Question

Teal company is an accrual basis taxpayer. On December 1, 2015, a customer paid for an item that was on hand, but the customer wanted the item delivered in early January 2016. Teal delivered the item on January 4, 2016. Teal included the sale in its 2015 income for financial accounting purposes. What must Teal do with regards to recognizing the income?

1) Teal must recognize the income in 2015.
2) Teal must recognize the income in the year title to the goods passed to the customer, as determined under the state laws in which the store is located.
3) Teal can elect to recognize the income in either 2015 or 2016.
4) Teal must recognize the income in 2016.
5) None of these.

Answer 1

Teal company, being an accrual basis taxpayer, must recognize the income in 2016, which is when they delivered the goods and effectively earned the income according to tax accounting rules.

Step-by-step explanation:

The Teal company, as an accrual basis taxpayer, must recognize income when all the events have occurred that fix the right to receive the income and the amount can be determined with reasonable accuracy. This is dictated by the accrual method of accounting. The fundamental question revolves around when the income is earned, which is typically when the product or service is delivered or the title passes to the customer, not necessarily when payment is received.

Given that the item was delivered on January 4, 2016, the income related to this sale should be recognized in 2016. The fact that Teal included the sale in its 2015 income for financial accounting purposes does not dictate tax treatment. Therefore, the correct response is that Teal must recognize the income in 2016 (4), which is the year in which the goods were delivered and income was actually earned for tax purposes.