 Hello and welcome to this session in which we will discuss permanent differences that deals with the third tax asset and the third tax liability. Now when we say permanent differences we have to understand we are discussing permanent differences in contrast to what we called temporary differences. So we have temporary differences which I discussed in a prior session and we have permanent differences which I will discuss in this session. So if you don't know what temporary differences are it will be helpful to understand what temporary differences are in contrast to permanent because temporary differences will reverse permanent differences by nature they're permanent they don't reverse. So what are permanent differences? Permanent differences are items, certain items, certain revenues, certain expenses they are included either remember we have two sets of books because we have to complete our taxes following the IRS rules and financial accounting follow gap. So those permanent differences they either go into gap but never in IRS but they are part of the IRS record but never in gap. So they don't reverse they're either they are accounted for for financial accounting but not for IRS or accounted for for IRS but not financial accounting. So they are included in gap financial income in gap pre pre tax financial income but never in the IRS record or in the IRS record included in the IRS record but never in gap financial income. This is what permanent they never reverse and they go to the other side. So permanent differences affect only the period in which they occur. As a result we have no deferred tax asset or liabilities as a result. So just you need to know what are those permanent differences and how do they affect you in this particular period. So it's easy you just have to know what they are. I'm gonna list them explain them show you and work an example. Now it's very important that you understand them because when you take your income tax course you're gonna have to deal with something called schedule M1 and this is what really what we are discussing or if you are learning schedule M1 it will be easy for you to learn those permanent and temporary differences. So what I'm gonna do I'm gonna go over some common examples that appears on the financial statement but not on the taxes and they're gonna be very easy to follow because I'm gonna explain them to you how would how would you learn them. First of all municipals and state bond interest revenue. Those are called tax exempt income. Simply put if you buy bonds state bonds municipal bond city bond county bond not federal government state or state or money not federal be careful because that's how they trick you on the exam and you would be receiving interest income from those bonds. Those interest income they are exempt. Exempt means they don't go on your taxes. So you go they go on your financial statements obviously you received income when you prepare your financial statement you would include them but they are not taxable. Now related to one is interest expenses incurred and obtaining tax exempt interest. So if you had to borrow money to invest in those bonds you're gonna be incurring interest expense. Well guess what your income is not taxable so that's okay then to be fair also your expense for that income is not deductible. So guess what we're not gonna tax you on the income that's fine we're gonna let it go but bear in mind the expenses that you incur to obtain those is not is not deductible as well. So it's not taxable the income is not taxable the expense to generate that income is not deductible. Life insurance proceeds which is a form of income carried by the company on key officers or employee. So what happened companies they buy life insurance on their key employees key officers in case something happened the company is compensated in case they lost the key employee or key officer sometimes partners they do that they buy life insurance on each other. So the income that you receive as a result of life insurance proceeds is not taxable. Also the premium paid so to obtain the insurance you have to pay premium basically you have to buy the insurance you have to pay a fee the the fee that you pay to obtain that insurance guess what also not deductible. So as long as the company is the beneficiary so what we do is we'll let you get the income for free but the premium paid cannot be deductible basically three and four they're related to each other and they should make sense. Also any fines and expenses resulting from violation of laws so simply put the government is saying we are not going to we are not going to reward you get simply reward you means giving you a deduction if you violate the law if you have to pay a fee you cannot deduct this for tax purposes of course you can also when you pay your federal income tax you can you cannot deduct federal income tax on your federal return. So those are items that go into the financial statements but they don't go on your tax record never go on your tax record the next on the next thing we're going to look at is the opposite we're going to see when it goes on your taxes but no on your income statement but before we proceed I would like to remind you whether you are an accounting student or a CPA candidate and most likely you are a student or a CPA candidate and you're looking for help this is how you end up on this video I can help you I don't replace your CPA review course I don't replace your accounting course my resources will help supplement your preparation how I provide the new resources lectures multiple choice through false I can help you do better I this is a list a partial list of my accounting courses my CPA are aligned with your Becker Roger Wiley Gleam so you can go back and forth between my material and your CPA review course really easily I give you access to 1500 previously released AICPA questions with detailed solution if you have not connected with me on LinkedIn please do so take a look at my LinkedIn recommendation like this recording share it with other connect with me on Instagram Facebook Twitter Reddit and I started a CPA exam group for CPA candidate to hold a discussion among CPA candidate preparing for the exam now let's discuss items that are taxable yes they are included in not taxable they are included on your tax record but not on the financial statement well there's not much couple we're going to discuss couple one is called the DRD the dividend received deduction for US corporations what does that mean it means US corporation when they invest another corporation they