📊 Accounting Income Example — CPA FAR Exam

Hello and welcome to this session. This is Professor Farhat in which we would look at an example that deals with accounting income when it comes to estate and trust. So we have the Falcon Trust here. It's a simple trust and is established for the benefit of Ms. Alvarez. Ms. Alvarez is obviously the income beneficiary and the sole the sole benny. The remainder interest is held for her children. They're called the remaindermen. The current financial are as follows: taxable interest from corporate bonds 80,000, tax-exempt interest from municipal bond 20,000, long-term capital gain sale of land 25,000, trustee assessment fee 16,000, therefore total interest expen- total interest income is 100,000 of which 20 is tax-exempt. Now, if you don't understand what is an estate or what is a trust, it's something that we looked at in the prior session. Please go back to the prior session to understand what is a trust, what's an estate. Because in this session, I'm focusing on one aspect of this and that's computing accounting income. Now, why do we need to compute accounting income? Because we need this figure later on when we compute the taxes for the estate and the trust on form 1041, how to find the taxable income, how to find the taxes, how to find something we call the income distribution deduction. So all of those are related, but they start with accounting income. Let's go ahead and solve this problem using three different scenarios and computing accounting income. Let's go ahead and get started. Before we proceed any further, I have a public announcement about my company farhatlectures.com. My AI turns any lecture into a complete study system. You can create summary table, formulas, and example from each lecture. Flashcards builds from the lesson itself, a quiz built on the lesson, and as a bonus, convert any lecture into a portable short audio on the go. So, it helps you with the retention. No noise, no genetic responses, and just clarity based on that specific lecture. Don't just watch, interact, test yourself, and retain the material using Farhat AI. Now, go to farhatlectures.com now and see how the AI can help you understand, practice, and retain the material. >> Let's take a look at the first scenario. Scenario one, we're going to assume it's a default scenario. In other In other words, silent rules, and under those circumstances, fees and gains will go to the corpus. So, the trust agreement does not specify how these items are allocated, but under the state law, if we are silent, default is to keep the interest intact. Anything related to the to the principal will be intact. So, the capital gains are kept in the trust to grow the principal. The trustee fees are considered cost of maintaining the principal. Therefore, the fees will be part of the corpus of the trust. So, they are paid by the corpus, not the income. So, how much would Ms. Alvarez receive under this scenario? Well, interest income of 100,000. That's it. No capital gain. Ms. Alvarez does not absorb any fees. Therefore, the trust accounting income to Ms. Alvarez is 100,000. So, simply put, she received $100,000 of interest or 100,000 in cash, whatever you want to call it. Let's look at scenario two. Here, the fees are allocated to income. Income means who? Income means Ms. Alvarez. So, the trust agreement here explicitly state that administrative cost must be paying must be paid from current earnings. Who gets current earning, Ms. Alvarez? Simply put, we're going to take out the money from her. So, before Ms. Alvarez can take a draw, the bills, the fees must be paid. So, what what would Ms. Alvarez income would look like? We have interest income of 100,000 minus notice here minus 16,000 full fee charged to income. What's left to her is 84,000. So, Ms. Alvarez check is reduced by 84,000 as she is responsible for paying the fees under this scenario. Let's take a look at the third scenario. Gains to income and fees split 50/50. Here the trust agreement is generous to the income benny regarding profit. So, the profit here is the sale of the land. But she has the burden of the cost. So, the benny will have to absorb 50% of the cost. So, the logic here is the trust treats capital gain as cash income. It split the trustee fee equally just to be fair between the two. So, what would Ms. Alvarez end up with? Interest income of 100,000 gains of 25,000 allocated to her to income fiduciary fees would reduce her income by the 8,000. Trust accounting income will be 117,000. So, notice it all depends on how we how we organize the trust. Under scenario one, Ms. Alvarez would receive 100,000. Under scenario two, 84. Under scenario three, 117,000. So, knowing knowing accounting income is important. Why? Here's why, because first we have to determine accounting income, then we're going to have to compute taxable income before deduction distribution or distribution deduction, then determine DNI, then determine the deduction distribution, then compute the final taxable income. So, that's why we computed accounting income because we will need the step later on when we get all the way down here. What should you do now? Whether you are an accounting student, enrolled agent, CPA exam candidate, the best investment you can make is invest in yourself, and that's by going to Farhat Lectures. Look at additional resources, lectures, podcasts, exercises, simulations, video simulations that will help you with your career. Invest in yourself. Good luck and God bless.