 Hello and welcome to the session. This is Professor Farhad and the session we're going to be working with temporary and permanent differences. However, I'm going to go over practice questions to learn what you have to practice what you have learned in the prior session. So in the prior session, which will be in the description below, I explain temporary and permanent differences in a form of a lecture. Now you want to see, do I understand this? Let's try to work some questions. This topic is covered in intermediate accounting and it's very complicated topic for students as well as well as the CPA exam, the FAR section. As always, I would like to remind you to connect with me on LinkedIn. YouTube is where I house all my 1500 plus accounting, auditing, tax and finance lectures. And this is a list of all the courses that I cover. If you like my recording, please like them. It helped me tremendously. Click on the like button, share them, put them in playlists. If you're benefiting from my recordings, it means other people might benefit as well. So share the wealth also on my website. I do have additional resources such as PowerPoint sites, note, multiple choice questions, true, false, as well as 2000 plus CPA questions, especially for CPA candidate. I strongly suggest you look into my website. If you're studying for your exam or as a supplemental tool for your accounting studies, the prior session. Once again, it's in the, it's in the description. Please click on it in case you want to view the related lecture. What I'm going to do first is go a series of true, false, multiple choice questions to make sure you have a good understanding of the basic concepts that we cover. Then we'll dive into multiple choice questions. So the first true, false questions, as always, I don't have to remind you, either work those questions first or pause the video now and tell me if this statement is true or false. The appreciable property related to expense and losses that are deductible from taxable income after they are recognized in financial income. What are we saying is this? When we have the appreciable property, first they are deductible from taxable income and the financial income. So what we're saying is this, we have financial statements and we have tax. And this statement says when we are dealing with the appreciable property, they are first deducted on the financial statement, then they are deducted on the tax. Generally speaking, that's not true. Why? Because remember, when it comes to taxes, we use makers. Makers take more deduction than the financial statement which uses the straight line. Therefore, the answer will be before they are recognized in the financial statement. They also are deductible first before they are deducted in the financial statement. Generally speaking, that's the case. Assuming we are using makers for taxes and straight line for financial reporting purposes. Let's look at the second statement and see if you can answer if it's true or false. An originating temporary difference is the initial difference that occur when the book basis of an asset exceed but not exceeded by the tax basis of a liability. Hold on a second. It exceeds but it doesn't work the other way if it exceeded by. No, the temporary difference is initiated when there is either a difference between the book basis of an asset exceeds or exceeded by or the book basis and the tax basis of a liability exceeds or exceeded by. So it doesn't have to be only asset exceeded by the tax basis of a liability. The difference could be exceeded by or exceeded between the book basis and the tax basis of an asset or a liability. So this statement is false. Let's look at this statement. A reversing difference occur when a temporary difference that originated in prior period is eliminated and the related tax effect is removed from the deferred taxed account. Is this the definition of a reversing difference? Yes, that's exactly what happened. A reversing difference is eventually reverse and it gets eliminated from the deferred taxed account. As a reverse, let's assume you had a deferred taxed asset. You would remove the deferred taxed asset. Let's assume you have related deferred tax liability. You would remove the deferred tax liability. So this statement is true as far as reversing difference. A permanent difference result when the tax law causes an item reported on the income statement to be different from the same item. Reported on the balance sheet. Wow, hopefully this is a false statement because there's no such thing as an amount different reported on the income statement than on the balance sheet. A permanent difference result when some items is reported on the financial statement. It's reported on the financial statement but never go into the tax or reported on the tax but never on the financial statement. An example will be the dividend-received deduction. The dividend-received deduction is reported on tax but never reported for financial statement or another example will be municipal interest. It's reported on the financial statement but never for tax. Let's take a look at this question. Let's take a look at this question. A corporation has tax-free income that has a tax-free income has an affected tax rate that's less than the statutory regular tax rate. If you really think about it from a logical perspective, if you have tax-free income, it means you're going to pay less taxes. Therefore, it's going to be lower than your regular rate because your regular rate would include your financial accounting rate. But on your taxes, the tax-free income is basically not taxable. You don't have to worry about it. Therefore, it's going to be lower than that regular rate. In computing the third income taxes, a new tax rate should be used if it's probable that a future tax rate will occur and the rate is reasonably estimatable. This is really funny the way this question is written. When you compute your third income taxes for future years, which rate do you use? Do you estimate what the rate is going to be? No, you don't estimate. You would use the rate that is enacted. It's already passed by law, enacted. That's the keyword. The rate has to be already approved by Congress, by the IRS. Once it's enacted, then that's the rate that you would use. You don't guess how much rate it's going to be. You should know what the current rate is. And if the rate changes, you have to change your deferred tax asset and deferred tax liability. You just have to change them. It's as simple as that. Let's look at multiple choice questions. A major distinction between temporary and permanent differences is what? What's the major difference between them? Permanent differences are not representative of an acceptable accounting practice? No, that has nothing to do with the accounting method you are using. B, temporary differences occur frequently, whereas permanent differences only once. It has nothing to do with how many times it's occurring. B is out, so we're down to 50-50. Once an item is determined to be a temporary difference, it's maintained that status. However, a permanent difference can change in status with the passage of time. No, permanent difference never changes with the passage of time. Once an item is not included in tax, that's it. It's by law it's not included in tax, so C is out. So by the process of elimination, we know the answer is D, but let's make sure we got it right. Temporary differences reverse themselves in subsequent accounting period, whereas permanent differences do not reverse, and that's exactly the difference between them. Temporary differences, and that's why temporary differences, they give you DTA and DTL, and those DTA and DTL would reverse in the future. While permanent differences, permanent differences, remember permanent differences know the third tax asset, know the third tax liability for them because they never reverse. The use of accelerated depreciation for tax purposes, which is a.k.a. makers, and straight-line depreciation for accounting purposes result in what? Before we look at the answers, what does it result into? It results in some sort of reversing. It's going to reverse down the road, okay? How is it going to reverse? Well, if you're using accelerated method, remember, makers for tax and for financial statement, you would use the straight line. Makers will have more depreciation early on. So it means you're going to have D deferred tax liability because you're going to have less depreciation. So let's look at the answer. So first, you just want to make sure you understand what you are giving. So before you look at the answers, you kind of know what you are looking for, okay? Result in larger amount of depreciation expense shown on the tax return than one on the income statement so far so good over the asset use for life. Whoa, hold on a second. No. So makers does show more tax return initially than on the income statement, but over the asset use for life, they both equal to each other. They is out. They both equal to each other. The asset being fully depreciated for tax purposes and half the time it takes to become fully depreciated for accounting purposes. There's no such thing the rate half of the time we take B out. A larger amount of depreciation expense shown on the income statement than on the tax return in the last year of the asset use for life. And let's look at this question. Let's look at this answer. Let's examine this one. A larger depreciation amount, a larger amount of depreciation expense shown on the income statement and on the tax return in the last year. And this is true. So you have to be very careful. This is a true statement. Let me tell you what they're saying here to make sure if you didn't get it, I explain it to you in detail. What we're saying is this. Early on, for example, if we have the asset year one, year two, year three, year four, and year five, you're going to have more depreciation for makers, less for financial, more, less, more, less. At some point, at some point, it's going to reverse. At some point, SL will be less. SL will be more and makers will be less. Usually that happens the last year or two. So on the last year, you're going to have more depreciation for S straight line than makers. Why? Because you took most of the depreciation early on. And now in the last year, everything is reversing. So make sure you understand this 100%. Make sure you understand this. Let's just make sure this is not the answer. A loss on a sale of an asset in question, if it's sold for its book value before its useful life expired, it has nothing to do with that. Whether its useful life expired or not does not determine the loss on the sale. The loss on the sale is basically you compare what you received in cash versus the book value of the asset, the book value of the asset. Which of the following temporary differences that are normally classified as expenses or losses that are deductible after they are recognized in the financial statements? So are deductible later? So they are for financial statements. They are deductible now for tax purposes. They are deductible later. So which of these items? Advanced rental receipts. First of all, advanced rental receipts are receipts. So they are not deductible. You can take A out. Product warranty liability. Okay, product warranty liability. You take the expense now for the financial statement. And we did a lot of these examples. You debit an expense. You credit a liability. When the sale takes place, but nothing on the tax return and you'll take the deduction later on when the customer comes back for the product. And the answer is B, indeed. The preachable property. No, the preachable property is the opposite. The preachable property. You will take the deduction now, like in makers. And later on you will have less deduction. Fines and expenses resulting from a violation of the law. This should be eliminated because this is a permanent difference. Which of the following is a permanent difference that is recognized for tax purposes but not for financial accounting purposes? So it's recognized for tax. A, the dividend, the deduction for dividend received from U.S. corporation. That's the answer. So you have tax and you have financial statement. The dividend received deduction is a deduction taken for your tax return never shown on the financial statement. And that's what they're asking. You can look at the others, but the answer is one. Which of the following is a temporary difference classified as a revenue or a gain that's taxable after it's recognized on the financial statement? So first it's recognized on the financial statement. So the revenue or gain is recognized on the financial statements. Then later on it's recognized for tax. It's recognized for tax. Which of those? Subscription received in advance. Not at all. Subscription received in advance. It's taxed first because we receive the money. Prepaid royalty received in advance. Same concept taxed first. Now we're down to 50-50. Well, actually we can get the answer immediately. Interest received on money bond. That's a permanent difference. That's out. So the answer must be C. An installment sales accounted for on the accrual basis for financial reporting purposes. So on the accrual basis you will debit account receivable, you credit revenue. But for tax purposes, you are using the installment method. Installment method means what? The installment method means you don't have taxes until you receive the cash. Let's take a look at this question. Once there's a lot of data, look at the question first. For Kiput's company, the amount of temporary difference used to measure the third income taxes is what? We have interest received on money bond. That's not a temporary difference. That's out. Fines from a violation of the law. That's out too. So the answer is there is no temporary difference in this question. The answer is zero. Because neither of them is temporary difference. They're both permanent difference. Again, once there's a lot of data, look at the question first. What is the amount of the third tax liability at the end of 2017? So what is DTL? So to find out what's DTL, we have to find out the difference between the book basis and the tax basis and multiplied by the rate. And they're telling us it's the third tax liability. So they don't even want us to know if it's whether it's a liability or an asset. What is the amount? That's all they're asking. So send the company deduct an insurance expense of $21,000 for tax purposes in 2017. But the expense is not recognized for accounting purposes. In 2018, 2019, and 2020, taxable income will be higher than financial income because no insurance expense will be deducted for tax purposes. But 7,000 of the insurance expense will be reported for accounting purposes in each of these years. Kind of they give us the answer in the first statement. Send the company has a tax rate of 45% and income tax is payable of $18,000 at the end of 2018. Well, guess what? They already told us right from the get go. They told us they deducted an insurance expense of $21,000 for tax, but they did not deduct it for accounting. So the basis is for that prepaid insurance. What does that mean? It means I have a $21,000 difference. If I multiply this by 45%, that's going to give me $9,450 and that's my deferred tax liability, $9,450. Actually, in this question, they also gave you income taxes payable. Therefore, also you credit income taxes payable $18,000. And your income tax expense, your income tax expense is those two combined, which is 27,450. If my math is right, 27,450. But all what they're asking you in this question is about the $9,450. But they gave you the $18,000 and you can find out the income tax expense. Very, very interesting. All right. So this is the, okay, I jumped the gun, but that's okay. So what's the journal entry should be made? It's the same company. So notice you figure out, first of all, you could eliminate A and you could eliminate C, because the deferred tax liability should be $9,450. They already gave you income tax liability of $18,000. Therefore, the answer is B. Sorry, I just, but that's okay. That is okay. Assuming that income tax is payable, income tax is payable for 2018 is $24,000. What is the income tax expense for 2018? So they're asking us for 2018 income tax expense. All right. Let's see. Income tax is payable is $24,000. This is the check that you will need to write for the IRS. Now, what is that going to do with this? Now, it's based on the same information here. So what happened is this, when you establish this deferred tax, deferred tax liability account, deferred tax liability account, you had in there $9,450. When you initially did this, you had $9,450. Then in 2018, some of the difference would reverse. How much of the difference would reverse for 2018? Let's see. So $21,000. Okay. It's $7,000, $7,000, and $7,000. Therefore, we're going to take $7,000 for year 2018. Let's do this. We're going to take $7,000 would reverse times .45. That's $3,150. It means your D2L would be reduced by $3,150, will be reduced by $3,150. This is 2017 when it was initiated. For 2018, it will be reduced by $3,150. Why $3,150? Because remember, in 2018, 2019, and 2020, each year, $7,000 of the $21,000 would reverse. And as they reverse, what's going to happen? The rate is 45%, 45%, and 45%. So every year, you would reverse $3,150. Okay. Therefore, it's going to reverse by $3,150. But the question is, what's income tax expense? Income tax expense. Now, you have to remember the formula. It's your income tax is payable, $24,000. And you had a decrease in the third tax liability. It means you're going to deduct the decrease of $3,150. Therefore, your income tax expense for that year is $20,850. Let's book the journal entry. So this way, you see the full picture. So income tax is payable, which is given to you of $24,000. That's given to you. That's fine. That's given to you in the problem. Then, I'm going to erase this. Then we find out that we're going to be reducing the third tax liability, DTL. We're going to be reducing DTL by $3,150. Now, all we have to do is figure out the expense, the income tax expense. And the income tax expense is basically a plug. And the plug is the difference between those two, which is $20,850. $20,850, the income tax expense. So this is the journal entry. I hope they don't ask you for the journal entry next. No, they did not. Okay, that's good. Which of the following difference? Differences with result and future taxable amount. Future taxable means you have a deferred tax liability. So which one of these items? Simply put. Which one of these items gives you a deferred tax liability? Expenses or losses that are deductible after they are recognized in financial income? No. If they are deductible after, they're going to give us a deferred taxed asset, because they're going to give us a future deduction. Revenues or gains that are taxable before they are recognized in financial income? No. If we already pay the taxes, that's going to give us deferred taxed asset. A and B are the third taxed asset, which is they'll give us future savings. Revenues or gains that are recognized in the financial income, but never includeable in taxable income? This is an easy elimination. This is a permanent difference. By process of elimination, D should be the answer, but let's make sure it is the answer. Expenses or losses that are tax deductible before they are recognized for financial income? A case in point is depreciation. Makers. Makers versus straight line. Makers versus the straight line. First, they are deducted first. Then we lose that deduction, which in turn will give us a future taxable income, which in turn gives us deferred tax liability. Let's look at this question. Again, once you see a lot of data, what should you do? Look at the question. What amount of income tax expense should a net company report at the end of 2017? So you're looking at income tax expense. Income tax expense is the current taxes plus the deferred portion. So now we have to look at the data. A net company made the following journal entry for rent on property at leases. They debited cash, credited and earned revenue. Excellent. The payment represent rent for the years 2018, 2019. So this is what we received in 2017, but this rent is for the next two years. So for financial accounting purposes, the rent revenue will be recorded later. The period covered by the lease. A net company is a cash basis. Cash basis means as soon as we receive this money. So for tax purposes, what they did, they debited cash and they credited revenue for tax purposes. Therefore, the difference between the liability, we have a liability on the books for 80,000 and zero of it is on the zero liability for tax purposes. A net has income taxes payable of 123. So they give us a component of income taxes. So they give us 123,000 at the end of 2017 and the rate is 38%. Now what happened is we have a deferred component of 80,000. The deferred component of 80,000 and the tax rate is 0.38, which is give us a deferred taxed asset of 30,400. So what happened? Our deferred taxed asset. This is the deferred taxed asset because we're going to be paying the taxes on the 80,000 this year. In future years, we don't have to worry about the taxes. Therefore, it's going to reduce an increase in... So this was an increase in the deferred taxed asset. It's going to reduce our income tax to 92,600 in the insuracy. I am not going to do the journal entry because it might be on the next slide. It might be... Yes. So what's the journal entry for this? So basically that's the question here. What's the journal entry? Well, 123 is... Actually, no. Actually, assuming the taxes payable at the end of 2018 is 136. This is for 2018. Let me give you the journal entry for 2017. So this way you know how to do this. You know how to do this. So what the journal entry would be? It would look something like this. We have a deferred taxed asset of 30,000, 30,400. We have income tax expense, the income tax expense. That's a debit, too. Income tax expense of... That was given to us, 123. And income... I'm sorry. Income taxes payable is 123. Income taxes payable is 123. That's given. And we said income tax expense. We computed income tax expense as 92,600. Okay? 92,600. All right? This is what we have. Therefore, we are starting 2018 with the DTA, with the third taxed asset of 30,400. 30,400. Okay. Assuming taxes at the end of 2018 is 136,000. Which journal entry would we make? Well, first of all, income taxes payable should be 136. So we cannot eliminate this. We cannot eliminate this. We cannot eliminate this. We cannot eliminate any of those. Because they all have income taxes payable of 136. Okay. Now, what's going to happen the following year of this 80,000, 40,000 of it would reverse. It means half of it would reverse. Well, now we need to credit the third taxed asset for half of it. Well, the third taxed asset, here, what they're saying in transaction A, they're reversing the whole thing. That's incorrect because we only need to reverse half. The third taxed asset reversed half. This looks good. Yes, this is reversed half. So your income taxes payable is 136. That's giving. We're going to need to reverse half of the third taxed asset because half of it reversed in 2018. Therefore, the answer is B. Okay. It cannot be... Oh, well, hold on. Yeah. It cannot be C because they reversed the whole thing. And indeed, they debited the third taxed asset. They increased it. It should not be increased. It should be decreased. So the answer is B. Understanding the journal entry, it's going to make your life much, much easier. Okay. Let's take a look at this question. When a change in the tax rate is enacted into law, so basically there was a change in the rate, it's a fact on the existing... It's a fact on the existing the third income tax account should be what? Okay. So basically we had a change in the tax rate. So, we simply put, how do we treat changes in tax rate? That's the question. Well, when there's a change in tax rate, we have to do something. Is it A, handled retroactively? Retroactively means do we have to go back and change anything? And the answer is no. This is not a change in accounting principle. Consider it, but if only it recorded in the account, if it reduces the third tax liability or increase at the third taxed asset. That will be nice, but you cannot choose what's