 Hello and welcome to this session. This is Professor Farhad in which we would look at CPA questions specifically dealing with FAR. These questions could also appear in an intermediate accounting course and the topic is the third taxes. A topic that's heavily covered and many students find hard time understanding this topic. However, I do have it heavily covered in my intermediate accounting course, close to three, three and a half lectures and explanation. So I'm going to work some questions, but I'll also tell you if you need more help. I have plenty of help about this topic, which will deter some students from even passing the exam. So I'm here to help you check out my intermediate accounting. 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 1,700 plus accounting, auditing, tax, finance lectures, as well as Excel tutorial. If you like my lectures, please like them, share them, subscribe to the channel. If they benefit you, it means they might benefit other people, share the wealth, connect with me on Instagram. On my website, farhadlectures.com, I have additional resources in addition to the lectures. I have practice exercises through false multiple choice over 2,000 CPA questions. And this is where you'll be able to learn about the third income taxes and details. So if you are looking to pass your CPA exam at those 10 to 15 points, check out my website. It might help you do so. So let's take a look at the first question. Once again, these question deals with the third taxes. With regard to the third taxes, the use of the installment sales method for tax purposes would typically result in what? So if we use the installment sales method for tax purposes, what does it result into? Does it result into a deferred tax asset? Does it result under deferred tax liability? Both or neither. So the best way to approach this topic, which is this is how I teach the third taxes on my website, is to look at how do we do things for taxes and how do we do things for GAP. So how do we do things for IRS and how do we do things for GAP? So for using the installment method for tax purposes, what is the installment method? The installment method means every time you receive money, its installment, you have a taxable transaction. Well, under the GAP method, guess what? If you sell something under the GAP method, if you sell something, if you completed the transaction, you don't have to wait for the cash. So if you sold something for, let's assume you sold something for $10,000 and you're going to receive five payments of $2,000. So you made the sale, the sale is completed, you debit your account receivable, you credit sales, $10,000. This is what you did. But guess what? You are going to be paid. This is year one. So this is for year one. You're not going to get anything for year one. What's going to happen is this? Starting in year two, you're going to start to receive the money. And you're going to be receiving, let's make it two payments. So you're going to be receiving year two and year three. So as far as GAP, the sales is recorded in year one. As far as tax, you don't do anything for tax purposes because you did not receive any money for the sale. In other words, it's not really a sale, it's not a taxable event. But here's what's going to happen. As soon as you booked $10,000 in sales, this is going to generate kind of a future tax liability. Why? Because what's going to happen in year two and year three, you're going to get $5,000 and $5,000. Therefore in year two, you debit cash $5,000. You will credit sales $5,000. And in year three, you will debit cash $5,000. And you will credit sales $5,000. What does that mean? It means for tax purposes. It means for tax purposes, you're going to have a future $10,000 of revenue, which you already accounted for under GAP. What does that mean? That's going to give you a future tax liability. If you have a future revenue that's going to be taxable, that's basically the definition of a future tax liability. You're going to have an obligation down the road to pay taxes. In year two and year three, what's going to happen when you forget all you have to do is debit cash, credit receivable for $5,000. Every year. So you have no revenue. The revenue will start to appear on your taxes in year two and year three, which in turn gives you a future tax liability. So it's very important. So why is the third taxes challenging? I'm going to say difficult because you need to know your knowledge from tax. You need to know accounting rules and you need to combine those two together. So you need to know your tax and your accounting principles and how do they interact together. So it's very important that you have a good understanding about this topic. And I could assure you many students when they come to me for help. Usually that's the topic that they're being challenged with. It's either this or pension. Those are the two main topics. Let's take a look at this question. Station, toy train, a cash basis taxpayer prepares a cruel basis financial statements and year 13 balance sheet. State state and the third income tax liability increase compared to year 12. So we have the third tax liability and all what we're saying, for example, the third tax liability was 5,000. Now it became 15,000. That's all we're saying. So it increased the third tax liability increase, which of the following changes during year 13 would cause this increase in the third tax liability. So all what they're asking us is, which of these would result? Which of these activities one, two, three would result in this? I'm going to make it 10,000 increase. I made it 10,000, five to 15. So simply put, what would increase your third tax liability? That's the question. That's the question. So let's take a look at what we are giving and try to analyze it again. What I like, I'm going to grab this question and work with it on one note because I'm going to need more room to work with. So what would lead to this increase in the third tax liability? Let's take a look at what we have. An