©2008 Prentice Hall, Inc.

ACCOUNTING PERIODS AND METHODS Overall accounting methods Inventories Special accounting methods Imputed interest Change in accounting methods Tax planning considerations Compliance & procedural considerations ©2008 Prentice Hall, Inc.

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 ©2008 Prentice Hall, Inc.

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 ©2008 Prentice Hall, Inc.

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 ©2008 Prentice Hall, Inc.

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 ©2008 Prentice Hall, Inc.

Returns for Periods of Less than 12 Months (1 of 2) No annualization of income required Taxpayer’s first or final return Annualization required Change from one accounting period to another ©2008 Prentice Hall, Inc.

Returns for Periods of Less than 12 Months (2 of 2) Annualization procedure Determine modified taxable income Must use itemized deductions No personal and dependency exemptions Multiply modified taxable income by (12 ÷ # of months in short period) Compute tax on resulting amount Multiply resulting tax by (# of months in short period ÷ 12 ©2008 Prentice Hall, Inc.

Overall Accounting Methods Overall accounting method used in one trade or business not needed to be used in a second trade or business Cash receipts and disbursements method Accrual method Hybrid method ©2008 Prentice Hall, Inc.

Cash Receipts and Disbursements Method (1 of 2) Report income for the tax year in which payments are received Expenses deducted in the year paid Must capitalize fixed assets and recover through depreciation or amortization ©2008 Prentice Hall, Inc.

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 for sales and cost of goods sold ©2008 Prentice Hall, Inc.

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 ©2008 Prentice Hall, Inc.

Accrual Method (2 of 2) Deduction is met when liability established and amount of expense can be determined with reasonable accuracy ©2008 Prentice Hall, Inc.

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 cash method for cost of goods sold ©2008 Prentice Hall, Inc.

Inventories (1 of 2) Lower cost or market LIFO Must also use LIFO for financial accounting Cannot use lower cost or market ©2008 Prentice Hall, Inc.

Inventories (2 of 2) Uniform capitalization rules (UNICAP) Required for taxpayers whose average gross receipts for 3 prior years >$10M Must capitalize some period costs Cycle inventory valuation Congress specifically permits method Inventory counted following a schedule ©2008 Prentice Hall, Inc.

Special Accounting Methods Long-term contracts Installment sales method Deferred payment sales ©2008 Prentice Hall, Inc.

Long-Term Contracts For items that are not completed in same tax year in which they begin For manufacture unique item not normally carried in finished goods inventory Services not eligible for long-term contract methods ©2008 Prentice Hall, Inc.

Long-Term Contracts Completed Contract Method Income and expenses reported in year contract completed Only available in two circumstances Small companies w/avg gross receipts for prior 3 years is ≤ $10M for contracts expected to take < 2 years to complete AND Home construction ©2008 Prentice Hall, Inc.

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 ©2008 Prentice Hall, Inc.

Installment Sales Method (1 of 2) Any disposition of property where at least one payment received after close of tax year of disposition Not applicable for sale of Inventory Marketable securities Special rules for related parties sales ©2008 Prentice Hall, Inc.

Installment Sales Method (2 of 2) Computation under §453 Compute gross profit from sale Determine contract price Compute gross profit percentage Gross Profit ÷ Contract Price Compute gain to be reported Proceeds X Gross Profit Percentage Depreciation recapture recognized in year of sale ©2008 Prentice Hall, Inc.

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 ©2008 Prentice Hall, Inc.

Imputed Interest Imputed interest computation Accrual of interest 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 ©2008 Prentice Hall, Inc.

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 ©2008 Prentice Hall, Inc.

Change in Accounting Methods (2 of 2) Reporting the amount of the change The amount Change voluntary or involuntary Any specific statutory mandates Obtaining IRS consent ©2008 Prentice Hall, Inc.

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 ©2008 Prentice Hall, Inc.

Compliance & Procedural Considerations Installment Sales reported on Form 6252 Procedures for changing to LIFO ©2008 Prentice Hall, Inc.

©2008 Prentice Hall, Inc.