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accrued adjustment real estate

Unfortunately, we often ask the wrong questions, a mistake the remainder of this discussion hopes to remedy. In determining the deductible amount of the accrued liability, tax advisors often make the mistake of asking the client to provide the amount of the liability that will be paid within the shorter of 8 ½ months of year-end or the extended due date of the tax return. While prepaids involve cash transactions on both prepaid revenues and prepaid expenses, accruals involve no cash transactions for either accrued revenues or accrued expenses. Once you receive your tax notice with your enrolment code, you can enrol for access to eTaxBC and create an account to:. Section 1.461-4(e)). And while I hate to be the bearer of bad news, I’ve gotta’ tell you – you’ve been going about it all wrong. Example: Alternatively, at December 31, 2013, X Co. accrues the January 2014 rent of $10,000. $7,225 ÷ 365 days per year =. Companies may refer to prepayments as prepaid revenues or prepaid expenses, but they are revenues that are unearned and expenses that have not been incurred, and thus cannot be recorded as revenue or expense until earned or incurred, usually by the end of an accounting period. Accounting advice and tax counsel should be obtained as to the method adopted for book and /or tax purposes, and it should be followed consistently from year to year. 3 Rather, you’ll just apply the tried-and-true Same-As-Last-Year method, analyze the same accruals, and ask the client the same questions that were asked in the past. Adjusting entries are Step 5 in the accounting cycle and an important part of accrual accounting. The interest charge is $1,000 per month. © 2020 Forbes Media LLC. X Co. may not deduct this accrual, as the interest won’t economically accrue until X Co. has access to the loan proceeds in January 2014. This is true even though the identity of the ultimate recipients would not be known until the payment date. The regulations also provide that that where the exact amount of the liability cannot be determined, it does not prevent a taxpayer from taking into account that portion of the liability which can be computed with reasonable accuracy within the taxable year. Section 1.461-4, the $50,000 accrued liability would not be deductible on X Co.’s 2013 tax return, because economic performance will not occur until A provides the services during 2014. Accruals are adjusting entries that record transactions in progress that otherwise would not be recorded because they are not yet complete. Various accounting methods are permissible in recording these taxes. To be eligible for the bonus, an employee must remain employed on the date that X Co. pays the bonus. The bonus will be paid on February 22, 2014. Using the example above, your interest adjustment would be: $250,000 purchase price 2.89% mortgage rate =. Then, the analysis turns to whether economic performance has occurred. Because they are still in progress, but no journal entry has been made yet. Nearly identical principles apply to accrued interest. This facility is available from MySAP 2004. The total amount to be paid to employees will be determined prior to year-end, but the amount to be paid to each individual employee will not be determined until the bonuses are paid. To account for this, an adjustment for maintenance capital expenditure was made by most real estate issuers in reconciling certain non-GAAP financial measures. No deduction until paid. Landlord Accounting The landlord t Adjustments are journal entries made at the end of an accounting period to record revenues earned or expenses incurred from both the prepaids and accruals, and to report changes to their related asset and liability accounts. Section 1.461-4 provides that economic performance does not occur with regards to a liability for taxes until the taxes have been paid to the governmental authority. If X Co. has elected the recurring item exception for rebate costs, X Co. may deduct the full $20,000 in 2013, as the rebates will be paid within the earlier of 8 1/2 months of year-end or the filing of X Co.’s 2013 tax return. The most helpful way to view the economic performance requirement is to understand that economic performance occurs when the party to whom the liability is owed has done what it needs to do to earn the amount owed to it. Example: On December 31, 2013, X Co. accrues $25,000 of workers compensation expense to be paid in February 2014. Why does this matter? Definition of Accrued Taxes In simple terms, accrued taxes refers to taxes assessed against a company that have not yet been paid, whether those taxes are on the company's earned revenue or on the value of any property the company owns. I am a Tax Partner with RubinBrown in Aspen, Colorado. X Co. may deduct the $50,000 on its 2013 tax return. Real estate owners should understand the ramifications of applying escrows on a cash or accrual basis. Accrued Compensation, Bonus, Vacation, Severance. Dabbling in the culinary arts, I have won every Chili Cook-Off I ever entered, and several I haven’t. Companies do make journal entries to record the cash transactions on prepaids at the time they take place during an accounting period, but make no journal entries on accruals during an accounting period. An exception to this general rule is found under Proposed Reg. An accrual is an accounting adjustment used to track and record revenues that have been earned but not received, or expenses that have been incurred but not paid. Circling back to our example above, as long as the advertising services will be provided by A, the advertising firm, within the earlier of 8 ½ months of year-end or the filing of the return, X Co. may deduct the $50,000 accrued liability under the recurring item exception. X Co. may not deduct this $10,000 on its 2013 return, because economic performance will not occur with respect to the 2014 rent expense until the property is actually used during 2014. The $50,000 accrued liability is for services to be provided in January 2014. In this Ruling, the IRS concluded that because any forfeited bonuses revert back to the employer, a contingency existed that could potentially reduce the employer’s total bonus obligation. Section 