chapter 06 taxable income from business operations answer key

Chapter 06 Taxable Income from Business Operations

Chapter 06 Taxable Income from Business Operations Answer Key True / False Questions

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1. For federal tax purposes, gross income from the sale of tangible goods is reduced by the seller's cost of goods sold. TRUE2. Taxable income is defined as gross income minus allowable deductions and credits. FALSE3. 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. FALSE4. A firm's choice of taxable year is usually dictated by the annual operating cycle of the firm's business. TRUE 5. Rydel Inc. was incorporated on August 9 and elected to use a calendar year for tax purposes. Rydel must annualize the income reported on its first tax return for the short period from August 9 to December 31. FALSE6. A taxpayer that operates more than one business may use a different method of accounting for each business. TRUE7. PPQ Inc. wants to change from a hybrid method of accounting to the accrual method of accounting for tax purposes. PPQ cannot make this change without receiving permission from the IRS. TRUE8. Every taxpayer may adopt either the cash receipts and disbursements method, the accrual method, or a hybrid method of accounting for tax purposes. FALSEMany large corporations are prohibited from using the cash method for tax purposes.9. Accurate measurement of taxable income is the only objective of the federal income tax laws. FALSE10. Federal and state political lobbying expenses are nondeductible. TRUE11. The after-tax cost of a dollar of meal and entertainment expense is 80 cents for a taxpayer with a 40% marginal tax rate. TRUEOnly 50 cents of the expense is deductible, so the tax savings at a 40% rate is only 20 cents.12. Poole Services, a calendar year taxpayer, billed a client for $1,675 of services on November 30, 2009, and received a check in full payment from the client on January 12, 2010. If Poole is a cash basis taxpayer, it reports $1,675 taxable income in 2009. FALSE13. Poole Company, a calendar year taxpayer, incurred $589 of long-distance telephone charges in December 2009 and mailed a check to the telephone company on January 4, 2010. If Poole is a cash basis taxpayer, it reports a $589 tax deduction in 2010. TRUE14. Mr. Stern, a cash basis taxpayer, was notified by his bank that he earned $1,193 of interest on his savings account in 2000. Mr. Stern has not withdrawn any funds from this account for eight years and did not receive the notification until January 26, 2010. Mr. Stern does not recognize the interest as income in 2009. FALSEHe must recognize the interest as income under the doctrine of constructive receipt.15. A cash basis taxpayer must account for any prepayment of interest expense under the accrual method. TRUE16. 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. TRUE

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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. FALSEUnder the 12-month rule, Elcox must deduct the $6,340 expense over the 36-month term of the payment.18. Taxpayers that sell merchandise to their customers must use the accrual method to account for purchases and sales of merchandise. TRUE19. Taxpayers that sell merchandise to their customers must use the accrual method as their overall method of accounting. FALSEThey must use the accrual method only for purchases and sales of merchandise.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. FALSEPersonal service corporations can use the cash method regardless of the amount of their gross receipts.21. Laine Services, a calendar year taxpayer, billed a client for $8,450 of services on November 30, 2009, and received a check in full payment from the client on January 12, 2010. If Poole is an accrual basis taxpayer, it reports $8,450 taxable income in 2009. TRUE22. Keagan Company, a calendar year taxpayer, incurred $1,490 of long-distance telephone charges in December 2009 and mailed a check to the telephone company on January 4, 2010. If Poole is an accrual basis taxpayer, it reports a $1,490 tax deduction in 2010. FALSE23. 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. TRUE24. The principle of conservatism reflected by GAAP is identical to that reflected in the tax law. FALSE25. A permanent difference between book income and taxable income affects only one taxable year. TRUE26. 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. FALSE27. Income tax expense per books is based on book income adjusted for all book/tax differences. FALSEIncome tax expense per books is based on book income adjusted for all permanent book/tax differences.28. An unfavorable temporary book/tax difference generates a deferred tax asset. TRUE29. A corporation cannot have an increase in deferred tax assets and an increase in deferred tax liabilities in the same year. FALSEChanges 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.30. If an accrual basis taxpayer receives a prepayment of rent income, the receipt results in an unfavorable temporary book/tax difference. TRUE31. If an accrual basis taxpayer prepays interest expense, the payment results in an unfavorable temporary book/tax difference. FALSE

