Question

The Maroon & Orange Gym, Inc., uses the calendar tax year and the accrual method of accounting. The corporation sells memberships that entitle the member to use the facilities at any time. A one-year membership costs $480 ($480/12 = $40 per month); a two-year membership costs $720 ($720/24 = $30 per month). Cash payment for the full amount of the contract is required at the beginning of the membership period. On July 1, 2019, the company sold a one-year membership and a two-year membership. For book purposes, the corporation reports the payments for months after the end of each calendar year as unearned income. Assuming the transactions are treated for income tax purposes as advanced payments for services, the company should report as gross income from the two contracts:

a. $1,200 in 2019. b. $420 in 2019. c. $780 in 2020. d. $600 in 2020. e. b and c are both correct.

Answer 1

c. $780 in 2020

The accrual basis taxpayer can allocate the income from services in the first year but must include the balance of the income on the contract in the following year. Therefore, for the 24-month contract, all of the income was reported by the end of the second tax year.   

($40 x 6 + ($720-$180) = $780.