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Chapter 13 Tax Accounting


TRUE-FALSE QUESTIONSCHAPTER 13
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. A partnership may adopt any tax year without IRS permission. A corporation ling its rst return must annualize its income if the tax period is less than 12 months. A taxable year may be as short as one day and may exceed 366 days. Under no circumstances may a corporation change its scal year without IRS permission. A taxpayer engaged in two or more separate and distinct businesses may use different accounting methods for both businesses. A grocery store may use the cash basis of reporting sales. In general, a CPA on the cash basis method will never have a bad debt deduction. A cash basis taxpayer may deduct prepaid business expenses currently. Both cash and accrual basis taxpayers will be taxed on a dividend when it is actually received. Computing cost of goods soldand being on the accrual basis are independent of each other. If, in the IRSs opinion, the taxpayers books do not clearly reect income, the IRS may revise them so that they do. Taxpayers must generally obtain the permission of the IRS to change accounting methods. A correction of an error in a tax return is usually considered a change in accounting method. The IRS can require a change in accounting methods if the method used by a taxpayer does not clearly reect income. IRS permission is not required for a change from FIFO to LIFO. The installment method cannot be used unless the total selling price is known. Repossessions of real property sold on the installment basis are generally nontaxable. The installment sales rules do not apply to sales at a loss.

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MULTIPLE CHOICE QUESTIONSCHAPTER 13


19. A short tax year with the subsequent annualizing of taxable income is required for which of the following? a. In the year of death of an individual b. In the year of termination of a partnership c. In the rst year of a new corporation d. In the year of liquidation of a corporation e. None of the above 20. What is the amount of tax to be paid for a short period assuming the tax from placing the short period on an annual basis is $2,300; the tax computation for the short period without annualizing is $2,100; and the tax computation using the full 12 months and prorating is $2,200. a. $2,300 b. $2,200 c. $2,100 d. $100 e. None of the above 21. Which of the following is not a method of accounting? a. Cash receipts and disbursements method b. Accrual method c. LIFO inventory d. Long-term contracts method e. None of the above 22. The following statements about the cash basis method of accounting are false, except: a. The prepayment made for future services may be deducted currently. b. Interest credited to a savings account is not taxed until withdrawn. c. Stock received for services rendered are taxed only in the year sold. d. The exchange of services may lead to gross income to both parties. 23. Jake Turner realized last December that he had almost reached the point where his medical expenses exceeded the 7.5 percent of AGI limitation. As a result, he insisted on paying his physician, Dr. Grope, $6,000 on account for future services for the Turner family. The results of this prepayment are: a. Turners deduction: when paid; Dr. Gropes income: when received b. Turners deduction: when services are rendered; Dr. Gropes income: when received c. Turners deduction: when services are rendered; Dr. Gropes income: when services are rendered d. Turners deduction: when paid; Dr. Gropes income: when services are rendered 24. Robert Graves sold his house to George Tombs for a total of $100,000. Earnest money of $5,000 was received at the end of the year prior to the closing. The remaining $15,000 of the down payment was received at closing. George assumed a $50,000 mortgage on the property and signed a second mortgage for $30,000. If Roberts basis was $35,000 the tax results, in part, are as follows: a. Contract price: $65,000; gross prot: 100%; payments in year of sale: $35,000 b. Contract price: $50,000; gross prot: 100%; payments in year of sale: $50,000 c. Contract price: $65,000; gross prot: 100%; payments in year of sale: $20,000 d. Contract price: $80,000; gross prot: 65/80%; payments in year of sale: $30,000

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25. Sylvester Sueem, attorney-at-law, reports his income on the cash basis. Last year his books reected the following:
Cash collected on billed fees Retainers received for next years work Uncollected but billed fees for work performed Expenses paid Unpaid bills for ofce supplies Amount received from client and put in a third-party escrow account pending the outcome of a lawsuit $100,000 12,000 15,000 30,000 500 20,000

Sylvesters net self-employment income last year was: a. $70,000 b. $84,500 c. $82,000 d. $96,000 26. Greg Owens owns a four-at building. Last year, he recorded the following items:
Rents paid, of which $3,000 was for the previous year Security deposits to be returned Rent due, but uncollected Expenses paid Prepaid rent $15,000 2,000 4,000 30,000 1,000

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His gross rental income, depending on whether he is on the cash or accrual basis, amounted to: a. Cash: $16,000; accrual: $17,000 b. Cash: $13,000; accrual: $17,000 c. Cash: $18,000; accrual: $16,000 d. Cash: $17,000; accrual: $17,000 An accrual basis taxpayer must recognize income when a sale is made, even if on credit. This means that income is recognized: a. When the order is received b. When the delivery is made c. When the invoice is mailed d. At any of the above events, if consistently used A corporation must annualize a short taxable year resulting from: a. Going out of business b. Starting in business c. Changing from one scal year to another d. Joining an afliated group and ling consolidated returns The following statements about cash and accrual basis taxpayers are all false, except: a. Both cash and accrual basis taxpayers include prepaid rent in gross income. b. Both cash and accrual basis taxpayers are taxed on rent paid late when received. c. The timing of dividend income may depend on the record date. d. Constructive receipt is a concept affecting both cash and accrual method taxpayers. A developer primarily involved in long-term construction may in whole or in part use any one of the following accounting methods, except: a. Cash method b. Percentage-of-completion method c. Completed-contract method d. Modied percentage-of-completion method

