11-1 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-2 ACCOUNTING PERIODS AND METHODS (1 of 2)  Accounting periods  Overall accounting methods  Inventories  Special accounting methods  Imputed interest Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-3 ACCOUNTING PERIODS AND METHODS (2 of 2)  Change in accounting methods  Tax planning considerations  Compliance & procedural considerations Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-4 Accounting Periods  Fiscal year is any 12-month period other than calendar year  Partnerships, S corps, and PSCs  Generally must have same tax year as majority owners (> 50% ownership)  Required payments and fiscal years  Changes in the accounting period  Returns for periods of < 12 months Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-5 Required Payments and Fiscal Years  C corporations, other than PSCs, can choose any fiscal year  Partnerships, S corps, and PSCs can choose a fiscal year if deferral is 3 months or less (§444 election)  Required payments must be made by April 15 to offset advantage of deferral from §444 election Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-6 Changes in the Accounting Period (1 of 2)  Generally need IRS approval to change accounting period  Must establish substantial business purpose to change accounting period Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-7 Changes in the Accounting Period (2 of 2)  IRS approval not necessary  Conformity of newly married spouses  Change to 52/53 week year ending in same calendar month as prior tax year  Certain corporations which have not changed accounting periods within 10 years Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-8 Returns for Periods of Less than 12 Months (1 of 2)  Taxpayer’s first or final return  No annualization of income required  Change from one accounting period to another  Annualization required Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-9 Returns for Periods of Less than 12 Months (2 of 2)  Annualization procedure 1. Compute modified taxable income (MDTI)  Must use itemized deductions  No personal and dependency exemptions 2. MDTI x [12 ÷ (short period # of mo)] 3. Compute tax on Step 2 4. Step 3 x [(short period # of mo) ÷ 12] Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-10 Overall Accounting Methods  Overall accounting method for one trade or business not needed to be used in a second trade or business  Cash receipts and disbursements method  Accrual method  Hybrid method Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-11 Cash Receipts and Disbursements Method (1 of 2)  Report income for the tax year in which payments are received  Generally deduct expenses in year paid  Prepaid expense capitalized and amortized if benefits extend beyond tax year  Must capitalize fixed assets and recover through depreciation or amortization Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-12 Cash Receipts and Disbursements Method (2 of 2)  Most individuals and many service businesses use the cash method  Cannot use cash method in a business where inventory is material income producing factor  Small business exception – see hybrid method Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-13 Accrual Method (1 of 2)  Report income under all-events test and economic performance test  All-events test  Taxpayer’s right to receive income & amount determined w/ reasonable accuracy  Economic performance test  Property or services actually rendered by other party Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-14 Accrual Method (2 of 2)  Deduction is met when liability established and amount of expense can be determined with reasonable accuracy Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-15 Hybrid Method  Use accrual method for sales and purchases, but may use cash method for other income and expenses  Small business exception  Businesses with inventory whose annual gross receipts for 3 prior years ≤ $1M may use cash method for sales and accrual method for cost of goods sold Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-16 Inventories (1 of 2)  Uniform capitalization rules (UNICAP)  Required for taxpayers whose average gross receipts for 3 prior years >$10M  Must capitalize some period costs Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-17 Inventories (2 of 2)  If using LIFO for tax  Must also use LIFO for financial accounting  May use lower of cost or market with any inventory method  Cycle inventory valuation  Congress specifically permits method  Inventory counted following a schedule Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-18 Special Accounting Methods  Long-term contracts  Installment sales method  Deferred payment sales Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-19 Long-Term Contracts In General  For items that are not completed in same tax year in which they begin  For manufacture of unique item not normally carried in finished goods inventory  Services not eligible for long-term contract methods Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-20 Long-Term Contracts Completed Contract Method  Income and expenses reported in year contract completed  Only available for  Construction contracts < 2 years OR  Home construction contracts  Qualifying taxpayers  Small companies w/ avg gross receipts for prior 3 years ≤ $10M in contracts Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-21 Long-Term Contracts Percentage of Completion Method  Income and expenses reported in each year of contract based on estimated percentage of completed work  Modified percentage of completion  Income deferred until 10% of estimated cost accumulated  Lookback interest  May apply if actual expenses paid are much different than calculated Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-22 Installment Sales Method (1 of 3)  Any disposition of property where at least one payment received after close of tax year of disposition  Elective provision  Not applicable for sale of  Inventory  Marketable securities Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-23 Installment Sales Method (2 of 3)  Computation under § Compute gross profit from sale 2. Determine contract price 3. Compute gross profit percentage Gross Profit ÷ Contract Price 4. Compute gain to be reported Proceeds X Gross Profit Percentage  Depreciation recapture recognized in year of sale Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-24 Installment Sales Method (3 of 3)  Disposition of installment obligations Selling price – Adjusted basis of installment note Gain recognized Face amount x [100% - gross profit percentage] Adjusted basis in installment note Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-25 Deferred Payment Sales  Installment method cannot be used when property sold at a loss  Obligations with indeterminate market value  E.g., mineral interest sold for 10% of value of future production  Value no lower than value of property sold less value of other property received Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-26 Imputed Interest  Imputed interest computation  Generally must be at least 100% of applicable federal rate  Accrual of interest  Generally reported as it accrues  Several major exceptions  Special rules for gift, shareholder, and other tax avoidance loans Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-27 Change in Accounting Methods (1 of 2)  Accounting period chosen by using for first year in which it is applicable  IRS approval required to change methods  May change to LIFO method without IRS approval  Amount of change  Due to timing of income and deduction recognition due to changes between cash and accrual methods Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-28 Change in Accounting Methods (2 of 2)  Reporting the amount of the change  The amount  Change voluntary or involuntary  Any specific statutory mandates  Must obtain IRS consent Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-29 Tax Planning Considerations  Accounting periods  Consider year-end and marginal tax rate in initial year  Accounting methods  Installment sales  Consider marginal tax rate and amount of gain to decide whether or not to elect out of installment method Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

11-30 Compliance & Procedural Considerations  Installment Sales reported on Form 6252  Procedures for changing to LIFO  Advanced IRS permission required except for first year inventory carried  Form 970 in 1 st year using LIFO Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall