Question

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You are currently working at a mid-sized certified public accounting firm. Your client is Bob Jones. Bob, age 60 and single, has recently retired from IBM. He has $690,000 available in his 401(k) fund and he is thinking of using that money to open a used car business that will be located at 210 Ocean View Drive in Pensacola, Florida. Bob has estimated that the business might make $300,000 in taxable income. Bob’s personal wealth including investments in land, stocks, and bonds is about $14,000,000. He reported an interest income of $20,000 and dividend income of $6,000 last year. The $14,000,000 includes land worth $9,000,000 that Bob bought in 1966 for $450,000. Bob has hired your firm for professional advice regarding whether he should operate as a sole proprietor, a partnership, an S corporation, or a C corporation. He is also considering transferring a possible 40% interest in his new business to his daughter Mandy, age 23 and single.

Required

Summarize, using moral reasoning, cash or accrual basis accounting systems in relation to the selected business entity. Consider how the accounting system impacts revenue recognition, consistent with Internal Revenue Code and Treasury regulations.

Answer 1

Answer

Even though, the IRS Code permits S Corporations to file their tax return using either cash basis of accounting or accrual method of accounting, Bob will be only permitted to use the accrual method of accounting for filing his income tax returns because he will be managing inventory in his new used car business. For that same reason, we recommend that the accounting and tax file be done using the accrual method of accounting. Bob’s business will be managing inventory and complex transactions due to the nature of the used car sales. If Bob ends up using cash basis of accounting for his business and files his income tax return using the accrual method, in order to comply with the IRS Code, he would have to convert his cash basis accounting into the accrual method by accumulating all the invoices due and all the estimated expenses corresponding to the year to be filed. Also,Bob will have to register all the income associated to the sales completed even though,the cash may not have been received yet. On the other hand, if Bob uses the accrual method of accounting for his day to day business and for this income tax return,adjustments to the financial statement won’t be necessary in order to comply with the IRS Code.