 Hello, and welcome to this session. This is Professor Farhad. I will go over the third tax asset and the third tax liability. A question that's sent to me by one of my subscribers, farhadlectures.com. And this is what I do for my subscribers. If you have another CPA course and you have a question and you're stuck on it, you're one of my subscribers, you can send it to me. I'll be more than happy to look at it. And if I see it benefit you, it benefit others, I may share it and that's what I am doing. So this question is about the third tax asset. This question can be easily turned into a complicated simulation. But let's go over the question to show you how it solved this question. This I would say challenge, initially it looks like a challenging question, but I will show you how to solve it practically without doing any computation. But I'm gonna explain everything in details because this is my nature, I'm a teacher. That's why people like my lectures because I explain stuff, but I can assure you you can answer this question without even doing any computation. So let's start with the problem. Gyro company began business on January 1st, January 2nd, year one. They used the double declining balance method, the depreciation for financial statement purposes for its building and the straight line for income tax. So simply put we have gap and you don't have to be writing this, but on the exam just have, or you can write it if you want to, it doesn't matter. The reason I'm doing this is for you to explain it. So for financial statement, they use gap for the tax for the IRS, they use the tax for this method, they use the double declining balance. And for this method, they use straight line. Simply put, this is gap and this is tax. That's what we have. On January 16th, year three, so something happened in year three, Gyro elected to switch to the straight line method for both financial and tax purposes. So that's what they decided to do to switch. And that's, they should have started and stick with the same method from the beginning, but that's beside the point for simplicity, but that's not what we are doing here. So here what they did in year three, in year three, so if we have year three, they switch both to the straight line. So this becomes a straight line. The building cost is 240,000 in year one, which has an estimated useful life of 15 years and no salvage value. Data related to the building is as follows. So they're giving us the data about the depreciation. Now, how can I turn this into a complicated simulation? Well, here what they gave us is they gave you the building cost. Well, rather than give you the building cost, I can give you an exhibit. And in that exhibit, I can put down the closing working papers for when they bought the building two years ago. And in the closing paper, someplace in the closing paper, you have to scan it and you would know that the cost of the building is 240,000. Now you have the cost, 240,000. Rather than giving you this information, I can give you, rather than doing the computation for you here, I can either make you complete the computation or I can give you an intimidated depreciation schedule and you have to pull those numbers from that complicated or intimidated depreciation schedule. And those are two more exhibits. I'll give you one schedule for the double declining balance, one schedule for the straight line. Or I don't give you anything, I would say you compute this. So I can turn this into an easy, easy, PZ, intimidated simulation. But let's go back to what we are being asked here. So they're giving us this information and they're asking us to choose between A, B, C, D. Now here's what I need to tell you. I'm not gonna say all, because if I say all that's like, I don't wanna take risk by saying all, it means everything, most. Let me put it this way. You should be able to eliminate two answer choices on most CPA exam questions, on most. If not all, I'm gonna say all but most. Why? Well, let me eliminate two questions here because initially you think, I really, I cannot eliminate anything. Look, if you know anything about basic depreciation and you should know something about depreciation when you walk into that exam, if you know anything about the third tax asset, the third tax liability, even basic information, basic understanding, and how do you, how do you get that basic understanding? Look, if you have a CPA course and you don't get it, go to farhatlectures.com. I explain those information, whether it's depreciation, the third tax asset, the third tax liability, or all these combines together, it doesn't matter. If you know anything about this, you should be able to eliminate two answer choices, which two answer choices you can eliminate. A, it says there should be no reduction in gyros, the third tax liability, or the third tax asset. Look, there's gonna be a reduction, a change, some sort of a reduction in the third tax asset and the third tax liability, a reduction. And here they made it easy for you. They made it either asset or liability. No, there's gonna be a reduction. Therefore, I can eliminate, there's gonna be a change. Gyro, the third tax asset should be eliminated, or asset or liability should be eliminated. What they're saying in B is once we switch, everything is reversed and it reverse 100% and as a result, whether you have an asset or a liability, you should be able to get rid of it. No, when we switch from the double declining balance to the straight line, we're gonna have some sort of a reversal, but it's not gonna be 100% because you are not starting at the same level. So you could also eliminate B because there would be some sort of a third tax asset or the third tax