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Learning Objectives
1)
2)
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5)
Business Income
8-3
Business Income
Gross income includes all income from
whatever source derived. (IRC Section 61)
Tax laws specifically include gross income from
business in this definition.
Source of income:
Inventory sales
Services
Renting or leasing
8-4
Business Deductions
8-5
Business Deductions
Not extravagant
Compare the amount of expense to a market price or
an arms length amount.
8-7
Capital expenditures
8-8
Personal expenses
8-9
Mixed-motive expenditures
8-10
8-12
8-14
8-15
Start up costs
Bad debt expense
Domestic Production Activities Deduction (DPAD)
8-16
Bad debts
8-17
Formula:
8-18
DPAD example
Brian recorded $100,000 of receipts from a
qualified domestic production activity.
Brian allocated $55,000 of expenses to the
qualified domestic production activity including
$12,000 of wages.
Brian had modified AGI of $47,000 (or the
business has taxable income before the
deduction of $47,000 )
What is Brians domestic production activities
deduction?
8-19
8-21
8-22
Accounting periods
Short tax year is < 12 months. (First year of existence, last year
of existence or change in tax year.)
Year ends
8-24
Cash method
Accrual method
8-26
8-27
Cash prepayment
Example 8-14
1) On July 1 of this year, Rick (calendar year end) paid $1,200 for a 12month insurance policy that covers his business property from accidents
and casualties from July 1 of this year, through June 30 of next year.
How much of the $1,200 expenditure may Rick deduct this year if he
uses the cash method of accounting for his business activities?
2) Suppose the insurance policy was for 12 months but the policy ran
from February 1 of next year, through January 31 of the following year.
How much of the expenditure may Rick deduct this year if he uses the
cash method of accounting for his business activities?
3) Suppose Rick had paid $1,200 for an 18-month policy beginning July
1 of this year, and ending December 31 of next year. How much may he
deduct this year if he uses the cash method of accounting for his
business activities?
Accrual income
All-events test (1) Recognize income when all the events have
occurred which fix the right to receive such income and (2) the
amount can be determined with reasonable accuracy.
Assuming amount of income can be determined, allevents test is met at the earliest of these dates:
Payment is due
Payment is received
8-29
Accrual income
Unearned revenue
Rental and interest income
Services provided
Goods sold
Inventories
Uniform capitalization
Cost flow assumptions
8-30
8-31
Inventories
8-33
Inventory cost
Tax
GAAP
Capitalized inventory
cost
Cost flow
assumptions
8-34
Inventory cost
Example 8-18
8-35
Accrual deductions
1. All-events test
8-36
Accrual deductions
Accrual income
All-events test
Accrual deductions
8-37
Accrual deductions
Receiving
party.
Renting or leasing property from another
party
Payment liabilities
Bad debt expense
Accrual deductions
Accrual deductions
Example 8-20
1) On December 15, 2014, Rick hires Your New Fence LLC (YNF), to
install a concrete wall for one of his clients by paying $1,000 of the cost
as a down payment and agreeing to pay the remaining $7,000 when
YNF finishes the wall. YNF was not going to start building the wall until
early 2015, so as of the end of the year Rick has not billed his client for
the wall. Rick expects YNF to finish the wall by the end of April. What
amount associated with his liability to YNF is Rick allowed to deduct in
2014 and 2015 under the accrual method and cash method?
2) Assume that Rick expected YNF to finish building the wall by the end
of January 2015. What amount associated with this liability to YNF is
Rick allowed to deduct in 2014 and 2015?
Accrual deductions
Renting
party
Accrual deductions
Example 8-21
1) On May 1, 2014, Rick paid $7,200 in advance to rent his
shop for 12 months ($600 per month). What amount may
Rick deduct for rent in 2014 if he accounts for his business
activities using the accrual method?
2) Assuming the original facts, what amount of the $7,200
rental payment may Rick deduct in 2014 if he is using the
cash method of accounting for his business?
Accrual deductions
Payment
liabilities
Workers compensation
Taxes
Accrual deductions
Generally,
Choosing or changing an
accounting method
8-47
Practice questions
49