 Hello and welcome to this session in which you would look at an actual CPA simulation from the AICPA released question. The purpose of this session is to show you how to solve simulations, proper techniques, proper methods. The first thing you do when you look at a simulation is not to panic. What do you do first? First you want to know what type of simulation am I dealing with? There are five types of simulations, so if I scroll down here, I see there's a letter here, that's all where I didn't read anything else, and I see there is, I have to change the statement or keep it the same. So I'm giving few statements and I'm told whether I should accept the original statement or change the statement. This is the type. This is good. So that's excellent. So don't panic. I'm not looking for journal entries. I'm not looking to do any computation. I'm looking to make a judgment and I'm going to be looking at information. Once you are given a simulation like this, you might be giving emails to review, to determine whether that statement is accurate or not. You might be given telephone conversation. You might be given financial statements. You might be given partial schedules. You might be given purchase invoices, sales invoices, all sorts of documents. But don't panic. Just because you have a lot of documents to deal with, you have to focus. I see what am I looking for? Okay? All you have to do is what type of simulation am I dealing with? The next thing I do, if I was in your shoes, is I will click real quick on each exhibit so just to see what's inside of it. This is a tax depreciation schedule. Great. I would say this is tax depreciation schedule. This is the color copier invoice. Great. This is the color copier invoice. Then I would look at this letter here and just see what it is. Just take me a second. Letter from the borough of beach head. That's fine. Once the borough of beach head mentioned, I will come back to this, manufacturing equipment invoice. That's that. A letter to Stephen Black, okay? Land and exchange for toll corporation, delivery van invoice. So all what I did is it just, it took me 10 seconds to see, to just review my exhibit. I didn't read anything inside of them. Now everything that I'm saying is easier said and done. What would practice, you will get better. Before we proceed any further, I have a public announcement about my company, 4hatlectures.com. 4hat accounting lectures is a supplemental educational tool that's going to 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. The key is not to panic. So the first thing I do now, I'm going to read what's given to me here and understand it. So after I know what type of simulation, now I need to know, get an idea. What is the main simulation is about? What are they asking me about? What's the main theme? Let's take a look at this. Smith & Company CPAs has been engaged to prepare for 1120 US Corporation tax return for toll corporation. Toll is our customer. As part of the engagement, the year nine purchases of property and equipment were reviewed to determine whether the tax basis of each fixed asset acquired in year nine is accurately reflected on the tax depreciation worksheet shown above. I stop right here. This is what the simulation is about. It's about tax basis. I know it's a document review simulation about tax basis. That's it. Your level of confidence should start to go up and your nervousness should start to decrease because I know. I know my tax basis. I learned about them. Documentation of the purchases can be found above. OK, now I know what these documents is all about. There are various purchases and each document most likely belongs to a purchase. After an initial review of documentation of the documentation, staff associate prepared a draft letter to Toll's controller. So we prepared this letter to the customer. John Park, the partner in charge of the toll engagement, the partner in charge at the CPA firm has asked you to review the documentation and revise the letter correcting any errors because the staff wrote it. They want you to read the letter and see if the staff put this information properly. And specifically, they're looking for the tax basis. That's all what I'm looking for now. Now to revise each document, click on the segment of the underlying text below and select the correct answer. Now, I always say each simulation can be turned into a multiple choice. For example, here we're talking about the 10th Street manufacturing facility. And you are giving options A, B, C, D, E. You're given five options here rather than four options. But the simulation is more than a multiple choice frame differently. So that's what I'm trying to tell you. And hopefully this simulation, each question will be independent from the other. And it looks like because we have different assets and each asset will have a different tax basis. We hope so. We hope that the simulation will not have interconnected material. Now you are starting to, now you know what it's about. What type and what is it about? Now you start to read the letter. Dear Michael, we have completed our review of the year nine property plan equipment purchases as detailed in the tax depreciation worksheet that you provided. Notice they provided the tax depreciation worksheet. 