 Hello and welcome to the session in which we will discuss the third tax asset, the valuation allowance. First, we need to understand to make sure we understand what is a third tax asset. Well, the first tax asset is an asset. It's clearly stated in the name. Now, what is an asset? An asset, it's something that's going to benefit the company in the future. How do a the third tax asset benefit the company in the future? Well, you're going to have lower taxes, you're going to have tax savings, you're going to have tax benefits in the future as a result of a temporary difference. Now, if you don't know what a the third tax asset is, please go to the prior session, because in this session, we assume you know what the third taxed asset is, we're going to be focusing on the valuation allowance. But the point is, we have to remember the third taxed asset is an asset. And just like any asset like inventory, just like any asset like receivable, just like any asset like property, plant and equipment, just like any asset like investments, we have to be conservative. When we report those assets, we cannot if they are under if they are over reported overstated, we have to reduce them to their true value. For example, in inventory, we have an account called allowance to reduce inventory to write down our inventory. Our receivable, we report receivable at the net realizable value we reduce receivable by the allowance for doubtful account. For property, plant and equipment, we have we write them down through impairment. For investments, we have evaluation allowance as well. So what is evaluation allowance? Basically, it's a reserve account to reduce the third taxed asset, just like when we report inventory at a reduction, account receivable, property, plant and equipment. Also, the third taxed asset is an asset. And if we don't think if it's more likely than not, so this is what we ask ourselves, is it more likely than not, which is 50% or more chance that the deferred taxed asset will not be realized, then we have to reduce the deferred taxed asset by the valuation allowance. Simply put, if you don't reduce your valuation of your DTA, then your assets are overstated. And that's not what we want to do as accountant, we are conservative. Our numbers should reflect reality. And this is what is it what's evaluation allowance is. It's an account that's going to reduce the third taxed asset when needed. The best way to illustrate the concept is to actually look at an example. Adam Company has a deferred taxed asset with a balance of 80,000 at the end of 20x1, due to a single cumulative temporary balance of 400,000. Well, if I take 400,000, I multiply it by 20% tax rate, I'm going to get 80,000. Now, the tax rate is given here, but I can figure it out by saying, well, if I have a deferred taxed asset of 80,000 as a result of a temporary difference of 400,000, if I take 80,000 divided by 400,000, I'm going to get 20%. So the first thing is intact in year x1, I do have a deferred taxed asset of how much of 80,000 as a result of this temporary difference. At the end of x2, the same temporary difference increase to a cumulative amount of a cumulative amount of 500,000. So this 400,000 increased to 500,000. So the difference increased. So the difference is 100,000 taxable amount for 20x2 is 900,000 and the tax rate is 20% for all years, which is kind of, I figured it out for the 80,000, but this is what we are told. So the question is, what is the DTA balance for 20x2? Journalize the 20x2 income tax related entry. Assume more likely than not that 12% of DTA will be unrealized. We're going to be answering those three questions, question by question. But before we proceed, if you are watching this recording, most likely you are an accounting student or a CPA candidate looking for some additional help. If you are, please visit my website, farhatlectures.com. I can provide you with additional resources. I can help you do better, whether you are taking a CPA review course, which you keep, I don't replace, or you are taken an accounting course. And I have practically all of your accounting courses covered. I provide lectures, multiple choice, true, false, that's going to help you do better, whether you are taking an accounting course or studying for your exam. If you're studying for your exam CPA exam, my resources are aligned with your backer, Wiley, Roger, Gleam, or Miles. I do also give you access to 1500 previously released AI CPA questions with detailed solution. In addition to thousands of multiple choice practice questions. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording, share it. If you're watching this, it means you need this help. Benefit other people, share it with other people, connect with me on Instagram, Facebook, Twitter, Reddit, and I started a CPA exam support group on GroupMe. Please join us. So let's take a look at the first example. What's the DTA balance for 20x2? We know from 20x1, we have 80,000. The temporary difference increased from 400,000, increased by 100,000 to 500,000. So simply put, the 100,000 additional increase in temporary difference will be subject to another 20%. The third tax benefit, 20,000. Therefore, the third tax asset as of x2 is 100,000. So the answer to the third tax asset is 100,000. The balance as of 20x2, 80,000 that's given to us. And as the result of this additional increase from 400,000 to 500,000 of the temporary difference, we had an increase of 100,000 times 20%, it's going to give us 20,000. I should have used a different number than 100,000 because I don't want to have to 100,000. So the DTA balance is 100,000. Journalize the 20x2 income tax related entry. Now remember how I always instruct you to prepare this entry. The first thing you do is you come up with income taxes payable. So first you have to find out how much you are paying to the government because this is the not the easiest one. This is how you should prepare the journal entry income taxes payable. To find out your income taxes payable, you have to find your taxable income. Luckily, your taxable income is given as 900,000. If we take 900,000 times 20%, you're going to have to pay the IRS 180,000. This is your income taxes payable. Well, the third taxed asset, we already know that the third taxed asset will increase by 20,000. We already figured this one out 100,000 times 20%. Now your income tax expense, which is your income tax expense is 180 minus 20, which is 160. This is your income tax expense and this is the entry. So this is your the amount that you have to pay the IRS. This is the future savings. And because you have future savings, your income tax expense is lower now by 160,000. Now obviously, when the deferred tax asset would reverse, it means once we start to credit the deferred taxed asset, it will it's going to increase your income tax expense. Okay, so this is basically what we are looking for for question two, for question two. It's also worth mentioning that how you come up with the 160,000, your income tax expense, it's 180,000. And I showed you minus 20 equal to 160. Also from a T account perspective, remember DTA and DTL, the corresponding entry to them is income tax expense. So if I'm increasing DTA, I'm reducing my income tax expense. Therefore, I am reducing my income tax expense by 20,000 and increasing my DTA by 20,000 in future years. And future years, which is let me put it in a different color. So show you what's going to happen in future years. When I start to reduce my DTA, it's going to increase my income tax expense. But what's going to happen is I reduce when I credit my DTA, when I'm using my DTA, I'll pay less to the IRS because now I am using my tax savings, which I am booking now, I will be using in the future. I just want to show you what's going to happen in the future. Now let's take a look at number three. Number three is saying, assume that more likely than not that 12% of the DTA will not be realized. So this is what we're dealing with the allowance entry. So if 12% will not, at 12,000 will not be realized, what's going to happen is this, we're going to increase our income tax expense by 12,000, reduce our allowance, I'm sorry, increase our allowance for the third taxes by 12,000. Simply put, what we're saying, remember we had a DTA of 100,000. What we're saying 12,000 of this will not be realized. Simply put, we're not going to be profitable enough to have the tax savings. That's what we're saying. Well, as a result, what's going to happen? We have to increase our income tax expense now and reduce our allowance. So this is how we show things on the balance sheet. We'll show DTA at the gross amount, which is this was question one was the DTA, minus less the allowance. The allowance is a contra asset. It's going to reduce our asset, just like the allowance for doubtful account, just like the allowance to reduce inventory. It's a contra asset. And this is what we were discussing earlier, the allowance for the allowance for DTA is to reduce DTA. Therefore, DTA is showing net of the allowance of 88,000. What should you do now? Go to farmhatlectures.com, work MCQs, work through faults. Don't shortchange yourself. You are making an investment in your accounting career. You are making an investment in your CPA. Throw everything at it. It's going to pay you dividend down the road in terms of income career. Good luck, study hard, and of course, stay safe.