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ACC 377 Lecture Notes - Lecture 3: Accrual, Basis Of Accounting, Financial Accounting

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indigolion532
18 May 2018
School
EMU
Department
Accounting
Course
ACC 377
Professor
Brickner

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income subject to the federal income tax. gross income does not include all economic income. That is,
certain exclusions are allowed
recovery of capital doctrine
when a taxable sale or exchange occurs, the seller may be permitted to recover his or her investment in
the property before gain or loss is recognized
income
an increase of wealth that has been realized
economic income
the change in the taxpayer's net worth, as measured in terms of market values, plus the value of the
assets the taxpayer consumed during the year. Not used for tax purposes
accounting income
the accountant's concept of income is generally based upon the realization principle. Financial
accounting income may differ from taxable income
taxable year
the annual period over which income is measured for income tax purposes. most individuals use a
calendar year , however some use a fiscal year
accounting method
the method under which income and expenses are determined for tax purposes. Important accounting
methods include the cash basis and the accrual basis
cash receipts method
a method of accounting that reflects deductions as paid and income as received in any one tax year
accrual method
a method of accounting that reflects expenses incurred and income earned for any one tax year
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Document Summary

Income subject to the federal income tax. gross income does not include all economic income. Not used for tax purposes accounting income the accountant"s concept of income is generally based upon the realization principle. Such a procedure will not avoid income recognition by the taxpayer making the assignment if the income was earned at the point of the transfer. In this case, the income is taxed to the person who earns it partnership for income tax purposes, a partnership includes a syndicate, group, pool, or joint venture, as well as ordinary partnerships. In an ordinary partnerships two or more parties combine capital and/or services to carry on a business for profits as co-owners. S corporation the designation for a small business corporation community property. Louisiana, texas, new mexico, arizona, california, washington, idaho, nevada, and wisconsin have community property systems. Alaska residents can elect community property status for assets.

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Related Questions

The IRS, Congress, and the courts have rejected the economicconcept of income as impractical. The Supreme Court expressed aninclination toward the accounting concept of income. For tax purposes, "Income" represents an increase inwealth recognized for tax purposes only upon realization. Which ofthe following choices is a correct statement of the taxlaw?

a. The courts allow into evidence the method used by the IRSto reconstruct a taxpayer’s unreported taxable income. This methodmeasures the increase in the taxpayer’s net assets from thebeginning of the year to the end of the year. The increase in thetaxpayer’s net assets that exceeds the taxable income reported bythe taxpayer is the amount of unreported taxable income attributedto the taxpayer. The assets included in this calculation arelimited to “titled” assets, and the value of the “titled” assets isbased on the actual cost of acquisition. Thus, the taxpayer isattributed with taxable income based on the mere annual increase inthe net assets even though the taxpayer did not sell these assetsin a taxable transaction.

b. The courts allow into evidence the method used by the IRSto reconstruct a taxpayer’s unreported taxable income. This methodmeasures the increase in the taxpayer’s net assets from thebeginning of the year to the end of the year. The increase in thetaxpayer’s net assets that exceeds the taxable income reported bythe taxpayer is the amount of unreported taxable income attributedto the taxpayer. The assets included in this calculation includeall assets, and the value of all assets is based on the fair valueat date of acquisition. Thus, the taxpayer is attributed withtaxable income based on the mere annual increase in the net assetseven though the taxpayer did not sell these assets in a taxabletransaction.

c. The courts allow into evidence the method used by the IRSto reconstruct a taxpayer’s unreported taxable income. This methodmeasures the increase in the taxpayer’s net assets from thebeginning of the year to the end of the year. The increase in thetaxpayer’s net assets that exceeds the taxable income reported bythe taxpayer is the amount of unreported taxable income attributedto the taxpayer. The assets included in this calculation arelimited to “titled” assets, and the value of the “titled” assets isbased on the fair value at date of acquisition. Thus, the taxpayeris attributed with taxable income based on the mere annual increasein the net assets even though the taxpayer did not sell theseassets in a taxable transaction.

d. The courts have consistently refused to allow the IRS toreconstruct the taxpayer’s unreported taxable income based upon anycalculation of taxable income other than what is used in filing atax return. The courts have reasoned that such alternativecalculations are too speculative and violate the taxpayer’sconstitutional right of due process.

e. None of the other choices are correct.

Architect, a cash basis TP, has been conducting a business as a sole proprietorship for several years. Architect decides to incorporate, and on July 1 of the current year he forms Design, Inc., to which he transfers the following assets:

Assets AB FMV

Accounts Receivable $0 $60,000

Supplies 0 20,000

Unimproved Land 60,000 120,000

Total $60,000 $200,000

The land was subject to contingent environmental liabilities that Architect had not taken into account (i.e., had not deducted or capitalized) for tax purposes at the time of the incorporation. The supplies were acquired nine months ago and their cost was immediately deducted by Architect as an ordinary and necessary business expense.

In exchange, Architect receives 100 shares of Design common stock with a FMV of $100,000. In addition, Design assumes $70,000 of accounts payable to trade creditors of Architect's sole proprietorship and a $30,000 bank loan incurred by Architect two years ago for valid business reasons, and it assumed the environmental liabilities associated with the land.

Design elects to become a cash method, calendar year TaxPayer. During the remainder of the current year, it pays $30,000 of the accounts payable and collects $40,000 of the accounts receivable transferred by Architect. In the following taxable year, Design paid $20,000 in environmental remediation expenses that qualified for a current deduction when paid or accrued under Section 162.

(a)What are the tax consequences (gain or loss recognized, basis and holding period) of the incorporation to Architect and Design, Inc.?

(b) Who will be taxable upon collection of the accounts receivable: Architect, Design or both?

(c) When Design pays the accounts payable assumed from Architect and incurs the environmental remediation costs, may it properly deduct these expenses?

(d)Assume that Architect is in the highest marginal individual tax bracket and Design, Inc. anticipates no significant TI for the current year:

•What result, if Architect decides to pay (and deduct) personally all the accounts payable. and transfers the accounts receivable to the C?

(e) Would your answers be any different if Architect had been an accrual method Taxpayer?

(f) Is Design, Inc. limited in its choice of accounting method (i.e., cash or accrual) or taxable year? See §§ 441; 448

What is the net Form W-2 wages?

What is miscellaneous income?

What is Schedule B income (Interest anddividends)?

What is Schedule C net income (Businessincome)?

What is Schedule D net income (Capital gains andlosses)?

What is Schedule E depreciation (Rentalproperty)?

What is Schedule E net income (Rental income & Sub-Sincome)?

What is the total “For AGI” deductions?

What is Adjusted Gross Income?

What is the Schedule A deduction for taxes?

What is the Schedule A deduction for interestexpense?

What is the Schedule A deduction for charitablecontributions?

What is the Schedule A total itemizeddeductions?

What is the total personal and dependentexemptions?

What is taxable income?

What is the tax on ordinary income?

What is the tax on long-term capital gain (loss) andqualified dividends?

What is the self-employment tax?

What is the kiddie tax?

What is the balance due or (refund)?

Answer above questions with the factsbelow:

Paul Turner is single and has two children, Allen and Lee Ann,from his previous marriage. Allen lives with Paul and Paul providesmore than half of his support. In the current year, Allen earned$300 of interest income and $5,000 working at a fast-foodrestaurant. Allen graduated from high-school in December 2015 andwas not a registered student during 2016. Lee Ann lives with hermother, Wilma (Lee Ann lived with Wilma for all of the currentyear). Wilma provides more than half of Lee Ann's support. Paulpays “alimony” of $400 per month to Wilma. The payments are tocontinue until Lee Ann reaches age 18, when they will be reduced to$250. Paul uses the cash method of accounting and a calendar yearfor reporting. Paul's birthday is May 31, 1975. Allen's birthday isOctober 5, 1998. Lee Ann's birthday is December 1, 2002. Paulprefers to report any “kiddie tax” on his tax return.