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31. The following statements about inventories for tax purposes are all true, except: a. Inventories may not be valued on the basis of the base stock method, the prime cost method, nor the variable cost method. b. If inventories are required to be kept, the taxpayer must be on the accrual basis for purchases and sales of inventory, but it may be on the cash method for the service portion of the business. c. The use of the LIFO method invariably results in an annual reduction in taxable income. d. A strict adherence to GAAP is no guarantee that the IRS will allow a write-down of inventories. 32. The following statements about LIFO inventory are false except: a. The taxpayer needs IRS permission to adopt LIFO. b. LIFO must be used for both book and tax purposes, but the numbers may still differ. c. The use of LIFO results in tax deferral and increased earnings per share per books. d. LIFO was not acceptable for tax purposes until the 1954 Internal Revenue Code. 33. All of the following deferred payment sales qualify for installment reporting except: a. Sale of depreciable property at a gain to sellers brother b. Transfer of a building subject to a mortgage in excess of basis where no other consideration is paid c. Sale of real property used in a trade or business d. Sale of depreciable property to the sellers 82 percent owned corporation 34. The following statements about dispositions of installment obligations are all true, except: a. If a father sells property at a gain to his daughter for an installment obligation, then forgives one of more installments, gain is recognized by the father, or his estate. b. A sale of an installment obligation to the spouse for its fair market value does not accelerate the gain. c. A gift of an installment obligation triggers gain, even if no consideration is received. d. If the seller elected out of the installment method, a disposition of the obligation may result in a loss, but not in gain, since the gain was recognized up-front. 35. Paul Panda purchased property from Walter Wolf by assuming an existing mortgage of $12,000 and agreeing to pay an additional $6,000, plus interest, over the next three years. Walter Wolf had an adjusted basis of $8,800 in the building and paid selling expenses totaling $1,200. What were the sales price and the contract price in this transaction? a. Sales price: $6,000; contract price: $12,000 b. Sales price: $18,000; contract price: $10,000 c. Sales price: $18,000; contract price: $8,000 d. Sales price: $18,000; contract price: $6,000 36. All of the following tax years are acceptable tax years except: a. 52-53-week tax year. b. Short tax year which occurred because a business was not in existence for an entire year. c. Short tax year which occurred because a business had a change in accounting period. d. Fiscal tax year (other than a 52-53-week tax year) that ends on any day of the month other than the last day. 37. All of the following statements regarding accounting methods are true except: a. If inventory is a material, income-producing item for your business, you must use the accrual method for your sales and purchases. b. If you use the cash method for reporting expenses, you can use the accrual method for guring income. c. If you use the accrual method for reporting expenses, you can use the cash method for guring income. d. If you operate more than one business, you may use a different accounting method for each separate and distinct business, provided that the method clearly reects income. 38. The uniform capitalization rules apply to which one of the following properties? a. Property you produce under a long-term contract b. Personal property you purchase for resale, if your average annual gross receipts are $10,000,000 or less c. Costs paid or incurred by an individual (other than as an employee) or a qualied employee-owner of a personal service corporation in the business of being a writer, photographer, or artist d. Real property or tangible personal property which you produce for sale to customers

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39. Which of the following entities may select any tax period (calendar or scal)? a. sole partnership b. partnership c. S corporations d. trusts e. corporations other than S corporations. 40. Which entities must have tax years that conform with the tax years of their owners? a. partnerships b. S corporations c. personal service corporations d. all of the above e. none of the above 41. Which factors should be considered when selecting a tax year for a taxpayer? a. business factors b. natural business year c. timing of income and deductions d. tax law requirements e. all of the above f. none of the above 42. Jones has two separate businesses. Jones: a. must use the same accounting methods for each business b. may use different accounting methods for each business with no restrictions c. may use two different accounting methods but must reconcile the differences between businesses d. may use two different accounting methods if separate books and records are kept for each business e. none of the above 43. Simond is the owner of a hair salon. In addition to hair styling, he sells some hair products but the sales account for little revenue. Regarding accounting methods, Simond: a. must use the accural basis to account for income and expenses b. may use the cash basis to account for income and expenses c. may use the cash basis to account for income and expenses except for inventory, for which he must use the accrual basis d. none of the above 44. Which of the following accounting changes is not considered a major change? a. change in the method of valuing inventory b. change from the accrual basis to the cash basis c. change in the use of a specialized method of computing income, such as the crop method for farmers d. correction of a mathematical error e. all of the above are major changes f. none of the above are major changes 45. Stanton Inc. is a calendar year, cash basis taxpayer. The IRS required Stanton Inc. to change to the accrual method of accounting for 2011. Net income for 2011 under the accrual basis was $60,000 before any adjustments. On December 31, 2010, the balances in inventory, accounts receivable, and accounts payable were $5,000, $15,000, and $6,000, respectively. Stantons 2011 adjusted net income is: a. $46,000 b. $74,000 c. $34,000 d. $86,000 e. none of the above

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46. Schull Co. uses the LIFO method to account for its inventories. It can use the following method in combination with LIFO: a. specic identication b. lower cost or market c. dollar value techniques d. all of the above e. none of the above 47. Rubin Inc. uses the FIFO and lower of cost market methods to account for its inventory. Information regarding inventories is as follows.
Product X Y Z Cost $1,200 900 1,900 Market $1,400 600 1,700

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Total $4,000 $3,700 Rubin Incs ending inventory will be valued at: a. $3,500 b. $3,700 c. $4,000 d. $4,200 e. none of the above Mallie Co. uses the dollar-value LIFO inventory method. Inventory of January 1, 2011 was $100,000 at base year prices. Inventory on December 31, 2011 was $160,000 at base year prices and was $200,000 at actual prices. What is the value of Mallie Co.s ending inventory? a. $160,000 b. $175,000 c. $200,000 d. $275,000 e. none of the above Hock Brothers uses the simplied dollar-value LIFO method to account for its inventory. Ending inventory at actual prices in 2011 and 2012 was $80,000 and $120,000, respectively. The Consumer Price Index for 2011 and 2012 was 102% and 107%, respectively. The value of Hock Brothers ending inventory in 2012 is: a. $114,393 b. $116,079 c. $120,000 d. $127,607 e. none of the above Campbell Co. incurred a variety of costs associated with its long-term construction contract. Which of the following costs must be capitalized and deducted as prots are recognized? a. construction period interest b. general and administrative expenses relating to specic contracts c. scrap and spoilage costs d. all of the above e. none of the above Peter sold a painting in 2011 for $100,000. Peter bought the painting in 2000 for $60,000. Peter received $30,000 in 2011 and is to receive $15,000 per year (plus interest) for 2012 through 2015. How much gain must Peter recognize in 2011?

