Discussion:Gleim Study Wrong? - Accrual Advance Payment for Services

I figure this post is OK, since it's not homework, and I'm questioning their correctness. At least for me, it's Gleim Online Part 2 Unit 1 Multiple Choice Question 13.

If I'm wrong, I would appreciate it if anyone would spend a moment to point me in the correct direction.

Alayna is a voice and singing coach. She is a calendar-year taxpayer using the accrual method of accounting. On November 2, 2006, she received $3,200 for a 2-year contract for 64 one-hour voice and singing lessons beginning on that date. The contract provided that Alayna give 8 lessons in 2006 and 48 lessons in 2007, with the remaining lessons to be given in 2008. What is the amount that Alayna should report on her 2007 return?

(A) $0 (B) $2,800 (C) $3,200 (D) $2,400

I chose (A) $0, and their site says that is incorrect -- that (B) $2,800 is correct.

I spent a lot of time studying their applicable materials and IRS publications, and I remembered a part in Pub 538 that I relied on to chose (A) $0.

I don't see the logic of tax law requiring (A) $0, instead of (B) $2,800, but it seems to be what the publication states.

Pub 538 (pg 10) states: "Advance Payment for Services. . . However, you cannot postpone including any payment beyond that tax year."

Pub 538 continues (pg 11): "Service agreement. . . Postponement not allowed. Generally, one cannot postpone including an advance payment in income for services if either of the following applies. * You are to perform any part of the service after the end of the tax year immediately following the year you receive the advance payment. . . Example 3. You own a dance studio. On October 1, 2007, you receive payment for a one-year contract for 48 one-hour lessons beginning on that date. You give eight lessons in 2007. Under this method of including advance payments, you must include one-sixth (8/48) of the payment in income for 2007, and five-sixths (40/48) of the payment in 2008, even if you do not give all the lessons by the end of 2008. Example 4. Assume the same facts as in Example 3, except the payment is for a two-year contract for 96 lessons. You must include the entire payment in income in 2007 since part of the services may be performed after the following year."

I realize that "Postponement not allowed" is indented under "Service agreement" which refers to service agreements on property, however I still don't see a material difference between Gleim's question and the Example 4 quoted from Pub 538.

Are they wrong, or is there something I am missing?

Also, on a side note, would the service company be better off in either the Gleim question or Pub 538 Example 4 to write two contracts -- one for the current and next year lessons, and another for the lessons beyond the next year -- to at least get a deferral for the income for lessons in the next year? Or would this be against code/illegal/unethical?

I'm not going to continue posting all the Gleim questions I have issues with, just trying to get a handle on how to approach them. I'm asking about your research methods (if you don't mind) because I come up with tons of questions, and want to expand my research abilities to reduce the number of questions I would post that I could answer myself as I get into the field -- and to be able to better research answers to others before I contribute them to the forum.

I've always severely hated true/false and multiple choice questions, strongly preferring short answer or essay style.

What's a good strategy on the SEE when you can't tell how far they want you to think about the question?

Are the questions on the SEE better than the Gleim ones quoted below, or will they be a bit ambiguous (at least to me) also?

Gleim Online Part 2 Unit 1 True/False Question 10 :

Earl, who is in the VCR cleaning and repair business, has a calendar tax year and uses the accrual method of accounting. In Year 1, Earl received $5,000 for 1-year service contracts (ending in Year 2) under which he will repair the VCRs if they fail to work properly. Earl can properly report this income as he earns it over the period of each contract.

I view this question as ambiguous. Pub 538 (pg 11) states "Service agreement. You can postpone reporting income from an advance payment you receive for a service agreement on property you sell, . . . However, this applies only if you offer the property without a service agreement in the normal course of business."

This Gleim question doesn't state whether the service contracts come with all of the VCR's Earl sells, or whether it's an optional service contract Earl's customers can choose. I chose false, deciding to go with the conservative option since the question didn't give enough information that allowed any of the income to be deferred. [Note I haven't read Rev Proc 2004-34 yet, so perhaps Pub 538 is wrong on this also.]

Gleim Online Part 2 Unit 1 True/False Question 14 :

An inventory is necessary to clearly show income when the production of merchandise is an income-producing factor. If you must account for an inventory in your business, you must use an accrual method of accounting for your purchase and sales.

I also view this as a poorly worded question, and ambiguous. There are exceptions to needing to use accrual for inventory, and although I don't have the statistics on how many inventory-bearing taxpayers qualify for the exceptions, it has to be a non-significant percentage. Gleim study materials and Pub 538 go over exceptions for Qualifying Taxpayers (Rev Proc 2001-10) [3 year average annual gross receipts for each tax year ending on or after 12/17/1998 $1 million or less] and Qualifying Small Business Taxpayers (Rev Proc 2002-28) [3 year annual average gross receipts for each tax year ending on or after 12/31/2000 $10 million or less; not a C Corp; not changed from cash method due to Rev Proc 2002-28; and principal activity is service, fabricating tangible personal property to customer specifications or NAICS code not being mining, manufacturing, wholesale or retail trade, or information industries].

This Gleim question says "you must use", rather than "you must use. . . unless you qualify for an exception", or even "you generally must use". I can know how to handle a particular situation in real life, but I'm not sure how to condense a complex (albeit not very complex) issue into a true or false with no gray area -- and figure out whether to answer true because it's the general rule, or false because from a logic point of view, a single negation of the statement means the entire statement is false.

Sigh, like I've said, I've always hated pigeon-hole tests.

Most of us are too lazy to go hunting for it, or we don't know how to find it. I'll give you a hint though, it used to be found in books. Hellfire if I know where they keep it now, but I know they are fixin' it where it will cost you dearly to find it.

See if you can snag a copy of "Federal Tax Research" 7thEd. Rabbe, Whittenburg, Sanders (Thomson South-Western) It's better than nothing to get you started on a life of misery.