Paul is employed as a nuclear engineer with Atom SystemsConsultants, Inc. (ASCI). Paul's pay stubs indicate that he had$7,320 withheld in federal taxes, $4,987 in state taxes. He earned$80,000 of wages subject to employee Social Security taxes andMedicare taxes. ASCI has an extensive fringe benefits program forits employees.

Paul earned salary of $82,500 (before subtracting his 401(k) andflexible spending plan contributions). He contributed $6,500 to his401(k) account, and he contributed $2,600 to his flexible spendingaccount.

ASCI paid $497 of whole life insurance premiums to cover Paul'spersonal whole life insurance policy. ASCI also paid health clubdues of $825 to a nearby health club on Paul's behalf.

Taking advantage of ASCI's educational assistance program,during the fall Paul enrolled in two graduate engineering classesat a local college. ASCI paid his tuition, fees, and othercourse-related costs of $5,300.

Paul received free parking in the company's security garage thatwould normally cost $200 per month.

Paul manages the safety program for ASCI. In recognition of hissuperior handling of three potential crises during the year, Paulwas awarded the Employee Safety Award on December 15. The cashaward was $400.

On January 15, of the current year, Paul's father died. From hisfather's estate, he received stock valued at $30,000 (father’sbasis was $12,000) and his father's house valued at $95,000(father’s basis in the house was $55,000).

Paul owns several other investments and received the followinginformation reports for the current tax year:

Form 1009-Div:

General Dynamics – Gross qualified dividends - $400

Form 1099-Int

New Jersey Economic Development bonds – Gross interest -$300

IBM bonds – Gross interest - $600

State of Nebraska bonds – Gross Interest - $200

Form 1098-Mortgage InterestStatement

Sunbelt Credit Union – Mortgage interest - $7,100

Northeast Bank – Home-equity loan interest - $435

Form K-1 Grubstake Mining andDevelopment:

Distribution to shareholder - $1,000

Ordinary income (1% of $200,000) - $2,000

In addition to the investments discussed above, Paul owns 1,000shares of Grubstake Mining & Development common stock.Grubstake is organized as an S corporation and has 100,000 sharesoutstanding. Grubstake reported taxable income of $200,000 and paida distribution of $1.00 per share during the current year. Pauldoes not materially participate in Grubstake's activities.

Paul slipped on a wet spot in front of a computer store lastJuly. He broke his ankle and was unable to work for two weeks. Heincurred $1,300 in medical costs, all of which were paid by theowner of the store. The store also gave him $1,000 for pain andsuffering resulting from the injury. ASCI did not pay his salaryduring the two weeks he missed because of the accident. However,ASCI's disability insurance plan paid him $1,500 in disability payfor the time he was unable to work. Under this plan, ASCI pays thepremiums of $500 for the disability insurance as a taxable fringebenefit. The disability plan premiums and the disability benefitpayments were not included in Paul’s W-2 wages reported inparagraph 3.

Paul received a Form 1099-B from his broker for the sale of thefollowing securities during the current year. The adjusted basisamounts were reported to the IRS.

Security

Sale Date

Purchase Date

Sales Price

CommissionPaid Sale

His Basis

Nebraska bonds

03/14/16

10/22/07

$2,300

$200

$1,890

Cassill Corp

(500 shares)

10/20/16

02/19/12

$8,500

$425

$9,760

In addition to the taxes withheld from his salary, he also madetimely estimated federal tax payments of $175 per quarter andtimely estimated state income tax payments of $150 for the firstthree quarters. The $150 fourth-quarter state payment was made onDecember 28 of the current year. Paul would like to receive arefund for any overpayment.

In August of the current year, he received a federal refund of$60 and a state tax refund of $200 related to the tax returns hefiled for the prior year. His itemized deductions for the prioryear were $18,430.

