 Hello and welcome to the session in which we would look at CPA questions that deals with the BEC section of the exam. Although these questions are BEC or some of them are BEC, I want to make the point that it's very important to take your FAR first and I will illustrate this concept today in these questions or at least in one of the questions. I always tell students to take FAR first and I will show you why in the session. Now these practicing questions is one of the most important things for the exam but you only practice questions after you have learned the material. You don't try to learn the material by practicing questions. The questions are for you to find out whether you know the material or you don't know the material. Now if you are studying for the exam I strongly suggest you take a look at my website farhatlectures.com. I don't replace your CPA review course. I can't do that, I don't intend to do that. I can be a useful addition. I can add 10 to 15 points to your score by explaining the material differently. If I explain it differently you understand your CPA review course. If you understand your CPA review course you will do better on the CPA exam. Your risk to my offer is one month of subscription. It's a nominal fate. Your potential gain is passing the exam. So are you willing to take that risk? Try me for a month. Find out if I can help you pass. If yes, you keep my subscription. If not you cancel and if not for anything take a look at my website to find out how well or not well your university doing on the CPA exam. I do have resources for other courses and CPA sections as well. If you haven't connected with me on LinkedIn please do so and check out my LinkedIn recommendation. Like this recording, share it with other connect with me on Instagram, Facebook, Twitter and Reddit especially Reddit as I'm growing my followers. So let's take a look at the first questions. And Adam's annual depreciation tax shield from the asset would be how much? So we're looking for the tax shield or the tax savings from depreciation. Adam's garage purchased an asset for 45,000 and has an expected salvage value of $5,000 and a 10-year loss. Adam's effective income tax rate is 30% and it uses the straight line depreciation method for income tax reporting purposes. For book purposes Adam also depreciate this asset using the straight line. So the straight line for both and there's an expected salvage value also for the book of 5,000. So what is the depreciation shield or the depreciation savings? So that's why here it's important for you to understand what depreciation is and what do you learn about depreciation? You learn about depreciation and for. So that's the first thing that's why I said at the beginning it's very important that you understand for. Now how do we compute depreciation? Depreciation is the cost of the asset divided by its life minus salvage value. But there's another trick to this. In this example they're asking you about the tax shield. So remember we have tax and we have gap. We have tax rules and gap rules. Here we have to be using the tax. Now also you have to know this is also from reg not from far. So the idea of depreciation coming from far is under reg you ignore the salvage value of the asset because for tax purposes you depreciate the full asset. Therefore what I'm going to do I'm going to take 45,000 minus 0 divided by 10. Under gap I would have took 45,000 minus 5,000 divided by 10. So I don't use gap I'm going to be using the tax. In tax there is no salvage value. If I put zero to remind you you depreciate everything. So simply put your depreciation expense is 4500. The first thing you can do is the first thing you can do is eliminate answer A because the depreciation amount cannot be the tax shield. Now what does it what does it mean the tax shield? The tax shield is an important concept or the tax savings. It means when you have depreciation it's going to lower your tax bill. Let me show you what I mean by this. Let's assume your taxable income of 20,000 and what's going to happen? This is your taxable income. It's the income that's going to be taxable. You pay 0.3 and your tax bill is 6,000. Now let's assume you have depreciation of 4500. Let's see what happened. So if your taxable income is 4500 minus now we're going to add that you have a depreciation of 4500. Your taxable amount becomes 15500. Now let's go ahead and compute the taxes on this amount. So your amount is 15500 times 0.3. That's going to give you 4650 times 0.3. That's going to give you 4650. So notice what happened to your tax bill. Your tax bill was 6,000 without the depreciation. When we introduced the depreciation your tax bill went down to 4650. Now I can't find the savings. The difference is 1350 and this is my tax shield. Now you don't have to go and make up some numbers. All what you have to do is say my expense is 4500. You'll take your expense that you can deduct for tax purposes multiplied by the tax rate. That's going to give you 1350 and that's your tax savings. But again I showed you here where scenario one you paid $6,000 because you did not have depreciation and scenario two when we added the depreciation to the equation