the effect of it. Reported as an adjustment, yes, to tax expense in the period of change. That's right. You would report it as an adjustment to tax expense. It's an adjustment to tax expense. Therefore, you have to report it as so. Let's take a look at this question. It's basically, in a sense, think of it as a simulation. So, you could see something like this on the CPA exam as a simulation. Basically, what you are being asked to do, you have the definition of temporary differences, the definition of permanent differences, and they're giving you items. Do you know how does it work? Can you match the item with the topic? For example, numerous item create differences between taxable income and pre-tax financial income for purposes of accounting recognition. These differences are two types, temporary and permanent. These two classification are further divided into other six categories. So, they're giving us the permanent differences, two types of permanent differences, and the four types of temporary differences that I went over into the lecture. So, let's see if we can identify them. If you can identify them, that's good. It means you are starting to get this under control. Litigation accrual. What type of adjustment is litigation accrual? First of all, is it temporary? First, you have to decide if it's a temporary or a difference because you don't want to kind of go through them. Litigation accrual is temporary. Is it going to be a revenue or an expense? Well, it's not going to be a revenue, it's going to be an expense. Okay, so we're down to A and B. Is it an expense or loss that are tax-deductible after they are recognized in the financial income? And the answer is yes. That's the definition of litigation accrual, temporary difference. Basically, they are deducted later on in the income tax. Fines and expenses resulting from a violation of the law. Are they temporary or are they permanent? Well, they are permanent. So, that's it. We don't have to worry about A, B, C and D. It's either E or F. Well, item recognized for accounting purposes but not tax purposes? Yes, that's the answer. Fines and penalties are recognized for financial accounting purposes but never for taxes. Three, percentage depletion. You have to know whether it's temporary or permanent. And percentage depletion is not temporary, it's a permanent difference. Is it item recognized for accounting purposes but not for tax? No, actually it's recognized for tax but not accounting. So, the percentage of depletion is accepted for tax purposes but it's not accepted. So, it gives you more depletion, more deduction but it's never accepted for financial accounting purposes. Therefore, it's F. Four, proceeds from life insurance carried by the company on a key officer. Is this temporary or permanent? And the answer, you should know it's permanent. Therefore, it's either E or F. E, items recognized for accounting purposes but not for tax? Yes, proceeds from life insurance, they are recognized for financial accounting but not for tax. Advanced rental payment. Are they temporary or are they differences? Advanced rental payment, they are temporary. Therefore, we have to be looking here. So, those are advanced rentals. So, it's not expenses, we are dealing with revenues. So, is it C or D? Revenues or gain that are taxable before they are recognized in the financial statements? Yes, that's true. When they pay us rent, we tax the rent immediately. Although it's advanced rental, we have to tax it immediately. Six, depreciation property. Depreciation property is temporary difference. And depreciation is an expense, therefore we'll take out C and D or A and B. Expenses that are tax deductible after they are recognized in the financial statements or expenses that are tax deductible before they are recognized in the financial statements. Remember, depreciation we assume we are using makers first. If we are using makers, it's going to give you more depreciation first. Therefore, the answer is B. Installment sales accounted for on the accrual basis for accounting and cash basis for tax purposes. First of all, this is a temporary difference and specifically, it's a revenue related item. It's either C or D. Well, revenue or gain that are taxable after they are recognized in the financial. Yes, they are taxable later, which would give us the answer is D. Royalties receive in advance. This should be easy. This should be similar to five, which is C, just like you receive something in advance. Product warranty liability. Hopefully, you're getting to know those. Product warranty liability is a temporary difference and it's an expense and it's similar to number one, which is A, litigation accrual. The expense is taking later for tax purposes. It's taken later. The expense is taken later. It's going to give you a deferred taxed asset because the expense is taken later. It's going to give you a deferred taxed asset because the expense is taken later. Deduction for dividend received from U.S. Corporation. Hopefully, this is a permanent difference and it goes on tax purposes, never on the financial return. Therefore, the answer is F, as in Frank. Interest received on state and municipal bond obligation. Well, that's also a permanent difference, but that item goes on the tax, but never on the financial accounting. Therefore, the answer is E, as in Edward. Look at this simulation. Basically, you can consider this a mini simulation or actually a complete simulation. Karma Company report pre-tax financial income of $300,000 in each of the three years, 2016, 2017, and 2018. So $300,000, $300,000, and $300,000. The company is subject to a 20% tax rate and has the following differences between pre-tax financial income and taxable income. An installment sale of $48,000 in 2016 is reported for tax purposes over two years, period at a constant amount per month, beginning July 1st, 2016. Well, the entire sale is recognized for book purposes. So as far as book purposes are concerned, the sale has been recorded. Now, for tax purposes, it's reported on a month. Basically, it's a pro-rated on a monthly basis over two years. So let's first do this computation real quick. We have 48,000. Divide this by 24 months, because that's what they want us to do. So let's do this first. You should be on the exam. You should be working this computation very quickly. 