10th Street manufacturing facility. Focus. Now we're looking at one asset, only 10th Street. Notice the letter breaking down the asset into various different assets. We agree with the tax basis of the $5,750,800 for the new manufacturing facility located at 10th Street. So there's no issue with the tax basis of the manufacturing facility. We did not, however, that you have incorrectly recorded the tax basis of the land related to this facility at 297,500. So the issue here is the land of the 10th Street manufacturing facility. And they recorded the land at 297,500. Now, if you go to the tax depreciation schedule that toll corporation provided and you look at the land, you would see that they indeed have the land recorded at 297,297,500. Okay, now we're going to close this. The proper tax basis of the land is you have to choose the answer. Is it 297,297,500, which is the agree with them, obviously, or 287, is it 10,500, is it 10,000, or is it should be the basis of zero? How do we know what's the basis of this land? Well, we need to know how did they acquire this land? How did they acquire this land? Again, I'm taking time to walk you through the logic, but on the exam you'd say, okay, I know this is what they recorded, but how did they acquire it? This is how you know the basis. Well, 10th Street, this is the color copy, it's not relevant for me. This is the manufacturing equipment that's not relevant for me. Let me take a look at this letter. A letter of borrow of Beachhead, because again, this is what I'm simulating what I will do on the exam. It was with great pleasure. We enclosed an affidavit of the title of 10 acre located at 10th Street. Okay, here's the land, here's the land. We are excited that you will be constructing your new manufacturing facility on the land, that the borrow of Beachhead has donated to your company. Okay, so this land, we know this land, we did not purchase this land. This land was donated to us. Now we are focusing, it's a land donated. Okay, we do not have any basis of the property. So guess what, this township, the borrow of Beachside, they have the land, they gave us 10 acre land to build a manufacturing facility, but the borrow don't know their basis. However, the fair market value of the land has been appraised at 287. Okay, now we stop, right now we need to know what are the rules, if land was gifted to us, donated to us, and what are the rules? What are the rules? If the fair value of the property exceeds the basis, then the recipient, which is us, basis is the same as the donor. Well, here we don't know the basis. The basis is, we don't know the basis. If we don't know the basis, they don't know it. We assume it to be zero, because we don't know the basis. They don't know, because most likely they bought it long time ago, or somehow by act of government they have this land. We don't know, but we know the fair market value. The fair market value obviously is gonna exceed the basis. Therefore, the donor basis will transfer. What's the donor basis? Zero at this point. We're not done yet. We look forward to joining you at the ribbon cutting ceremony. Now, John, Toll Corporation paid $10,000 to demolish an existing building prior to the construction of the new facility. Hold on a second. So we got this land for free, okay? And we don't know the basis. The basis would have transferred, but they don't know the basis, therefore it's zero. We paid $10,000 to get this land ready. How did we pay $10,000 to demolish the existing building? Remember, what are the rules here? This is a cost to acquire the building. Now, this is part of our basis. Now, I can tell you, now the basis of the land is $10,000. Okay, we also donated $500 to the Borough Recreation Fund as a token of appreciation for the gift of the 10 acres property. Do we include this of the basis? Did we have to pay this? No, it's not part of the basis. We did it as a token of appreciation. We did not have to do it, therefore it's not part of the basis. Well, guess what? The only basis we have for this land is $10,000. It's a donated land. So what