 hello and welcome to the session in which we would look at a CPA exam simulation. The first thing you do when you look at a CPA exam simulation is determine what type of simulation am I dealing with. Well it looks like here I need to do some computation so it's entry computation I have to input some numbers here. Okay second is what is the topic of the simulation just by looking at this column here it says adjusted adjustments to calculate federal taxable income I might be looking at schedule M1 well before I make that decision let me just take a look and read what's given to me quest is a calendar year a cruel basis C corporation nothing much about that uh refer to exhibit above for the description I've selected year two transaction I'm not gonna look at the I'm not gonna look at the exhibits yet in column B enter the amount to be reflected on schedule M1 reconciliation of income losses per books with income per return as an adjustment to calculate federal income taxes good now I know the topic of this simulation it's a schedule M1 what should happen now stress level should go down confidence level should go up now there's only one exhibit here it looks like here two transaction they could give you multiple exhibit it does not matter it does not matter schedule M1 a schedule M1 whether you know how to reconcile schedule M1 or not that's that's a separate story because I'm going to show you you are giving one exhibit but I can take this exhibit and turn it into multiple exhibits so the point is the topic is schedule M1 I'm studying with farhat I know schedule M1 inside out I can go ahead and get started before we proceed any further I have a public announcement about my company farhat lectures dot 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 so what I'm gonna do now I'm gonna look at the exhibit and if I look at the exhibit it's given me the information here below this is a description of year 2 transaction from quest financial statements and tax record now for each item I can give you a separate exhibit this is what I meant to say you are giving one exhibit you think it's easy but there are a lot of information here so let's go ahead and get started you focus on one topic at a time your income per books is 632,000 so simply put we're going from income per books to taxable income this is what schedule M1 is going from income per books to taxable income and what's the purpose of this the IRS wants to see if you are reporting too much net income per books and not a lot for taxable income they want to see that discrepancy that difference and again schedule M1 is fully covered at farhat lectures starting with depreciation well I need to know what am I giving about my depreciation here's what I'm giving quest recorded book depreciation of 200,000 simple English well for gap purposes we deducted 200,000 dollar on the financial statement and calculated a maker's depreciation deduction of a 224 and section 169 of 16 so there's a difference between the two what's the difference for book purposes I took 200,000 of deductions for tax purposes I'm taken 224 which is maker's a tax and section 179 deduction a tax so I am taking in total 240,000 in tax deduction what does that mean it means on schedule M1 I have to increase my deduction so it's a negative I have to increase my deduction of depreciation expense of how much of how much specifically 40,000 so for as far as this adjustment it's a negative 40,000 but again what is the negative it means it means if I'm going from 632 this is my net income per books I am going to deduct from this an additional 40,000 it's going to reduce my taxable income why it's going to reduce my taxable income because I am claiming more depreciation for tax purposes now remember depreciation the difference between book and book and tax sometimes you have you claim more sometimes you claim less you have to understand how the information is giving the information here 200,000 was deducted to come up to 632 well if you're going from book income to taxable income take an additional 40,000 because for depreciation for tax purposes they're giving more deduction now before we proceed make sure also I just I don't want to mislead you just make sure you read you read this real quick to make sure there is no other thing about depreciation if there is we're gonna read it then we'll go back and make an adjustment but make sure you know you're done with depreciation because the next topic is cash dividend okay that's easy quest declared and paid a 40,000 dollar cash dividend in june year two and declared a 30,000 cash dividend in december year two payable in january what's the adjustment on schedule m1 i'll give you a minute to think about it the adjustment is zero dividend has nothing to do with schedule m1 dividend has to do with schedule m2 if you're preparing m2 you have to be aware of how to reconcile this but we're dealing with schedule m1 and I do have a separate recording for schedule m2 if need be but for this you don't want to waste your time on the exam day zero move on third item charitable contribution let's see what we are told here quest paid 30,000 of cash contribution in year two and 10,000 of charitable contribution approved by the board of directors to qualifying organization were accrued at the end of year two and paid on the extended tax return filing date we have to be very very careful here this like there's a small trick here that if you if you don't pay enough attention to it you'll be in trouble okay we paid 30,000 dollar cash contribution that's fine that's deductible for tax and that's deductible for gap because for gap you can deduct anything you want to cash contribution but it's also deducted for tax because you paid it and 10,000 of charitable contribution were also deducted were accrued at year two for financial accounting purposes you can accrue anything you want to for gap you can also deduct this 10,000 how about for tax purposes can you take this 10,000 dollar as a deduction well let's see it was approved by the board of directors that box is checked because if it's accrued for tax purposes it has to be approved it has to be approved and it has to be paid by after three and a half month after the year end so by April 15th was it paid by April 15th no it was paid on the extended tax return filing date what does that mean it means for tax purposes I'm sorry you're not gonna get this for year two you're gonna get this deduction for