ACCTG 15 - Exam
2 (Ch. 6-11)
, ACCTG 15 - Exam 2 (Ch. 6-11)
CHAPTER 6
Exercise 6-27 (Algorithmic) (LO. 2)
Falcon, Inc., paid salaries of $707,200 to its employees during its first year of operations. At the end of the year, Falcon
had additional unpaid salaries of $70,720.
a. Calculate the salary deduction if Falcon is a cash basis taxpayer.
$
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A taxpayer's accounting method is a major factor in determining taxable income. The method used determines when
an item is includible in income and when an item is deductible on the tax return.
Answer: $707,200.
The expenses of cash-basis taxpayers are deductible only when they are actually paid. If the expense is for a period
longer than one year, the deduction will be allowed if the item is recurring or was made for a business purpose rather
than to manipulate income. Although the cash basis taxpayer must have actually or constructively paid the expense,
payment does not ensure a current deduction. Cash basis and accrual basis taxpayers cannot take a current deduction
for capital expenditures except through amortization, depletion, or depreciation over the life of the asset.
Under the cash method, Falcon can deduct only the salaries paid of $707,200. The $70,720 of unpaid salaries can be
deducted when paid next year.
b. Calculate the salary deduction if Falcon is an accrual basis taxpayer.
$
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Correct
Answer: $777,920.
A deduction for the accrual-basis taxpayer cannot be claimed until (1) all the events have occurred to create the
taxpayer's liability, and (2) the amount of the liability can be determined with reasonable accuracy. Once these
requirements are satisfied, the deduction is permitted only if economic performance has occurred. The economic
performance test is met only when the service, property, or use of property giving rise to the liability is actually
performed for, provided to, or used by the taxpayer.
Under the accrual method, the $707,200 is deductible because both the all events test and the economic performance
test are satisfied. These tests also are satisfied for the $70,720 of unpaid and accrued salaries. Consequently, Falcon
can deduct the $70,720 for a total deduction of $777,920 ($707,200 + $70,720).
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Correct
a. Calculate the salary deduction if Falcon is a cash basis taxpayer.
1
$ 707200
b. Calculate the salary deduction if Falcon is an accrual basis taxpayer.
2
$ 777920
Exercise 6-29 (Algorithmic) (LO. 3)
Vella owns and operates an illegal gambling establishment. In connection with this activity, he has the following
expenses during the year:
Rent $37,000
Bribes 55,500
Travel expenses 3,700
Utilities 22,200
Wages 264,250
Payroll taxes 18,500
Property insurance 1,850
Illegal kickbacks 33,300
,What are Vella’s total deductible expenses for tax purposes?
$
Feedback
, The tax law provides for the disallowance of certain types of expenses. Without specific restrictions in the tax law,
taxpayers might attempt to deduct items that, in reality, are personal expenditures.
Answer: $347,500.
The usual expenses of operating an illegal business (e.g., a gambling operation) are deductible. While allowing
deductions for illegal activity may seem inappropriate, recall that the law taxes net income from a business operation,
not gross revenue. However, § 162 disallows a deduction for fines, bribes to public officials, illegal kickbacks, and other
illegal payments whether these payments are part of a legal or illegal business.
An exception applies to expenses incurred in illegal trafficking in drugs. Drug dealers are not allowed a deduction for
ordinary and necessary business expenses incurred in their business. In arriving at gross income from the business,
however, dealers may reduce total sales by the cost of goods sold.
All of the usual expenses (rent, travel, utilities, wages, payroll taxes, property insurance) are deductible; payoffs and
kickbacks are not deductible. Of the $436,300 spent, $347,500 is deductible and $88,800 (bribes and kickbacks) is
not.
Exercise 6-29 (Algorithmic) (LO. 3)
Vella owns and operates an illegal gambling establishment. In connection with this activity, he has the following
expenses during the year:
Rent $37,000
Bribes 55,500
Travel expenses 3,700
Utilities 22,200
Wages 264,250
Payroll taxes 18,500
Property insurance 1,850
Illegal kickbacks 33,300
What are Vella’s total deductible expenses for tax purposes?
Exercise 6-32 (Algorithmic) (LO. 3)
Tobias has a brokerage account and buys on the margin, which resulted in an interest expense of $26,800 during the
year. Income generated through the brokerage account was as follows:
If required, round any division to two decimal places and use in subsequent computations. Round your
final answer to the nearest dollar.
How much investment interest can Tobias deduct?
$
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Certain income, such as interest on municipal bonds, is tax-exempt. Normally, the law also allows the taxpayer to
deduct expenses incurred for the production of income.
Answer: $22,244.
Certain income, such as interest on municipal bonds, is tax-exempt. The law allows the taxpayer to deduct expenses
incurred for the production of income. However, deduction disallowance provisions make it impossible to make money
at the expense of the government by excluding interest income and deducting interest expense.
The Code specifically disallows as a deduction the expenses of producing tax-exempt income. Interest on any
indebtedness used to purchase or hold tax-exempt obligations also is disallowed.
Tobias can deduct only the interest attributable to taxable income. The interest attributable to the municipal interest
income is not deductible. Thus, only $22,244 {[$268,000/($53,600 + $268,000)] × $26,800} is deductible.