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a. $12,000 b. $28,000 c. $30,000 d. $40,000 e. none of the above Hal sold a rare automobile in 2011 for $110,000. Hal bought the automobile in 1987 for $25,000. Hal received $50,000 in 2011 and will receive $60,000 (plus interest) in 2012. Hal elects not to use the installment method for this sale. The $60,000 note is worth $57,000 at the time of the sale. What gain (not including interest income) will Hal recognize in 2012 when he receives the $60,000? a. $-0 b. $3,000 long-term capital gain c. $3,000 ordinary income d. $57,000 ordinary income e. none of the above Gyan sold an oriental rug in 2011 for $25,000. He acquired the rug in 2001 for $17,000. He received $6,000 in 2011 and $10,000 in 2012. Gyan sold the installment obligation on January 3, 2013 for $8,500. Gyans long-term capital gain on the sale of the installment obligation is: a. $-0b. $2,380 c. $6,120 d. $8,500 e. none of the above In 2011, Rankin sold real estate he aquired in 1994 under an installment contract and used the installment method for tax purposes. In 2012, the buyer defaulted on the installment obligation and Rankin repossessed the property. Rankin sustained a $30,000 loss on the repossession. Rankins recognized position in 2012 as a result of the repossession is: a. $-0 b. $30,000 long-term capital gain c. $30,000 ordinary income d. none of the above Which of the following entities do not compute taxable income per se? a. C corporations b. Partnerships c. Estates d. Trusts e. Individuals In order to secure prior approval for a change in accounting period, the taxpayer: a. need do nothing, just le the short period return by its due date b. le Form 1040 requesting approval of the change c. le Form 1128 requesting approval of the change d. le Form 1120 requesting approval of the change Sturdy Co. led a short period return covering four months. It had an NOL of $75,000. With respect to the NOL, Sturdy Co.: a. Carry it back two years and then forward 20 years b. Carry it back two years but not carry it forward c. Cannot carry it back but can carry it forward for 20 years d. Cannot claim any benet from the NOL (i.e., cannot carry it back nor forward)

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58. Newco is a 90% subsidiary of P Company. With respect to its accounting period: a. Newco may select any accounting period b. Newco should select the calendar year c. Newco should select the same accounting period as P Company d. Newco should select the same accounting period as its minority shareholders 59. In 2011, X Company received full payment of an account payable from Jones Company. X Company had written the account off as a bad debt in 2010. In deciding how to treat the payment from Jones Company, X Company would use: a. the claim-of-right doctrine b. the tax benet rule c. the constructive receipt doctrine d. the Arrowsmith doctrine e. none of the above 60. Which taxpayers cannot use the cash basis method of accounting? a. Large C corporations b. Tax shelters c. Partnerships that have a C corporation as a partner d. All of the above must not use the cash basis e. All of the above may use the cash basis 61. Mars uses the cash basis of accounting and is a calendar year rm. On December 31, 2011, it mailed checks in payment of expenses. The checks were not cashed until January 2012. Mars may take a deduction for these expenses in: a. 2011 b. 2012 c. either 2011 or 2012, whichever it chooses d. no deduction is permitted until the expenses are incurred 62. It is late December 2011 and Jones Company, a calendar year taxpayer, wants to shift income from 2011 to 2012. Which of the following methods will not achieve its objective? a. delay shipping of goods that are F.O.B. destination b. use the installment method on current sales, if permitted c. defer paying bonuses to ofcers d. prepay nonrefundable commissions e. none of the above 63. B&B Company uses the cash basis for accounting purposes. B&B primarily performs a service; however, it does sell a signicant amount of inventory. a. B&B must use the cash basis to account for its inventory b. Since inventory is an income-producing factor, B&B must use the accrual basis to account for its inventory but may use the cash basis for its other transactions c. Since inventory is an income-producing factor, B&B must use the accrual basis to account for all of its transactions d. None of the above 64. CKC just received permission from the IRS to change its method of accounting. CKC is uncertain if it now wants to change methods. Since it already has received permission to change, a. CKC must use the new method of accounting b. CKC may continue to use its current method of accounting only if it makes a timely election c. CKC may continue to use its current method of accounting only if it makes a timely election and subsequently receives IRS permission d. CKC may continue to use its current method of accounting even if it does not make a timely election

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65. Susan and Tom had the same aggregate taxable income over the last ve years. Susans income was relatively smooth over this period but Toms income uctuated greatly over this same time period. Assuming that tax rates have remained reasonably constant over this time period who would experience the greater total tax liability? a. Susan b. Tom c. their tax liabilities would be equal 66. Failure to make a timely accounting election could result in: a. permanent loss of expected benets associated with the election b. deferral of expected benets associated with the election c. increased tax liability d. all of the above e. none of the above 67. X Company has made sales throughout the year. If prices have been rising constantly throughout the year, then: a. Taxable income will be lower under FIFO b. Taxable income will be lower under LIFO c. Taxable income will be lower under weighted average d. Taxable income will be lower under specic identication 68. Cash Co. normally takes a physical count of inventory throughout the year. Due to some unexpected circumstances, it is unable to take a physical count at year end. Cash Co. wants to determine its ending inventory using estimates for shrinkage. It may do so if: a. it normally uses this method to determine its inventory b. it uses this method in conjunction with another method to verify actual amount c. it normally takes a physical count on a routine basis d. it may not use this estimating technique 69. Long Company entered into a contract to build an ofce building for $9,000,000. The project is expected to be completed in two years at an estimated total cost of $6,000,000. Actual expenses incurred in each year were $2,000,000 and $3,000,000. The income reported by Long Company for the rst year would be: a. $0 under the percentage-of-completion method and $0 under the completed- contract method b. $1,000,000 under the percentage-of-completion method and $0 under the completed-contract method c. $1,500,000 under the percentage-of-completion method and $0 under the completed-contract method d. $2,500,000 under the percentage-of-completion method and $0 under the completed-contract method 70. Builders Inc. entered into a contract to build a state-of-the art warehouse for Smith and Company for $18,000,000. Midway through the project, a dispute arose. The dispute has not delayed the project; however, the dispute could affect the overall cost by $100,000. Builders Inc. uses the percentage-ofcompletion method to account for its long-term contracts. Because of the dispute, Builders should: a. revise its estimates, recompute previous years income and le amended returns for each year b. revise its estimates and base all subsequent income determinations on the new estimates c. reduce income in the year the dispute arose d. reduce income in the year the project is completed 71. Sally sold a painting to Jenny for $2,500. Sallys adjusted basis in the painting was $1,000. Sally received $1,250 in the year of sale and $1,250 the next year. Since Sally knew Jenny she did not charge interest on the deferred payment, upon audit the IRS will: a. impute interest at 6% on the deferred payment b. impute interest at the applicable federal rate on the deferred payment c. not impute any interest on the deferred payment d. require Sally to recompute the contract with the current market interest rate