48,000 divided by 24. That's going to give us 2,000 per month. 2,000 per month. And for 2016, what's going to happen for 2016, we're going to have to take out, because it's included in here. The whole 48,000 is included in the GAP income, and this is GAP income. It's included in GAP income. So we have to take out. We only have to keep, let's say, July. So we're getting July, August, September, October, November, and December. We only have to keep 12 months. We only have to keep, if it's 24, we have to take out, we have to keep 6. So we have to take out 18 months of this, 18. So 18 times 2,000 is 36,000. Therefore, we have to back out 36,000 for the installment sales. Back out 36,000. By back and out 36,000, we only included 2,000 times 12. We only included 2,000 times 6. We only included 12,000. So we backed out 36. We included only 12,000 for 2016. So taxable income. Now we can get to taxable income. So taxable income is 300,000 minus 36 is 264,000. We multiply this by 20%. And that's going to give us 52,800. Now we are ready to book the entry. We are ready to book the entry for 2016. What is the entry for 2016? Well, we know our income tax is payable. So for 2016, income tax is payable. We already know this amount is 52,800. Now the third component, the third component is in the future we're going to have more revenue. Remember, we had 48,000 in installment sales. 48,000 in installment sales. Of which, we already accounted for 12. It means we still have a difference of 36,000. Okay, remember, we still have a difference of 36,000. Well, this difference, this 36,000, it's going to give us the third tax liability because we have to pay taxes and they're telling us the rate is 20%. It means we're going to have the third tax liability of 7,200. Therefore, the third tax liability is 7,200. Now, what's the income tax expense? Or I'm just going to call it the expense for short. The income tax expense is those two together equal to 60,000. Therefore, income tax expense equal to 60,000. B, interest received by the company on the state municipal bond is 3,000 in 2017. And 2018, this is not recognized as revenue for tax purposes, but it's recognized for book purposes. Well, now we are told that for 2017 and 2018, there was $3,000 involved included here. That's part of the Munibond. And what do we know about Munibond? Munibond are not taxable as far as we're concerned. Therefore, what we have to do, we have to take the 3,000 out for each of these years because we don't include, we don't tax Munibond. Then for 2017, remember, we still have 36,000 reverse, for 2017, we have 12 months for 2017. And each month, remember, we're going to have to include the income at the rate of 2,000. Therefore, we have to include 24,000 of income from the installment sales that's going to reverse in 2017. Now, we come up with taxable income, 300,000, minus 3, plus 24, 321. We multiply this by 20%. That's our taxable income, multiplied by 20%. It's going to give us 64,000, 64,200. Again, our income tax is payable for 2017. Now, let's do 2017, 2017, income taxes payable, which is what we have to pay to the IRS. It is 64,200. Now, what happened is in 2017, 24,000 reversed, 24,000 reversed. It means now we pay the taxes. Therefore, we have to take our obligation. We have to reduce our deferred tax liability by 24,000 times 20% because it's reversing. Remember, it's reversing. It has to be taken out times 20%. And this is going to give us 4,800. 4,800. It means we're going to have to debit. So this is a credit. So we're going to have to debit the third tax liability. We're going to have to debit the third tax liability, 4,800. Now, what's the expense? The expense is the income taxes payable minus the decrease, which is, we already know what the decrease is, 4,800. So the expense or income tax expense, I'm just going to put expense for short. Expense for short will be 59,400. So notice we reduced the third tax liability by 4,800. Now, if you really keep in track of it, we started with 7,200. The third tax liability, we reduced it now by 4,800. It means the remainder is how much? 0,012,424,400. It means we still have the third tax liability of 2,400. Okay? Let's do 2,018. 2,018, we have 300,000. We have to take 3,000 out of the municipal bond. And what's left from the income, from the income, is six-month worth of the installment method, which is 12,000. So we have to add $12,000 from the installment method. So notice this 36,000, this 36,000 that we executed in 2016, some of it reversed in 2017, some of it reversed in 2018. So all of it is reversed now. It's easy. 300,000 minus 3,000 for the minibond, plus 12,000 will give us 3,09. Now the 309 times 20%, 309 times 20%, and that's going to give us income taxes payable of 61,800. Now I'm going to abbreviate income taxes payable, ITP, income taxes payable of 61,800. 61,800. Now the deferred tax liability has to be gone. So the deferred tax liability, the deferred tax liability, DTL should be gone. It should be gone. It should be now. What's left of it, which is 2,400. 