did you need to know? You needed to know is how do you deal with donated land? How do you deal with it? Well, it's the basis transferred to us because the fair value on the date of the gift exceeds the basis, which is zero. So you need to know the basis. If the fair value of the property at the date of the gift is less than the donor basis, then we have the dual basis rule, which is I'm not gonna go over here, but you need to know about the dual basis rule. I do cover, obviously, in my basis chapter. So the proper tax basis for the land is $10,000 and I am done, okay? It should take you two to three minutes to know this. Now, don't open this letter again from the Borough of Beachside. We know what's in that letter, it's done. Now, parcel of land in Hindenburg, New Jersey. The 10 acres of land acquired from Stephen Black. Okay, we have a letter from Stephen Black. Reflected as an asset on the tax depreciation schedule. So it's reflected on the tax depreciation schedule. However, the land is incorrectly recorded as a tax basis of 35. So if we look at the depreciation schedule, we see it's recorded at 35. Do you need to look at it? If you wanna look at it and just to see it, you can, but you don't have to. The tax basis of the land should be recorded at 30. So that's what we're saying. So again, we disagree with this. Well, what do I do? I'm gonna go to the letter to Stephen Black, okay? Because it's the land acquired from Stephen Black. This is what I'm gonna start. So I know which document. I don't go to the delivery van in voice. I don't go to the color copier. I don't go to the manufacturing facility. I'll go to that letter. Enclosed, please find, so this is December 1st. Enclosed, please find 1,000 shares of toll corporation stock representing 10% of the outstanding share of common stock. In addition, we have enclosed a check for $5,000 representing the difference between the land, the value of the stock and the land in Herdenburg, New Jersey, okay? So what did we do? How did we buy this land? We paid $5,000 in cash and we donated 1,000 shares. So it's an exchange cash and stock for the land. So we need to know what should the land be recorded at. John, toll corporation issued 1,000 shares of common stock, a new shareholder in exchange for the 10 acres. So this is how we bought it. The value of the stock was $50 per share and an appraisal value of the land is determined to be 55,000. Stephen Black originally purchased the land in year four at a cost of 35. That's irrelevant for me. I don't care what Stephen purchased the land for. What I care now is how much did I pay for it? Okay? Now, what do you do under those circumstances? How do you determine if there is an exchange, if there's an exchange of asset, non-cash asset? If we paid cash for it, let's assume we paid, the fair value is 55. If we paid 55, that's easy and we know the fair value, it's 55. Well, now what do we need to know? Well, what did we exchange? We exchange is 1,000 shares of common stock. Now we are not told, well, we are told the value of the stock was $50. So there we go. So we exchange 1,000 shares and we are told the fair value of the stock is 50. So right here, we gave them 50,000 in stocks and we gave them 5,000 in a check. And guess what, to kind of confirm this, the fair value of the land is 55, okay? So they happen, it has to be an equal exchange and indeed it's an equal exchange. But sometimes they'll try to, for example, they'll tell you the owner thinks it's worth 60. I don't care what the owner thinks. If I know I exchange is 1,000 shares at $50 and I know the fair value of my stock, we are told the value of the stock, $50 and $5,000 a check in cash is worth 5,000, I paid for this land 55,000. Therefore, the land should be, the basis of the land should be 55,000, okay? So it should be 55,000, not 30,000, 55,000. I accept, I accept. Now, the good thing about this simulation is each, notice each piece of land, and each piece of property is independent of the other. So we're done with this. Color copier, the color copier purchase on April 15 is properly reflected on the tax depreciation schedule as a five-year property. We are told it's a five-year property, it is. However, the asset is incorrectly recorded as the tax basis of 5,000. We are told, you are told, if you look at the depreciation schedule and you can, if you want to, it's recorded at 5,000, but we disagree. We disagree, the land should be recorded at what? Is it 9,000, keep it the same, blah, blah, blah. How do I know how much it's recorded? I don't guess, I just go to the, I know there's an invoice for the color copier. I'll go to the invoice. I'll pull the invoice and see what