 Hello and welcome to this session. This is Professor Farhad and this session we would look at an actual CPA simulation. Why do I say actual? Because this simulation was released by the AI CPA, the AI CPA administered the CPA exam. Specifically, this is a regulation simulation. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1600 plus accounting or I think finance and tax lectures. This is a list of all the courses that I cover for this session. You will focus on income tax and you do have additional CPA questions about drag section. On my website, you'll have additional resources such as PowerPoint slides through false multiple choice PowerPoint slides 2000 plus CPA questions. So let's go ahead and take a look at the simulation. And this is what the simulation would look like. Make sure you are familiar with the screens. Make sure you know where to pull the calculator. Here there's no additional exhibits so it's pretty straightforward. And the first thing you want to know is what is the simulation is about? So the first thing is what's the big picture? To know what's the big picture, read the instruction. Quest is a calendar year, a cruel sea corporation engaged in manufacturing listed in column A are year two transaction from quest financial statements and tax record. In column B entered the amount to reflect on schedule M1 reconciliation of income loss per books with income per return as an adjustment to calculated federal income tax. Right there. I know what the simulation is about. The simulation is about. The simulation is about schedule M1. So simply put, you know how to prepare schedule M1. Now the good news about this schedule is each situation is independent. So if you get one wrong, you can get the other one right. So that's that's good thing. And the good news is it's about one topic schedule M1. Now schedule M1 you may see it in the multiple choice here and there as a multiple choice question, but the simulation they want to see if you really know how to analyze and adjust for schedule M1. So what I'm trying to say is this. The exam tests you for your knowledge. They don't test you for your memory. They don't care about your memory anymore. So you can no longer memorize multiple choice questions for the exam. You have to understand it because they're going to give you the information in different format and the simulation is part of it. Each transaction should be considered independently of the others and to increase to net income per books as positive whole values and decrease to net income per books as negative whole values if the response is zero enter zero. Okay. So basically we're starting with year two net income per books six hundred and thirty two thousand. Now before we start, if you're not sure how to solve this problem stop right there. Go to my website. Go to my YouTube. Look up schedule M1. You know Google Farhat schedule M1. I have an explanation and I believe I have two exercises which are similar to assimilation for schedule M1. You want to make sure you understand schedule M1 before you try it. To simply put here they're giving you information. They're giving you net income per books and they're giving you additional information and you need to find out based on this information how are you going to adjust federal taxable income? Are you going to add to your federal taxable income to pay more taxes or are you going to deduct from your federal taxable income which you'll pay less taxes? So here's what you are giving the first thing. They're telling you maker's depreciation is two hundred and twenty four. Now you need to know immediately that maker's depreciation is tax depreciation. Section one seventy nine deduction is sixteen thousand. That's also tax deduction. Book depreciation is two hundred thousand. So what are they telling us here? Here's what they're telling us here. They're telling us simply put in simple English. Again the assimilation is a multiple choice. In simple English tax deduction is greater than book deduction. That's all they're saying. So what adjustments you would need to make? Well if tax deduction is greater then I'm going to take more deductions. It means I'm going to reduce my taxable income. And here's what I'm basically saying in simple English. In simple English my book deduction is two hundred thousand. It's two hundred thousand. I'm going to but my tax is my tax. Let me first show you your tax deduction. Your tax deduction is two twenty four plus sixteen thousand. That's how much you would need to take four. This is how much you will need to take as a deduction for four tax purposes. But you only took two hundred thousand for book purposes. Why two hundred thousand? Notice here it says two hundred thousand book depreciation. So the difference between two hundred and forty and two hundred thousand is an additional deduction of forty thousand. Therefore I have additional deduction of forty thousand. Simply put your tax deduction oops forty not four hundred thousand. Simply put your tax deduction is forty thousand more than your book deduction. Now in the example they could give you the reverse where the book deduction is higher than the tax deduction. Then you have to do the opposite. So you have to understand how the information is giving usually. Usually but that's not always the case. Usually they always tell you tax deduction is greater than book deduction. Usually usually. Therefore you need to deduct an additional amount of difference to arrive to your federal taxable income. It means you did not have enough deduction in depreciation for tax purposes. You need to add an additional forty thousand which is good for the taxpayer. That's good. Quest declared and paid forty thousand dollar cash dividend in June year two and declared a thirty thousand dollar cash dividend in December year two. Payable in January year three. What do we have to do for schedule M1? Well guess what? Easy answer. We don't have to do anything. Dividend don't go on schedule. Dividend don't go on schedule M1. So the answer is zero. We don't need to make any adjustment to schedule M1. Now this adjustment will be on schedule M2. If I have to guess and this is just a guess from my end most likely you will not see a simulation about schedule M2 but that's a guess from my end. Don't take my word for it but that's my guess. So dividend is not on schedule M1. Number four thirty thousand of cash contribution were paid in year two and ten thousand of charitable contribution approved by the board of directors. The qualified organization were accrued at the end of year two and paid on the extended tax return filing date. Okay. Is there an adjustment? No adjustments. Now obviously the thirty thousand dollar cash contribution definitely it's going to be deducted because you know tax