increase in prepaid insurance. So let's see. So we have tax and we have gap. So what happened when we buy prepaid? If we increase in prepaid, when we increase in prepaid, what do we do for gap? For gap, we debit prepaid and prepaid insurance, which is an asset and we credit cash. Again, let's make it 10,000 and 10,000. So for gap, when we, when we had the increase in prepaid, what happened is we increased an asset. This is an asset and this is an asset. Now for tax purposes, here's what's going to happen. For tax purposes, we are going to debit an expense 10,000 and we are going to credit cash 10,000. So what did really happen? For tax purposes, the increase in prepaid because for tax purposes, you are going to expense it. What happened is you used up all your expenses. What's going to happen is this is year one for both. What's going to happen in year two? Let me change colors. In year two, basically in year two, there's nothing about the tax because the whole amount was expense. In year two, you're going to have insurance expense and you're going to credit prepaid insurance for 5,000. So notice what happened. You have an expense on the books on gap, but you have no expense for tax purposes. So what did this trigger? It triggered an increase in the third tax liability. Simply put, in year two, you're going to have an increase in the third tax liability because you already used up all of your prepaid insurance in, quote, expense in year one. So in year two and year three, you're going to have an expense here. So in year three, same thing. In year three, you're going to have an insurance expense of 5,000 and you're going to credit your prepaid insurance of 5,000. And you're going to have nothing for tax purposes. So as a result, you took the expense up front. You're going to experience an increase in your, you will experience an increase in your third tax liability. So definitely one is one of the answers. So we could eliminate A. We could eliminate D. Okay. Now, all we have to know, all what we have to find out now is, is two part of the answer or not because we know three is out because we have to have one. If you understand that one is included, three is out. So let's take a look at two, an increase in rent receivable. Okay. Again, let's do the same thing for an increase in rent receivable. Let's assume you rented something on account. You rented something on account. That's good. So here we go. We have gap and we have tax and you rented something on account for $10,000. Again, let's use this number, $10,000. So for gap, you are going to debit, rent, receivable, 10K, you're going to credit, credit, rent, revenue, 10K. For tax purposes, if you receive no cash, you have no tax. Yeah, it says year one, you have no tax obligation. Why? Because you did not receive any cash. It was an increase in rent receivable. Now, what's going to happen in year two? Let's assume you're going to be paid that money in year two to keep the example simple. So in year two, what's going to happen is for gap, they're going to give you the money. You're going to debit cash, $10,000. You're going to credit rent receivable, $10,000. And we are basically done, but there's no revenue in year two. In year two, for tax purposes, you are going to debit cash, $10,000, and you're going to credit rent, revenue, $10,000. So what happened? When you had this receivable in year one, what happened? It triggered a future tax liability of $10,000. It tells you in the future, you're going to be receiving $10,000. It means you're going to have a future tax liability. What does that mean? It means, yes, indeed, an increase in receivable, an increase in rent receivable will increase your deferred tax liability because it's increasing your obligation into the future, your tax obligation. And we know three is not correct because by the process of elimination, we said one is two. But let's look at three just to make sure what would three would do anyway because it's very important. So let's look at three. Three, it says an increase in the liability for warranty obligation. So again, let's do gap and let's do this is gap and this is tax. So what do we do? Well, when we have an obligation, when we have a warranty, what we do is we debit warranty expense. Let's make it $10,000 credit warranty obligation or warranty liability $10,000. So this is year one. So in year one, we estimate we're going to have a warranty expense next year of $10,000. What do we do for tax purposes? We don't do anything. But what did this do? Well, it tells us in the future we're going to have because, you know, this warranty is it's an estimate for the future. So in year two, let's assume in year two, we did have we did have actually the warranty. Therefore, in year two, we debit warranty expense. Let's assume we had to pay cash $10,000. We credit cash $10,000. For gap purposes in year two, we debit warranty liability. We debit warranty liability to remove the liability $10,000 and we credit cash $10,000. So notice what happened. This liability for gap purposes in year one created a future deduction for us. It's a warranty expense in year two. So what would a future deduction gives us? Future deduction will lead to an increase in the third tax asset. In other words, it doesn't lead to an increase in the third tax liability. Okay. So hopefully this makes sense why number three is not correct. Again, you have to understand these topics in detail. I understand if you're not following 100%, here I'm just trying to work with people who already have an idea about the topic so they can try to practice. But if you feel that, you know, I'm a bit confused. That's why I have my intermediate accounting. Go to my intermediate accounting lesson. Let's take a look at this question. Good. This question had numbers, so I'll give you a feeling about the numbers. Okay. Let's see. Be company, a newly organized company reported pre-tax financial income, which is gap income of $100,000 for the current year. Among the item reported are premium on