2,400. And the expense is income taxes payable minus the decrease, which is 59,400 as well. 59,400. And this is the entry for 2018. I know this is a long problem, but if you can follow it, if you can follow this, because what we did, we did the, we computed taxable income, we went from gap income to IRS income, and for each entry and for each problem, we did the entry, we did the journal entry. If you could do this, this is excellent. This will be great. Let's take a look at more exercises or more multiple choice. Again, once you have a lot of data, just go ahead and skip to the question and see what the question is asking you, because they could be asking you a simple, a simple question, or they could be asking you a very complicated question. Don't waste your time looking at the whole problem. Look at the question first and try to focus on the data. Okay. How much would Aragano Corporation report taxable income? So they're asking for taxable income on the income statement. So taxable income on the income statement, taxable income on its income statement for December, for December 31st, year 20, year 30. Okay. Now we have to see what we are giving. Aragano report net income in its year 13 financial statements before income tax expense of 400,000. Aragano has been profitable in the past and expect to continue to be profitable. The company expense warranty cost in year 13 on the books for 35,000. I think what we're looking for really is report taxable income. It's IRS taxable income, because IRS taxable income, because, sorry, okay, let's take a look at this question. Once you see a lot of data, focus on the question first. Focus on the question first. How much would Aragano report as taxable income? It means IRS on the income statement. Taxable income means how much would they report for the IRS? Okay. So the A corporation reports net income on its year 13 financial statements before income tax expense of 400,000. So this is gap. A has been profitable in the past and expect to be continue profitable. The company expense warranty costs in year 3 on the books for 35, as expected to impact the tax return in year 16. So it's going to be later on. A corporation also had $60,000 in revenue that will not be taxed until 2015. So we have two items, the 35 and the 60 we have to make an adjustment for. A corporation has a tax rate for year 13 of 30%, and an act of tax rate of 40% before. In addition, Aragano Corporation made for installment payment of 25,000 in year 2015. So basically what's income tax is payable? Well, gap income is 400,000. Gap income is given as 400,000. Now from gap income, we have to make certain adjustments. We have to make certain adjustments. First of all, you eliminate D because D is gap income. What are the adjustments? Well, they included, they deducted warranty costs. Well, we cannot deduct warranty costs for IRS purposes. Therefore, we have to add 35,000. Simply put, from this 400,000 for financial accounting, they deducted 35, that deduction 35 is not acceptable. Therefore, we have to add it back. Then they included in this 400,000, what's included, a $60,000 revenue, which is not taxable yet. Therefore, we have to take out the 60,000 as far as taxes are concerned. I think those are the only two items. So taxable income is 400 minus 35 plus 60. So that's 375. So the answer is 375. 375,000. That's taxable income. Same problem. How much would a corporation report as current income tax expense? Now they're asking us how much they would report as current income tax expense. And be careful the word current. It means what should be their income taxes payable? Well, we already computed their income taxes are 375. Now you have to be very careful. Why do you have to be very careful? Because you have to use the tax rate that's enacted for future periods. The tax rate enacted for future periods is 40%. That's if you are computing DTA, but we're not actually computing DTA, we're computing the current. Therefore 375, actually this is easy, times 30% because they want the current. We don't have to worry about the 40%. So 375 times 30% is 112,500 and the answer is B. How much we have the third income tax expense? Now we have to be very careful. Now that's what I meant to say. You have to look at the future rate. The future rate is 40%. Remember in this problem we had the $35,000 insurance. That's going to be the third. That's an expense. And we had a revenue of $60,000. That's going to be the third. Now the rate is 40%. For the $35,000 we're going to multiply it by 40%. And that's going to give us a deferred tax liability. The third $35,000 times 40%. That's $14,000. Now for the revenue that's going to give us the expense. The expense will give us, yes, I'm sorry, the expense will give us a deferred tax asset. I apologize. The $14,000 will be a deferred tax asset. The $60,000 we have to pay taxes on it. Therefore it's going to be a deferred tax liability. Times 40%. And that's $24,000 of a deferred tax liability. So what's the deferred component? We net them. The deferred component is $10,000. The deferred component is $10,000. And specifically it's a DTL. DTL. A deferred tax liability. A deferred tax liability. So the current component is $1,112,500. This is the current component. And the deferred component is $10,000. And the last question is what's the total income tax expense? Well, the total income tax expense is the current plus the deferred, which equal to $1,22,500. $1,22,500. Now I'm going to go a step further. And I'm going to show you the journal entry for this. Again, I know I keep doing this, but the more you know it, the better off you are. So you debit income tax expense. That's the total. $1,22,500. You debit DTL. And you credit DTL. DTL was $14,000. And DTL was $24,000. And income taxes payable was $1,12,500. Now remember what I did. I already know all the answers, but in the real world, on the exam you will start with this, then you start with this, then you start with this, and this will be a plug. But we know all the answers. I just wanted to show you the journal entry. A lot of data read the question first. The enacted tax rate for the current year is 25%, and 30% thereafter. It refers balance sheet. What should they report as the third income tax liability? All right, let's see what they have. So B Corporation is a newly organized company reported pre-tax financial income of $100,000. That's gap for the current year. Among the items reported are premium on insurance, life insurance with the Broadford as the owner. Well, we don't count this because this is a permanent difference. This interest received on minibund, easy, permanent difference. So what is the third component? There is no third component because both of these items are permanent. Both of these items are permanent. So let's take a look at this question. Once you see a lot of data, just look at the question first. How much permanent differences between book and taxable income exist as of