 Hello, and welcome to the session in which we would look at the third income taxes, whether that's the third income tax asset or the third income tax liability or the third income tax expense. This topic is covered on the CPA exam as well as intermediate accounting. This topic give students many issues because you have to understand not only financial accounting, you have to understand tax accounting as well to understand the third tax asset as well as the third tax liability. You have to understand the differences between the IRS code as well as GAAP. So this is one of the complication that this topic give students beside many other complication, but that's the first one. So you need to have knowledge from your income tax course and you need to apply it in your intermediate accounting course. So students oftentimes, they don't make this connection. The good news is farhatlectures.com can help you. If I'm known for anything, I'm known for my third income tax asset and liability lessons. So if you are an intermediate accounting students or a CPA candidate, I strongly suggest you take a look at my website farhatlectures.com. I can help you understand the third tax asset and the third tax liability from zero. I don't assume any prior knowledge in contrast to your CPA review course. As a result, I can help you add 10 to 15 points to your CPA exam score. My courses are designed to mirror image your CPA review course. So they are set up the same way. So it's very easy for you to find me as a backup or as an alternative explanation because everything is organized just like your CPA review course. Your risk to try me is $29 a month. I don't replace your CPA review course. That's your risk. Your potential gain is passing the exam. If not for anything, check out my website to find out how well your university doing or not doing on the CPA exam. I do have resources for other colleges, for other course colleges as well in CPA sections. Please connect with me on LinkedIn if you haven't done so. And on LinkedIn, you will see recommendation from other students that took my course and succeed on the exam like this recording, share it on YouTube, connect with me on Instagram and Facebook. So let's take a look at this question. Adam Company has a year one, the third taxed asset on its books of 1900, which is not that evaluation allowance of 500. So simply put in your mind or on the piece of paper or on the board on the exam day, you have the third taxed asset, you have 1900, you have an allowance account for that 1900 and it is 500. This is what you are giving in year one. In year two, the company increased the valuation allowance by 300. Okay, that's good. We're gonna increase the valuation account. This is year two by 300. Therefore, we're up to 800. If the tax rate in year one was 40% and in year two and future years at 35%, the impact of the changes on year two will be what? A, a decrease of 300 in income tax expense. An increase of 300 on income tax expense. An increase of 600 in income tax expense. A decrease of 600 on income tax expense. So notice what they're asking us is what will that change, how will that change affect income tax expense? So notice the question is basically, first, well, you have to know whether it's an increase or a decrease. So if you have a basic understanding, you should be able to eliminate two choices, whether it's an increase or a decrease. You have to find out what's that gonna happen? Is it gonna increase or decrease the third tax asset? Now, we're gonna know shortly or immediately whether it's gonna increase or decrease income tax expense. Okay, but it has to do with income tax expense. How does DTA affect income tax expense? So this is what you need to know. I need to know if my deferred taxed asset increased, okay, if this result increased, it means I have to reduce, if I debit the deferred taxed asset, I have to reduce, I will decrease income tax expense. Now, is it 300 or 600? I don't know. If the deferred taxed asset, it's gonna go down, if the deferred taxed asset goes down, well, I'm gonna increase income tax expense, whether the answer will be either B or C. So immediately, once I know it's gonna be an increase or a decrease, remember, because look, if I debited this account, I'm gonna have to credit income tax expense. If I credited this account, I'm gonna debit income tax expense. So I know I should know this relationship immediately. So simply put, if DTA goes up, the expense will go down because I'm gonna have to debit this. Therefore, I'm gonna have to credit this. If DTA goes down, the expense will go up because this is a credit and the expense is a debit, okay? So this is the things that I explained in the tales when you go to farhatlectures.com, but this is where you need to be as far as your mentally before starting this problem. Now, so how do I know what happened here? Well, I do have enough information