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72. There are many advantages and disadvantages in using the installment method of reporting. All of the following are factors that affect these advantages and/or disadvantages except: a. an interest charge might be required b. marginal tax rates may change c. the seller might default d. depreciation recapture occurs in the year of sale e. all of the above are relevant factors f. none of the above are relevant factors 73. Barrack sold stock on November 6, 2011 for $20,000. He received $5,000 down and $15,000 was due on January 15, 2012. He acquired the stock on January 10, 2009 for $10,000. Barrack made numerous attempts to collect the $15,000 and on April 15, 2012 he repossessed the stock. He incurred $1,000 in repossession costs and the stock was worth $14,000 when repossessed. What is Barracks recognized capital gain (loss) on the repossession? a. $1,000 short-term capital loss b. $2,000 long-term capital loss c. $5,500 short-term capital gain d. $5,500 long-term capital gain 74. Sarah sold land on November 8, 2011 for $400,000. She acquired the land on October 5, 2006 for $100,000. She received $80,000 down and $320,000 was due September 20, 2012. Sarah was unable to collect the remaining $320,000 and repossessed the land on November 15, 2012 when the land was worth $410,000, incurring $2,000 fees in the process. What is Sarahs recognized gain on the repossession? a. $18,000 long-term capital gain b. $20,000 long-term capital gain c. $238,000 long-term capital gain d. $248,000 long-term capital gain 75. John sold a painting on November 8, 2010 for $100,000. He acquired the painting for $30,000 on May 16, 2000. He received $40,000 down and $30,000 on June 20, 2011 and June 10, 2012. He sold the installment obligation for $20,000 on January 15, 2012. What is Johns recognized gain (loss) on the sale of the installment obligation? a. $10,000 long-term loss b. $$1,000 long-term capital loss c. $11,000 long-term capital gain d. $14,000 long-term capital gain 76. Hillary Co. is a cash basis taxpayer. It sold machinery for $300,000 during the year. Hillary Co. acquired the machinery for $100,000 and took $60,000 in depreciation prior to the sale. The machinery is subject to a $30,000 liability. The buyer assumes the liability, gives Hillary Co. a $60,000 down payment and agrees to pay $70,000 per year for the next three years. What is Hillary Co.s gross prot percentage in the year of sale? a. 100% b. 96% c. 74% d. 63%

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77. In 2011, Zog Company enters into a two-year contract to construct a building for $40,000,000. Zog Company estimates it will cost $30,000,000 to complete the building. It completed the building in 2012, and actual costs were $21,000,000 in 2011 and $7,000,000 in 2012. What gross prot does Zog Company report in 2011 and 2012? 2011 2012 a. $7,000,000 $5,000,000 b. $9,000,000 $3,000,000 c. $8,000,000 $4,000,000 d. $6,000,000 $6,000,000 78. Christman Co. adopts the simplied dollar-value LIFO method in 2011. Ending inventory at actual prices in 2011 and 2012 was $100,000 and $160,000, respectively. Assume that the consumer price index was 1.20 and 1.25 in 2011 and 2012. What cost will Christman Co. use as ending inventory for 2012? a. $160,000 b. $155,833 c. $153,600 d. $150,000 79. Shapot Inc. obtains IRS permission to change from the calendar year to a scal year ending June 30, On July 1, 2011, it switched to the new accounting period. Its gross receipts and expenses for January 1, 2011June 30, 2011 were $190,000 and 80,000, respectively. What is Shapot Inc.s gross tax liability for the short period? a. $26,150 b. $33,129 c. $34,525 d. $69,050

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SUPPLEMENTARY PROBLEMSCHAPTER 13
80. Which annual accounting period may the following independent taxpayers use? a. A nonseasonal business organized as an S corporation where its shareholders are not all on the calendar year? b. A salaried employee with a part-time consulting practice. c. A C corporation that commenced business on January 2 and has a natural business year ending in December. d. A partnership with four equal partners, two on the calendar year and two on June 30 years, but with a natural business year ending in January. e. A partnership with two calendar year partners. f. An S corporation with one shareholder only, who is on November 30 year personally. 81. Space Funerals, Inc. is a calendar year accrual basis taxpayer. What is the tax status of each of the following items from the companys current year? a. Receivable known to be worthless in February. b. Prepaid rent of January, check received, but not deposited. c. Dividend declared to shareholders of record as of December 30, check not received. d. Payment for supplies ordered the previous year. e. Increase in unpaid accounts payable. f. Sale of securities at a loss at the end of December, settlement date January 4. g. Same as (f), but at a gain. h. Prepayment for services to be rendered this year, check cashed by payee in December. 82. Gregory McDonald sold a piece of land he purchased for $5,000 many years ago. He recently mortgaged the property for $30,000, but after six months he sold the land for $50,000 to his cousin, Gus. a. If Gus purchased the land for cash and Gregory paid off the mortgage, what is the contract price, the gross prot, and the gross prot percentage? b. If Gus took the land subject to the mortgage and paid $5,000 a year, plus 10 percent interest for four years, starting with the year of sale, what is the contract price and the gain in the year of the sale? 83. For each of the following changes in accounting method or period explain (1) if permission is needed and (2) the tax effect of the change. a. Changing from a calendar to a scal year b. Changing from FIFO to LIFO c. Changing from the cash to accrual method d. Changing from the expensing to capitalizing carrying charges e. Changing from ACRS to the units of production method f. Changing from accruing accounts receivable at the time the order is received to the time that title changes 84. Sandra Surrey sold her racehorse for $40,000 to Mickey Jockey and received $10,000 down and a note for $30,000 (value $25,000) due in three years together with accrued interest of 12 percent compounded semiannually. If the note is paid on time and the horse is Section 1231 property in which Sandra had a basis of $15,000, what are the tax consequences to Sandra if: a. Sandra elects out of installment reporting? b. Sandra reports her gain on the installment method? 85. Xeno Corporation was formed in 2008 and adopted a calendar year. In 2011, it switched to a scal year beginning April 1. The only available information is for January 1 through March 31. Taxable income for the three months was $23,000. Determine Xenos tax liability for the short period. When is the short periods tax return due? Is there any relief available to Xeno Corporation?

