Brown Thumb Landscaping is a calendar-year, accrual-method taxpayer. In Septembe

Question

Brown Thumb Landscaping is a calendar-year, accrual-method taxpayer. In September, Brown Thumb negotiated a $14,000 contract for services it would provide to the city in November of the current year. The contract specifies that Brown Thumb will receive $4,000 in October as a down payment for these services and it will receive the remaining $10,000 in January of next year.

How much income from this $14,000 contract will Brown Thumb recognize in the current year? Explain.

How much income from this $14,000 contract will Brown Thumb recognize in the current year if it uses the cash method of accounting?

Suppose that the total amount to be paid under the contract with the city is estimated at $14,000 but may be adjusted to $12,000 next year during the review of the city budget. What amount from the contract, if any, should Brown Thumb recognize as income this year? Explain.

Suppose that in addition to the basic contract, Brown Thumb will be paid an additional $3,000 if its city landscape design wins the annual design competition next year. Should Brown Thumb accrue $3,000 revenue this year? Why or why not?

Explanation / Answer

1. Under accrual method whole $14000 amount will be recognized in current year because under this method revenue is recognized when service is performed or ownership of product is transferred.

2. If Brown Thumb uses cash method of accounting then only $4000 will be recognized in the current year because under this method revenue is recognized on receipt.

3. Brown Thumb will recognize $12000 as income in this year because as per prudence concept we will adjust all future losses so here is a change of cutting in the fees thus he will record only $12000 in this year.

4. Brown Thumb will not accrue $3,000 revenue this year because this amount is conditional and as per prudence concept we cannot record expected income. Thus if this income is given to Brown Thumb then it will be recorded.

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