that's gonna allow me to solve this problem. I know from year one, the gross, not the gross net, the third tax asset is 1,900. If I take it and add to it the valuation allowance, I know the gross, the third tax asset was 2,400. Now, how do I have the third tax asset? I have a third tax asset because of a temporary difference. Remember, there's a temporary difference. You multiply it by a tax rate, you come up with the third tax asset. Now, what is that temporary difference? That temporary difference, I don't know how much it is in year one, but I know if I take that temporary difference, which is I called it X, I multiply it by 0.4, that gave me 2,400. Now, if I solve for X, I will take 2,400. I'll divide that by 0.4. I know that the temporary difference was the TD, the temporary difference, not TP, TD, the temporary difference was 6,000. Simply put, I took 6,000. I said this was a temporary difference. I multiplied by 0.4, I got 2,400. Of this, I take 500, I will not use. Therefore, the 500 went into the allowance and the 1,900 went to the third tax asset. So this is what happened in year one. Now, I know my temporary difference at 6,000. Now, in year two, I'm not giving any changes. All what I'm told is your tax rate changed. Well, if my tax rate changed and I have, all what I have is temporary difference of 6,000 and all what change is my tax rate. Well, it means I'm gonna take the 6,000 now and multiply it because I have to adjust my deferred tax asset because my tax rate changed. When your tax rate, future tax rate change, you have to recompute this times 0.35 because this is my new tax rate. Therefore, it's gonna be 2,100. So this is the gross amount and I know they already told me the valuation. The valuation was an additional 300. Therefore, I'm gonna take 2,100 minus 800, minus 800. So let's do this, 2,100 minus 800. My net, my net DTA will be 1,300. Therefore, DTA is 1,300. Okay, let's see. So I'm gonna have to do what? I'm gonna have to credit this account 600. What did I tell you? Well, immediately, if that's the case, if I'm gonna credit DTA because DTA went down, well, income tax expense, it's gonna, if I credit this, I have to debit income tax expense. So these two are out. So income tax expense will go up. By how much? Look, 600. So the entry would be credit deferred taxed asset and debit income tax expense 600. So this is what the entry would be. You will credit deferred taxed asset, you would reduce your deferred taxed asset and you will transfer it to income tax expense. So that's the answer. The answer is C. So notice, I told you from the beginning, once you know the deferred taxed asset, it's gonna go down. And you should know this. Now, how would I know the deferred taxed asset that's gonna go down? Well, because my tax rate went down. My tax rate went down. I had savings when I initially had that temporary difference when initially, so this is I'm giving you back to if you understand the concept, if initially I had a temporary difference and that temporary difference and that temporary difference led to a deferred taxed asset. Now, the higher the tax rate, the higher is my savings. If the tax rate goes down, my savings will go down. It means my interest expense will go up. So immediately, once I know my tax rate, if I have a basic understanding of this, once I know my tax rate went from 40 to 35, it means I have less savings. Less savings mean more income tax expense. So immediately I can take out A and D and you will guess between B and C. And this is what I told you at the beginning. I'll go back and tell you that basic understanding would help you to eliminate two choices. Then you are giving the $800. Then you will find the temporary difference times the new rate. The gross should be 2,100. The valuation amount was given to you, 800. The DTA should be 1,300. Therefore, we're reduced it by 600. We're reduced it by 600. We increase our income expense by 600. And I hope this is not, I'm not confusing you. But again, this is what I'm gonna invite you to do. This topic is challenging. I believe the CPA of the United States I believe the CPA review course don't do a good job. Not because they don't do a good job because they're not good. They don't do a good job because most likely you are not well prepared in college or if you are prepared in college, you forgot all the basics. And the CPA review course, any of them will assume you have a basic understanding and sometimes you don't. You did not do well in college. This is where I come into place. This is where I can bridge that gap between your education and your CPA review. Look, one month of subscription. Give me a try. You like it, you keep it. You don't like it, you cancel. Are you willing to risk that for one month to find out if someone can help you pass the exam? That's all what I'm asking you to do. It's less than a dollar a day. Anyhow, stay safe. Good luck.