liability. It will not be eliminated, it will not be eliminated. So notice I eliminate the two answer choices of I have to guess, I'll have to guess between C and D. And I'm gonna show you in a moment, if you think about this question like another 10 seconds, you say, oh, you would know the answer. Okay, so let me show you what's gonna happen here. So under the under gap, here's what's gonna happen. Under gap and under tax. And you can stop here and you could choose the right answer, but I'm gonna go all the way to the end. Under gap, you have an asset that you purchase for 240,000 and you took two years worth of depreciation, you have 50,000. So your book value for this asset on the books is 190. For tax purposes, you have an asset for 240,000 and you took 32,000 worth of depreciation, which in turn, it's gonna give you 208,000 basis. What do we see here? We see that they took more depreciation for book purposes than tax purposes. It means in the future, we're gonna have more tax deduction. Why? Because we did not really reduce our book value as much as, we did not really reduce our tax basis as much as our book value. What does that mean? It means we are dealing with the third tax asset situation. I'm done. Once I know I eliminated AMB, I'm down to C and D. There is no reduction in the third tax liability. I don't have the third tax liability. I'm dealing with the third tax asset and the answer is C. 554, but I'm gonna show you the computation. But at this point, you're done. If you don't have time, you will go with C and you should be confident C is the answer. So simply put, let me repeat myself. Once you know there should be a reduction, should be a reduction. There should be some sort of a reversal. Here, there should be no reduction. There should be a reduction. There should be a reversal, whether you have an asset or a liability. Once you know that something will exist, so if you understand A, you'd understand B and those two are not possible answers, you're down to C and D. Once you scan the C, you don't even have to do this. Once you know they took more for gap, they took more depreciation for gap than tax, it means in the future, we're gonna have more tax deduction. We have a deferred tax asset. C is the answer, done. That's it. But let's keep going to answer this question fully because I want you to see how we get to the 554. Okay, so here again, we have the difference between the two and first, now you need to know how much is the deferred tax asset. Well, if you compute the difference between the two, we have 18,000 of difference in book value because 190 and 208 is 18,000, so we have 18,000 worth of differences and they're giving us here, I'm sorry, the tax rate for this problem, I did not copy this down. The tax rate is 40%. So sorry about that. The tax rate is 40%. So the tax rate is 40%. As a result, we're gonna have a deferred taxed asset of 7,200. So as of year two, as of year two, we have a deferred tax asset of 7,200. And you know when they switch, it's not gonna be exactly 7,200 with reverse. Hopefully you know this because it's not gonna equal. It just mathematically it's not gonna equal. Now what's gonna happen? You have to compute year three. Again, you don't have to do this on the exam day. Again, once you know you're dealing with the third tax asset move on, okay? Let's keep on going. So we have a deferred tax asset. What's gonna happen in year three is this? In year three, let me put year three in a different color. In year three, this asset here under tax purposes, we're gonna keep on deducting 16,000. So we're gonna take 208 and reduce 208 by 16,000. That's gonna bring us down to 192. This is year three depreciation. We also have to compute year three depreciation for gap. Now gap will change. Gap will change, why? Because now we have to compute the gap, which is 190,000 and we'll have to divide this number by 13 years, the remaining years. Now it's a straight line. So we'll take basically the book value, what we have divided by 13 years and our depreciation becomes 17,615 for the remaining life at this point. Therefore we deduct 14,615 for year three. For this asset. Now the book value for gap purposes is 175,385. 175,385. Well, now we have to see how much is the difference in the book value and reverse some of it. Well, let's compute the difference. Let me get my calculator out. So we have 175,385 minus 192. So the difference in book value is 16,000, 16,618. The difference still 16,618. And we're gonna multiply this by 0.4. Therefore we should have 6,647 dollars in the third taxed asset, 6,647. So we should have 6,646, we should have in total 6,647. It means we have to reduce it. It's 554, the answer. Let me see. So if we take 7,200 and we're saying one of the answers should be a reduction by 554. And that's gonna give us 6,646, 6,647. So notice part of the entry is to reduce, sorry, is to reduce, sorry, is to reduce the third taxed asset by 554. And again, you don't have to go this far on the exam. If you went this far, it means you're not sure or you're really confused, okay? But if you understand this, you will be good to go. You'll be good to go. As soon as you have the third taxed asset, choose see and move on with confidence, okay? Now, once again, what I'm gonna do is invite you. Invite you to farhatlectures.com because on farhatlectures.com, the difference between what I offer on my website and what CPA prep course offer is this. I explain the material. I show you basically behind the scene what's going on so you understand it. And a CPA prep course, which is I don't compete with them. I wish I can compete with them. They will eat me alive. I can't. 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