happened there. What happened there is this. The color copier has a price of 26,852. That's the, that's the cop, that's the price of the copier, that's fine. What else do I need to know about this? Sales tax is 8%, we paid sales taxes of 8%. Well, that's also relevant to my computation because the, what I paid is sales tax as part of the deal, total build 29,000. Deposit due upon ordering. So you made the deposit, the company made a deposit of 5,000. When we ordered this copier, we made a deposit of 5,000 in good faith. So make sure they gave it to us. Amount financed is 24, that's fine, we financed 24. How much is the copier? What's the, what's the value of the copier? Let's just read everything else. We decided to finance the purchase over a four year period with a promotional loan offered by Elmer office equipment. We had initial deposit of 5,000 and it began making monthly payment of 500. Okay, we financed this amount. Do we care about the financing amount? Not at all, we are giving a clear cut in voice. The copier price, sales tax, the copier is worth 29, not worth. The cost of it is 29,000, 29,000. We paid five, we're gonna finance the rest. It's 29,000. This is the basis of the copier. Are we gonna pay interest on the payment? Sure, those are treated differently. So what's the basis of this copier? The basis of the copier is 29,000. The basis of the copier is 29,000. And I'm done with that. Manufacturing equipment. The manufacturing equipment that you purchase on June 15th is properly refactored on the tax depreciation schedule as a seven year property. Okay, it's a seven year property. The tax basis is 144, however, is incorrect. The amount to capitalize for the manufacturing equipment is 167,400. Well, where do I look for this? Don't look at the depreciation schedule. It's gonna show you 144. You want to know, is this correct or not? I would look at the manufacturing equipment invoice. This is what I would look for. And I will pull that invoice and see what really happened. Look, it's a good invoice, detailing everything. The machine itself costs 144, installation, 3,400, shipping cost to Smithville to Beachhead, 7,400, Beachside, transit insurance, 2,600, extended two year warranty, 2,800, subtotal 1,160,200, sales tax charged on the machinery only 7,200, total 167,400, okay? Is this the proper amount or is it 144? Well, I can tell you, if you know anything about purchasing an asset, we include all the costs necessary. Is 144 a necessary cost? Yes, I believe this is what they recorded the asset at. I know it's incorrect. Why? Because if they recorded the asset at 144, that's all what they accounted for. No, there are other costs that was necessary to buy this asset. Is installation part of the cost? Of course it is. If we take 144 plus 3,400, that's part of the cost. Shipping cost. Can you have the asset without shipping it? No, you have to ship it part of the cost. Transit insurance. I needed to buy insurance while in transit in case something happened to it in transit. Is this a necessary cost? Yes, 2,600 is added. Extended two-year warranty. Hold on a second. Do I need this warranty or is this technically optional? This warranty is optional. So guess what? This is not part of the cost. A sales tax part of the cost. Yes, 7,200. Now be careful because here's what some students will make a mistake. They would say, well, there's 7,200 of taxes, but if I remove the 2,800, the sales tax should be lower that I include. No, the sales tax is only for the machine. Therefore, the full sales tax is included. So what I will do, I will add 144 plus 3,400 plus 7,400 plus 2,600, I don't include the extended warranty because it's not part of the cost and I include the sales tax. Well, this is a simple, I would say, this is a simple basis, the cost of the machine. So the cost of the machine, if I add everything up, it's 164,600. Let me go in here and I'm gonna 164,164,600 and that's the amount. I'm done with this. Again, as I hoped each asset is independent from the other. On August 1st, you traded in a year five model delivery van for a new delivery van paying cash 8,600. As indicated on the invoice from beach side car and truck sales. So we have an invoice of this. The year nine delivery van tax is reflected in the tax depreciation schedule is 8,600 and we are told the basis is correct. So you traded a model delivery van and you paid cash of 8,600. Now, this is an exchange. Again, here we have to go back to how do we work in exchange? Well, let's see the invoice. What happened to that van? Cause we need additional information. Okay, we need to know the delivery van invoice. Here we go. The cost of the delivery van is 20,300. Destination