Brad operates a storage business on the accrual method. On July 1, Brad paid $48,000 for rent on his storage warehouse and $18,000 for insurance on the contents of the warehouse. The rent and insurance cover the next 12 months. What is Brad's deduction for the rent and insurance?

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BlackTom AI · Accepted Answer

The scenario involves Brad using the accrual method for tax purposes. Under accrual accounting, expenses are recognized when incurred, and prepaid expenses are allocated over the period they benefit rather than fully deducted when paid.

Option 1: $48,000 for the rent and $18,000 for the insurance. This would deduct the full amount upfront, but because both the rent and the insurance cover a 12-month period starting July 1, only the portion that applies to the tax year in question (the period benefited) can be deducted. Therefore this option overstates deductions.

Option 2: $24,000 for the rent and $18,000 for the insurance. While the rent portion might be correctly allocated over six months (July–December), the insurance portion should also be allocated over the period it benefits. Deducting the full $18,000 insurance ignores the fact that the policy covers 12 months, so this option overstates the insurance deduction for a partial year.

Option 3: $24,000 for the rent and $9,000 for the insurance. This reflects proper allocation for a 12-month prepayment starting July 1 when the tax year ends December 31: six months of rent at $4,000 per month totals $24,000, and six months of insurance at $1,500 per month totals $9,000. Each expense is matched to the period it benefits, aligning with accrual accounting rules.

Option 4: $48,000 for the rent and $9,000 for the insurance. This would treat the entire rent as deductible in the period of payment, which is inappropriate for a 12-month rent prepaid on July 1 under accrual accounting. The rent should be allocated over the 12-month period, not fully deducted in the first part of the year.

In summary, the correct approach is to prorate both the rent and the insurance over the 12 months covered, resulting in $24,000 for rent (6 months) and $9,000 for insurance (6 months) for the year in question. The other options either overstate or misstate the allocation, violating the accrual method treatment of prepaid expenses.

SU25-BL-BUS-A329-2695 Quiz 11

Brad operates a storage business on the accrual method. On July 1, Brad paid $48,000 for rent on his storage warehouse and $18,000 for insurance on the contents of the warehouse. The rent and insurance cover the next 12 months. What is Brad's deduction for the rent and insurance?

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