Chapter 6 - Taxable Income from Business Operations Chapter 6
Questions and Problems for Discussion
1.

a. The annual business cycle for a plant and garden center might end in the late autumn indicating an October 31 or November 30 fiscal year end.
b. A bakery has no obvious annual business cycle to suggest a particular taxable year.
c.

The annual cycle for a chimney cleaning business might end in late spring indicating an April
30 fiscal year end, or the cycle might end in early autumn indicating a September 30 fiscal year end.

d. The annual cycle for a moving and transport business might end in late summer indicating an August 31 fiscal year end.
e. A software consulting business has no obvious annual cycle to suggest a particular taxable year. 2.

Corporation DB can elect a different overall method of accounting for each of its three business ventures. 3.

This lucky event increased Firm LK’s net worth by $72,000 and, therefore, resulted in $72,000 realized income to the firm.

4.

If the two corporations have different marginal tax rates, an intercompany transaction could result in a shift of income from the high tax entity to the low tax entity or a shift of a deduction from the low tax entity to the high tax entity. A method of accounting that accomplishes such a shift and does not reflect an arm’s length transaction price between the related corporations is highly vulnerable to IRS challenge.

5.

Firms that provide audited financial statements to external users (investors, creditors, regulatory agencies, etc.) must prepare the statements in accordance with GAAP. The SEC requires publicly held corporations to follow GAAP in the preparation of financial statements.

6.

No, the cash method does not require that the taxpayer receive currency. The receipt of property
(such as the case of wine) triggers income recognition based on the value of the property.

7.

Evidently, the increase in the after­tax cost of business lunches reduced KJ Inc.’s demand for the service provided by Al’s Steak House. To the extent that the restaurant’s profitability declined because of the aggregate reduction in demand by the business community, the restaurant’s owners bear the incidence of the indirect tax increase.

8.

The death benefits received by a corporate beneficiary under its key­person life Insurance policies are nontaxable. Therefore, the cost associated with the nontaxable income (the annual premiums on the policies) is nondeductible by the corporation. In contrast, if other parties (the officer’s spouse and children) are named as beneficiaries, the premiums paid by the corporation represent additional officers’ compensation, which is a deductible business expense.

9.

Under GAAP, income is not realized until earned. If a firm receives payment for goods or services to be provided in a future year, the prepayment is recorded in a liability account as unearned revenue. Under the tax law, many prepayments of income must be included in taxable
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Chapter 6 - Taxable Income from Business Operations income, even if the income has not yet been earned. The GAAP treatment is conservative because it prevents an overstatement of book income. The tax treatment is conservative because it prevents an understatement of taxable income (financial ability to pay).

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Chapter 6 - Taxable Income from Business Operations
10. a. Taxable income exceeds book income by $55 (disallowed 50 percent of meal expense).
b. Book income exceeds taxable income by $700 ($3,500 tax­exempt interest − $2,800 nondeductible interest expense).
c.

Taxable income exceeds book income by $17,400 ($7,400 nondeductible lobbying expenses + $10,000 nondeductible political contribution).

11. Under the cash method, income from the provision of goods and services is not recognized until payment for the goods and services is received, an event that usually occurs after the income is earned under the accrual method. Thus, the