Question

for the second part i want to know how it is capitalized and amortized the 6,000 using cash and accrual method.

economic performance has occurred. "12-Month Rule" On November 1, 2019, Nada, a calendar year and cash basis taxpayer, pays $6,000 for a one-year premium on a catastrophic liability policy that takes effect December 15, 2019. Nada will receive a benefit from this policy from December 15, 2019, through December 14, 2020. Her benefit does not extend beyond 12 months after the benefit begins on December 15. It also does not extend beyond the end of 2020. Therefore, this payment satisfies the requirements of the 12-month rule and Nada can deduct the $6,000 in 2019. Assume the same facts as in Example 17, except that the benefit from the policy runs from February 1, 2020, through January 31, 2021. Nada's benefit now extends beyond the end of the tax year following the tax year in which the payment was made (December 31,2020), so the 12-month rule requirements are not met. Nada must capitalize the $6,000 payment in 2019 and amortize it over the benefit period. 6-2e Time Value of Tax Deductions

Answer 1

Answer.

Since the premium is being paid whose benefit will flow from one year to another year. We need to divide the premium by 12 months and spread it over two financial years. Now, the number of months that will fall in the 1st tax year is 11 and 1 month will fall in next tax year.

Now $6000 will be capitalized in the books.

Prepaid Premium A/c Dr 6000

To Bank A/c 6000

Now above $6000 will be amortized every month i.e 6000/12 = $500 will be amortized or expensed off every month. so in 1st tax year $500 x 11 Months = $5500 will be expensed off / amortized. Balance, $500 will be carried forward to new tax year and will be expensed off in next tax year.

Hence, on accrual basis premium is divided in two years.