 Hello and welcome to the session. This is Professor Farhad. In this session we would look at an actual CPA simulation that was released by the AICPA. The AICPA is the organization that administers the CPA exam. So this is the real deal. You're going to look at an actual simulation, what would you would see on the exam day. And this simulation deals with the regulation section. 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, auditing, finance and tax lectures. This is a list of all the courses that I covered and for this session my income tax course will cover this topic specifically. On my website in addition to my lectures I have additional resources such as notes, PowerPoint slides, true, false, multiple choice. If you're studying for your CPA exam 2000 plus CPA questions. So in this session we're going to look at an actual simulation. Let's go ahead and look at the simulation. So this is what the simulation would look like. Now the first thing I want you to notice is we're going to go through this simulation step by step. I want you to notice that this simulation covers only one topic and it covers the S corporation. What does that mean? It means that a simulation is no more than asking you the questions in a different format. It's asking you the same thing that's on the multiple choice except in a different format and this simulation it's covered only one topic. So simply put the AICPA giving you the simulation to test your knowledge whether you know how C corporation works or not. So let's go ahead and try to resolve this problem to see and as I'm going through this problem I will show you that these same questions could be asked in a multiple choice. So this simulation is nothing more than along several multiple choice questions combined together. Okay. Hopefully you can see my screen. Falcon Inc is a calendar year S corporation. This is important. It's S corporation owned equally by two shareholders, Jennifer and Marvin. Falcon reports its income and expenses on an accrual method of accounting. Falcon has always been an S corporation and has no debt. Falcon's controller has provided information for the completion of Falcon's year four 1120 S U.S. income tax return for S corporation. So they gave us the information to complete the 1120 S. A copy of Falcon's income statement for the year end of December 31st, year four and additional information related to Falcon and its shareholder can be found in the exhibit above. So there we go. They're giving you the income statement. They're giving you the numbers. Let's take a look at the income statement. So I'm going to have to go ahead and grab the income statement to the to the to the site. So they're giving you an income statement. So they're giving you sales cost of goods sold gross profit salaries and wages repairs and expenses scan through them real quick depreciation expense shareable contribution payroll taxes penalties and fines business insurance total expenses income before other expenses 445 other income bank interest income capital loss on land total other income and expenses and net income the maker's depreciation on our asset was 20 000 for year four we did not purchase any new asset in year four the capital loss for the sale of the land used in the trade or business to unrelated party the penalties and fines are for late payments of payroll. Okay so this is the first exhibit so it's basically they simply put an income statement and this is basically maybe a financial income statement so we're going to keep this on the site for now you can close it for now or we can close it until we answer the question and we have additional information in what are the additional information I don't think they're going to have to scroll back and forth on the exam day because this is a mock exam that's why I'm scrolling back and forth and what we have here is Falcon's accumulated adjustment account the AAA account January 1st 100 000 total distribution to shareholder during the year 30 000 it's distributed equally it means 15 000 each and Jennifer Sullivan's shareholder tax basis January 1st year 4 is 60 000 Marvin Starby shareholder tax basis January 1st year 4 75 000 fair enough so they're giving you a bunch of information they're giving you an income statement as well as additional information about this company so let's see what they're asking us and how would you approach this question so the first question which is the cell B2 Falcon's year four ordinary business income to be reported on the form 11 20 simply put what they're asking us is do you know how to compute the 11 20 income so I'm going to have to go to the income statement here right I start with sales and you you can do to you could pull your calculator here okay so you're going to have a calculator or you can do this manually it doesn't matter but you're going to have a calculator so I'm going to start with sales my sales is 1.2 million I'm going to start with sales that's going to go on the that's going to go on the 11 20 s minus cost of goods sold half a million I'm sorry I made a mistake let me clear this 1.2 million and you want to get used to this calculator before you sit for the exam minus half a million that's 700 of gross income do we deduct salaries and wages yes we do minus 203 that's equal to 479 do we deduct repairs and expenses sure we do those are regular expenses minus 10 000 do we deduct depreciation expense yes we do but what we are told depreciation expense was 20 000 notice down here it says depreciation expense 20 000 be careful to deduct 20 000 not deduct