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86. In 2011, Bust Company requested and received permission from the IRS to switch its accounting method from the cash method to the accrual method. Taxable income in 2011 (computed under the accrual basis) was $110,000. At the end of 2011, Bust had accounts receivable of $32,000, accounts payable of $27,000 and merchandise inventory of $10,000. Determine Bust Companys taxable income after all (if any) adjustments. Is any relief available to Bust Company? 87. Genesis Corporation began business in 2011. Its primary activity is the sale of appliances. It is uncertain as to which inventory method to useFIFO, LIFO, or weighted average. Given the information below, which method would you suggest? State your reasons for suggesting this method. Purchases:
February June Augus December 200 units $300 = 300 units $350 = 150 units $360 = 180 units $380 = 830 $60,000 105,000 54,000 68,400 $287,400

Genesis sold 600 units in 2011 and anticipates increased sales (in units and price) and increased unit costs. 88. Wonderworks Corporation sells and repairs equipment. Wonderworks is an accrual basis, calendar year taxpayer. In computing its taxable income for 2011, it is uncertain about the treatment of the following three items and seeks your advice: a. It repaired a machine for Dandy Co. and submitted a bill for $7,000. Dandy Co. paid $3,000 at delivery but did not pay the remaining $4,000 because the repairs were faulty. By the end of 2011 Dandy Co. still had not paid the $4,000 and had led a claim to recover the $3,000 already paid to Wonderworks. b. Wonderworks provides free service in the year of sale for equipment that it sells. Included in the sales price (but unknown to its customers) is the cost of such service plus a prot. Total sales in 2011 were $300,000, of which $15,000 represented the cost of service and $5,000 represented the prot on said services. However, the equipment is high quality and no service calls were made in 2011. Wonderworks does not know how to treat the $20,000 with respect to income and deductions. c. Wonderworks rents its premises from Acme Rental for $2,000 per month. In addition to making 12 monthly payments, Wonderworks paid $4,000 in January 2011 for November and December 2010 rents. Also, in December 2011, Wonderworks prepaid rent for January 2012 ($2,000). 89. Sunel Corporation uses the FIFO method of accounting for its inventories and uses the full absorption cost method. Its beginning inventory on January 1, 2011 was $4,000,000. During the year it incurred $20,000,000 in full absorption costs and $2,000,000 in additional Code Sec. 263A costs. Its ending inventory on December 31, 2011 was $6,000,000 (prior to any Code Sec. 263A costs). Determine Sunel Corporations ending inventory using the uniform capitalization rules of Code Sec. 263A. 90. Joe sold land on November 8, 2011 for $1,000,000. He acquired the land on October 24, 2002 for $200,000. Joe received $100,000 down and $900,000 was due September 20, 2012. Joe was unable to collect the remaining $900,000 and repossessed the land on October 31, 2012 when the land was worth $950,000. He incurred $20,000 in fees to repossess the land. What is Joes recognized gain on the repossession and basis in the repossessed property?

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CCH Federal TaxationComprehensive Topics

ANSWERS TO TRUE-FALSE QUESTIONSCHAPTER 13


1. False. Except for partnerships that qualify under the business purpose exception, a partnership must use the same tax year as that of its partners who have an aggregate interest in partnership prots and capital of greater than 50 percent. False. A corporation is not required to annualize its income in the rst and last years. True. False. If a number of requirements are met no permission is needed. True. False. Inventory must be reported on the accrual basis. True. This is true ignoring uncollectible business loans. False. Taxpayer has really purchased an asset which may be expensed as it expires. True. False. Taxpayer must be on accrual basis for purchases and sales of inventory. True. True. False. A correction of an error is not considered a change of accounting method. True. True. False. The selling price may be contingent on productivity, gross sales, or other events and may be subject to a oor and/or a ceiling after the installment sales Revision Act of 1980. True. True.

2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18.