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The accounting treatment of prepaid interest expense is the same for book and tax purposes.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. TRUE33. An accrual basis taxpayer must account for a legal settlement resulting from a tort under the cash method. TRUE34. 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. FALSEAccrued state income taxes are a payment liability that can be deducted only in the year in which payment is made.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. FALSEAs a result, Huml has a temporary unfavorable book/tax difference. The all-events test affects the timing, not the fact, of a deduction.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. TRUEGong's deduction is deferred only if Mexance used the cash method of accounting.37. The tax law does not allows deductions based on estimated expenses that result in an allowance or reserve for financial statement purposes. TRUE 38. 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. FALSEMolton must use the direct-write off method for tax purposes.39. Bolton Inc., a calendar year taxpayer, generated a $296,400 net operating loss in 2009. Bolton can carry the loss back three years and forward 20 years for tax purposes. FALSEThe carryback period is two years.40. 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. FALSEThe NOL resulted in a deferred tax asset that will reverse in the future.

Multiple Choice Questions

41. 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.

42. 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.

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43. 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 yearB. Fiscal year ending June 30C. Fiscal year ending August 31D. Pim can adopt a calendar year or any fiscal year as its taxable year.A corporate taxpayer can adopt a calendar year or any fiscal year.

44. 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. Statements a. and b. are true.

45. 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 must annualize its taxable income on its final tax return.D. None of the above is false.Income on a short-period return is not annualized if the reason for the short-period is that the corporation was not in existence for the entire year.46. Toro Inc. received permission from the IRS to change its taxable year from a fiscal year ending July 31 to a calendar year. Consequently, Toro filed a short period return for the five-month period from August 1 through December 31. The taxable income reported on the return was $65,000. Use the corporate tax rates on the front cover of the text to compute Toro's tax on this income (to the nearest dollar). A. $11,250B. $18,371C. $25,350D. $44,090Toro's tax must be computed based on $156,000 annualized income ([$65,000/5] * 12). The tax is $18,371 ([$44,090 tax on $156,000/12] * 5).

47. HHF Corporation received permission from the IRS to change its taxable year from a fiscal year ending August 31 to a calendar year. Consequently, HHF filed a short period return for the four-month period from September 1 through December 31. The taxable income reported on the return was $56,000. Use the corporate tax rates on the front cover of the text to compute HHF's tax on this income (to the nearest dollar). A. $9,000B. $14,000C. $16,257D. $48,770HHF's tax must be computed based on $168,000 annualized income ([$56,000/4] * 12). The tax is $16,257 ([$48,770 tax on $168,000/12] * 4).

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48. Which of the following statements about short-period returns is true? A. If a taxpayer must file a short-period return because the IRS granted permission for a change in the taxpayer's year, the tax for the year must be based on annualized income.B. The tax on a short-period return must be based on annualized income only if the taxpayer failed to obtain permission from the IRS to change its taxable year.C. The tax on every short-period return must be based on annualized income.D. None of the above is true.

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49. 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.

50. Which of the following methods of accounting is never permissible for computing taxable income? A. Cash receipts and disbursements methodB. Accrual methodC. Hybrid method that combines the cash and accrual methodsD. All of the above are permissible methods of accounting

51. When related parties enter into business transactions A. The parties must account for the transactions using the same method of accounting.B. The IRS has the right to reallocate income from the transactions to prevent distortion.C. The cash method of accounting must be used to account for such transactions.D. None of the above.

52. Which of the following business expenses always results in a difference between taxable income and book income? A. Rent expenseB. Interest expenseC. Client entertainmentD. Salary expenseOnly 50% of client entertainment expense is deductible.

53. Why does the federal tax law not allow 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.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.

54. Why does the federal tax law not allow 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.

55. 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 will not be taxable income.B. Stack Inc. can deduct the annual premium as a business expense. If Stack ever collects the $1 million death benefit, the benefit will be taxable income.C. Stack Inc. cannot deduct the annual premium as a business expense. If Stack ever collects the $1 million death benefit, the benefit will be taxable income.D. None of the statements is true.

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Stack Inc. cannot deduct the annual premium as a business expense. If Stack ever collects the $1 million death benefit, the benefit will not be taxable income.