the gap depreciation by telling you makers 20 000 is they do you understand that makers is 20 000 that's what they're asking you minus 20 000 so that's the depreciation amount so if you computed the depreciation correctly you will notice that everything else will be incorrect okay then payroll taxes 18 000 that's deducted then we deduct uh do we deduct penalties and fines hopefully you know this penalties and fines are not deductible do you deduct business insurance yes you do minus 9 000 equal to 440 do you add bank interest income no we don't this is a separately stated item here you need to know what are separately stated items oh by the way and I skipped charitable contribution of 5000 I did not deduct this 5000 here why because charitable contribution is separately stated item capital loss on sale of land capital loss separately stated item it's not deducted well I accounted for everything and it seems as my answer should be 440 000 so this is the answer to the first question so the first question is 440 000 except so this is your answer so basically what did this question ask you this question asks you do you know do you know what gets deducted on 11 20 s and do you know what are separately stated items so I listed what's deducted and they they gave you the depreciation kind of you if you don't know that tax depreciation is called makers then you should not be sitting for the exam but the point is tax depreciation is makers okay so that's that uh sums of falcons year four separately stated item of taxable income and deductible expenses to be reported on form 11 20 s schedule k shareholder pro rata share item well simply put like two and three if you don't know how to do three you're gonna you're not gonna know how to do if you don't know how to do three I'm sorry if you don't have to do two ends if you don't know how to answer two you cannot answer three why because when you answer two I told you what which one are the separately stated item so notice what the so here's what I'm trying to tell you this is the big picture what is the big picture for the CPA simulation multiple choice only ask you one specific thing about about about about s corporation in a simulation the AI CPA the industry wants to know if you understand everything the big picture does that make sense okay because if two is if two is incorrect three will be incorrect automatically if you included anything as separately stated item in your deduction or in your income then you don't know what which one are the separately stated item I hope you're getting you're you're seeing what I'm trying to say so my point for all of this is you got to know your things you cannot answer multiple choice questions practice multiple multiple choice questions in order to pass the exam you have to understand all about s corporation and to know all about s corporation well again on my youtube channel I have a whole thing about s corporation several lectures and several exercises and several multiple choice that's gonna strengthen your your knowledge so you cannot know it halfway through because if you know what halfway through and notice if we make one mistake you're gonna see if we made a mistake and b2 all the other answers will be incorrect so that so three will be incorrect if we made an answer into why because if you don't know what are the separately stated items then you don't know how to add them how to add the separately stated items so let's to compute the separately stated item remember to clear your table that's the first thing you want to know and what are the separately stated item we said we had three separately stated item charitable contribution which we did not deduct which is negative 5000 so we're gonna start with negative 5000 remember this is a negative number because it's an expense okay then penalties and fines are penalties and fines separately stated item because we did not deduct them no they are still not deductible on a personal level so penalties and fines are still not deductible therefore we do not separately stated item not deductible just let them go bank interest income that one thousand dollar we did not include now we can include plus one thousand that were negative four thousand and we have capital loss that's also separately stated item we did not deduct minus 24 000 minus 20 000 sorry 20 so the total separately stated items are negative 24 000 5000 charitable contribution deduction one thousand of interest income that this goes to the to the shareholder and the capital loss of 20 000 let's go ahead and input the answer okay it says if an answer is zero enter zero uh what about if it's negative let's see um you have an ask for review so make sure you read the construction enter income and gain as positive and losses and expenses as negative so I have to enter it as negative so be careful negative 24 000 so remember what the read the instruction carefully we're done with this once again I know I'm repeating myself but if you don't know the separately stated item versus non separately stated item two and three will be wrong automatically falcons non deductible expense so which one we could not deduct which expense there's nothing we can do about is the fines and penalties two thousand dollars fines and penalties two thousand dollar remember to enter those as negative negative two thousand dollar and that was that was fines and penalties we could not deduct again if you don't know this like if you took the two thousand and you deducted it on under falcons then you're going to get this question wrong what if you took this two thousand and use you consider it separately stated you're going to get this question wrong because you don't know it's non deductible okay so notice it's all interconnected either they're going to know you know something about s corporation or you don't know okay so all five could be wrong if you get if you make one mistake that's so far so far actually all of them will be wrong you'll see all of them will be wrong if you make one mistake now how would they grade you that's interesting I don't know how you know how do they grade you because they cannot see your work but that's I cannot answer that question because grading you is still a black box really um falcons year four accumulated adjustment account balance so now they want the year end AAA account and again if you don't know what AAA account please go to my website under under s corporation I have a one whole lecture just about the AAA account and what is the AAA account so what is the AAA account what's the beginning balance of AAA account we go to additional information the beginning beginning balance was 100 000 now you need to know what affects the AAA well net income affects the AAA separately stated items penalties and fines although you cannot deduct them the effect AAA any distribution to shareholders so we have all of those so let's go ahead and compute our AAA ending balance so let's start let's look at our calculator here and start to look at the AAA the beginning AAA again make sure to clear your tape before you start that the beginning AAA this is for the whole company is 100 000 then we're going to add to the AAA ordinary income ordinary income was computed at 440 000 I'm sure you're you're starting to see why if you make one mistake that's it your answers will be incorrect so you will add you will add 440 000 then separately stated items they have expenses we deduct those negative negative 24 000 then we deduct the penalties although we cannot deduct them for tax purposes for the AAA account they're deducted minus 2000 now the distribution also reduced AAA minus 30 000 equal to 484 000 therefore the ending AAA the ending AAA is 484 000 once again if you don't know what the AAA account is please go to my website to my website or to my youtube to learn about this okay now the last question is Jennifer Sullivan shareholder tax basis at December 31st at December 31st December 1st Jennifer's basis was 60 000 what's going to happen is this Jennifer's basis it's gonna let's clear the tape Jennifer basis it's going to increase and decrease by certain items well if we have income it's going to increase the basis if we have loss it's going to decrease the basis here we have income if we have penalties okay penalties we're going to decrease the basis although they are not deductible but they will decrease the basis any distribution will decrease the basis we had distribution here so you want to know the items that affect the basis the items that affect the basis starting with her with her basis is $100 000 now here at this point if what you want to do is on a piece of paper basically you know take 440 000 and hopefully you know 50% of 440 is 220 so basically you will need to start with the beginning balance the beginning balance is 100 000 I'm sorry the beginning balance is 60 000 Jennifer's beginning balance is 60 000 beginning basis is 60 000 then we're going to add half of the income half of the income is 220 hopefully it'll give you numbers where you can you don't have to do the computation so why did I add why did I add 220 not 440 because she owns half of the half of the partnership then we're going to deduct half of the separately stated item minus 12 000 that's going to reduce her basis then we're going to deduct half of the penalty which is a thousand because she get half of it and we're going to deduct the distribution half of the distribution 15 000 so overall her basis will be 252 000 so as again as you saw in this exercise as this exercise clearly shows that you need to have a good understanding of S corporation in other words on the multiple choice here's what the CPA is trying to combat they're trying to combat that you answer some of the questions by mistake correctly okay so on the multiple choice they can ask you only about one answer in this question they would know for sure or they will have the assurance look this candidate understand S corporation or this candidate is missing items so therefore just by not knowing what separately stated items are all your answers will be incorrect all of them all five of them okay hopefully this this this simulation kind of gave you a different point of view and that's my that's my purpose gave you a different point of view about how to approach your study how to approach the the studying for the exam because if someone tells you just answer multiple choice questions and you'll be fine you will not be fine my philosophy was and would always be you have to be prepared and to be prepared you have to understand the information inside out how can I help you in this process well go to my website I have additional resources subscribe and I have many exercises all what we went through is an exercise in a typical college undergraduate textbook this is what it is so if you open an undergraduate textbook I'm sure all of you were accounting students remember the homework this is basically a homework from an exercise from your chapter that's all what the simulation is don't let the word simulation intimidate you I'm here to help you study hard reach out to me and good luck