Question

ABC Inc. accrues a warranty in year 1 of $150,000 but incurs no costs in connection with the warranty during year 1. What is the tax basis of the warranty accrual?

Answer 1

The tax basis of the warranty accrual in year 1 is $150,000.

Step-by-step explanation:

Accrual Accounting: The question mentions that ABC Inc. accrues a warranty in year 1 amounting to $150,000. Accrual accounting recognizes expenses when they are incurred, not necessarily when the cash is paid. In this case, the company acknowledges the warranty liability even though no costs were incurred during the same period.

Tax Basis: Tax basis refers to the value assigned to an asset or liability for tax purposes. In this context, the tax basis of the warranty accrual is $150,000. This is because, for tax purposes, the company can typically deduct expenses when they are incurred or when economic performance occurs, irrespective of when the actual payment is made.

No Incurred Costs: It's crucial to note that even though ABC Inc. accrues a warranty in year 1, there are no costs incurred during that period. The tax basis is determined by the accrued amount, regardless of the absence of actual cash outflow.