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ANSWERS TO MULTIPLE CHOICE QUESTIONSCHAPTER 13


19. e. Annualization is not required in any of the instances. 20. b. The tax for the short period is the lesser of annualized computation for the short period or the tax for the short period without annualizing; however the tax cannot be less than the tax computation for the full 12 months and prorated. 21. e. Methods of accounting include overall methods and the accounting treatment of any item. 22. d. The fair market value of services bartered is gross income to both parties regardless of accounting method. 23. b. Jack Turner is buying an asset, i.e., medical services receivable, but Dr. Grope is taxed currently, if he, like most physicians, is on the cash basis. 24. a. The contract price ($5,000 + $15,000 + ($50,000 - $35,000) + $30,000) and the gross prot ($100,000 $35,000) are the same. 25. c. Mr. Sueems income equals $100,000 + $12,000 - $30,000. 26. a. Prepaid rent is gross income for both cash and accrual taxpayers. 27. d. Either event is proper, if consistently used. A change requires IRS permission. 28. c. No annualization is required for the rst and last year, nor for mandatory changes. 29. a. As an exception to the general rules, even accrual method taxpayers must include prepaid rent in gross income. 30. a. The cash method cannot be used because inventories are required. 31. c. This is only true if both prices and inventories increase each year. 32. b. Since LIFO inventory may be written down to lower market only for book purposes, book may be lower than tax. 33. d. Sales of depreciable properties to an 80 percent or more controlled partnership or corporation do not qualify for installment reporting. 34. d. Gain is recognized if the amount realized exceeds the sellers adjusted basis in the obligation. 35. c. Sales price = $12,000 + $6,000 = $18,000. Contract price = $6,000 (cash to be received) + $2,000 (excess of assumed mortgage ($12,000) over adjusted basis plus expenses to sell ($8,800 + $1,200 = $10,000)). 36. d. In general, the tax year must end on the last day of a month. 37. c. A taxpayer cannot use the cash method for reporting income and the accrual method for reporting expenses. 38. d. The uniform capitalization rules apply to real property or tangible property produced for sale to customers. 39. e. Sole propietors must use the same period for business tax purposes that they use for their personal purposes. Partnerships generally must use the same tax period of its partners who have a majority interest, or if not acceptable then the same tax year of its principal partners. If neither are acceptable then it must use the least aggregate deferral method to determine its tax year. S corporations and trusts generally must use a calendar. Only a corporation (other than an S corporation) may select a calendar year or any scal year. 40. d. All three entities must have tax years that conform with their owners and if a change is required then the entity must le a short period return. 41. e. All of the factors are relevant in selecting a tax year. 42. d. A taxpayer may use different accounting methods for two or more separate and distinct businesses only if they have separate books and records. 43. d. Since inventory is not a signicant income producer, Simond does not need to use the accrual method to account for inventories. Also, Simond is not required to use the accrual basis. 44. d. Only the correction of a mathematical error is not considered a major change. 45. b. The ending inventory was expensed previously so a positive adjustment is needed. The accounts receivable have not been recognized as income, so a positive adjustment is needed. The accounts payable have not been recognized as an expense, so a negative adjustment is needed. The net adjustment is $14,000 ($5,000 + $15,000 - $6,000), bringing net income to an adjusted amount of $74,000 ($60,000 + 14,000).

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46. c. Specic identication is a general inventory method and would be used in lieu of LIFO. Lower of cost or market cannot be used with LIFO. Dollar-value LIFO is an acceptable method. 47. a. Lower of cost or market is applied on an item-by-item basis. Thus, product X is valued at $1,200, product Y is valued at $600, and product Z is valued at $1,700, for a total of $3,500. 48. b. $175,000
Inventory at base year prices: 1/1/11 Inventory at base year prices: 12/31/11 Increment $100,000 $160,000 $ 60,000

Price index: $200,000/$160,000 = 1.25 Adjusted increment: $60,000 1.25 = $75,000 Ending inventory: $100,000 + $75,000 = $175,000 49. b. $116,079 2012 ending inventory at assumed base year prices: $120,000 1.02/1.07 = $114,393
Increment at base price: Increment at 2012 base price: Ending inventory value: $114,393 - $80,000 = $34,393 $34,393 1.07/1.02 = $36,079 $80,000 + $36,079 = $116,079

50. d. All of the costs must be capitalized during the construction period and expensed as prots are recognized. 51. a. $12,000
Overall gain on sale: Contract price: Gross prot percentage: Gain recognized in 2011: $100,000 - $60,000 = $40,000 $100,000 $40,000/$100,000 = 40% $30,000 x 40% = $12,000

52. c. $3,000 ordinary income Overall gain on sale if installment method is used: $110,000 - $25,000 = $85,000
Contract price: Gross prot percentage: Gain recognized in 2011: Gain recognized in 2012: $110,000 $85,000/$110,000 = 77.3% $50,000 x 77.3% = $38,650 long term capital gain $60,000 x 77% = $46,350 long-term capital gain

If Hal elects not to use the installment method then the recogized gain in the year of sale is an $82,000 longterm capital gain ($107,000 - $25,000 = $82,000). In 2001 when Hal collects on the note he will recognize ordinary income of $3,000 ($60,000 - $57,000 basis). 53. b. $2,380
Overall gain: Contract price: Gross prot percentage: Long-term capital gain recognized in 2011: Long-term capital gain recognized in 2012: Unpaid balance of installment obligation: Basis in installment obligation: Gain on sale of installment obligation: $25,000 - $17,000 = $8,000 $25,000 $8,000/$25,000 = 32% $6,000 x 32% = $1,920 $10,000 x 32% = $3,200 $25,000 - $16,000 ($6,000 + $10,000) = $9,000 $9,000 - ($9,000 x 32%) = $6,120 $8,500 - $6,120 = $2,380 (long-term capital gain)

54. a. $-0- Loss is not recognized and no bad debt deduction is allowed on the repossession of retail property.