charge, $514. The cost obviously is part of the cost. The destination charge, of course, that's a cost necessary to buy this asset and less trade in of the five year van. Then they give us 7,100 for the five year van. The subtotal is 17,714. Then we paid sales tax of 5%. The total amount due is 18,600. This is the total amount due. Is this the cost of the asset? Is this the cost of the asset? Well, let's think about it. And but they told us it's only cash. All what they accounted for is the cash amount that we paid. The cash amount that we paid. Well, let's think about it for a moment. The trade in for five years, they said they gave us 7,100. It doesn't matter what they gave us. Let's look at the calculator here. They quoted the price of 24,300. Then we paid, I believe we paid 18,500. 18,600, 18,600. So really what they told us the trade in value, that's not really the true trade in value. If the cost is, let's add the cost plus the transportation in. I'm doing this just to kind of go over the rules. Let's clear the tape. If I have 24,300 plus 514, that's 24,814, I'm gonna add to it the sales tax. Well, I'm gonna add the sales tax. This is the total cost before the trade. I paid 18,600. Therefore the trade value really is 6,214. They told you they gave us 7,100. I don't care what they said they gave me. The true trade in value is 6,214. So what do I need to do? Well, how much did that asset cost me? How much did that asset cost me? Well, it cost me 24,300 plus 514 plus the tax 886. So the asset cost me 25,700. Now I only paid 18,600. Therefore the remaining, as I mentioned, the good news about this simulation is each asset is independent. So on August 1st, you traded in a year five model delivery van for a new delivery paying 18,600. So you traded an old van and paid 18,600 in cash as indicated on the invoice, which is we have an invoice. You remember we have an invoice for that van delivery. The year nine delivery van tax basis is 18,600. And the basis is correct, incorrect, or something else. Well, I don't know. I have to look at what happened in that trade. It's basically a trade. Here's what happened. The cost of the delivery is 24,300. Destination charge 514 is that part of the cost. Sure it is. Then they gave us for the old van, 7,100. Subtotal 17,714, then we paid sales tax. Now, how much did we pay for this land? Let's think about it for a moment. Let's pull the calculator here. Let's clear the tape and let's see what happened. We paid, the cost is 24,300. That's what they told us. Then they said there is a destination charge of 514 and there's sales tax of 886. Those are all part of the cost of the vehicle, 28,700. That's the cost of the vehicle. This is how much you paid. Just to confirm, you only paid 18,600 in cash. It means the trade was for 7,100. So what did you really paid? What did you really pay for this car? The cost of this car is 25,700. The cost is 27,500. How much did you pay? Well, you paid two things. You get the trade in, 7,100 plus 18,600. It will add up to 25,700. So the invoice clearly show you how much you paid for that car. But even if you wanna go from a trade perspective, you gave up an old asset that's worth 7,100. This is what you paid. An old asset worth 7,100. Fair market value of that is that much and you paid 18,600. If you add those, you'll get the 25,700. Or you can go through the invoice. The cost of the van, destination charge, sales tax, that's my cost, which is, when I did this, it's 25,700. Therefore, my asset, the basis of this asset is 25,700. Now, I know, going over this, this is, we're done with this simulation. Now, going over the simulation, it took a little bit of time because I wanted to walk you through what you would do when you are on the exam day. How would you approach this on the exam day? It should not take this long. Again, let's review the rules. One, what type of simulation am I dealing with? Remember, I'm dealing with a document review simulation. I need keep, replace, or delete the data. Two, what is the topic? The topic is tax basis for purchases. Good. Now, I need to focus on each asset separately and answer the question. I cannot do any of this. I cannot solve the simulation if I'm not familiar with my tax basis rules. Now, how can I help you, Farhat Lectures? Farhat Lectures provide lectures, resources that's gonna help you understand the tax basis. Then you can answer this simulation. You cannot answer a simulation without knowing the rules. It's not the simulation. If you don't know the tax basis, you can't even answer a multiple choice question, let alone a simulation. Stay safe, stay motivated, and study hard for your CPA exam. It's worth it.