Exercise 6-32 (Algorithmic) (LO. 3)
Tobias has a brokerage account and buys on the margin, which resulted in an interest expense of $26,800 during the
year. Income generated through the brokerage account was as follows:
2 (Ch. 6-11)
, ACCTG 15 - Exam 2 (Ch. 6-11)
CHAPTER 6
Exercise 6-27 (Algorithmic) (LO. 2)
Falcon, Inc., paid salaries of $707,200 to its employees during its first year of operations. At the end of the year, Falcon
had additional unpaid salaries of $70,720.
a. Calculate the salary deduction if Falcon is a cash basis taxpayer.
$
Feedback
A taxpayer's accounting method is a major factor in determining taxable income. The method used determines when
an item is includible in income and when an item is deductible on the tax return.
Answer: $707,200.
The expenses of cash-basis taxpayers are deductible only when they are actually paid. If the expense is for a period
longer than one year, the deduction will be allowed if the item is recurring or was made for a business purpose rather
than to manipulate income. Although the cash basis taxpayer must have actually or constructively paid the expense,
payment does not ensure a current deduction. Cash basis and accrual basis taxpayers cannot take a current deduction
for capital expenditures except through amortization, depletion, or depreciation over the life of the asset.
Under the cash method, Falcon can deduct only the salaries paid of $707,200. The $70,720 of unpaid salaries can be
deducted when paid next year.
b. Calculate the salary deduction if Falcon is an accrual basis taxpayer.
$
Feedback
Correct
Answer: $777,920.
A deduction for the accrual-basis taxpayer cannot be claimed until (1) all the events have occurred to create the
taxpayer's liability, and (2) the amount of the liability can be determined with reasonable accuracy. Once these
requirements are satisfied, the deduction is permitted only if economic performance has occurred. The economic
performance test is met only when the service, property, or use of property giving rise to the liability is actually
performed for, provided to, or used by the taxpayer.
Under the accrual method, the $707,200 is deductible because both the all events test and the economic performance
test are satisfied. These tests also are satisfied for the $70,720 of unpaid and accrued salaries. Consequently, Falcon
can deduct the $70,720 for a total deduction of $777,920 ($707,200 + $70,720).
Feedback
Correct
a. Calculate the salary deduction if Falcon is a cash basis taxpayer.
1
$ 707200
b. Calculate the salary deduction if Falcon is an accrual basis taxpayer.
2
$ 777920
Exercise 6-29 (Algorithmic) (LO. 3)
Vella owns and operates an illegal gambling establishment. In connection with this activity, he has the following
expenses during the year:
Rent $37,000
Bribes 55,500
Travel expenses 3,700
Utilities 22,200
Wages 264,250
Payroll taxes 18,500
Property insurance 1,850
Illegal kickbacks 33,300
,What are Vella’s total deductible expenses for tax purposes?
$
Feedback
, The tax law provides for the disallowance of certain types of expenses. Without specific restrictions in the tax law,
taxpayers might attempt to deduct items that, in reality, are personal expenditures.
Answer: $347,500.
The usual expenses of operating an illegal business (e.g., a gambling operation) are deductible. While allowing
deductions for illegal activity may seem inappropriate, recall that the law taxes net income from a business operation,
not gross revenue. However, § 162 disallows a deduction for fines, bribes to public officials, illegal kickbacks, and other
illegal payments whether these payments are part of a legal or illegal business.
An exception applies to expenses incurred in illegal trafficking in drugs. Drug dealers are not allowed a deduction for
ordinary and necessary business expenses incurred in their business. In arriving at gross income from the business,
however, dealers may reduce total sales by the cost of goods sold.
All of the usual expenses (rent, travel, utilities, wages, payroll taxes, property insurance) are deductible; payoffs and
kickbacks are not deductible. Of the $436,300 spent, $347,500 is deductible and $88,800 (bribes and kickbacks) is
not.
Exercise 6-29 (Algorithmic) (LO. 3)
Vella owns and operates an illegal gambling establishment. In connection with this activity, he has the following
expenses during the year:
Rent $37,000
Bribes 55,500
Travel expenses 3,700
Utilities 22,200
Wages 264,250
Payroll taxes 18,500
Property insurance 1,850
Illegal kickbacks 33,300
What are Vella’s total deductible expenses for tax purposes?
Exercise 6-32 (Algorithmic) (LO. 3)
Tobias has a brokerage account and buys on the margin, which resulted in an interest expense of $26,800 during the
year. Income generated through the brokerage account was as follows:
If required, round any division to two decimal places and use in subsequent computations. Round your
final answer to the nearest dollar.
How much investment interest can Tobias deduct?
$
Feedback
Certain income, such as interest on municipal bonds, is tax-exempt. Normally, the law also allows the taxpayer to
deduct expenses incurred for the production of income.
Answer: $22,244.
Certain income, such as interest on municipal bonds, is tax-exempt. The law allows the taxpayer to deduct expenses
incurred for the production of income. However, deduction disallowance provisions make it impossible to make money
at the expense of the government by excluding interest income and deducting interest expense.
The Code specifically disallows as a deduction the expenses of producing tax-exempt income. Interest on any
indebtedness used to purchase or hold tax-exempt obligations also is disallowed.
Tobias can deduct only the interest attributable to taxable income. The interest attributable to the municipal interest
income is not deductible. Thus, only $22,244 {[$268,000/($53,600 + $268,000)] × $26,800} is deductible.
Exercise 6-32 (Algorithmic) (LO. 3)
Tobias has a brokerage account and buys on the margin, which resulted in an interest expense of $26,800 during the
year. Income generated through the brokerage account was as follows:
