 Hello and welcome to the session in which we would look at two CPA exam questions that deals with the third tax asset, the third tax liability and income tax expense. This topic is challenging for many students because you need to have a good understanding about taxes. You need to have a good understanding about your gap accounting. Then you need to reconcile these two. So you're going to have temporary differences, permanent differences. You're going to have the third tax asset, the first tax liability, current portion, long term portion. And the way I'm going to look at the same example, I'm going to show you that it's temporary difference. Then I'm going to change the scenario and say, let's assume we are working with permanent difference. Now, whether you are an accounting students or a CPA candidate, I strongly suggest you take a look at my website, farhatlectures.com, if you want to learn more about this topic. I don't replace your CPA review course. 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If you're studying for the exam or taking accounting courses, subscribe to my YouTube, like this recording. Connect with me on Instagram, Facebook, Twitter and Reddit. I'm all over social media. Please connect with me. Let's take a look at the first scenario and it's year one income statement. Adam Company reported income before taxes of 600,000. Well, immediately in your mind, you would say my gap income is 600,000. The taxable income is 560. Immediately in your mind or on a piece of paper, you write down taxable income. This is how much I have to pay to the IRS, 560. And there's a difference of 40,000. And we are told in this first example, the difference is a permanent difference. It means it's never going to reverse. I either have less revenues that's not taxable like municipal bond or more expenses that are permanent in nature. They're not going to reverse. Okay, it doesn't matter. The company made estimated current income tax payment of 50,000. So they wrote a check of 50,000. The company debited income tax expense for this 50,000. That's fine. You don't have to write it down. But if you really want to, you can say I debited income tax expense 50 and I credited cash 50. So I accounted for 50,000 of my expenses. I paid them. Adam is subject to a 21% tax rate. What amount should Adam report as income tax expense? So that's the question. What is the amount of income tax expense? Let me tell you this. If you understand the concept. If you understand the concept, in other words, all you have to do to answer this question, if you understand the concept, literally 30 seconds or a minute max. What does that mean? I'm asked what is my income tax expense? Well, my income tax expense, first of all, I'm not going to have any deferred portion because my differences are permanent. Therefore, my income tax expense is how much do I have to pay to the government? Well, my income tax expense is 560 times 0.21 and that's going to give me 117,600. So the answer will be 117,600 based on the information giving. What's my income tax expense? Because remember your income tax expense equal to your current portion and noncurrent portion and long term portion. You have no long term portion. You don't have any deferred income tax asset or any deferred income tax liability in this example. Why? Because you have a permanent difference. It's never going to reverse. Let's change the scenario. Same example, except that this difference is temporary difference. In other words, you remember these numbers here. We have gap 600,000. We have IRS 560. Now we have a difference of 40,000. What does that mean? This is tax and this is gap. This means that for tax purposes you are paying, you're going to have to pay less taxes now because your taxable income is lower of 40,000. Why is this lower? Again, you could have less revenues that's not taxable now or more expenses that are deductible now. That's the difference. As a result, I'm going to have a deferred as a result of these two scenarios or a combination of these two scenarios. I have a deferred tax liability because in the future they are temporary. I'm going to have more revenues in the future and less expenses. Therefore, I will be responsible for more taxes. The question here asks, what is the income tax expense? Well, how do we compute total income tax expense? That's what they're asking. Well, I already find the current portion. From the previous example, I multiply this. This is how much I have to pay now. The answer is 117,600. This is the current portion of my taxes. To generalize the current portion, I'm going to have to debit income tax expense 67,600 credit income taxes payable or liability of 67,600. Hold on a second. Didn't you say 117,600? Yes, I said so. But remember, the company already made the payment of 50 and they debited income tax expense. In other words, in the past, they did debit income tax expense 50,000 and they credited cash of 50,000. That's in case you are being asked about the entry. So notice here, if we look at the entry, this is income tax expense 50. This is income tax expense 67,600. Together they should add up to, if my math is right, it should be right, 117,600. But that's not the question. This was the first question. What's your total? What's your income tax expense? That was when the difference was permanent. Now the difference is temporary. It means I have to account for income tax liability. I already told you this. We have 40,000 of difference. Therefore, I'm going to multiply this. We're going to assume the future tax rate is 21%. This is the Trump tax rate. And as a result, I'm going to have 20, I believe 8,400. Let me just double check my math. It should be 8,400. So 40,000 times, we're going to assume the future tax rate is 21. 8,400. Remember, you have to use the future tax rate. Now you're going to have another entry to make. Now you're going to have income tax expense 8,400 and you're going to credit the third tax liability 8,400. Now, if you are being asked what amount should Adam report as income tax expense, which is total income tax expense, we're going to have to add to this 8,400. And by adding 8,400, the answer will become a 126,000. So be careful whether the difference is temporary or permanent. If it's temporary, if it's permanent, it's easy. You don't have any third tax asset, the third tax liability. If the difference is temporary, now you have to be very careful. Do I have a third tax asset? Do I have a third tax liability? Remember, are you being asked for the current portion? Are you being asked for the long-term portion? Or are you being asked for the total? Here, I'm asking you for the total. The current portion, as I told you, is 117,600. The long-term portion is 8,400. I understand this topic is challenging. I totally understand this. But this is where I can help you. On the exam, the questions test your basic knowledge. Truly, believe me, you have to be prepared as if they're going to ask you advanced topics. But when they ask, the topics are basics. What does that mean? It means as long as you have a strong foundation in your topics, you should be well prepared for the exam. How do you get the strong foundation? You get the strong foundation in college, not through your CPA review course. Now, what happened if you didn't get the strong foundation in college? Or you did get that strong foundation in college, or you forgot about it by the time you got to the exam. Or you have strong foundation, but there is a gap between your education and sitting for the CPA exam. So there could be some issues. Or for some students, some schools, they may not cover these topics. So you have zero strong foundation. So when you get to your CPA review course, you feel it's a foreign language to you. This is where far-hat lectures can come into place and help you understand the material better. Again, your risk is one month of subscription. That's your maximum risk. Try me. You see it. It's helpful. You keep it. You don't see it helpful. You cancel. My resources are aligned. I designed them to align with your CPA review course so you can easily go back and forth. Your exam is a 20 to 30 to 40 year investment. Don't shortchange yourself. It's worth it. Study hard, good luck, and invest in yourself. Thank you.