 Hello and welcome to this session in which we would look at schedule M2 of form 1120. Now in the prior session we looked at something similar which is schedule, hello and welcome to this session in which we would look at schedule M2 and explain what goes on schedule M2 of form 1120. In the prior session we discussed schedule M1 of form 1120, just real quick to review what schedule M1 is all about. M1 is taking your book income which is your gap income and reconciling your back, your gap income to your taxable income, your taxable income which is IRS. So what we're doing is we're taking your net income for book purposes and we reconcile to tax or IRS purposes and what the IRS wants to see from schedule M1 are the differences. Why is your net income for gap is different than your in quote net income for tax? What are those main differences? Why? Because the government they want to know if you are reporting more income for book purposes so you are you are showing profit to kind of look good be able to raise money your stock goes up but once comes the taxes you are not paying enough taxes so they're looking for that discrepancy and if it's consistent they will investigate why. In this session we'd look at schedule M2. Well so that was schedule M1. What is the schedule M2 about? Schedule M2 is about retained earning. Before we proceed any further I have a public announcement about my company farhatlectures.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 we need now to go back and review real quick what is retained earnings. So what is retained earnings? Retained earnings is how much the company kept of its earnings over the years and did not pay out in dividend. So how do we compute retained earnings? There's a formula and that formula is important. It's important that you know it whether you are an introductory accounting students or an advanced accounting student. Oftentimes in my advanced courses I find it. I find it odd that students don't understand advanced concept because they're missing some basic formula like the formula of retained earnings and that's why they find hard time understanding advanced accounting. So simple basic formulas although they are basic but they are important. So retained earnings is beginning retained earnings plus net income of the company generated net income minus net loss of. When a company starts and this is important they have no retained earnings because they have not made any profit to keep it. It's zero. Then the company makes a net income of $100 then the company might take out withdrawals or dividend that's assumed they take withdrawal of $30 then they will end up in ending retained earnings of $70. So this is how we computed retained earnings. This is for year one or period one. In year two or period two the $70 becomes beginning retained earnings. So notice this is an important concept which we should know. Ending balance becomes your beginning balance next period. Then you add net income subtract dividend or withdrawal to get to your ending retained earnings. So schedule M2 is looking for the retained earning per box. Now what is the IRS looking for specifically? So why do they want you to publish this M2 schedule on your form 1120? Here's what they're looking for specifically. They want to make sure that your beginning retained earnings is matching your ending. Why? Because what they're looking for is any adjustments. Adjustments. If you made any adjustments to beginning retained earnings when you make an adjustment it means something is changing. And what is changing? Many things could be changing. You could be making an adjustment due to an error. There was an error in the prior year. It could be a mathematical error, MS application of fact, MS application of accounting rules. There was some fraud going on. There was some adjustment to your beginning retained earnings. So they want to know if this adjustment changed your taxes and specifically well if you are increasing your beginning retained earnings means you are reporting more profit they want to know what is our share in that profit. So that's exactly what they're looking for. Therefore corporations are required to reconcile the retained earnings at the beginning of the year to the retained earnings at the end of the year using schedule M2 that looks something like this. And this is what schedule M2 would look like. Analysis of unappropriated retained earnings. Unappropriated means not restricted. That's all what it is. Look, it looks exactly like a statement of retained earnings. You have your beginning balance. Let's use the same numbers that we use earlier beginning balance. It's a new company zero net income is $100. Notice here other increases itemize them. If there's any increases, you itemize them. Then zero plus 100 equal to 100. Then we deduct the distribution. The distribution, what we're talking about here is dividend. Whether that dividend is cash, stock or property. And we said for our purposes, there was a $30 cash dividend. Then other decreases again, anything that you had to change your retained earnings for any reason you listed here. So 100 minus 30. We have nothing left. It's ending retained earning of $70. Now next year, what you need to know the $70 becomes your beginning retained earning. Then you go through schedule M2. Now, as I said, corporations are required to do so, but there are exceptions. And who's not required to file schedule M2? Well, if you have a gross receipts and assets less than $250,000 and this number could change in the future. In other words, if you're considered a small company, the requirements are eased. Now, here in mind, although the requirement are eased. When I was in practice, we had many clients that have gross receipts less than $250. Nevertheless, we still prepared schedule M2 for them and M1 for that matter. M1 and M2, they're not required. But guess what? We can charge them extra for that. It's a service. The return would look good. Why not? So why don't they want you to report schedule M1 and M2 of your small company? Just for simplification, ease of compliance. Because it costs money to prepare schedule M1 and M2. You might be saying, it should not. It's simple. You think it's simple. Wait until you prepare one. Things don't reconcile properly. So things could happen. Okay, so that's why I'm just telling you because for some companies, if you purchase many other companies, if you have a lot of consolidation, things could get a little bit complicated. But for our purposes, if you're an accounting student, CPA candidate, this is what you have to know. Now, the best way to illustrate schedule M2 is to actually look at an example to illustrate schedule M2. So we have Farhad Corporation has the following information. Net income per books, taxable income, federal income taxes per books, cash dividend, unappropriated retained earning. They want you to prepare schedule M2. Well, let's see. The first thing I will do is I would say, hold on a second, if I'm preparing schedule M2, that's my book book. So why am I giving taxable income is to confuse you? Why am I giving federal income tax per books? I don't need it because this federal income tax per books is already factored into this. So how do I prepare my schedule M2? Well, I start with beginning retained earnings. Beginning retained earnings. I'm giving beginning retained earnings 510,000. This is my beginning retained earnings. Then I'm giving net income per books 400,000. There was no adjustments. If there's any adjustments for any reason, it will be listed here. Beginning retained earnings plus net income equal to 910,000. What I'm doing specifically is beginning retained earning 510, as I showed you earlier, plus net income. Then I will subtract the dividend. Did I pay dividend? Yes, we paid cash dividend of 140 dollars. Now, what we're going to do, we're going to take 910,000, 910,000 minus 140,000. It's going to give us, there is no other deduction, 770,000. So minus 140,000, 140,000 dividend. And that's going to give us 770,000. Again, this is what we started with. Beginning plus net income minus withdrawals or dividend equal to ending. And this is what it looks like on schedule M2. It's pretty straightforward computation. As long as you have no adjustments, whether increases or decreases. Now, you know, in the real world, you have adjustments. But again, you just need to know what they are in case that's the case. Usually they are. If you have any adjustments, what would you do? You would look at the notes to the financial statements and in the notes of the financial statements because look, we're looking at the book, the earnings per book. So they'll have to explain why retained earning was adjusted either upward or downward. Again, the IRS is looking for upward adjustments. If you're reporting more retained earnings, what did we miss? Okay, this is what they're looking for. What should you do now? Go to Fahad Lectures. Look at additional MCQs, true, false, exercises, lectures. That's going to help you do what? Do better. Whether you are a CPA exam candidate, accounting student, enrolled agent. Schedule M2 of Form 1120 is an important document. Good luck, study hard, and of course, stay safe.