officers life insurance with effort as the owner and the beneficiary. So notice premium on life insurance with the company as the owner and the company is the beneficiary of $5,000 interest received on municipal bond $10,000. The enacted tax rate for the current year is 25% and 30% thereafter and it's December 31. What should the company report as the third tax liability? So the kind of their lead in you here and telling you this is it's going to be a third tax liability. And this is, they should have, if I was, you know, I would say the third tax liability or asset use, what are we going to have? Because why the third tax liability? There's no reason. So this is an easy reason. If you got this question, this is an easy question. This is really easy as long as you understand the following as long as you understand that premium on officers life insurance with the company as the owner as the beneficiary. Is a permanent permanent difference and interest received on municipal bond. Also a permanent difference. So both of these differences are permanent differences. Permanent means they are never taxable or never deductible. So they will never, they will never like, for example, we looked at the warranty expense. The warranty expense was deductible down the road. We looked at the rent or the rent was taxable down the road. So it's a temporary difference. The premium on life insurance with the company as the owner and the beneficiary. It's a permanent and interest received on this one. It's a permanent. This is this is a permanent non deductible. What is non deductible? The premium is non deductible. This is never not deductible under the circumstances. And this is not taxable under any circumstances. Therefore, we consider those elements as permanent. And you need to understand that permanent differences would result in no deferred taxed asset. No deferred tax liability. So knowing this information, you would immediately zoom in. And the answer is the it's there's no deferred tax asset. No deferred tax liability as a result of those permanent differences. In other words, you need to be familiar with what are your permanent differences? Because if you get, if they ask you about permanent differences, those are easy questions. There's no, there's they don't affect the third tax asset. They don't defer. They don't affect the third tax liability. Easy question. Okay. Let's take a look at this question on June 20th, year one, be company lease the building and receive rental payment in the amount of 42,000. The payment was for the rental period, July 1st, year one through July 1st, year two. B's tax rate are 25%. For year one, 30% for year two, assuming no other temporary differences. And that the rental income is taxable when received what amount of the third tax should Benson report in year one balance sheet. So I think I'm better off grabbing this and working with it on a note. So let me take a look at the note here. And grab this question. So we received the money July 1st, year one. So let's see. Okay. So this is what you should do is something like this. So this way you see what's going on. We have year one and we have year two. I received the money July 1st, year one and it's for July 1st, year two. So it's going to be covering this period and this period. So they already told you the money is taxable as soon as you get as soon as you receive it. So as soon as I receive the money, as soon as I receive the money, I debit cap for tax purposes. Let's do tax and tax and gap. And here's what's going to happen under tax under tax. I have the cash 42,000 and I will credit rent revenue 42,000. Okay, because that's it. And I'm going to be paying taxes on that rent revenue in year one and year one for gap. I'm going to debit cash 42,000. I'm going to credit rent revenue 21,000. It's for this period. Then I'm going to have unearned revenue of 22,000. Now, so for tax purposes, I'm practically done. I paid my taxes on that obligation. I paid my taxes in year two. What's going to happen is this in year two. There's nothing for tax purposes because that money is already been taxed in year two. I'm going to debit unearned. Sorry. I'm just unearned revenue 21,000. I'm going to debit unearned revenue and I'm going to debit. Sorry. I didn't catch that. Rent revenue 21,000. Stop it, please. I'm going to credit rent revenue of 21,000. So what happened is this in the future, I'm going to have a rent revenue on debt, but it's not taxable because I already paid my taxes. So what is that going to do? Well, they already told you that's going to give you the third tax asset. How much is the third tax asset here? We have to be very careful and please listen to me carefully. So the amount of future revenue that's already been taxable is 21,000. Now, the question is, do I multiply it by 25 or 30% and you multiply it by the future tax rate 30% because they're giving you the answer here as 25. You have to be very careful. I'm assuming that's 25. Let me just double check the math before I can fuse you. So if we take 21,000 times 0.25, see, that's not the answer. They're giving you the answer. So you have to multiply it by the future and act the tax rate. Remember that. And sometimes they try to give you an easy question with the future and act the tax rate. That's different. So I'm going to take 21,000 times 0.3 and that's going to give you 6,300. And the answer is B, B as in boy. Okay. So again, what I can tell you about this topic, it's challenging for the students and for challenging for the students. But what I can do, I can help you. I help many students overcome this topic by referring to my intermediate accounting lectures, working my CPA questions. Check out my website. That's all I suggest you do. It's a supplementary material to your CPA course. So you don't have to give up your CPA course. It's going to help your CPA course invest in your career, invest in your professional education. You study for your CPA once. Good luck and stay safe, especially during those coronavirus days.