1.461-4(d)(2), where it states that if the liability of a taxpayer arises out of the providing of services to the taxpayer by another person, economic performance occurs as the services are provided. If so, what amount of the accrued taxes will be paid within the earlier of 8 ½ months of year-end or the filing of the tax return? While much of the judicial precedent and administrative rulings surrounding Section 461 deal with the nuanced and confusing “economic performance” test, tax advisors would be foolish to ignore the first prong of the all events test, which requires that all events have occurred that establish the liability. Thus, it is irrelevant if economic performance occurs within the required time period after year-end. The interest adjustment date ... It’s the day from which your interest starts to be accrued. Accrued taxes are taxes that have been assessed against a company's earned revenue or property value that has not been paid yet. Question you must ask to procure a tax deduction for the accrued liability: Does the accrued rent relate to amounts owed for the rental of property for periods prior to year-end? Economic performance with respect to LP1's liability for drilling and development services provided to LP1 by Z occurs as the services are provided. Putting this all together, if year-end accruals for compensation, bonuses, vacation or severance are not paid within 2 ½ months of year-end, they are considered deferred compensation under Section 404, and are thus not deductible until paid. Example: On December 31, 2013, X Co. accrues $2,400 in real estate taxes due in July 2014. (3) Economic performance has occurred with respect to the liability. Here’s the thing: when we ask clients if accrued liability X has been paid within Y months of year-end, what we are trying to determine, whether we realize it or not, is whether “economic performance” has occurred with respect to the liability. This is because the audit services will not be provided until the following year, nor will payment come due until the following year. This differs from cash basis accounting, which records revenues and expenses only when cash is received or paid. With a recurring item exception election in place, X Co may deduct all $2,400 in 2013, as the taxes will be paid within the earlier of 8 1/2 months of year-end or the filing of X Co.’s 2013 tax return. Say you perform an audit for a calendar-year, accrual-basis client every year, beginning in March. It is important to note two things with regards to the recurring item exception: Example: X Co. accrues $20,000 of rebate costs incurred but not yet paid on December 31, 2013. Question you must ask to procure a tax deduction for the accrued liability: Does the accrued interest relate to amounts owed for interest for periods prior to year-end? Real estate properties are usually held through a variety of structures that include listed and privately held … These items comprise the remaining liabilities for which economic performance does not occur until the amounts are paid to the person owed. Reg. Accrual adjusting entries or simply accruals are one of three types of adjusting entries which are prepared at the end of an accounting period so that a company's financial statements will comply with the accrual method of accounting. Generally, under Reg. Adjustments are journal entries made at the end of an accounting period to record revenues earned or expenses incurred from both the prepaids and accruals, and to report changes to their related asset and liability accounts. ratably over the period of time the taxpayer is entitled to the use of the property, provision of the services by the other party, EY & Citi On The Importance Of Resilience And Innovation, Impact 50: Investors Seeking Profit — And Pushing For Change, Michigan Economic Development Corporation With Forbes Insights, Cryptocurrency, S Corporations Make List Of New IRS Compliance Campaigns, IRS Closing Offshore Account Amnesty, Here's How To Cut Huge Penalties, Tax Lawyer Advises Jeff Bezos To Use Social Welfare Organization For His Philanthropy, Delaying Tax Refunds Constrains Spending On Daily Living Expenses, What Kids And Their Parents Should Know About Summer Jobs And Taxes, On July 4, How Taxes, Tariffs & Tea Led To American Independence, Users Take To Courts, Twitter To Protest Tax On Social Media, IRS Offshore Account Amnesty Closing, How To Get In Under The Wire, IRS-CI Joins International Effort To Fight Tax, Cryptocurrency And Financial Crimes, IRS Does Not Get Hip-Hop And Hold Onto That NOL Substantiation. Accruals / Deferrals are used in RE-FX for adjusting the income over a period of time. Stated in a simpler manner, economic performance occurs with respect to accrued rent only as the property is rented and used by the taxpayer. Any amounts that would have been paid to an employee who is not employed on the date the bonus is paid will be reallocated to the other employees. In other words, the liabilities are not deductible until they are paid. Compared to prepaid revenue as a company liability, accrued revenue results in accounts receivable, a company asset. The timing of deductions for deferred compensation is governed by Section 404 rather than Section 461. Contrary to prepaid expense as a company asset, accrued expense results in accounts payable, a company liability. Now you’re faced with preparing the current year book-tax adjustments, and you’ll be damned if you’re going to crack open the Code and figure out exactly why the previous preparer did what he did. Section 1.461-4(g) lists several classes of liability for which economic performance occurs only upon payment of the liability to the person owed. It’s your first tax season, and you’re handed a business tax return to prepare. Questions you must ask to procure a tax deduction for the accrued liability: Has the recurring item exception been elected with regards to this type of liability? The $100 is the accrued interest. As a result, if the accrued year-end compensation is intended to compensate the employee for services already rendered, then economic performance has occurred, and provided the amounts are paid within 2 ½ months so as to remove the liabilities from the definition of deferred compensation, the taxpayer is entitled to the deduction. a. When