 Hello, and welcome to the session. This is Professor Farhad. In this session, I'm going to look at a CPA question that's covered in the FAR section. And this CPA question is covered in my advanced accounting to be more specific. This is where I teach this topic. And the topic is intercompany sale of depreciable assets. So the student looked at the question, actually looked at the answer for the test review preparer, and they could not follow the answer. And I believe the student is competent. This question is a little bit tricky. So I'm going to take this opportunity to explain this topic to that student, as well to everybody else, so everybody else can benefit. As always, I would like to remind you to connect with me only then if you haven't done so. YouTube is where you would need to subscribe. I have over 1,700 plus accounting, auditing, tax, finance, and Excel tutorial. For example, intercompany sale of depreciable asset is covered in my advanced accounting. I have right now 100 plus advanced accounting lectures. So if you are taking advanced accounting or if you are studying for your CPA exam, you might need some additional lectures, some additional exercises to strengthen your knowledge. I'm not saying I substitute your CPA prep course. I don't. I supplement your CPA prep course. I don't substitute your college course. I supplement your college course. So this is how I can help. Please connect with me on Instagram. If you like my recordings, please like them, share them, and again, subscribe to the YouTube. And on my website, this is what I was talking about earlier, I do have an advanced accounting course. And once you subscribe, advanced accounting, as well as 10 more, and once you subscribe to one course, you have access to everything. And I have a lot of resources to pass the CPA exam. For example, if you're looking for FAR, I have a CPA course for Becker, Wiley, Roger, Sargent, and Glyme that supplement all these courses. So I strongly suggest you check out my website. Let's go ahead and take a look at this question so we can dive into what we need to learn about today. So we have Port Inc, which is the parent company, owns 100% of Salem Inc, which is the subsidiary. On January 1st, the parent company sold Salem a delivery truck at a gain. What does that mean? It means they had an asset and with the book value of $50 and they sold it, let's assume the book value for the asset was equal to $50. Let's make it 60, you know what? Let's make it 60. If the book value is 60, so they sold 475. Now what does that mean? It means if they sold 475, they had a gain of $15. But remember, this gain is between P and S, which is parent and subsidiaries. Okay, so let's make sure we are aware of this. So this gain is an intercompany gain. P had owned the equipment for two years and used it for five years using the straight line depreciation with no residual value. Okay, so the subsidiary is using the three year depreciation rate with no residual value. So simply put, the asset has, for the parent company, for the parent company, it had five year life. They used it for two years, minus two. So when they sold it, it was three years left and coincidentally, coincidentally, the subsidiary are going to be using three years as well. So simply put, the asset will have a life of five years between the parent and the subsidiary. In the consolidated income statement, salems recorded depreciation expense on the equipment by year one will be decreased by how much? They're already telling you that somehow you have to decrease your depreciation on the consolidated financial statement and how much it's gonna be decreased by. Now, the easiest way to look at this problem is to kind of use numbers. So let me use some numbers. Let's assume, and let's use some numbers, just illustrate the concept. You could use any numbers, but I'm gonna use a set of numbers. So let's assume the parent original cost was 1,000. That was the original cost at the parent company. You could use any number you want to. Now, they were depreciating this asset over five years. So if we take the cost with no residual value divided by five, it means every year they were depreciating the asset $200. Year one, 200, year two, 200. Now what they did in year two, they sold it. So if we have $1,000 minus $400 of accumulated depreciation between year one and year two, we have a book value of 600. We have a book value of 600. So this is the book value. Now they sold it to S company. And you could use any numbers and the problem would work perfectly fine. And let's assume they sold, let's make something divisible by three. Let's assume they sold it for $690. So they sold it. So the sale was for 690 minus the book value of 600. The parent company will have a gain of $90. So they sold it and they have a gain of $90. Now what happened to that gain? Well, that's a gain for the parent company. But that gain, what that gain did, increased the cost of S company. So the gain on the parent company, so S company, Salem company, now their cost for that asset is $690. Not 600 because they paid $90 more. The parent company will have a gain but it's an intercompany gain. So now Salem company will have to depreciate this asset over a life of three years. So notice the original depreciation, let me highlight the original depreciation. So this way, let me pull the calculator because I'm gonna need the calculator. So let's have a calculator fixed here. So the original depreciation was $200 per year. Now when we take 690, Salem company, and they're gonna depreciate this asset over three years. So we're gonna take 690, which their new cost divided by three. It's gonna be $230 per year. So every year, so year three, year four, and year five, 230, 230, and 230. It doesn't matter, so this way they depreciate the asset over three years. But they're asking us for year one alone. So for year one alone, the question is how much do we need to reduce depreciation by? What happened is when we have an intercompany sale, we have to act as if, because it went from the parent company to Salem company. As a result, we have a gain that needs to be eliminated, but we also have additional depreciation that needs to be reduced as well. So they're asking us about the depreciation. So simply put, what do we have to do? Well, we have a gain of $90. As a result, our depreciation increased by 30. Why by 30? Because the increase in cost, so let me just highlight the increase in cost in a different color. So here's the increase in cost. The increase in cost. Now, why did I choose 690? I could choose any number. I just want it to be divisible by three, because it's over three years. So that additional $90 would increase our depreciation expense by $30 at Salem company. Now, this is year three, but for Salem it's year one. This is what we're being asked about. So what's going to happen is we have to reduce our depreciation by one-third of the gain. Why one-third of the gain? We need to reduce our depreciation by $30 for year one out of $90. So every year we're going to reverse back out $30 of depreciation because it's booked on Salem company books. 230 is supposed to be only 200. Therefore, we have to reduce the depreciation by 30, which is we're going to take the gain and allocate it over three periods, year three, year four and year five. Every year we would reduce it by 33 and one-third, which is 33.33%, which is the amount of the gain. Now, once again, if you used 690 or if you used 10,000 holler, you take 10,000 minus 600, whatever the gain is, then you have to reduce the gain by one-third every year. And that's what the question is asking about. And this is a very, very important concept. If you could understand this, it means what do you need to understand here? You need to understand what is a gain? How do we have a gain? Well, we have a gain when the asset is sold more than the book value. That's fine. That gain is intercompany gain. What does that mean? It means the gain will need to be eliminated, which we did not talk about this here, because if you want to, you can go to my website for additional lectures. But here they're asking us about the depreciation. As the result of the gain, Salem company's depreciable base increase. While that increase in depreciable base increase the depreciation. So simply put, the depreciation will have to go back as if we never sold the company, which is 200. It means every year, since we have three years left, we have to reduce the depreciation amount by the one-third of the gain. Why the gain? Because the gain is what increased our depreciable base. So this is basically, if you understand this, the steps that I went through, now you understand the logic and you would understand why we need to reduce it by 33.13, 33 and one-third of a percent, which is 33.33. As always, I'm going to go back and remind you and invite you to visit my website. A topic like this is covered heavily in advanced accounting. Again, I have over 100 different lessons. The difference between my offer, what I offer and what a CPA review offer is something like this. A CPA review course assumes you know all of this. So when they reviewed it with you, they don't explain it in details. That's the difference between my product and the CPA course. And this is why individual, that individual sent me the question because they could not follow. And obviously this individual is not a subscriber to my website, it's a subscriber to my YouTube, but if they were subscriber to my website, they'll be able to look at many questions. Anyhow, again, please like the lecture. If you like it, share it, study hard for your CPA exam and stay safe, especially during those coronavirus days.