are calculated from the same rate schedule.
D) If a corporation has no permanent differences between book income and taxable income, tax expense per books equals tax payable and tax expense per books and tax payable are calculated from the same rate schedule.
Difficulty: 2 Medium
Topic: Tax Expense versus Tax Payable
Learning Objective: 06-08 Explain the difference between tax expense per books and tax payable.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
82) Eddy Corporation engaged in a transaction that generated $100,000 book income but only $81,000 taxable income. Which of the following is true?
A) If the $19,000 excess of book income over taxable income is temporary, the transaction has no effect on Eddy's deferred tax accounts.
B) The $19,000 excess of book income over taxable income is an unfavorable difference.
C) If the $19,000 excess of book income over taxable income is permanent, the transaction has no effect on Eddy's deferred tax accounts.
D) None of the above is true.
Explanation: The $19,000 excess of book income over taxable income is a favorable difference.
Difficulty: 2 Medium
Topic: Tax Expense versus Tax Payable
Learning Objective: 06-08 Explain the difference between tax expense per books and tax payable.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
83) Porter Inc. incurred a $20,000 expense only $13,400 of which was deductible. Which of the following is true?
A) This transaction resulted in a $6,600 unfavorable difference between book income and taxable income.
B) This transaction resulted in a $6,600 favorable difference between book income and taxable income.
C) If this transaction resulted in a temporary book/tax difference, it had no effect on Porter's deferred tax accounts.
D) If this transaction resulted in a permanent book/tax difference, it had no effect on the computation of Porter's tax expense per books.
Explanation: A temporary difference affects deferred tax accounts. A permanent difference affects the computation of tax expense per books.
Difficulty: 3 Hard
Topic: Tax Expense versus Tax Payable
Learning Objective: 06-08 Explain the difference between tax expense per books and tax payable.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
84) CSQ Inc. reported $1,339,700 book income before tax this year. CSQ had $46,600 favorable permanent differences and $103,500 unfavorable temporary differences between book income and taxable income. Assuming a 21 percent tax rate, which of the following statements is true?
A) CSQ's tax payable is $271,551.
B) CSQ's tax expense per books is $271,551.
C) CSQ's tax payable is $281,337.
D) CSQ's tax expense per books is $293,286.
Explanation: ($1,339,700 book income − $46,600 favorable permanent differences) × 21% = $271,551 tax expense per books. ($1,339,700 book income − $46,600 favorable permanent differences + $103,500 unfavorable temporary differences) × 21% = $293,286 tax payable.
Difficulty: 3 Hard
Topic: Tax Expense versus Tax Payable
Learning Objective: 06-08 Explain the difference between tax expense per books and tax payable.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
85) Mundo Company is a calendar year, accrual basis taxpayer. In June 2019, Mundo received a $72,000 cash payment from a tenant who leases space in a commercial office building that Mundo owns. The payment was rent for the 24-month period beginning on July 1, 2019. As a result of the payment, Mundo should report:
A) $6,000 book income and taxable income
B) $72,000 book income and taxable income
C) No book income and $72,000 taxable income
D) None of the above
Explanation: Mundo should report $18,000 book income (six months) and $72,000 taxable income.
Difficulty: 3 Hard
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
86) GH&F is a calendar year, accrual basis taxpayer. In October 2019, GH&F received a $18,000 cash payment from a tenant who leases space in a commercial office building that GH&F owns. The payment was rent for the 18-month period beginning on November 1, 2019. As a result of the payment, GH&F should report:
A) $2,000 book income and taxable income
B) $2,000 book income and $18,000 taxable income
C) $18,000 book income and taxable income
D) None of the above
Explanation: GH&F should report $2,000 book income (two months) and $18,000 taxable income.
Difficulty: 2 Medium
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
87) BugLess Inc, a calendar year, accrual basis corporation, provides pest extermination services to its customers. In October 2019, BugLess contracted with Mr. Cass to provide monthly service calls for 24 months. Each service call costs $60, and Mr. Cass prepaid $1,440 when he signed the contract. BugLess made three service calls to Mr. Cass' home in 2019. As a result of the contract, BugLess should report:
A) $1,440 taxable income in 2019.