56. Which of the following statements about the domestic production activities deduction is false? A. This deduction is a tax preference.B. This deduction is intended to help U.S. businesses compete in the global marketplace.C. This deduction improves the measurement of taxable business income.D. This deduction creates a permanent difference between book income and taxable income.

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.

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 should recognize: A. No taxable incomeB. $1,930 taxable incomeC. $15,000 taxable incomeD. $16,930 taxable income

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 must recognize: A. No taxable incomeB. No taxable income until it sells the ConAgri shares for cashC. $24,500 taxable incomeD. It is illegal for a cash basis taxpayer to accept a noncash payment.

60. On December 12, 2009, 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 2009.B. According to the substance over form doctrine, Hook does not recognize $5,600 income until 2010.C. As a cash basis taxpayer, Hook does not recognize $5,600 income until 2010.D. As a cash basis taxpayer, Hook can elect to recognize $5,600 income in either 2009 or 2010.

61. Which of the following statements about the constructive receipt doctrine is false? A. The doctrine applies to cash basis taxpayers but not to accrual 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.

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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 physical 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.

63. Eaton Inc. is a calendar year, cash basis taxpayer. On October 1, 2009, 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 2009.B. Eaton can deduct $600 in 2009 and the remaining $4,200 in 2010.C. Eaton can deduct $600 in 2009, $2,400 in 2010, and $1,800 in 2011.D. None of the above is true.Because the expense resulted in a benefit extending more than 12 months, Eaton must capitalize it and amortize it over 24 months.

64. Addis Company operates a retail men's clothing store. Because Addis has merchandise inventory, it must: A. Use the accrual method as its overall method of accounting.B. Use the accrual method to account for sales of merchandise.C. Use the accrual method to account for purchases of merchandise.D. Use the accrual method to account for both sales and purchases of merchandise.

65. Which of the following businesses cannot use the cash receipts and disbursement method of accounting for tax purposes? A. A sole proprietorship with $8 million average annual gross receiptsB. A corporation with $15 million average annual gross receiptsC. A partnership with six individual partners with $20 million average annual gross receiptsD. A personal service corporation with $50 million average annual gross receipts66. Which of the following businesses is prohibited from using the cash receipts and disbursement method of accounting for tax purposes? A. A partnership with two individual partners with $9 million average annual gross receiptsB. A personal service corporation with $8 million average annual gross receiptsC. A corporation with $3 million average annual gross receiptsD. None of the businesses are prohibited from using the cash methodCorporations with $5 million or less average annual gross receipts are allowed to use the cash method.

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.

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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.

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.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.

70. Which of the following statements describes a permanent book/tax difference? A. An expense that is reported on this year's income statement but is deducted on next year's tax returnB. A revenue item that is included in current year taxable income but is not reported on the income statement until next yearC. An expense that is never deductibleD. A revenue item that is reported on this year's income statement but will not be included in taxable income until an indefinite future year

71. Which of the following does not result in a permanent book/tax difference? A. Business meal and entertainment expenseB. Domestic production activities deductionC. Premiums paid on key-person life insurance policiesD. All of the above result in a permanent book/tax difference.

72. Which of the following does not result in a permanent book/tax difference? A. Tax-exempt interest on state and local bondsB. NOL carryforwardsC. Domestic production activities deductionD. Lobbying expenses

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.

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74. Southlawn Inc.'s taxable income is computed as follows.

Using a 34% rate, compute Southlawn's tax expense per books and tax payable. A. Tax expense per books $643,824; tax payable $579,564B. Tax expense per books $579,564; tax payable $643,824C. Tax expense per books $817,904; tax payable $579,564D. None of the above($2,405,600 - $512,000 permanent differences) * 34% = tax expense per books. Tax payable is always based on taxable income.

75. Southlawn Inc.'s taxable income is computed as follows.

Southlawn's tax rate is 34%. Which of the following statements is true? A. The permanent differences caused a $174,080 net increase in Southlawn's deferred tax liabilities.B. The permanent differences caused a $174,080 net decrease in Southlawn's deferred tax liabilities.C. The temporary differences caused a $64,260 net increase in Southlawn's deferred tax liabilities.D. The temporary differences caused a $64,260 net decrease in Southlawn's deferred tax liabilities.