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55. b. Partnerships are conduits. As such, they determine their ordinary income, which passes through (with other items) to the partners. 56. c. Form 1128 needs to be led on or before the 15th day of the third calendar month following the close of the short period. 57. c. The NOL can be carried forward only. The exceptions to this rule are not met. 58. c. Consolidation return regulations require all members of the same group to use the same tax period. Thus, Newco should select the same tax year as its parent, P Company. 59. b. The tax benet rule deals with recoveries of amounts previously deducted. 60. d. Large C corporations, partnerships that have a C corporation as a partner, tax shelters, and trusts that are subject to tax on unrelated trade or business income (but only with respect to such income) cannot use the cash basis. 61. a. Cash basis taxpayers take the deduction when the expense is paid, not when it is incurred. The expense is considered to be paid when the check is mailed or delivered, not when it is cashed. 62. d. Prepaying nonrefundable commissions will produce a deduction in the year of prepayment (2001). This will reduce income in 2001, which is not Jones Companys objective. 63. b. Since inventories are an income-producing factor then the accrual basis must be used to account for them. However, a cash basis taxpayer can use the cash basis for all other transactions. 64. d. The taxpayer should advise the IRS within 30 days of receiving permission to change accounting methods that it intends to continue to use the current method of accounting. However, even after the 30 days expire, a taxpayer is not precluded from continuing to use its current method of accounting. 65. b. Tom would have had the greater tax liability due to the progressive tax rates structures. 66. d. Failure to le a timely election usually leads to a loss of benets associated with the election. This loss could be permanent or be deferred until a timely election is made. Additionally, tax liability increases because the tax benet is not achieved. 67. b. In periods of rising prices, LIFO produces the largest cost of goods sold which produces the smallest taxable income. 68. c. Cash Co. may use estimates of inventory shrinkage to determine its closing inventory if it normally takes a physical count of its inventory on a regular and consistent basis (and makes proper adjustments to its inventories and to its estimating methods to the extent its estimates differ from actual shrinkage). 69. b. Under the completed-contract no income is recognized until the project is completed (i.e., in year 2). Under the percentage of completion method income is recognized as work is nished. Gross revenue in year 1 is $3,000,000 (($9,000,000 x ($2,000,000/$6,000,000)). The expenses of $2,000,000 are subtracted from the $3,000,000 to produce $1,000,000 income for the year. 70. d. Since the amount in dispute is not substantial, Builders Inc. can wait and reduce gain or increase loss in the year of completion. 71. c. Since the sales price was not in excess of $3,000 no interest is imputed. 72. e. All four factors can affect the benets associated with the installment method of reporting. 73. d. Barracks overall gain on sale is $10,000 ($20,000 - $10,000). The gross prot percentage is 50% ($10,000/$20,000; gross prot/contract price). He reported $2,500 long-term capital gain in 2011 (50% $5,000). The adjusted basis of the installment obligation on April 15, 2013 is $7,500 ($15,000 (50% $15,000)). His gain (loss) at repossession equals the stocks fair market value on April 15, 2013 minus the installment obligations basis increased for repossession costs incurred by Barrack = $14,000 ($7,500 + $1,000) = $5,500 long-term capital gain (the same as under the installment method). 74. b. Sarahs long-term capital gain on sale is $300,000 ($400,000 - $100,000). The gross prot percentage is 75% ($300,000/$400,000). Sarah recognizes $60,000 long-term capital gain in 2011 (75% x $80,000). In 2012, when Sarah repossesses the land, her recognized gain on repossession is $20,000, the lesser of $20,000 ($80,000 received - $60,000 gain previously recognized) or $238,000 ($240,000 gain not yet recognized $2,000 repossession costs).

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75. c. Johns long-term capital gain on sale on November 8, 2010 is $70,000 ($100,000 - $30,000). The gross prot percentage is 70% ($70,000/$100,000). He recognizes a $28,000 long-term capital gain on sale (70% $40,000). He recognizes $21,000 long-term capital gain in 2011 (70% $30,000). His basis in the installment obligation in 2012 is $9,000 ($30,000 remaining balance $21,000 amount of income reported if remaining balance is paid in full). His gain on sale of the installment obligation is $11,000 ($20,000 - $9,000). 76. c. The $60,000 depreciation must be reported in the year of sale. The gross prot is $200,000, which equals the selling price (adjusted basis + depreciation taken) = $300,000 ($40,000 + $60,000). The contract price is $270,000, which equals the greater of the gross prot ($200,000) or selling price minus liability assumed by the buyer ($270,000). The gross prot percentage equals the gross prot/contract price = $200,000/$270,000 = 74%. 77. a. Zog Company must use the percentage-of-completion method to account for the contract as follows. 2011
Revenue* Costs incurred Gross prot $28,000,000 21,000,000 $ 7,000,000

2012
$12,000,000 7,000,000 $ 5,000,000

*2011: $21,000,000/$30,000,000 $40,000,000 = $28,000,000 2012: $40,000,000 - $28,000,000 = $12,000,000 78. b. Christman Co. determines its ending inventory using simplied dollar-value LIFO as follows. 2012 ending inventory at assumed base year prices: $160,000 x (1.20/1.25) = $153,600 Increment at 2011 base prices: $153,600 - $100,000 = $53,600 Increment at 2012 base prices: $53,600 (1.25/1.20) = $55,833 2012 ending inventory: $100,000 + $55,833 = $155,833 79. c. Shapot Inc.s taxable income for the six-month short period is $110,000 ($190,000 - $80,000). Its shortperiod tax is determined as follows. Taxable income annualized: $110,000 x 12/6 = $220,000 Tax on annualized income:
$50,000 15% $25,000 25% $25,000 34% $120,000 39% Total =$ 7,500 = 6,250 = 8,500 = 46,800 $69,050

Tax for short period: $69,050 6/12 = $34,525

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ANSWERS TO SUPPLEMENTARY PROBLEMSCHAPTER 13


80. a. A nonseasonal business organized as an S corporation where its shareholders are not all on the calendar year may only use the calendar year. b. A salaried employee with a part-time consulting practice may only use the calendar year. c. A corporation that commenced business on January 2 and has a natural business year ending in December may use any year the corporation wants if initially adopted. d. A partnership with four equal partners, two on the calendar year and two on June 30 years, but with a natural business year ending in January, may use the calendar year or a January 31 year (with permission). e. A partnership with two calendar year partners must use the calendar year unless permission is granted to use the natural business year. f. An S corporation with only one shareholder, who is on a November 30 year personally, may use the calendar year. 81. a. A receivable known to be worthless this year is nevertheless income last year. A bad debt will result this year. b. Prepaid rent is taxable last year. c. Dividends are not income until received. d. A payment for supplies ordered the previous year has no effect on the present tax year. It was accrued the previous year. e. An increase in unpaid accounts payable is an accruable expense. f. The loss on the sale of the securities is currently deductible. g. The sale of securities at a gain at the end of the year, with the completion of the transaction the next year, is taxable in the rst year. h. Prepayment for services to be rendered this year is not deductible until services are rendered. 82. a. The contract price for the property is $50,000. The gross prot is $50,000 - $5,000 = $45,000. The gross prot percentage is 90% ($5,000/$50,000 x 100). b. The contract price for the land is $50,000 - $30,000 + $30,000 - $5,000 = $45,000. (Liabilities in excess of basis are included.) The gross prot percentage is 100% ($45,000/$45,000). Payments in the year of sale are $30,000 - $5,000 + $5,000 = $30,000. The gain in the year of sale is also $30,000. 83. a. To change from a calendar year to a scal year, permission is needed. Form 1128Application for Change in Accounting Periodmust be led within three months after the resulting short year. Income in the short period must be annualized. b. To change from FIFO to LIFO, no permission is needed. Form 970Application to Use LIFO Inventory Methodmust be included with the return for the year of change. Any previously written down inventory must be restored to cost. c. To change from the cash to the accrual method, permission is needed under Code Sec. 446(e) on Form 3115Application for Change in Accounting Methodto be led within 180 days of the beginning of the year of change. Any adjustment is spread over a maximum of 10 years (or years of accumulation, if less). d. To change from expensing to capitalizing carrying charges, permission is needed. See (c) above for requirements. e. To change from the ACRS to the units of production method, no permission is needed. Can be done for assets newly placed in service only. ACRS is mandatory unless method not based on time is adopted. No switches may be made. f. To change from accruing accounts receivable at the time the order is received to when title changes, permission is needed. See (c) above for requirements.