B) $180 taxable income in 2019, $720 taxable income in 2020, and $540 taxable income in 2021.
C) $180 taxable income in 2019, and $1,260 taxable income in 2020.
D) None of the above
Explanation: Under the special one-year deferral method of accounting for prepaid service income, BugLess recognizes the amount of prepayment earned in 2019 and defers recognition of the remaining prepayment until 2020.
Difficulty: 3 Hard
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
88) Hitz Company, a calendar year, accrual basis taxpayer, recorded $1,735 accrued interest expense and $1,735 accrued interest payable when it closed its books on December 31. The interest relates to a loan from First State Bank and accrued over the last two months of the year. Which of the following statements is true?
A) Hitz can't deduct the accrued interest expense until the year of payment.
B) Hitz can deduct the accrued interest expense this year only if it pays the interest within eight and one-half months after the close of the year.
C) Hitz can deduct the accrued interest expense this year.
D) Hitz can never deduct the interest expense.
Explanation: The accrual satisfies the all-events test and economic performance has occurred.
Difficulty: 2 Medium
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
89) Which of the following statements about the all-events test is false?
A) An accrued expense is not deductible unless the liability for the expense is fixed.
B) An accrued expense is not deductible unless the amount of the expense is determinable with reasonable accuracy.
C) An accrued expense is not deductible unless economic performance with respect to the liability has occurred.
D) None of the above is false.
Difficulty: 1 Easy
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
90) Jackey Company, a calendar year, accrual basis taxpayer, did not pay the $44,200 December rent on its commercial office space until January 8. As result, Jackey's accountant made a routine year-end accrual of $44,200 rent expense. Which of the following statements is true?
A) Jackey can deduct the $44,200 accrued rent expense.
B) Jackey can deduct the $44,200 expense in the year of payment.
C) The accrued rent expense results in a permanent book/tax difference.
D) The accrued rent expense results in a temporary book/tax difference.
Explanation: The accrual satisfies the all-events test and economic performance has occurred.
Difficulty: 2 Medium
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
91) RRK, a calendar year, accrual basis taxpayer, is involved in a legal dispute over an alleged trademark violation. At the end of the year, RRK's accountant recorded a $750,000 accrued expense for the estimated settlement cost of the dispute. Which of the following statements is true?
A) RRK can deduct the $750,000 accrued expense.
B) RRK can't deduct the $750,000 accrued expense because the liability fails the all-events test.
C) RRK can never deduct the $750,000 expense.
D) RRK can deduct the accrued expense only if the dispute is settled within eight and one-half months after the close of the taxable year.
Explanation: The accrued expense fails the all-events test because the liability is not fixed.
Difficulty: 3 Hard
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
92) Timm Inc., a calendar year, accrual basis taxpayer, is being sued by a customer who was injured when she tripped over a loose carpet in Timm's retail store. Timm's auditors required the corporation to accrue a $500,000 contingent liability and current year expense. Which of the following statements is true?
A) Timm can deduct the $500,000 accrued expense.
B) Timm can never deduct the $500,000 expense.
C) Timm can deduct the expense in the year in which the liability becomes fixed and determinable.
D) Timm can deduct the expense in the year of payment.
Explanation: This accrued expense is a payment liability.
Difficulty: 2 Medium
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
93) Unex Company is an accrual basis taxpayer. This year, an employee sued Unex for unlawful age discrimination, and the company's auditors required it to accrue a $500,000 liability for the estimated expense of settling this lawsuit. Which of the following statements is true?
A) Unex can deduct the accrued expense only if it makes a written disclosure to the IRS of the contingent liability.
B) Unex will be allowed a deduction in the year in which its liability for the settlement becomes fixed and the amount of the settlement can be estimated with reasonable accuracy.
C) Unex will be allowed a deduction in the year that it actually pays the settlement to the employee.
D) Unex can never deduct any expense in connection with this lawsuit.
Difficulty: 2 Medium
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
94) Derik Inc., a calendar year, accrual basis corporation, accrued $278,000 vacation pay expense and a corresponding liability at the end of 2019. Derik paid $22,000 of the accrued liability to employees who took vacation between January 1 and March 15, 2020. How much of the accrued vacation pay expense is deductible in 2019?
