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Business 223F – Research Exercises Spring 2010 90 points The following exercises are designed to improve your understanding of the rules on the timing of income and expense recognition and accounting method changes, by having you find, interpret and apply the rules to real life issues. Some of the exercises may require some research beyond what you have been given in the reading materials for this class. Your answer should clearly indicate the question you are answering and what the answer is (that is, don't bury the answer in your explanation but instead state the answer, such as "the amount is deductible in 2009" and then provide your explanation). Your answers are to be brief and to the point – long narrations are not necessary, but complete and clear answers are required. Authority (code, regulations, cases, rulings, etc.) should be noted for all of your answers. Point values and due dates are shown in [brackets] at the beginning of each question. * For these questions only, you may work with one classmate and turn in one paper with your joint answer. The point of allowing you to work with someone else is to allow for a good discussion of the question and answer (which should be a good learning experience for both of you). You should each be contributing equally to the determination of the answer and the write-up. 1. * [10 points, DUE April 24 (email to firstname.lastname@example.org)] Senator Smith proposed to change the $5 million limit in §448 to $10 million. a. How will this proposal affect Able Corporation which is a C corporation with inventory and average annual gross receipts of $6 million? b. How will this proposal affect Beely Corporation with is a C corporation that provides legal services and has average annual gross receipts of $9 million? c. How will this proposal affect Carter Corporation with is a C corporation that provides security patrol services and has gross receipts of $7 million? d. How will this proposal affect Deede Company which is a partnership with inventory and average annual gross receipts of $8 million? e. List one GOOD argument for why the senator's bill should be enacted. f. List one GOOD argument for why the senator's bill should not be enacted. 2. [15 points, DUE May 8 (turn in at start of class)] When should the following accrual method calendar year taxpayers report income and how much? a. Altony Corporation is a travel agency that started business in 2007. On 12/2/09, it booked a trip for Sam that he will take in February 2010. This trip included a few hotel reservations for which Altony earns a 10% commission. Sam had to pay for the hotels in advance to get a special rate. Thus, Altony collected the payment from him in December 2009. If Sam cancels, he will get 85% of his money back and Altony will lose part of its commission (it will have to repay a portion within 10 days of Sam's cancellation). When should Altony report the commission for booking Sam's hotel reservations? b. On 11/1/09, Digital Audio Works, which sells digital files of international folk music, received an order from Alice. Alice ordered a gift subscription that Digital is to send to Alice's sister on December 24, 2009. Under a special promotional offer, Digital will not bill Alice until January 2010. c. Hair Works Corporation sells gift cards that can be used for salon services or hair care products at its hair salons. The cards do not have an expiration date. For financial reporting purposes, HWC includes the gift card face value into income 1/36 per month over 36 months starting in the month the cards are sold. Assume HWC has adopted Rev. Proc. 2004-34. For $38,000 of gift cards sold in January 2010, how much should HWC report on its tax return for 2010, 2011 and 2012? 3. [16 points, DUE May 8 (turn in at start of class)] When are the following items deductible for ABC Corporation, an accrual method, calendar year retailer. Be sure to explain each answer using the §461 framework. a. $18,000 paid to a cash basis attorney on 5/5/10 for work performed in 8/09. b. ABC has arrangements with some sports teams that if they advertise ABC goods and services on their website, they will receive 10 cents every time a viewer clicks on the ABC ad. In 2009, there were 350,000 clicks, but this figure could not be verified until 4/1/10. ABC paid the sports teams for the 2009 clicks on 4/8/10. b. $120,000 of rent paid on 4/10/10 covering all of 2008. ABC was delinquent in paying its rent (it was due in 2008). c. $1,300,000 accrued on its books for 2009 as an estimate of what ABC might owe in a personal injury lawsuit brought against it in October 2008. ABC expects to reach a settlement with the injured party by August 2010 with payments to be made over a 6-month period. 4. [18 points, DUE May 15 (email to email@example.com)] For each of the following independent fact patterns, explain whether it involves an error, change of facts, or method of accounting. If it is a method, also explain which Revenue Procedure is applicable to make the necessary accounting method change. a. Angel Company wants to change from the simplified service cost method for Unicap to a facts and circumstances cost method. b. Barnacle Corporation has treated certain equipment purchased over the past few years as depreciable property although it is primarily held for sale to customers. c. Creamy Corporation changed its book method of reporting interest income to be in compliance with Staff Accounting Bulletin (SEC document) 402. Creamy would like to follow the same treatment for tax purposes. d. Divit Corporation, a calendar year taxpayer discovered that property placed in service in 2008 has been treated as 5-year property when it should be 39-year property. It is now February 1, 2010 and the 2009 return has not yet been filed. e. Eager Corporation discovered this year that it omitted a zero from its total advertising expense on its 2008 return (reported $1,561 when it should have been $15,610). f. Field Company, an accrual method taxpayer, provides soil inspection services to customers. In the past, customers were billed monthly. Field is in need of cash and plans to begin to offer customers a discount if they enter into 12-month prepaid contracts. Field would like to report the prepaid amounts over the term of the contracts, rather than when received. 5. *[21 points, DUE May 26 for Session A and June 2 for Session B] Norton, Inc. has used the cash method of accounting and a calendar year since it was formed in 2001. Much of Norton's work is done on a prepaid contract basis to provide security consulting services to customers. Clients enter into 3- year prepaid contracts. Clients get 3 scheduled consultations per year plus up to 4 consultations that can be scheduled at any time. It has come to the attention of Norton's CFO that the accrual method might be better for them because they would also be able to adopt Rev. Proc. 2004-34. Norton wants to adopt this method for 2010. Norton only has one line of business and is not part of a consolidated group. Norton also wants to adopt the recurring item exception for its recurring items. Assume Norton has correctly been using the cash method. Norton has the following items: Item 12/31/09 Accounts receivable $134,000 Accounts payable $79,000 Federal income taxes payable $230,000 Notes payable $540,000 Interest payable $38,000 In addition, in 2009 Norton collected $490,000 on maintenance contracts entered into that year and reported $210,000 of that amount on its 2009 audited financial statements (with the balance to be reported in 2010 and 2011). In 2008, Norton collected $111,000 on maintenance contracts and reported $23,000 on its 2008 financial statement and $42,000 on its 2009 financial statement with the balance to be reported on its 2010 financial statement. a. Identify which Revenue Procedure/regulations/etc. apply to Norton and prepare Norton's Form(s) 3115 to accomplish: • a change from the cash to the accrual method • adoption of the recurring item exception for taxes, utilities, and advertising • adoption of Rev. Proc. 2004-34 b. Prepare a LIST of instructions for Norton that you will give to the CFO along with the completed 3115(s) stating how, when and where to file and anything else you think the CFO should know about this transaction. Be sure to also state what Norton should do with any §481(a) adjustment you compute. NOTE: You are also to prepare the Form 3115. c. While the Form(s) 3115 is in its final review by Norton's accountant, Norton receives a phone call from an IRS Revenue Agent informing him that Norton's 2008 tax return has been selected for examination and he wants to schedule an appointment. List and briefly explain Norton's options for continuing with its desired accounting method changes. 6. * [10 points, DUE May 26 for Session A and June 2 for Session B] Allergy Clinic is an S corporation that provides medical services to patients suffering from allergies. As part of the services rendered, the doctors develop special allergy medications for each patient, which is given to patients weekly. Is the serum considered supplies or inventory? Explain with reference to appropriate primary authorities.
"Business 223F – Research Exercis"