76. B&B Inc.'s taxable income is computed as follows.

Using a 34% rate, compute B&B's tax expense per books and tax payable. A. Tax expense per books $3,360,081; tax payable $3,239,551B. Tax expense per books $3,512,265; tax payable $3,239,551C. Tax expense per books $3,512,265; tax payable $3,512,265D. Tax expense per books $3,087,367; tax payable $3,087,367($9,882,590 + $447,600 permanent differences) * 34% = tax expense per books. Tax payable is always based on taxable income.

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77. B&B Inc.'s taxable income is computed as follows.

B&B's tax rate is 34%. Which of the following statements is true? A. The temporary differences caused a $272,714 net decrease in B&B's deferred tax liabilities.B. The permanent differences caused a $152,184 net increase in B&B's deferred tax assets.C. The permanent differences caused a $152,184 net decrease in B&B's deferred tax assets.D. The temporary differences caused a $272,714 net increase in B&B's deferred tax liabilities.

78. Goff Inc.'s taxable income is computed as follows.

Using a 34% rate, compute Goff's tax expense per books and tax payable. A. Tax expense per books $345,508; tax payable $372,004B. Tax expense per books $345,508; tax payable $533,572C. Tax expense per books $507,076; tax payable $372,004D. Tax expense per books $372,004; tax payable $533,572($1,016,200 + $77,930 permanent differences) * 34% = tax expense per books. Tax payable is always based on taxable income.

79. Goff Inc.'s taxable income is computed as follows.

Goff's tax rate is 34%. Which of the following statements is true? A. The permanent differences caused a $26,496 net increase in Goff's deferred tax liabilities.B. The permanent differences caused a $26,496 net increase in Goff's deferred tax assets.C. The temporary differences caused a $161,568 net increase in Goff's deferred tax assets.D. The temporary differences caused a $161,568 net increase in Goff's deferred tax liabilities.

80. Tax expense per books is based on: A. Before-tax book incomeB. Before-tax book income adjusted for permanent differencesC. Before-tax book income adjusted for temporary differencesD. Before-tax book income adjusted for both permanent and temporary differences

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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 both calculated from the same rate schedule.D. Statements b. and c. are both false.

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.The $19,000 excess of book income over taxable income is a favorable difference.

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.A temporary difference affects deferred tax accounts. A permanent difference affects the computation of tax expense per books.

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 35 percent tax rate, which of the following statements is true? A. CSQ's tax payable is $448,980.B. CSQ's tax expense per books is $452,585.C. CSQ's tax payable is $505,120.D. CSQ's tax expense per books is $485,205.($1,339,700 book income - $46,600 favorable permanent differences) * 35% = $452,585 tax expense per books. ($1,339,700 book income - $46,600 favorable permanent differences + $103,500 unfavorable temporary differences) * 35% = $488,810 tax payable.

85. Mundo Company is a calendar year, accrual basis taxpayer. In June 2009, 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 with July 2009. As a result of the payment, Mundo should report: A. $6,000 book income and taxable incomeB. $72,000 book income and taxable incomeC. No book income and $72,000 taxable incomeD. None of the aboveMundo should report $18,000 book income (six months) and $72,000 taxable income.

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86. GH&F is a calendar year, accrual basis taxpayer. In October 2009, 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 with November 2009. As a result of the payment, GH&F should report: A. $2,000 book income and taxable incomeB. $2,000 book income and $18,000 taxable incomeC. $18,000 book income and taxable incomeD. None of the aboveGH&F should report $2,000 book income (two months) and $18,000 taxable income.

87. BugLess Inc, a calendar year, accrual basis corporation, provides pest extermination services to its customers. In October 2009, 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's home in 2009. As a result of the contract, BugLess should report: A. $1,440 taxable income in 2009.B. $180 taxable income in 2009, $720 taxable income in 2010, and $540 taxable income in 2011.C. $180 taxable income in 2009 and $1,260 taxable income in 2010.D. None of the aboveUnder the special one-year deferral method of accounting for prepaid service income, BugLess recognizes the amount of prepayment earned in 2009 and defers recognition of the remaining prepayment until 2010.

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. Which of the following statements is true? A. Because of the all-events test, Hitz cannot deduct the accrued interest expense this year.B. Hitz can deduct the accrued interest expense this year because it uses the accrual method of accounting for tax purposes.C. Hitz can deduct the accrued interest expense this year if the expense meets the all-event test.D. Hitz can never deduct the interest expense.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 payment is made within three months after the close of the taxable year.D. None of the above is false.

