Question

Bryan followed in his father’s footsteps and entered into the carpet business. He owns and operates I Do Carpet (IDC). Bryan prefers to install carpet only, but in order to earn additional revenue, he also cleans carpets and sells carpet cleaning supplies. Compute his taxable income for the current year considering the following items:

a) IDC contracted with a homebuilder in December of last year to install carpet in 10 new homes being built. The contract price of $80,000 includes $50,000 for materials (carpet). The remaining $30,000 is for IDC’s service of installing the carpet. The contract also stated that all money was to be paid up front. The homebuilder paid IDC in full on December 28 of last year. The contract required IDC to complete the work by January 31 of this year. Bryan purchased the necessary carpet on January 2 and began working on the first home January 4. He completed the last home on January 27 of this year.

b) IDC entered into several other contracts this year and completed the work before year-end. The work cost $130,000 in materials and IDC elects to immediately deduct his supplies. Bryan billed out $240,000 but only collected $220,000 by year-end. Of the $20,000 still owed to him, Bryan wrote off $3,000 he didn’t expect to collect as a bad debt from a customer experiencing extreme financial difficulties.

c) IDC entered into a three-year contract to clean the carpets of an office building. The contract specified that IDC would clean the carpets monthly from July 1 of this year through June 30 three years hence. IDC received payment in full of $8,640 ($240 a month for 36 months) on June 30 of this year.

d) IDC sold 100 bottles of carpet stain remover this year for $5 per bottle (it collected $500). IDC sold 40 bottles on June 1 and 60 bottles on November 2. IDC had the following carpet cleaning supplies on hand for this year, and IDC has elected to use the LIFO method of accounting for inventory under a perpetual inventory system: Purchase Date Bottles Total Cost November last year 40 $120 February this year 35 $112 July this year 25 $85 August this year 40 $140 Totals 140 $457

e) On August 1 of this year, IDC needed more room for storage and paid $900 to rent a garage for 12 months.

f) On November 30 of this year, Bryan decided it was time to get his logo on the sides of his work van. IDC hired We Paint Anything, Inc. (WPA), to do the job. It paid $500 down and agreed to pay the remaining $1,500 upon completion of the job. WPA indicated it wouldn’t be able to begin the job until January 15 of next year, but the job would only take one week to complete. Due to circumstances beyond its control, WPA wasn’t able to complete the job until April 1of next year, at which time IDC paid the remaining $1,500.

g) In December, Bryan’s son, Aiden, helped him finish some carpeting jobs. IDC owed Aiden $600 (reasonable) compensation for his work. However, Aiden did not receive the payment until January of next year.

h) IDC also paid $1,000 for interest on a short-term bank loan relating to the period from November 1 of this year through March 31 of next year.

Answer 1

Solution: Taxable income under cash method: $47,003; Taxable income under accrual method: $137,330

Working:

Particulars	Cash	Accrual	Explanation
a. Prepaid carpeting services	$0	$80,000	In the prior year the income was received and need to be included in gross income when it was received
b. Carpeting services	$220,000	$240,000	In cash method, income is not recognized until received
c. Cleaning services	$8,640	$1,440	In accrual, the amount earned will only berecognized (6 * $240)
d. Stain remover sales	$500	$500
	$229,140	$321,940
a. Carpet supplies	$50,000	$50,000	Under the accrual method, the economic performance requires that IDC gives the carpet to the homebuilder to deduct the cost. In the current year the home was finished
b. materials needed for contracts	$130,000	$130,000
d. Stain remover	$337	$335	Under the cash method, you can deduct cost in year paid. Under Accrual method it will be computed as $127 for 1st sale (35 from February plus 5 from January) and $208 from 2nd sale (40 from August plus 20 from July).
Cost of Goods/Services	$180,337	$180,335
Gross Profit	$48,803	$141,605
b. Bad debt	$0	$3,000	Not deductible under cash method as bad debt was never included in income.
e. Prepaid rent	$900	$375	Under cash method, 12- month rule is applicable. Under the accrual method, economic performance occurs over the period of lease (5 months this year).
f. Prepaid paint job	$500	$500	Under the accrual method, IDC expects completion within the payment of 3½ months, it can deduct amount paid this year
g. Compensation to Aiden	$0	$0	Until paid to the related cash-method recipient, it is not allowed for deductions
h. Prepaid interest	$400	$400	Until interest accrues (2 months this year), it is not allowed for deductions
Total Deductions	$1,800	$4,275
Taxable Income	$47,003	$137,330