A) None of the accrued expense is deductible in 2019.
B) $22,000.
C) $256,000.
D) The entire accrued expense is deductible in 2019.
Difficulty: 1 Easy
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
95) Tabco Inc., a calendar year, accrual basis corporation, accrued $48,800 wage and salary expense and a corresponding liability at the end of 2019. How much of the accrued expense is deductible in 2019?
A) None of the accrued expense is deductible in 2019.
B) The entire accrued expense is deductible in 2019.
C) The amount of the accrued expense paid by September 15, 2020, is deductible in 2019.
D) The amount of the accrued expense paid by March 15, 2020, is deductible in 2019.
Difficulty: 1 Easy
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
96) Mr. John Carre owns 67% of the stock of JC Inc. and is employed as the corporation's CEO. The corporation is a calendar year, accrual basis taxpayer. On December 14, 2019, the board of directors authorized a $45,000 year-end bonus for Mr. Carre, which was paid to him on February 1, 2020. In which year can JC Inc. deduct the bonus?
A) 2019.
B) 2020.
C) JC Inc. can deduct only $14,850 (33%) of the bonus in 2019.
D) The related party accrued expense is deductible in the year Mr. Carre includes the bonus payment in gross income. JC Inc. can never deduct the bonus.
Explanation: The related party accrued expense is deductible in the year Mr. Carre includes the bonus payment in gross income.
Difficulty: 2 Medium
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
97) Bendom Inc, a calendar year, accrual basis corporation, hired Rukel Company to provide professional services. Rukel completed the services on November 30, 2019, and immediately sent Bendom a bill for $37,750. Bendom paid the bill on January 4, 2020. Which of the following statements is false?
A) If Bendom and Rukel are related parties, Rukel must report $37,750 income on its 2019 tax return regardless of its method of accounting.
B) If Rukel uses the accrual method, it must report $37,750 income on its 2019 tax return.
C) If Bendom and Rukel are unrelated parties, Bendom can deduct the $37,750 accrued expense on its 2019 tax return.
D) If Bendom and Rukel are related parties, Bendom can deduct the $37,750 accrued expense on its 2019 tax return only if Rukel uses the accrual method of accounting.
Explanation: Even if Bendom and Rukel are related parties, Rukel will report the income based on its method of accounting.
Difficulty: 3 Hard
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
98) On December 19, 2019, Acme Inc., an accrual basis corporation, accrued $50,000 compensation expense for a routine year-end bonus payable to Mrs. Tabor, who is Acme's CFO. Acme paid the $50,000 to Mrs. Tabor on January 15, 2020. Which of the following statements is false?
A) If Mrs. Tabor owns no stock in Acme (i.e. is not a related party), Acme can deduct the accrued expense in 2019.
B) Mrs. Tabor includes her $50,000 bonus in 2020 gross income.
C) If Mrs. Tabor owns 75 percent of Acme's stock (i.e. is a related party), Acme can't deduct the expense until 2020.
D) If Mrs. Tabor owns 75 percent of Acme's stock (i.e. is a related party), Acme can never deduct the bonus expense.
Difficulty: 2 Medium
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
99) On December 19, 2019, Logo Inc., an accrual basis corporation, accrued $50,000 compensation expense for a routine year-end bonus payable to Mr. Craig, who is Logo's CFO. Logo paid the $50,000 to Mr. Craig on April 25, 2020. Which of the following statements is true?
A) If Mr. Craig and Logo are not related parties, Logo can deduct the accrued expense in 2019.
B) If Mr. Craig and Logo are related parties, Mr. Craig must include his $50,000 bonus in 2019 gross income.
C) Regardless of whether Logo and Mr. Craig are related parties, Logo can't deduct the accrued compensation expense in 2019.
D) If Mr. Craig and Logo are not related parties, Mr. Craig can elect to include the $50,000 bonus in gross income in either 2019 or 2020.
Explanation: Logo can't deduct the accrued expense because the bonus was not paid by March 15, 2020.
Difficulty: 2 Medium
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
100) Earl Company uses the accrual method of accounting. Here is a reconciliation of Earl's allowance for bad debts for the current year.
Beginning allowance for bad debts | $ 950,000 | |||
Actual write-offs of accounts receivable during the year | (899,600 | ) | ||
Addition to allowance | 845,000 | |||
Ending allowance for bad debts | $ 895,400 |
Which of the following statements is true?
A) Bad debt expense per books is $845,000, and the deduction for bad debts is $899,600.
B) Bad debt expense per books is $899,600, and the deduction for bad debts is $845,000.
C) Bad debt expense per books and the deduction for bad debts is $899,600.
D) Bad debt expense per books and the deduction for bad debts is $895,400.
Difficulty: 2 Medium
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
101) Monro Inc. uses the accrual method of accounting. Here is a reconciliation of Monro's allowance for bad debts for the current year.
Beginning allowance for bad debts | $ 61,150 | |||
Actual write-offs of accounts receivable during the year | (80,000 | ) | ||
Addition to allowance | 88,500 | |||
Ending allowance for bad debts | $ 69,650 |
Which of the following statements is true?
A) Bad debt expense per books and the deduction for bad debts is $69,650.
B) Bad debt expense per books and the deduction for bad debts is $88,500.
C) Bad debt expense per books is $80,000, and the deduction for bad debts is $88,500.
D) Bad debt expense per books is $88,500, and the deduction for bad debts is $80,000.
Difficulty: 2 Medium
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
102) Two years ago, Ipenex Inc., an accrual basis taxpayer, wrote off a $17,500 account receivable as uncollectible. This year, Ipenex received an entirely unexpected check for $17,500 from the debtor. Which of the following statements is false?
A) The receipt has no effect on current year book income.
B) The receipt has no effect on current year taxable income.
C) Ipenex must recognize $17,500 taxable income under the tax benefit rule.
D) Ipenex credited the receipt to its allowance for bad debts.
Difficulty: 2 Medium
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
103) Earl Company uses the accrual method of accounting. Here is a reconciliation of Earl's allowance for bad debts for the current year.
Beginning allowance for bad debts | $ 950,000 | |||
Actual write-offs of accounts receivable during the year | (899,600 | ) | ||
Addition to allowance | 845,000 | |||
Ending allowance for bad debts | $ 895,400 |
Because of the difference between the GAAP rules and the tax rules for accounting for bad debts, Earl Company has a:
A) $54,600 permanent excess of book income over taxable income.
B) $54,600 permanent excess of taxable income over book income.
C) $54,600 temporary excess of taxable income over book income.
D) $54,600 temporary excess of book income over taxable income.
Explanation: Earl's $899,600 tax deduction is $54,600 more than its book expense, so its taxable income is $54,600 less than book income. The difference is temporary.
Difficulty: 3 Hard
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
104) Monro Inc. uses the accrual method of accounting. Here is a reconciliation of Monro's allowance for bad debts for the current year.
Beginning allowance for bad debts | $ 61,150 | |||
Actual write-offs of accounts receivable during the year | (80,000 | ) | ||
Addition to allowance | 88,500 | |||
Ending allowance for bad debts | $ 69,650 |
Because of the difference between the GAAP and the tax rules for accounting for bad debts, Monro Inc. has an:
A) $8,500 permanent excess of book income over taxable income.
B) $8,500 permanent excess of taxable income over book income.
C) $8,500 temporary excess of taxable income over book income.
D) $8,500 temporary excess of book income over taxable income.
Explanation: Monro's $80,000 tax deduction is $8,500 less than its book expense, so its taxable income is $8,500 more than book income. The difference is temporary.
Difficulty: 3 Hard
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
105) Valley Inc. incurred a $71,400 net operating loss this year. Which of the following statements is true?
A) Valley can use the NOL only as a carryforward deduction.
B) Valley can use the NOL only as a carryback deduction.
C) Valley can elect to use the NOL as a carryforward deduction.
D) None of the above is true.
Difficulty: 1 Easy
Topic: Net Operating Losses
Learning Objective: 06-10 Explain how the NOL deduction smooths taxable income over time.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
106) Shey is single and operates two businesses. This year, business A generated $300,000 of taxable profit. Business B generated a $(625,000) loss. How much of Shey's business loss is not currently deductible due to the excess business loss limitation?