year three assuming there's no other limitation but the 10,000 it did not check the approved it checked one box not the other box which is payment by by the original due date which is three and a half month after the after the deduction so simple English what does that mean it means for book purposes you deducted if I believe 40,000 right um yes for book purposes you deducted 40,000 dollar of so to come up to this 632 you you deducted 40,000 that's fine you are allowed to do that for gap if you're going from gap to taxable income guess what you have to add back you you're gonna lose that you have to add back 10,000 as an adjustment so in other words you're gonna increase your taxable income by 10,000 because you're going from book income to taxable income at the 10,000 why because the 10,000 is not deductible this year for tax purposes why not because it was paid with the extension you have to pay it within the original due date which is three and a half month if we were talking about a calendar year tax payer it's the April 15th ordinary gain on sale of office equipment let's take a look at that we are told quest calculated an ordinary gain of 8,000 for tax purposes we have a gain of 10,000 on the sale of fully depreciated office equipment to a 60 percent shareholder so we have a gain well it doesn't matter it's a gain whether it's 60 percent 30 percent gain is a gain there is no limitation on the gain so for tax purposes we have 8,000 of a gain quest recorded a gain of $2,000 on this sale for book purposes so remember because we have a different depreciation for book purposes the gain was 2,000 why 2,000 for tax why 2,000 for books 8,000 for tax well different depreciation method different depreciation method will give you different book value different book value will give you different gains and losses between book and tax but you are told the difference so to arrive to this net income per books we were we added $2,000 of a gain where if we're going from books to taxable income the gain should be 8,000 so what do I need to do I need to add to my to this income an additional $6,000 which is the gain is good but it's gonna be taxed I'm gonna have to add $6,000 okay $6,000 gain losses on sale of investments what are we given about this quest recorded the following gains and losses on sale of investment in public companies for book and tax purposes so sort of the same for book and tax they have a loss May 1st a gain June June 2nd for 7,000 a loss on September 4th of 8,000 so let's net them out okay if we net them out we have 4,000 of losses plus 8,000 of losses 12,000 in losses 12,000 in losses 7,000 in gains overall we have $5,000 in gains that's that's basically what we have I'm sorry $5,000 in losses there are more gains and losses $4,000 in losses well for gap purposes what do we do for gap purposes we would report the $5,000 of losses the $5,000 is deducted capital gains $5,000 it's deducted to arrive to the $632,000 how about tax purposes how about tax purposes can you deduct access losses because we have $5,000 in access capital gains losses can we deduct this and the answer is no we cannot deduct this because we can only deduct losses against capital losses against capital gains and we have access so if we have access losses and that losses reduced our tax reduced our book income by $5,000 to come up to federal taxable income I have to add back those $5,000 because I cannot take it as a deduction so there's a $5,000 deduction taken to come up to the $632 imagine there's a negative $5,000 to come up to $632 well I have to add $5,000 to go to my taxable income ordinary ordinary gains and losses on sale of property well quest recorded the following ordinary gain losses on the sales of property to a 25% shareholder for book and tax purposes so we have $6,000 $6,000 of gain $2,000 of gain that's $8,000 $8,000 of losses on July 15th and $4,000 of losses on May 18th so those are ordinary gains ordinary gains so what do we need to do with this ordinary gains well for one thing ordinary gains there's no special rules they're not like capital gains and losses okay and we are told it's the same for book and tax there's no difference the only thing you are giving here is the losses are for a 25% shareholder again it does not make a difference because 25% shareholder the related party rules don't kick in what does that mean overall it doesn't mean anything there's no difference here remember we're dealing with ordinary gains and losses and we are told they are computed the same way for tax and books there's no difference between the two and the only thing that my throw students off is the 25% shareholder it does not matter it's it's 25% the losses are regular ordinary losses there's nothing to worry about therefore the answer is zero now if you know what should they have done also they should have told you to compute taxable income which is you will take 632 minus 40,000 plus 10,000 plus 6 plus 5 and you will come up with taxable income so let's let's summarize and after we looked at the simulation what is the key to the simulation well the key the well actually yeah the answer would be wrong the last one if you had one of them wrong which is that's that's unfair so that's good they gave it to you separately so the key is you need to know schedule M1 adjustments and each adjustment was independent from the other ones some of them are really easy as long as not they're all easy as long as you understand schedule M1 you're saying but but professor Farhad this is an easy simulation I don't have a lot of exhibits well yes how about if I gave you for example for this for this line here just to give you an example okay I would give you one exhibit the schedule of depreciation of the assets and I you know somehow the 200,000 dollar is there another schedule for makers where I don't even I don't even view the schedule for makers I'll give you the tables I'll say compute makers based on the following and you have to come up with 224 and 16 so yes this simulation could involve exhibits and it may not involve exhibits as the information is given here directly the point it does not matter if you know your rules for schedule M1 if you're using Farhad and know the rules inside out bring it on bring schedule M1 on you should be happy when you see schedule M1 whether it's a multiple choice or a simulation all what I'm gonna tell you now is to stay motivated invest in yourself good luck and stay safe