you saved 1350 because your tax bill became 4650. So that's your tax savings. So there's a lot in this exercise. You have to know you have to understand the concept of depreciation. You have to understand the concept of tax savings in a sense that in a sense that if you don't know what tax savings is you won't be able to answer this question. Now if you started with this formula gap formula your answer would have been 1200 and it would have been incorrect. So you have to be very careful in what they are asking you. Very careful and in this question you are giving the salvage value twice to trip you. For tax purposes you ignore the salvage value because you depreciate everything. The idea of tax depreciation is to get those tax savings. That's why the government, that's why Congress gives you those depreciation amounts. Let's take a look at this question. Adam Inc. is considering purchasing a new equipment to replace an older and efficient model. The new equipment has a cost of 320. The old equipment has a salvage value of 9500. Which of the following cost would not be included in the capital budgeting analysis as part of the net cash outflow of the equipment? So the question is which of the following will not. So the first thing is will not and part of net cash outflow. Okay transportation cost of the new equipment. Well would that be included? Of course it will be included. If I am buying an asset how much am I paying for it? My cash outflow is the cost. Therefore one is included. I will take out B immediately and D as well because none of the above cannot be because well no D is not out yet. Installation cost of the new equipment with installation cost sure I have to pay some money to install this asset therefore it will be part of my capital budgeting. Therefore two is out and it's going to make two is out too. So all what I have to know now is depreciation expense times the tax rate. Would that be included in the net cash outflow or that would not be included? And notice I have those questions back to back for a reason is because I wanted to kind of illustrate the point. So the depreciation expense times the tax rate I just showed you this is the tax savings. Those are tax savings. Tax savings look at the prior problem look the tax savings or tax shield. So those are the tax savings. Those are the tax savings from the from the asset. So if that's the case it cannot be part of the outflow of cash. It cannot be part of the outflow of cash. Therefore it will be the answer is A because depreciation expense is not an outflow. Actually it's helping you. It's a positive. It's going to save you money in that project because the question specifically asking about the net cash outflow outflow. Let's take a look at this question. Adam company owns a land that could be developed in the future. That's fine. It estimate it can sell it to George for 950,000 net of selling costs. If the land is not sold Adam will continue its plans to build three single family homes on the land. So that's the alternative. If Adam decide to develop this property what type of cost would the potential selling price of the land represent in Adam's decision? So what they're asking us is this 950,000 what do we call this 950,000 if we went ahead and build those three single family homes? Well let's start with a sunk cost. Do you know what a sunk cost is? A sunk or sunk or you know sunk cost. What is sunk cost is a cost that already occurred in the past. It's not avoidable. Therefore it's not relevant. That's not that's the doesn't fit this definition here. Isn't incremental incremental? Okay. Incremental cost is production cost. Basically when you want to produce more what's the incremental the additional cost or revenue? Well that's it has nothing to do with this decision here. Is it opportunity opportunity? What is opportunity cost? Opportunity cost is the potential benefit that you gave up to make another decision? Well I would say this fits here because I am given up selling the asset for building three homes. So given up selling the asset is my opportunity cost. Therefore I would say C is a good answer. Let's look at the variable cost or variable. Variable cost is the cost that you incur as you are producing more units. Your variable cost will go up. It varies with each unit. Well it's not really what we're asking about here. What we're asking about is C opportunity cost. You are given up selling the land to build the homes. That's an opportunity cost. You want to make sure you know sunk increment incremental opportunity and variable because all of them could be right answers depending on the decision that you are not the decision the scenario that you are giving. At the end of this recording I'm going to remind you farhatlectures.com I don't replace your CPA review course. I can be a useful addition. It's a nominal fee. Are you willing to take that risk? If I was in your shoes I will do it. I'm going to study for the exam once in my lifetime. I'm going to throw everything at it and you're not throwing a lot and you're not signing a contract. One month try it. You don't like it. You cancel. You like it. You keep it. Good luck. Study hard and stay safe.