Question

3) Carter had assets with a FMV of $60,000 and liabilities of $75,000. By agreement of its creditors, the liabilities were reduced to $55,000. Assuming no special elections are made, what amount of income must Carter report as a result of the cancellation of indebtedness?

a) $0 b) $5,000 c) $15,000 d) $20,000

4) Margaret Mason entered into a 10-year lease to rent property. During the first year, in addition to $5,000 for that year’s rent. Margaret received $5,000 in advance as rent for the last year of the lease, and a $4,000 security deposit. What income must Margaret report for the first year?

a) $5,000 b) $9,000 c) $10,000 d) $14,000

Answer 1

3) (d) $20,000

(Because the liabilities are reduced from $75,000 to $55,000 that is by $20,000.

The Journal entry passed irrespective of Assets FMV will be :

Creditors Dr $20,000

To P&L $20,000

Thus, as a result of the cancellation of indebtedness, Carter must report income of $20,000.)

4) (a) $5000

(Because the rent received for the year is only treated as income. The security deposit and advance rent received are Liabilities.

The Journal entry passed will be :

Cash Dr $14,000

To Rent Income $5000

To Security Deposit $4000

To Advance Rent $5000

Thus, Margaret must report Income of $5000 for the first year.)