A) $(625,000)
B) $(375,000)
C) $(70,000)
D) $0
Explanation: Shey's net business loss is $(325,000). Because he is single, $(255,000) of this loss is deductible and the $(70,000) excess is not currently deductible.
Difficulty: 1 Easy
Topic: Excess Business Losses
Learning Objective: 06-11 Apply the excess business loss limitation.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
107) Ladow Inc. incurred a $32,000 net operating loss in 2019. If Ladow's 2020 taxable income was $38,000 before NOLs, compute Ladow's 2020 NOL deduction.
A) $0
B) $25,600
C) $30,400
D) $32,000
Explanation: The maximum NOL carryforward deduction equals 80% of taxable income before the deduction ($38,000 × 80% = $30,400).
Difficulty: 1 Easy
Topic: Net Operating Losses
Learning Objective: 06-10 Explain how the NOL deduction smooths taxable income over time.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
108) Which of the following taxpayers is subject to the excess business loss limitation?
A) Delta Corporation, which incurred a $(2 million) business loss this year.
B) Kenny, who is married filing a joint return and incurred a $(675,000) business loss this year.
C) Linda, a single individual, who is a 50 percent partner in QT Partnership. This year, QT incurred a business loss of $(300,000).
D) LetGo Partnership, which incurred a $(730,000) business loss this year.
Explanation: Kenny's loss exceeds the $510,000 threshold for married filing jointly.
Difficulty: 2 Medium
Topic: Excess Business Losses
Learning Objective: 06-11 Apply the excess business loss limitation.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
109) Which of the following statements about the NOL deduction is false?
A) The deduction prevents the tax distortion that could result from an inflexible one-year reporting period.
B) The deduction can reduce taxable income to zero in carryforward years.
C) The deduction has value based on the NPV of its related tax savings.
D) None of the above statements is false.
Difficulty: 2 Medium
Topic: Net Operating Losses
Learning Objective: 06-10 Explain how the NOL deduction smooths taxable income over time.
Accessibility: Keyboard Navigation
Type: Static
Gradable: automatic
110) Assuming a 21% marginal tax rate, compute the after-tax cost of the following business expenses.
a. $12,300 business meals.
b. $42,000 rent on factory equipment.
c. $8,050 business entertainment.
a. $13,592 ($12,300 expense − $1,845 tax savings from $6,150 deduction).
b. $33,180 ($42,000 expense − $8,820 tax savings from deduction).
c. $8,050 nondeductible expense.
Difficulty: 1 Easy
Topic: Tax Policy Objectives
Learning Objective: 06-04 Explain why tax policy objectives affect the taxable income computation.
Accessibility: Keyboard Navigation
Type: Static
Gradable: manual
111) Randall Company uses the calendar year and the cash method of accounting. On December 31, 2019, Randall made the following cash payments. To what extent can Randall deduct the payments in 2019?
a. $50,000 for a two-year warehouse lease beginning on March 1, 2020.
$b. 95,000 of inventory items held for sale to customers.
c. $1,800 to purchase a new refrigerator for the employees' lounge. The refrigerator was delivered on February 1, 2020.
d. $5,000 compensation to a consultant who spent two weeks in January 2020 analyzing Randall's payroll system.
e. $22,000 property tax to the local government for the first six months of 2020.
a. None of the payment is deductible in 2019.
b. None of the payment is deductible in 2019.
c. None of the payment is deductible in 2019.
d. $5,000 is deductible in 2019.
e. $22,000 is deductible in 2019.
Difficulty: 2 Medium
Topic: The Cash Method
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.
Accessibility: Keyboard Navigation
Type: Static
Gradable: manual
112) Zephex is a calendar year corporation. On December 1, 2019, Zephex received a $12,000 check from a tenant that leases office space owned by Zephex. This payment was rent for the four-month period from December 1, 2019, through March 31, 2020. On December 2, 2019, Zephex billed a client $38,250 for services rendered to the client in November. The client did not pay the bill until January 14, 2020.
a. If Zephex is a cash basis taxpayer, how much 2019 income should it recognize with respect to the above transactions?
b. If Zephex is an accrual basis taxpayer, how much 2019 book income should it report and how much 2019 taxable income should it recognize with respect to the above transactions?
a. Zephex should recognize $12,000 rent income and no service income.
b. For book purposes, Zephex should report $3,000 rent income (earned in December) and $38,250 service income. For tax purposes, Zephex should recognize $12,000 rent income (under the prepaid income rule) and $38,250 service income.