year 2013? Okay, now you can look at the data and it's easier to see what you're looking for. P has pre-tax financial income of $125,000, a.k.a. gap income. They have interest income received on the state of Florida, $18,000. That's permanent. Depreciation and access of financial statements, that's temporary. Rent received in advance, that's temporary. And they made four installment payment. So it's $18,000, very easy because I know what I'm looking for. What amount of taxable income should be reported for P company? So they're looking for taxable income. Well, guess what? You have gap income of $125,000. We have gap income of $125,000. Interest income received on the state of Florida bonds, well, this has to be taken out. This is not taxable. Therefore, I need to deduct this $18,000. I have to deduct this $18,000 because it's not taxable. Tax depreciation and access of financial statements. So I have more depreciation as far as taxes are concerned. So I have to deduct $8,000 of depreciation. $8,000 of depreciation. Then, so I took care of this. I took care of this. Rent received in advance, well, I'm going to have to add the rent because if I receive the money, I have to pay taxes on it. Therefore, my taxable income is $113,000. $113,000. What is my current income tax expense? Well, easy. If my taxable income is $113,000 and I'm dealing with year 2013, 2013, my tax rate is how much in 2013? 2013 is $35,000. Therefore, I have to multiply this by 35%. And that's going to give me, that's going to give me what, 35%, $39,550. What amount of current income taxes payable should be reported? Now, we computed income tax expense, but what's the amount that should be reported on the balance sheet? Well, that's easy because we computed the number as $39,550, but we made, we made installment payment for installment payment. We paid $36,000 already. We paid $36,000 already. So how much do we have to report? Only $3,550. This is how much we report. As company has a temporary difference in year one, that's from a non-current liability and expected to reverse in year two, three and four. In year one, the tax rate is 30%. In year two, three and four, the enacted rate is 40%. Under US GABA, the third tax liability is based on which of the following tax rate? So simply put, they're asking us, we're computing the third tax asset. Which rate do we use for that? Well, we're going to be using the rate that's enacted in those future years. And that's the enacted rate for year two, three and four. So when we computed the third tax asset and the third tax liability, we use the enacted future rate, the enacted future rate. In year one, it's first year of operation. Mac Industries has a temporary difference resulting from the following two items, depreciation expense, warranty expense. Which of the following differences should be reported as a current, the third tax asset liability on year one, balance sheet? This is a tricky question, especially if you took the exam long time ago. As far as the third tax asset and the third tax liability, none of it is current. We used to have a current section and a non-current section. That's no longer the case, neither. The only thing that we have now is long-term. We no longer have current and long-term for the third tax asset and the third tax liability. It's all non-current. Before it used to be, look at the asset or the liability. Is it a long-term or a short-term? And you will determine your current, whether it's a current, the third tax asset, or a current, the third tax asset, or a current, the third tax liability. Or it's a long-term. No longer the case. It's all non-current, easy, easy. What amount should T report in year one balance sheet for the third income tax liability? So they told us you're looking for a DTL. So just what the amount should be. So T received cash in the amount of 20,000 that was included in year one financial statement, of which 12,000 will be taxed in year two. All right. So we have 12,000 of temporary difference, because this is the amount that's going to be reversing. T enacted tax rate is 30% for year one, 25% for year two. I'm interested in the 25% because it's going to reverse in year two. That's equal to 3,000. Therefore, my deferred tax liability equal to 3,000. Again, read the question first. Assuming no other temporary differences and rental income is taxable when received, what amount should we have at the third tax asset? So they're asking us for the deferred tax asset. On June 1st, year one, on June 20th, year one, sorry, not June 1st, on June 20th, year one, Benson leased the building and received rental payment in the amount of 42,000. The payment was for the rental period beginning July year one till July one, year two. So basically, here's what happened. This is year one and this is year two. So they received the payment and the payment covered one half of year one, one half of year two. So if we received 42,000, it means 21,000 belong to year one and 21,000 will be deferred. Okay. Benson tax rate are 25% for year one and 30% for year two. So what's the deferred tax asset? Well, we're going to be deferring 21,000 and it's going to be based on year two rate, which is 30%, which is equal to 6,300, 6,300. Okay. What's the total temporary difference for FISC? Now they're asking for temporary difference. Okay. Life insurance policies, that's permanent. Estimated for future expenses, estimated for future warranty expense, yes, that's a temporary difference. Estimated for bad debt, sure, it's a temporary difference. The answer is C43,000. Those are the temporary differences. If you have any questions about this topic, please let me know about any questions that we went over. Please let me know. In the next session, I will start to work with NOL or Net Operating Losses and it's going to be based on the Tax Cuts and Jobs Act, which is the latest NOL. Again, this topic will be covered in intermediate accounting. Once again, I strongly encourage you to visit my website and I strongly encourage you to subscribe as it's an investment in your career. Good luck and study hard for your CPA experience.