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. IDC contracted with a homebuilder in December of last year to install carpet in 10 new homes being built. The contract price of $92,000 includes $54,800 for materials (carpet). The remaining $37,200 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. IDC entered into several other contracts this year and completed the work before year-end. The work cost $178,000 in materials. Bryan billed out $244,800 but only collected $220,000 by year-end. Of the $24,800 still owed to him, Bryan wrote off $4,200 he didn’t expect to collect as a bad debt from a customer experiencing extreme financial difficulties. 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 $9,504 ($264 a month for 36 months) on June 30 of this year. 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 it uses the LIFO method of accounting for inventory under a perpetual inventory system: Purchase Date Bottles Total Cost November last year 40 $312 February this year 35 208 July this year 25 205 August this year 40 380 Totals 140 $1,105 On August 1 of this year, IDC needed more room for storage and paid $2,340 to rent a garage for 12 months. 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 $980 down and agreed to pay the remaining $2,940 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 1 of next year, at which time IDC paid the remaining $2,940. In December, Bryan’s son, Aiden, helped him finish some carpeting jobs. IDC owed Aiden $1,080 (reasonable) compensation for his work. However, Aiden did not receive the payment until January of next year. IDC also paid $5,800 for interest on a short-term bank loan relating to the period from November 1 of this year through March 31 of next year. Compute his taxable income for the current year considering the following items: (Negative amounts should be indicated by a minus sign. Enter zero for no effect on taxable income. Do not round intermediate calculations.

Answer 1

Description	Cash method	Accrual method	Explanation
a.Prepaid carpeting services	$                  -	$          92,000.00	The $92,000 was received in the prior year and would have been included in gross income when it was received.
b.Carpeting services	$ 220,000.00	$       244,800.00	Income not recognized until received for cash method.
c.Cleaning services	$      9,504.00	$            1,584.00	For accrual, only amount earned is recognized (6 mos. x $264).
Sale of Inventory:
d.Stain remover sales	$          500.00	$               500.00
Gross Income	$ 230,004.00	$       338,884.00
a.Carpet supplies	$    54,800.00	$          54,800.00	Economic performance under the accrual method requires that IDC provide the goods (carpet) to the homebuilder in order to deduct the cost. The home was finished in the current year.
b.Materials needed for contracts	$ 178,000.00	$       178,000.00
d.Stain remover	$          793.00	$               668.00	Cash method may deduct cost in year paid (August purchase of $380 + July purchase of $205 + February purchase of $208 = $793). Accrual method: $247 for first sale (35 bottles from February + 5 bottles from November last year) and $421 from second sale (40 bottles from August + 20 bottles from July).
Supplies	$ 233,593.00	$       233,468.00	Bryan no longer needs to account for inventory except as misc. supplies
Gross Profit	$     (3,589.00)	$       105,416.00
b.Bad debt	$                  -	$            4,200.00	Under cash method its not deductible because bad debt was never included in income.
e.Prepaid rent	$      2,340.00	$               975.00	For accrual, economic performance occurs over lease period (5 months this year). 12-month rule applies for cash method.
f.Prepaid paint job	$          980.00	$               980.00	Because IDC expects completion within 3½ months of payment, they may deduct amount paid this year under the accrual method.
g.Compensation to Aiden	$                  -	$                        -	Not deductible until paid to the related cash-method recipient (Aiden)
h.Prepaid interest	$      2,320.00	$            2,320.00	Not deductible until interest accrues (2 months this year).
Total Deductions	$      5,640.00	$            8,475.00
Taxable Income	$     (9,229.00)	$          96,941.00