Difficulty: 2 Medium
Topic: The Cash Method; Temporary Book/Tax Accounting Differences
Learning Objective: 06-05 Apply the cash method of accounting to compute taxable income.; 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: manual
113) Krasco Inc.'s auditors prepared the following reconciliation between book and taxable income. The corporation has a 21% tax rate.
Book income before tax | $ 8,288,900 | |||
Net permanent differences | (35,770 | ) | ||
Net temporary differences | 112,400 | |||
Taxable income | $ 8,365,530 |
a. Compute Krasco's tax expense per books and tax payable.
b. Compute Krasco's net increase in deferred tax assets or deferred tax liabilities (identify which) for the year.
a. Tax expense per books is $1,733,157 ([$8,288,900 − $35,770 permanent differences] × 21%). Tax payable is $1,756,761 ($8,365,530 × 21%).
b. Krasco's net deferred tax assets increase by $23,604 ($112,400 unfavorable temporary differences × 21%).
Difficulty: 3 Hard
Topic: Permanent versus Temporary Differences; Tax Expense versus Tax Payable
Learning Objective: 06-07 Differentiate between a permanent and a temporary book/tax difference.; 06-08 Explain the difference between tax expense per books and tax payable.
Accessibility: Keyboard Navigation
Type: Static
Gradable: manual
114) Marchal Inc., a calendar year, accrual basis taxpayer, made the following state income tax payments during 2019.
|
|
|
|
March 11 | Balance due of 2018 tax | $ | 13,600 |
April 2 | Estimated 2019 tax payment | $ | 15,250 |
June 2 | Estimated 2019 tax payment | $ | 15,250 |
September 3 | Estimated 2019 tax payment | $ | 15,250 |
December 2 | Estimated 2019 tax payment | $ | 15,250 |
On December 28, Marchal's tax department calculated that the corporation's actual 2019 state income tax liability was $67,140. Consequently, Marchal accrued a $6,140 liability for state income tax payable at year end.
a. Compute Marchal's 2019 state income tax expense per books.
b. If Marchal has not adopted the recurring item exception as its method of accounting for state income taxes, compute Marchal's 2019 federal deduction for state income tax.
a. Marchal's state income tax expense is $67,140.
b. Marchal's federal deduction for state income tax is $74,600 (tax paid during 2019).
Difficulty: 1 Easy
Topic: Temporary Book/Tax Accounting Differences
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.
Accessibility: Keyboard Navigation
Type: Static
Gradable: manual
115) Slumar, an accrual basis, calendar year corporation, reported $7,289,200 net income before tax on its financial statement prepared in accordance with GAAP. The corporate records reveal the following information.
The allowance for bad debts on January 1 was $104,700. Write-offs for the year totaled $113,228, and the addition to the allowance for the year was $105,000.
Slumar incurred $22,000 of entertainment costs and $32,000 of business meals.
At its December 16 meeting, Slumar's board of directors authorized a $100,000 salary bonus for the corporation's CEO. Slumar paid the bonus to the CEO on January 4. The CEO owns 62% of Slumar's outstanding stock.
Slumar was incorporated last year. On its first tax return, it reported a $334,712 net operating loss.
Compute Slumar's taxable income.
Book income | $ 7,289,200 | |||
Bad debt deduction in excess of book expense | (8,228 | ) | ||
Entertainment costs | 22,000 | |||
50% of meals | 16,000 | |||
Nondeductible related party accrual | 100,000 | |||
NOL carryforward deduction | (334,712 | ) | ||
Taxable income | $ 7,084,260 |
Difficulty: 3 Hard
Topic: Temporary Book/Tax Accounting Differences; Net Operating Losses
Learning Objective: 06-09 Apply the tax accounting rules for prepaid income and accrued expenses.; 06-10 Explain how the NOL deduction smooths taxable income over time.
Accessibility: Keyboard Navigation
Type: Static
Gradable: manual