Chapter 3 Problem Assignments

Check Your Understanding

1. Realization Principle
Explain the realization principle.
2. GAAP vs. Tax
Provide three reasons why generally accepted accounting principles are not allowed for tax
purposes.

3. Book/Tax Differences
What are two major categories of differences between financial accounting income and taxable
income?

4. Tax-favored Investments
What types of investments are favored by tax law and why?

5. Choice of Tax Year

Michelle (a calendar-year individual) begins a new business as a sole proprietorship. She would
like to use an October 31 fiscal year-end for her business because the calendar year ends during
her busy season. What must Michelle do to use a fiscal tax year?

6. Accounting Methods
Jabba Company uses the cash method of accounting. Jabba received a computer from a customer
as payment for a $2,000 bill. Can Jabba avoid recognizing income because it received payment
in a noncash form? Explain.
7. Accounting Methods
Murphy Company, a cash-basis, calendar-year taxpayer, received a call on December 28, year
1, from a client stating that a check for $9,000 as payment in full for their services could be
picked up at their offices, two blocks away, any weekday between 1:00 and 6:00 P.M. Murphy
does not pick up the check until January 3, year 2. In which year does Murphy recognize the
8. Accounting Methods
Are there any restrictions on business use of the cash method of accounting? Explain.

9. Tax vs. Financial Accounting

Explain why accrual-method taxpayers treat prepaid income differently for GAAP and tax
purposes.

10. Long-Term Construction Contracts

What is a long-term contract? Briefly describe the two possible accounting treatments for long-
term contracts.

11. Assignment of Income

Ryan's annual salary is $120,000 per year. He asked his employer to pay $20,000 of his salary
2 Solutions Manual for Taxation for Decision Makers

to his elderly grandmother who is in a nursing home. The employer pays the $20,000 directly to
the grandmother and the balance to Ryan. What is Ryans gross income?

12. Community Property Laws

Explain how the community property laws can affect the allocation of income between
spouses.

13. Income Tax Effects of Gifts

Virginia gave her 14-year-old grandson, Tommy, $10,000 in common stock. One month later,
Tommy receives a $100 dividend on the stock. How much income is taxed to Tommy and how
much to Virginia?
Tax-Exempt Bonds
14Why is interest income on state and local bonds tax exempt?
15.Original Issue Discount
At the beginning of the current year, Martha, a cash-basis taxpayer, purchased a $10,000 three-
year bond from Lauderhill Corporation at its issue price of $7,000. At the end of the year, $840
of the interest had accrued. How much income does Martha report for the current year?

26. Prepaid Service Revenue

On December 1, year 1, Peak Advertising (a calendar-year, accrual-basis taxpayer) received a
$24,000 retainer fee for a two-year service contract.
a. How much income should Peak report in year 1 for tax and financial accounting?
b. How much income should Peak report in year 2 for tax and financial accounting?
c. How much income should Peak report in year 3 for tax and financial accounting?