Question

Erin is considering switching her business from the cash method to the accrual method at the beginning of next year (year 1). Determine the amount and timing of her §481 adjustment assuming the IRS grants Erin's request in the following alternative scenarios.

a. At the end of end of year 0/beginning of year 1, Erin's business has $15,000 of accounts receivables and $18,000 of accounts payables that have not been recorded for tax purposes.
b. At the end of year 0/beginning of year 1, Erin's business reports $25,000 of accounts receivables and $9,000 of accounts payables that have not been recorded for tax purposes.

Answer 1

Answer and Explanation:

1a .Account receivable $15,000

Less Account payable $18,000

=$3,000

Hence Erin would be required to make a IRC §481 adjustment in order to ensure that she does not omit receivables and payables from the taxable income under the accrual method of accounting in which she is switching to. Her net IRC§481 adjustment would be to decrease net income by $3,000 ($15,000 receivables minus the $18,000 payables) due to the fact that this is an income decreasing adjustment which would make Erin would deduct the full adjustment amount in year1

1.b.Account receivable $25,000

Less Account payable $9,000

=$16,000

Erin's net IRC §481 adjustment will be to increase net income by $16,000 ($25,000 receivables minus the$9,000 payables). Because it is a income increasing adjustment, therefore Erin would include 25 percent of the net adjustment ($4,000) in taxable income in each of the next four years starting with year 1.