income per book six thirty two. You would assume it meets the threshold. So there's no question about the thirty thousand or not being told anything about any phase out. Now the other ten thousand here and we deducted another ten thousand of charitable contribution approved by the board to qualified organizations. So far so good. It approved by the board in its qualified organization that was accrued at the end of the year. So far so good. Here's the problem. Paid on the extended tax filing date. Well remember if you have to if you accrued it you have to pay it within a certain period of time. I don't remember the exact date but definitely not on the extended tax return. So since you waited too long to pay that you cannot take the deduction. For book purposes you took this deduction for ten thousand dollar you took it and made your income six thirty two. But guess what for tax purposes the ten thousand cannot be taken. If it's cannot be taken it means it has to be added to your federal income tax. So you have to add ten thousand dollar to your federal income tax which in turn increase your taxes. You have to pay to the IRS. Okay. Now you cannot take it this year. You can take it next year but not for this year. Okay. So you have to add it back and adding back is not good for tax purposes. It means I'm going to have to pay more taxes. Okay. I have a charitable contribution. I have my own lecture about this. It's quite extensive. So you want to make sure you understand how it works. In other words the ten thousand dollar I mean it was all it was good all the way until it was paid on the extended period of time. I don't know there's a period of time. I don't know if it's two and a half months I believe. You know from memory I don't remember but you should know it. Okay. Yeah. If this is if this is approved to a qualified organization the crude but it has to be paid. It did not meet the payment date. Okay. Ordinary gain on the sale of fully depreciated office equipment to a 60% shareholder. Gain for tax purposes eight thousand gain on the books is two thousand. I have to be careful very careful here. First of all the gain is to a 60% shareholder which is a related party but guess what? It's a gain. I don't care. We only worry about the loss. So if it's a gain for book we only computed two thousand. For tax we should compute eight thousand. Why do we compute the difference? Because there is a difference spaces between the book and the tax. In other words we already booked two thousand in this amount baked in this amount. The remaining we have to book eight therefore the remaining is six. Simply put we have to increase our taxable income by six thousand which is not good because our tax for tax purposes we have more gains. We have total eight two thousand already already baked already factored into the book income. We have to factor at another six. Let's take a look at number six. Gains and losses on sale of investment in public companies recorded for book and tax purposes may first a loss of four thousand negative a gain of seven thousand a loss of eight thousand. There are no other assets sales during the year. Okay. So what does that mean? It means as far as as far as book purposes as far as book purposes what does that mean? Let's bring a calculator. So we had a gain of seven thousand minus four thousand losses minus eight thousand dollar losses. We have in total a loss of five thousand. Now what did we do with this loss of five thousand? This loss of five thousand was factored into this six hundred and thirty two thousand because we can deduct capital losses as far as we are concerned for financial or gap purposes. So no problem whatsoever. Now when we want to go from financial to tax can we take this access five thousand of capital losses? Now you need to know the rules. The capital losses you can only deduct them up to capital gains. Any excess capital losses has to have to be carried. Okay. What does that mean? It means we have to add back five thousand dollar to taxable income which is not good. It means we're increasing our taxes. We're increasing our taxes. We're increasing our taxes because we're increasing our taxable income by five thousand dollar. Okay. Hopefully this makes sense. So remember the rule. Capital losses for tax purposes you can only take them up to capital gains. Any excess can be carried forward or backward but you cannot use them. You cannot deduct them. Let's look at number seven. Ordinary gains and losses on sale of property to 25% shareholder recorded for books and tax purposes. First of all this is not related party 25% shareholder. Two those are ordinary gains. Ordinary gains. Ordinary gains versus number six capital gains. That's what they're trying to test. So on January 15th you have an ordinary gain of six. May 15th ordinary loss. Ordinary loss of eight in the capital gain of six. And this is what you did for book purposes and the net effect of all these figures which is negative 12 plus six plus two. So overall you have negative four thousand dollar. Negative four thousand dollar. Why? Let me just show you. Although it's not necessary but I'm going to show you. So you have a gain of six. Let's clear the tape. You had a gain of six thousand. You had a gain of six thousand. You had a loss of four minus four. You had a loss of eight. You have a gain of two. Overall you have a loss of four thousand. What do you have to do with this loss? Guess what? Guess what? You don't have to do anything with this loss. Why? Because this loss is an ordinary loss. An ordinary loss is deductible. Ordinary loss is deductible for book and tax purposes. It means you don't have to make any adjustment whatsoever. It means you don't have to make any adjustment whatsoever. What does that mean? It means I'm done. It's zero. It's zero. Now if they ask you compute taxable income you take 632 minus 40 plus 10 plus 6 plus 5 but they're not asking you. They might ask you to do that and that will be your taxable income. This is how you go from your book income 632 to taxable income by netting those amounts out. Once again I cannot emphasize this enough. Simulations are no more than multiple choice questions. Long multiple choice questions. Luckily in this example each situation is independent so if you make one mistake on one scenario you don't have to make the mistake on the second scenario. This topic is heavily covered on my YouTube as well on my website. And I'm gonna tell you I'll bet with you. You will see schedule M1 either in a simulation or in a multiple choice. You will see it. You will see it. So you want to make sure you're familiar with it. Go to my website. Subscribe. You can only invest and study once in your lifetime for your CPA exam. Do it right so you can succeed in your career. Good luck!