 Hello and welcome to this session in which we will discuss the third tax liability Well, the third tax liability is a liability and what is a liability a liability means you are Responsible for settling something into the future making a payment rendering a service Satisfying an obligation. What is that obligation? The result of well, it's the result of the third taxes It means in the future you're gonna have to pay more taxes because the taxes are being deferred and this is where the third tax Liability is now. How does it third tax liability comes to life? How is it created? Well, it's created from something we called a temporary difference So we have temporary and we have permanent the deferred tax liability is a result of temporary difference That is the difference between the tax basis of an asset or a liability and It's reported carrying or book basis. So we have an asset or a liability Let's assume we have an asset, but this could be an asset or a liability and As a result we have two sets of books. We have the IRS which is tax and we have gap and As a result for gap purposes, we have an asset and that asset is let's assume $100,000 and This is the result to be more specific from an account receivable because we made the sale on account as a result We debit account receivable. We credited sales for tax purposes We don't record this revenue because it's not It's not cash as far as the IRS are concerned. This is tax For tax purposes, we don't have an account receivable. So there's a difference of $100,000 And this is what we mean by a difference between a tax basis of an asset and its book value in the financial statement That will result in a future taxable amount or future deductible amount Which we don't we don't worry about deductible amount future deductible future taxable amount because we are discussing the third tax liability Now another way to put this it's a future taxable and income That is an estimation of the amount that income will be subject to income taxes So in the future in the future, let's assume our tax rate is 20% So in the future this $100,000 will be subject to 20% tax rate as a result. We are responsible for 20,000 not now for tax purposes This will be in the future. So it's a future taxable income. The future taxable income is $100,000 Which will be subject to a 20% tax rate which will result in a $20,000 the third tax liability So revenue accounted for under a cruel basis for accounting purposes and cash basis under tax basis So as a result, we have an account receivable for gap. We have no account receivable for IRS As a result, we have to see in the future the account receivable of gap will eventually be taxable when it becomes taxable What do we have to do? We have to pay taxes So we have to book our the third tax liability now to reflect this future 20,000 of future liability the best way to illustrate this is using an example with figures Before we proceed any further, I have a public announcement about my company farhat-lectures.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. No obligation. No credit card required Let's assume Aram Corporation has one temporary difference Which is an account receivable at the end of 20x1 that will reverse and cause a taxable amount of 60,000 in x2 50,000 in x3 and 70,000 in x4 Okay, let's translate this. We have an account receivable at the end of 20x1 Well, this account receivable will reverse in the next three years. So as far as gap We have a receivable of 50 plus 60 is 110 plus 75 is 185. We have an account receivable of 185 For tax purposes, we don't have an account receivable. So this account This is an account receivable for tax or IRS. We don't have an account receivable Notice we have a difference of 185,000 and we are told this difference will reverse and they're giving us the year and rate 60,000 of that difference will reverse in 20x2. In other words, we expect the customer to pay 60,000 in x2 and of x3 we're gonna add to our taxes 50,000 in x3 and we're gonna add another 75,000 in x4. So this is how it's going to reverse Well Adam pre-tax financial income for 20x1 is 300,000 and the tax rate is 20% for all years to make it easy because you could have a different tax rate in future years because the government can't change it or they you know Based on planning purposes, they will tell you for example in two years the tax rate will go up but for some simplicity The tax rate is 20% there are no other deferred taxes compute taxable income Income taxes payable and income tax expense for 20x1. So notice I can ask you several questions about this exercise So let's see. Let's take a look at what's going on here. So we're starting with x1 Which is the current year we have financial income of 300,000. That's giving to us financial means gap income We have to back out of it 185,000 to come up with our taxes because this is for book purposes But we have to back out 185,000 of revenues and a counter receivable to come up to our taxable income, which is 105 So as far as 20x1, this is 20x1 The company is responsible for paying 21,000 in taxes, which is if we take 105 Which is the taxable income 105,000 multiplied by 20% and that's going to give us 21,000 So this is what we are responsible for paying today, which is the CD income taxes payable What's gonna happen is this remember 60,000 of it of this amount will reverse an x2 50,000 and x3 and 75,000 and x4 So assuming the same tax rate in the future for 20x2. We're gonna pay 12,000 For that amount for so for the 185,000 as a result of this an x2 were responsible for signing a check for 12,000 for x3 We are responsible for signing a check for 10,000 because 50,000 reverse and for x4 were responsible for paying 15,000 because 75 will reverse and notice if you add them up once they reverse the net effect is 0 So let's start with a journal entry The first thing I am going to do is to book your income taxes payable because I always advise you to start with that figure Income taxes payable means how much do we have to pay the IRS this year? So we're computing this income taxes payable with which is the check that you have to write to the IRS and this amount is 21,000 After you book the income taxes payable you figure out What is your net deferred tax liability or net deferred taxed asset? We know what's a liability Here what we have to do is credit 12 Plus 10 is 22 plus 15 is 37 in the future. We are responsible for paying 37,000 dollar now. We also learned that How we do we compute income tax expense? So the first tax liability is done. We are we computed that How do we have to compute income tax expense? Well income tax expense It's income taxes payable We are paying now plus if we have any future liability because our liability is increasing Therefore our income tax expense is the addition of those so and don't worry We'll look at more about income tax expense how to compute that income tax expense a little bit more than the tails because sometime You're gonna have income taxes payable the third tax liability going up Sometimes the third tax liability go that goes down, which is the opposite of what we just did You're gonna have income taxes payable and the third tax asset going up or the third tax liability going down We'll figure out how to do that down the road What should you do now go to far hot lectures look at additional mcqs through false questions? That's gonna help you understand this topic better and help you Answer questions you might face in your courses in your CPA exam CMA exam. Good luck study hard and invest in yourself Stay safe