90. Jackey Company, a calendar year, accrual basis taxpayer, did not pay its $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 rent expense this year.B. Jackey can deduct the $44,200 expense next year.C. The accrued rent expense results in a permanent book/tax difference.D. The accrued rent expense results in a temporary book/tax difference.The accrued expense clearly meets the all-events test for deductibility

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91. RRK, a calendar year, accrual basis taxpayer, is involved in a dispute with its union employees concerning the correct computation of the employees' vacation pay. At the end of the year, RRK's accountant recorded $750,000 accrued vacation pay expense, based on her worst-case estimate of the cost of settlement with the union. Which of the following statements is true? A. RRK can deduct the $750,000 expense this year.B. RRK cannot deduct the $750,000 expense this year because the liability for the expense is not fixed until the dispute is settled.C. RRK can never deduct the $750,000 expense.D. RRK can deduct the expense only in the year of payment.The accrued expense fails the all-events test because the liability is not fixed. However, this accrued expense is not a payment liability because it does not result from settlement of a tort, breach of contract, or violation of the law.

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 expense this year.B. Timm can never deduct the $500,000 expense.C. Timm can deduct the liability in the year that it becomes fixed and determinable.D. Timm can deduct the liability in the year of payment.This accrued expense is a payment liability.

93. Unex Company is an accrual basis taxpayer. In 2009, 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 in 2009 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.

94. 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, 2009, JC's board of directors authorized a $45,000 year-end bonus for Mr. Carre, which was paid to him on February 1, 2010. In which year can JC Inc. deduct the bonus? A. 2009B. 2010C. JC. Inc. can deduct only $14,850 (33%) of the bonus in 2010.D. JC Inc. can never deduct the bonus.The related party accrued expense is deductible in the year Mr. Carre recognizes the bonus payment as gross income.

95. Bendom Inc, a calendar year, cash basis corporation, hired Rukel Company to provide professional services. Rukel completed the services on November 30, 2009, and immediately sent Bendom a bill for $37,750. Bendom paid the bill on January 4, 2010. Which of the following statements is false? A. If Bendom and Rukel are related parties, Rukel must report $37,750 income on its 2009 tax return regardless of its method of accounting.B. If Rukel uses the accrual method of account, it must report $37,750 income on its 2009 tax return.C. If Bendom and Rukel are unrelated parties, Bendom can deduct the $37,750 expense on its 2009 tax return.D. If Rukel uses the accrual method of accounting, Bendom can deduct the $37,750 expense on its 2009 return.

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Even if Bendom and Rukel are related parties, Rukel will report the income based on its method of accounting.

96. On December 19, 2009, 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, 2010. 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 2009.B. Mrs. Tabor includes her $50,000 bonus in 2010 gross income.C. If Mrs. Tabor owns 75 percent of Acme's stock (i.e. is a related party), Acme cannot deduct the accrued expense in 2009.D. If Mrs. Tabor owns 75 percent of Acme's stock (i.e. is a related party), Acme can never deduct the bonus expense.

97. Earl Company uses the accrual method of accounting for tax purposes. Here is a reconciliation of Earl's allowance for bad debts for the current year.

Which of the following statements is true? A. Earl's bad debt expense per books is $845,000, and its deduction for bad debts is $899,600.B. Earl's bad debt expense per books is $899,600, and its deduction for bad debts is $845,000.C. Earl's bad debt expense per books and its deduction for bad debts is $899,600.D. Earl's bad debt expense per books and its deduction for bad debts is $895,400.

98. Monro Inc. uses the accrual method of accounting for tax purposes. Here is a reconciliation of Monro's allowance for bad debts for the current year.

Which of the following statements is true? A. Monro's bad debt expense per books and its deduction for bad debts is $69,650.B. Monro's bad debt expense per books and its deduction for bad debts is $88,500.C. Monro's bad debt expense per books is $80,000, and its deduction for bad debts is $88,500.D. Monro's bad debt expense per books is $88,500, and its deduction for bad debts is $80,000.

99. 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.

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100. Earl Company uses the accrual method of accounting for tax purposes. Here is a reconciliation of Earl's allowance for bad debts for the current year.

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.Earl's $845,000 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.

