 Hello and welcome to the session in which we will review a CPA exam simulation that's part of the financial accounting and reporting exam. My strategy for CPA exam simulation is to take a look first at what type of a simulation is this. It take you five seconds. If I look at it, we're looking at journal entries because there are usually five types of simulation. Journal entries, computation, drop down, research and document review. Well, this looks like a journal entry, that's fine. Let's move on. Now, we want to know now, what is the topic of the simulation? Is it one topic or is it more than a topic? Because it could give you a simulation with many topics or just one topic. So let's go ahead and start this simulation. The JRM granted its employee 1,000 shares of stocks on January 1st. On the grand date, the fair value of each share was $36. Once you read the statement, your brain should be going toward share-based compensation. The shares cliff vested at the end of the three year and no forfeiture are expected. Well, we're gonna expense those shares over three years. Management expect that all shares will vest because the staff performance indicate a successful three-year period. Dirtelinas don't worry about any forfeiture, just they're all gonna vest. The fair value of the stock on the following dates were $39 a year, one 45 a year, two 48 a year, three. This is obviously estimated. For each of the following situation, prepare the information for the appropriate journal entry for year two. Okay, including the tax effect. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's gonna help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead, start your free trial today. Excellent. So here's what you are being asked. Prepare the journal entry to record the appropriate expense for the share-based compensation year two. It is a share-based compensation. Excellent. What am I dealing with here? I'm dealing with one million shares of stock. So the company granted one million shares of stock. Make sure to use the calculator on the exam day, one million shares. What is my expense? What's the expense of the company? Well, the fair value at the grand date is $36. I'm gonna multiply this by $36. The total compensation expense for this company is 36 million. Now, remember, expense will have to be spread over what period? Three-year period. They're telling us it's three-year period. Therefore, I'm gonna divide this by three and every year I'm going to expense $12 million. So year one, I will expense $12 million. Year two, I will expense $12 million. How do I expense this? I'm gonna debit compensation expense or compensation cost. Now, what I need to tell you here, if you are not familiar with share-based compensation, this is what I do at farhatlectures.com. I teach you share-based compensation. So you need to know how to do this. What do you credit? Well, what do you credit? Are you paying cash? Well, if you are paying cash, that's easy. You're not paying cash. All what the company did, think about it, they declared it. They declared the stock compensation. So you cannot credit cash yet. What do you credit? Well, what can you credit? You are going actually to credit additional paid and capital. So notice. Here's what I want you to notice as well. You are debiting an expense. You are crediting capital. So they might even ask, what is the effect on equity? The effect on equity is zero because compensation expense will do what? Compensation expense will increase your expenses which reduces your equity. Then you credited additional paid and capital which will increase your equity. Equity goes up, equity goes down. The net effect is zero. And I make sure I debit and credit 12 million. So this is the entry that I make year one, year two, and year three, okay? So that's the first entry. Now the second entry that they're asking us to do has prepared the journal entry to record the tax effect in year two, assuming a 20% tax rate. So notice now, as I told you, it was about shared-based compensation, which is true. But notice this question is not really about shared-based compensation. This question is really about the third taxes because they're asking us to record the tax effect. Now what is the tax effect? What is the tax effect? Let's see, here's what I want you to see. Year one, we're gonna debit an expense, credit APIC for 12 million. We did this for year one, we did this for year two. So this is year one and this is year two entry. So we're dealing with year two. So here's what happened in year two. In year two, for financial accounting purposes, for GAAP, what we did is we have an expense of 12 million. Right, we debited an expense of 12 million. For IRS, no expense now. We don't have an expense now because the IRS, if you did not pay for the expense, you cannot book this expense. You cannot book this expense. Eventually, the company will have to expense this stock option, but down the road. So what's gonna happen is this. We have a future expense of 12 million. This future expense will give us a the third tax asset of how much? Well, it's 12 million times, we are told the tax rate is 20%. So if we take 12 million times 20%, times 20%, we're gonna have a the third tax asset of 2.4 million. In other words, in the future, we are going to have an expense. And once we enjoy, once we recognize this expense for IRS, we're gonna have 12.4 million. So what do I do? Well, I debit my third tax asset. Now, again here, it doesn't matter. What the simulation is about is, do you know you're the third tax asset, the third tax liability? Because I can ask you, I can take this information and tell you, give me the third tax asset or the third tax liability for this transaction. Well, here they're giving it to you in a form of a journal entry. I will debit the third tax asset and I will credit what's the corresponding credit the third tax benefits. So I'm gonna have a benefit in the future and what's the amount? 2.4 million, okay? And that's that. And I'm done with this simulation. So notice, there is no exhibits here. Nothing's unusual. You can see the same information in a multiple choice except you are seeing it in a simulation. So let's review real quick. One, it's a journal entry simulation. Good, two, topics covered. The first thing is shared based compensation plus the tax effect. Well, really the third tax asset, the third tax liability. You know those two topics inside out and how do you know it? Far have lectures. This is what I pride myself on. I pride myself on teaching you the material. So whatever simulation they give you, you will survive the exam day. Because really, you may not see the same simulation but you might see the same concept. If you know the topics, you can take care of it. Once again, I'm gonna ask you to check out Farhad Lectures for additional resources, study hard for your exam. Good luck and of course, stay safe.