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84. a. If the seller elects out of installment reporting, the tax consequences on the sale of the race horse are as follows:
Year of Sale: Amount realized: Down payment Value of note Less: Adjusted basis Section 1231 gain Year of Collection: Amount realized on note Less: Basis in note Ordinary income (no sale or exchange)

$10,000 25,000

$25,000 15,000 $20,000 $30,000 25,000 $ 5,000

b. Interest paid is ordinary income. c. If Sandra Surrey reports her gain on the installment method, the tax consequences on the sale of the race horse are as follows:
Gross prot percentage $40,000 - $15,000/$40,000 100% Section 1231 gain in year of sale 5/8 or 62.5% $10,000 Section 1231 gain in year of collection 5/8 or 62.5% $30,000 62.5% $6,250 $18,750

d. Interest income is the same as in (a). Thus, electing out of Section 453 accelerated gain as well as converting $5,000 of Section 1231 gain to ordinary income. 85. Xeno Corporations tax liability for the short period is as follows: Annualized short-period income = $23,000 12/3 = $92,000 Tax on $92,000 = $19,530 Short-period tax = $19,530 3/12 = $4,883 There is potential relief. Xeno must wait until it can compute taxable income for the period January 1, 2011 to December 31, 2011. It will nd a tax on this amount and prorate the tax to the short period based on taxable incomes. If this prorated tax is less than $4,883, then Xeno can request a refund for the difference. 86. Bust Companys taxable income for 2011 is as follows:
Net adjustment Beginning accounts receivable Beginning inventory Beginning accounts payable Net adjustment (increase) to taxable income $32,000 10,000 (27,000) $15,000

2011: Taxable income = $110,000 + $15,000 = $125,000 Bust Company can spread the $15,000 equally over 2011 and the two preceding years (2010 and 2009) if this will result in a lower overall tax liability. 87. A comparison of the three inventory methods is set forth below.
Ending Inventory* $86,400 70,500 79,641 Cost of Goods Sold $201,000 216,900 207,759

FIFO LIFO Weighted Average

*FIFO = 230 units; 180 at $380 + 50 at $360 = $86,400; LIFO = 230 units; 200 at $300 + 30 at $350 = $70,500 $287,400

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Weighted Average = 230 units; 230 $287,400 = $79,641


830

Genesis should select the LIFO method since it produces a larger cost of goods sold and, therefore, a smaller taxable income. As long as it expects unit costs to increase, this will continue to result. 88. a. $3,000 is gross income under the claim of right doctrine. The $4,000 is not income in 2011 since its collectibility is in doubt. b. $20,000 is included in gross income. Also, it does not have a $15,000 deduction because no service calls were made. c. November and December 2010 rents, paid in January 2011, are not deductible in 2011. The expense was accrued in 2010. The prepayment is not deductible in 2011 since it was not required. 89. Sunel Corporations ending inventory under Code Sec. 263A is determined as follows: Absorption Ratio = Additional Code Sec. 263A costs Full absorption costs for the year Increase in ending inventory = 10% ($6,000,000) = $600,000. Thus, ending inventory is valued at $6,600,000. The remaining Code Sec. 263A costs ($1,400,000) are included in cost of goods sold. 90. Joes gain on sale is $900,000 ($1,000,000 - $100,000). The gross prot percentage is 90% ($900,000/$1,000,000). Joe recognizes $90,000 long-term capital gain in 2011 (90% 100,000). In 2012, when Joe repossesses the land, his recognized gain on repossession is $10,000, the lesser of $10,000 ($100,000 received - $90,000 gain previously recognized) or $790,000 ($810,000 gain not yet recognized 20,000 repossession costs). His basis in the land is $120,000 (the $90,000 basis of the installment obligation + the $10,000 gain recognized on repossession + $20,000 repossession costs). The basis of the installment obligation = $900,000 - (90% $900,000) = $90,000.

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CCH Federal TaxationComprehensive Topics

DIFFICULTY LEVEL RATINGSCHAPTER 13


The following table denotes the relative difculty level of each question. Teachers may wish to organize test questions based on the difculty level of the particular class. True-False Question Ratings 1. Easy 2. Easy 3. Easy 4. Easy 5. Easy 6. Easy 7. Easy 8. Easy 9. Easy 10. Easy 11. Easy 12. Easy 13. Easy 14. Easy 15. Easy 16. Easy 17. Easy 18. Easy Multiple Choice Question Ratings 19. Moderate 20. Moderate 21. Moderate 22. Moderate 23. Moderate 24. Difcult 25. Difcult 26. Moderate 27. Moderate 28. Moderate 29. Moderate 30. Moderate 31. Moderate 32. Moderate 33. Moderate 34. Difcult 35. Moderate 36. Moderate 37. Moderate 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Difcult Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Moderate Difcult

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77. Moderate 78. Moderate 79. Easy Supplementary Problem Ratings 80. Moderate 81. Moderate 82. Difcult 83. Moderate 84. Moderate 85. Moderate 86. Moderate 87. Moderate 88. Difcult 89. Difcult 90. Moderate

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