101. Monro Inc. uses the accrual method of accounting for tax purposes. Here is a reconciliation of Monro's allowance for bad debts for the current year.

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.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.

102. Valley Inc. incurred a $71,400 net operating loss in 2009. 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 only as a carryforward deduction.D. None of the above is true.103. Which of the following statements about an NOL deduction is false? A. A taxpayer who deducts an NOL against taxable income for a previous year receives an immediate benefit in the form of a tax refund.B. The value of an NOL carryforward deducted next year is more than the value of an NOL carryforward deducted in five yearsC. The value of an NOL carryforward deduction depends on the taxpayer's discount rate and future marginal tax rate.D. None of the above is false.

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104. Ladow Inc. incurred a $32,000 net operating loss in 2009. Ladow's 2007 taxable income was $28,000, and its 2008 taxable income was $149,200. Use the corporate tax rates printed on the inside cover of your textbook to compute Ladow's refund from an NOL carryback deduction. A. $5,760B. 10,880C. 12,480D. None of the aboveThe NOL carryback reduces 2007 income to zero and 2008 income to $145,200. The refund equals $5,750 ($28,000 * 15%) + ($4,000 * 39%).

105. In 2009, Garfield Inc. generated a $25,000 net operating loss. Which of the following statements is false? A. If Garfield can carry the entire NOL back to deduct in 2007, the NOL will have no deferred tax consequences in 2009.B. If Garfield cannot use any of the NOL as a carryback deduction, the NOL will result in a deferred tax liability.C. Garfield can elect to give up the carryback of the NOL to 2007 and 2008.D. If Garfield cannot use any of the NOL as a carryback deduction, it can carry the NOL forward for 20 years.If Garfield cannot use any of the NOL as a carryback deduction, the NOL will result in a deferred tax asset.106. The NOL deduction A. Prevents the tax distortion that could result from an inflexible one-year reporting period.B. Results in a tax refund if the NOL can be carried back against previous years' taxable income.C. Has value based on the NPV of its related tax savings.D. All of the above.

Application Problems

107. Assuming a 30% marginal tax rate, compute the after-tax cost of the following business expenses. a. $12,300 meals and entertainmentb. $42,000 rent on factory equipmentc. $8,050 premium for key-person life insurance. a. $10,455 ($12,300 expense - $1,845 tax savings from $6,150 deduction)b. $29,400 ($42,000 expense - $12,600 tax savings from deduction)c. $8,050 nondeductible expense

108. Randall Company uses the calendar year and the cash method of accounting. On December 31, 2009, Randall made the following cash payments. To what extent can Randall deduct the payments in 2009? a. $50,000 for a two-year warehouse lease beginning on March 1, 2010.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, 2010.d. $5,000 compensation to a consultant who spent two weeks in January 2010 analyzing Randall's payroll system.e. $22,000 property tax to the local government for the first six months of 2010.

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a. None of the payment is deductible in 2009.b. None of the payment is deductible in 2009.c. None of the payment is deductible in 2009.d. $5,000 is deductible in 2009.e. $22,000 is deductible in 2009.

109. Zephex is a calendar year corporation. On December 1, 2009, 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, 2009, through March 31, 2010. On December 2, 2009, Zephex billed a client $38,250 for services rendered to the client in November. The client did not pay the bill until January 14, 2010. a. If Zephex is a cash basis taxpayer, how much 2009 income should it recognize with respect to the above transactions?b. If Zephex is an accrual basis taxpayer, how much 2009 book income should it report and how much 2009 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.

110. Krasco Inc.'s auditors prepared the following reconciliation between book and taxable income. The corporation has a 34% tax rate.

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 $2,806,064 ([$8,288,900 - $35,770 permanent differences] * 34%). Tax payable is $2,844,280 ($8,365,530 * 34%).b. Krasco's net deferred tax assets increase by $38,216 ($112,400 unfavorable temporary differences * 34%).111. Marchal Inc., a calendar year, accrual basis taxpayer, made the following state income tax payments during 2009.

On December 28, Marchal's tax department calculated that the corporation's actual 2009 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 2009 state income tax expense per books.b. Compute Marchal's 2009 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 2009).

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112. 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 earned $3,072,800 net income from its U.S. manufacturing activity and $4,101,700 from its foreign manufacturing activity. 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.

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chapter 06 taxable income from business operations answer key

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