Paul found a renter for his father's house on August 1. Themonthly rent is $400, and the lease agreement is for one year. Thelease requires the tenant to pay the first and last months' rentand a $400 security deposit. The security deposit is to be returnedat the end of the lease if the property is in good condition. OnAugust 1, Paul received $1,200 from the tenant per the terms of thelease agreement. In November, the plumbing froze and several pipesburst. The tenant had the repairs made and paid the $300 bill. InDecember, he reduced his rental payment to $100 to compensate forthe plumbing repairs. Paul provides you with the followingadditional information for the rental in the current year.

Propertytaxes $720

Other maintenanceexpenses 285

Insuranceexpense 495

Managementfee 350

Depreciation (to becomputed) ?

Local practice is to allocate 10percent of the fair market value of the property to the land. (See¶8 for basis information.) Paul makes all decisions with respect tothe property.

Paul paid $2,050 in real estate taxes on his principalresidence. The real estate tax is used to pay for town schools andother municipal services.

Paul drives a 2013 Acura TL. His car registration fee (based onthe car year) is $50 and covers the period 1/1/16 through 12/31/16.In addition, he paid $280 in property tax to the state based on thebook value of the car.

In addition to the medical costs presented in ¶11, Paul incurredthe following unreimbursed medical costs:

Dentist $ 310

Doctor 390

Prescriptiondrugs 215

Over-the-counterdrugs 140

Optometrist 125

Emergency room charges 440

LASIK eyesurgery 2,000

Chiropractor 265

On April 1, Paul took advantage of low interest rates andrefinanced his $75,000 home mortgage with her original lender. Thenew home loan is for 15 years. He paid $215 in closing costs and$1,600 in discount points (prepaid interest) to obtain the loan.The house is worth $155,000, and Paul's basis in the house is$90,000. As part of the refinancing arrangement, he also obtained a$10,000 home-equity loan. He used the proceeds from the home-equityloan to reduce the balance due on her credit cards. Paul receivedseveral Form 1098 statements from her bank for interest paid by himin the current year. Details appear below. (See also ¶9)

Primary homemortgage $7,100

Home-equityloan 435

Creditcards 498

Carloan 390

On May 14 of the current year, Paul contributed clothing to theSalvation Army. The original cost of the clothing was $740. He hassubstantiation valuing the donation at $360. In addition, he madethe following cash contributions and received a statement from eachof the following organizations acknowledging his contribution:

LarkinCollege $800

UnitedWay 152

First MethodistChurch 790

Amos House (homelessshelter) 200

Local Chamber ofCommerce 100

On April 1 of the current year, Paul's house was robbed. Heapparently interrupted the burglar because all that's missing is anantique brooch he inherited from his grandmother (June 12, 2005)and $300 in cash. Unfortunately, he didn't have a separate rider onher insurance policy covering the jewelry. Therefore, the insurancecompany reimbursed him only $500 for the brooch. His basis in thebrooch was $6,000, and its fair market value was $7,500. Hisinsurance policy also limits to $100 the amount of cash that can beclaimed in a theft.

Paul sells real estate in the evening and on weekends(considered an active trade or business). He runs his business froma rental office he shares with several other realtors. Paul hasbeen operating in a business-like way since 2003 and has alwaysshown a profit. He had the following income and expenses from hisbusiness:

Commissionsearned $21,250

Expenses:

Advertising 2,200

Telephone 95

Real estate license 130

Rent 6,000

Utilities 600

He has used his Acura TL in his business during the currentyear. During the year, he properly documented 5,000 business miles.The total mileage on his car (i.e., business-use and personal-usemiles) during the year was 15,000 miles. Paul elects to use thestandard mileage method to calculate his car expenses. He spent $45on tolls and $135 on parking related to the real estatebusiness.

Paul's company has an accountable expense reimbursement plan foremployees from which Paul receives $12,000 for the followingexpenses:

Airfare $4,700

Hotel 3,400

Meals 2,000

Car rentals 600

Entertainment 900

Incidentals 400

Total 12,000

During the current year, Paul also paid $295 for businesspublications other than those paid for by his employer and $325 fora local CPA to prepare his tax return for the prior year.