 Hello, and welcome to this session in which we will discuss temporary differences that arises in a business combination What are temporary differences temporary differences occurs when there's a difference between the tax basis of an asset or a liability and its Related book basis. So for example for tax basis, we have an account receivable for a hundred thousand That's for tax basis when it comes to gap the account receivable is 120,000 or 80,000 it doesn't matter there's a difference between the two and once we have a temporary difference between The tax basis and the book basis and the reason I say temporary difference because we have temporary differences and we have permanent differences Temporary differences eventually Reverse themselves and that's why they create a deferred taxed asset or a deferred tax liability So those are what temporary differences are now if you don't know what temporary differences by all means you have to go Back to my intermediate accounting course and learn that lesson. This is an advanced accounting course The assumption is you have a good idea what DTA the third taxed asset and deferred tax liability and for the purpose of this session I am not discussing the existing Deferred taxed asset and deferred tax liability those assets and liabilities They get consolidated just like any other asset and any other liability what I'm discussing here is the new different The third taxed asset and liability that emerges from the business combination as a result of the business combination Well, you might have a deferred taxed asset deferred tax liability because what I'm trying to say is this the sub already Could have the third taxed asset deferred tax liability That's fine when we consolidate just like we add those to our assets We add those to our liabilities and that's the end of the story the temporary differences I'm discussing here is a new and it's a different one It's a different one. Why because now the sub might have an asset with a different tax basis than the consolidated book value So the sub will have an asset and will work an example with a basis of a hundred thousand dollar when we consolidate That that basis is different for financial reporting So as the result of this consolidation the difference arises and as a result we have to create this new The third taxed asset and the third taxed liability before we proceed any further I have a public announcement about my company farhat lectures comm 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 No obligation no credit card required Now fast be state that an acquirer shall recognize the deferred taxed asset or the third tax Library arising from the assets acquired and libraries assume in the business combination So those are new and shall account for its potential tax effect of any temporary difference Now the best way to illustrate this is to actually do what look at an example So we're gonna go ahead and switch to the Excel sheet and look at an example Let's trade this concept We're gonna assume we have a sub and for simplicity the sub owns one building and that building has a tax basis of 220 The fair value of that building is $300,000 the parent company purchased the sub which is it all what it has is the building for 420,000 now when the parent company Consolidate consolidate the sub well in the consolidated financial statement They have to report the building at its fair value $300,000 well what this is great what this created a temporary difference of $80,000 so on the books on the consolidated books We have a book value of 300 and we have a tax basis of 220 so notice. We have a difference of $80,000 well what's gonna happen is this this difference will create a deferred tax liability How much is the deferred tax liability? Well, it's gonna be $80,000 times the tax rate We're gonna be assuming a tax rate of 21% we're gonna have a DTL of 16,800 now this DTL Eventually, what's gonna happen to it? It's gonna be reversed how it's gonna be reversed you're gonna see but this is the new DTL knew the third tax liability because we have we're gonna have to take more depreciation for book purposes Okay, so let's see how we're gonna account for this So the consideration paid for this company, which is simple company 420,000 the building fair value is 300,000 we're gonna deduct from the building fair value the deferred tax library is therefore It's gonna be 283,200 the difference between what we paid and this amount will give us the goodwill 136,800 now let's go ahead and start to see how this will play itself on the Financial statements, so let's assume for the purpose of this illustration this building generated $50,000 of revenue Whether it's tax or gap the $50,000 of revenue is the same so for gap We're gonna have $50,000 of revenues now this new building the $300,000 building we're gonna divide this we're gonna assume it's gonna be have a life of 10 years Therefore for gap purposes, we're gonna have using straight line depreciation. We're gonna have 30,000 of depreciation expense Well 50 minus 30,000 will give us income of 20,000 income of 20,000 times 21% will give us 4200 for tax purposes also we have to report 50,000 and income the depreciation remember the building has a tax basis of 220 We're all we're also going to assume straight line for simplicity over 10 years remaining and they will have 22,000 and depreciation expense for tax purposes Therefore their taxable income is 28,000 multiplied despite 21% they have to pay 5,880 I always like to start with this entry once I know this is the 5,880 this is how much they have to pay this is income taxes payable credited now a Few remember we had a deferred tax liability deferred tax liability created when we started this acquisition and it was 16,800 Here's what's gonna happen now Now we're gonna compute the differences which is the differences between The two the gap and the tax basis is is is 8,000 the difference is 8,000 We're gonna multiply it by 21% and simply put for this period We are starting to in quote amortize or reduce the third tax liability by 1680 So every year when we'll pay the taxes we are gonna have at the third tax liability of 1680 and over 10 year period over 10 year period what's gonna happen? This is the third tax liability will go down to zero therefore. We paid 58 80 We reduced our liability by 1680 and what's left is the income tax expense, which is 4,200 so what should you do now this topic is a little bit challenging for many students because we are combining business Consolidation as well as temporary differences together to create the third taxed asset the third tax liability What should you do now go to far hat lectures and look at additional mcqs through false multiple choice questions That's gonna help you Understand this topic better the third taxed assets the third tax liability Temporary differences important topic in advanced accounting important topic on the CPA exam take your education seriously Invest in yourself. Good luck and stay safe