Your client is a partnership, ARP Associates, which is an engineering consulting firm. Generally, ARP bills clients for services at the end of each month. Client billings are about $50,000 each month. On average, it takes 45 days to collect the receivables. ARP's expenses are primarily for salary and rent. Salaries are paid on the last day of each month, and rent is paid on the first day of each month. The partnership has a line of credit with a bank, which requires monthly financial statements. These must be prepared using the accrual method. ARP's managing partner, Amanda Sims, has suggested that the firm also use the accrual method for tax purposes and thus reduce accounting fees by $600.

Assume that the partners are in the 35% (combined Federal and state) marginal tax bracket. Complete the letter to your client which outlines which method should be used for its tax return.

Maloney, Young, Nellen, & Persellin, CPAs 5191 Natorp Boulevard Mason, OH 45040

October 1, 2020

Ms. Amanda Sims Managing Partner ARP Associates 100 James Tower Denver, CO 80208

Dear Ms. Sims:

I am responding to your suggestion that ARP Associates should change to the accrual method of accounting for tax purposes as a means of reducing accounting fees. Under the accrual method of accounting, receivables must be recognized as income as the services are performed. This is to be contrasted with the cash method of accounting, where income is recognized when payment is received .

Each year under the accrual method , accelerated tax payments would occur so long as the billing and collection pattern remains the same. Therefore, the partners will pay tax on an additional ____ in the first year's income, and those payments will not be recovered until the company ceases its operations. Assuming the partners are in the 35% marginal tax bracket, the deferred taxes under the ___ are ___ 6. If the partners earn a ___ return, or greater, on the deferred taxes, the additional accounting fees will be recovered. Therefore, I recommend that you ____ method. The partnership required to use the accrual method for tax purposes.

Sincerely,

Tara Kelly, CPA Tax Partner