get a deduction a deduction basically a deduction an expense but that expense is really does not exist so it's a it's a deduction let's call it a deduction because the terminology is deduction you'll get a deduction but that deduction does not go on your financial statement so if you look on your financial statement you don't see a dividend received deduction this is a tax deduction basically it's a phantom deduction also you don't have to worry about this just know what in case it appears on the exam percentage depletion of natural resources so you deplete like you depreciate an asset you deplete natural resources if you use the percentage depletion you can take expenses which is depletion and access of your cost so although you might pay a certain amount of cost you might be able to get a little bit more now to put all these permanent differences and temporary the permanent and temporary differences together will work in exercise that's going to help us illustrate how this all fits together so we have this company adam company reports pre-tax financial income which is a gap income 100 000 for 20x1 the following item causes differences between taxable and pre-tax income the tax rate is 20 for this and future years and i keep saying future years because we have to understand the rules later on in case future years are different the tax rate for future years is different than the current year so that's why i keep mentioning i keep mentioning this so here are the differences we have makers depreciation which is sometimes they tell you it's makers depreciation sometimes they call a tax depreciation is greater than book depreciation simply put on your tax record you took more depreciation than for financial accounting and sometimes it could be the opposite you have to read those very carefully rent reported on the tax return is 15 000 greater than the rent reported on the financial statement simply put you have rental income 15 000 reported on your income tax return and access of your financial income revenue and adam also paid 23 000 fines for pollution related activities bad bad adam okay so the first thing we're going to do is we're going to compute the taxable income because we're not giving taxable income we're going to start with financial income of 100 000 now we're going to work backward working backward means we're going to take a look at what we are giving and start to work backward we are told that the depreciation for tax should be 20 000 greater simply put we have to deduct an additional 20 000 from this 100 000 because the depreciation for tax is higher that's done for one is done access rent collected well we also have to report an additional 15 000 in rent revenue that's not reported for the financial number because it's not tax it's not it's not earned yet as far as financial accounting but it's taxable therefore we have to add 15 000 and we paid fines of 23 000 now the fines were deducted from this numbers the fines were deducted to get to the 100 000 but IRS cannot allow you to to deduct the fine therefore you have to add it back add back the 23 000 so all in all if my math is right your taxable income which is the IRS income is 118 000 now our tax rate is 20 we're going to multiply this by 20 and we're going to come up with our tax bill which happens to be 23 600 we can start to prepare the journal entry we credit income taxes payable 23 600 that's income taxes payable now we're going to start to compute our the third tax asset and the third tax liability starting with the excess rent remember we already paid we already included the 15 000 in taxes right we included the 15 000 in taxes for this year therefore in future years we're going to have we're going to have a third tax asset the third tax asset 15 000 15 000 times 20 percent will give us 3000 therefore we're going to book the third tax asset of 3000 now this is easy because in this example we're always assuming that the prior balance is zero so we went from zero the 3000 it means our the third tax asset went up 3000 now the excess depreciation here since we took the depreciation now we cannot take it in the future it's going to create a third tax liability of 20 000 times 20 percent that's going to be the third tax liability of 40 000 40 000 we credit the third tax liability so the third tax liability was zero and now it is let me put it here so the third tax liability was zero and now it went up to 4000 it's important to see it went up to 4000 because what matters is the change in the third tax asset and the third tax liability okay that's fine now we are left with is the income tax expense what is income tax expense what is our income tax expense well we know so i'm going to just break this down for you we know that the current income tax expense is 23 000 so 23 600 is the current now when we increased the third tax liability by 4000 when we increase by it happens to be the increase and the same thing as the journal entry of 4000 that's going to increase our taxes by 4000 this is for the third portion so in the future we have to pay additional 4000 but also in the future we're going to save 3000 minus so 4000 plus minus 3000 for the third tax therefore if we take 23 000 plus 4000 minus 3000 income tax expense is 24 600 24 600 so i'm going to show you this in a journal entry perspective a little bit simpler not simpler maybe you will understand it a little bit better so hopefully we all understand that at the 23 600 this number here is the current tax expense the current income tax expense what happens since our the third tax asset went up by three always the corresponding entry to the to the third is the income tax expense so we have an income tax expense so if the third went up by three the third tax asset went up by three your income tax expense went down by three if you're the third tax liability went up by four your income tax since we credited it 4000 we're going to debit this increase this by four so overall net of a thousand so your the third portion is net of a thousand so simply put all in all your the third portion is net of a thousand okay net of a thousand let me use a different color so you will see it net of a thousand therefore 1000 plus plus 23 600 will give us income tax expense of 24 600 what should you do now go to farhatlectures.com work mcqs true false don't shortchange yourself your education is important your account and education is important you are investing in yourself you are investing in your career take it seriously it's going to pay dividend down the road good luck study hard and of course stay safe