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    Compute Pamello's allowable tax deductions: 5 prepaid items

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    Prepaid Expenses. Pamello, Inc., an engineering consulting firm, uses the cash method of accounting. Compute the amount of Pamello's current year deductions for the following transactions:

    a. On November 1 of the current year, it entered into a lease to rent some office space for five years. The lease agreement states that the lease payments are $12,000 per year, payable in advance each November 1 for the following 12-month period. Under the terms of the lease, Pamello is required to pay a $5,000 deposit, refundable upon the termination of the lease.

    b. On December 1 of the current year, Pamello also renewed its malpractice insurance, paying $18,000 for the three-year contract.

    c. On December 31 of the current year, Pamello mailed out a check for $5,000 for drafting services performed for it by an individual who lives in another city.

    d. On December 31, the firm received a shipment of $700 worth of stationery and other office supplies. Pamello has an open charge account with the office supply company, which bills the firm monthly for charges made during the year.

    e. Finally, on December 31, Pamello picked up some work that a local printing company had done for it, which amounted to $1,000. The firm charged the $1,000 with its corporate credit card

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    Solution Preview

    The use of the term 'deduction' rather than 'expense' leads me to believe that this is a tax problem. The answers reflect tax treatment:

    Generally speaking, a cash-basis entity would have no prepaid expenses or accounts payable on its books, but there are a few exceptions.

    a. A true refundable deposit to be repaid in more than one year is a non-current asset. It wouldn't be a prepaid ...

    Solution Summary

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