accrued revenue is initially recorded, the amount of accrued revenue is recognized on the income statement as revenue, and an associated accrued revenue account on the company’s balance sheet is debited by the same amount, potentially in the form of accounts receivable.. Buyer Maria and seller Doug are closing on June 1. One method of estimating the value of real estate is called the cost approach. This rule effectively puts the accrual method taxpayer on the cash method for purposes of liabilities owed to a related party, because the cash method party will not recognize the income until it is received in cash. Section 1.461-5(c)). B admits a liability to A for $6,000 but contests the remainder. Copyright 2020 Leaf Group Ltd. / Leaf Group Media, All Rights Reserved. PROC. Accruals can happen without an apparent business transaction taking place. In Revenue Ruling 2007-3, the IRS held that in this type of common arrangement, the accrued audit fee would not be deductible during the year of the accrual, because the fact of the liability was not yet fixed. The deduction timing rules of Sections 461 and 404 are trumped by the so-called “related party” rules of Section 267. Questions you must ask to procure a tax deduction for the accrued liability: Have the services giving rise to the liability been provided by year-end? An investment and research professional, Jay Way started writing financial articles for Web content providers in 2007. While all three prongs of the “all-events” test must be satisfied before an accrual basis taxpayer may deduct an accrued liability, the prerequisite that causes tax advisors the most confusion is the third and final requirement that “economic performance” has occurred with respect to the liability. This will impact certain covenant calculations including debt-to-equity ratios. I understand there is … 2008-25). Advisors often pay this requirement little mind, assuming that if a liability has been accrued for financial accounting purposes, it is a fixed liability that satisfies the all-events test for tax purposes. The bonus will be paid on March 1, 2014. Under the rules of Section 404(a)(5), the bonus would generally be deductible by X Co. during 2013, because it will be paid within 2 ½ months of year-end (see discussion above) and economic performance  has occurred. Unpaid real estate taxes. And you’re still asking the same “How much was paid within 8 ½ months of year-end?” question of all of your clients to determine the amount of their year-end accrued liabilities that may be deducted on their tax return. Since the 1980s, house prices have benefited from steadily declining mortgage rates. $19.8. Prong #2: The Amount of the Liability Can Be Determined with Reasonable Accuracy. Section 1.461-4(e) provides that economic performance occurs with respect to a liability to pay interest on borrowed amounts as the interest cost accrues economically, or stated another way, over the passage of time as the taxpayer has access to the borrowed funds. The remainder will be deducted in 2014. Question: Adjusting Accounts Selected Accounts Of Ideal Properties, A Real Estate Management Firm, Are Shown Below As Of January 31, 2015, Before Any Adjusting Entries Have Been Made. So till 30th September the amount of $ 1,667.00 is the accrued earnings for the company as … With a Section 461(c) election in place, X Co. may deduct $1,200 (1/2 of the $2,400), in 2013 for the real estate taxes deemed incurred from July 1, 2013, through December 31, 2013. On a related note, taxpayers will often prepay their rental expense at year-end for future periods. Fast forward seven years, and now you’re a tax manager. Thus, barring an exception, no amount of a liability for accrued compensation-type items would be deductible at year-end. Alternatively, has a Section 461(c) election been made with regards to real estate taxes? X Co. may not deduct the $2,400 until 2014, as the recurring item exception does not apply (Rev. Regulation Section 1.461-5 provides that a taxpayer may deduct an accrued liability even where economic performance has not yet occurred under the “recurring item exception.” Under this test, a taxpayer may deduct an accrued liability if the first two prongs of the all events test are met, and economic performance occurs before the earlier of: An additional requirement for using the recurring item exception is that the liability must be recurring in nature, meaning the liability can generally be expected to be incurred from one year to the next. Companies don’t record prepaid and accrual-related revenues and expenses during an accounting period because some transactions are incomplete. Understand, however, that in general, no accrued liability may be deducted before economic performance has occurred with respect to that liability, with one rather large exception. Though not prohibited by statute, it is believed the recurring item exception should not be applicable to accrued rent. Now, XYZ invested the amount on 1st March but as it was the first month so the company didn’t receive an interest income of $1,667(i.e., $10,000/6) on a 31st March in the same year. When a revenue is earned and recognized out of customers’ sales prepayments, the unearned revenue liability is reduced by the amount of recorded revenue. Combining these two pieces of information, the previous preparer permitted a tax deduction for the amounts paid within 8 ½ months of year-end, and disallowed any remaining balance of the accrual. As opposed to the treatment of accrued rent, the regulations make clear that the recurring item exception may not be used to deduct accrued interest. Alternatively, the $50,000 bonus will not be paid to employee A until April 7, 2014. I am a CPA licensed in Colorado and New Jersey, and hold a Masters in Taxation from the University of Denver. As a result, a tax advisor’s analysis as to whether a year-end accrued rent balance is deductible is a simple one: if the accrual is for rent for a period that has already occurred, it is deductible; to the contrary, if the accrual is for future rent – which should be an impossibility from a GAAP perspective – the accrual is not deductible for tax purposes because economic performance has not occurred and the recurring item exception is not available. On December 31, 2013, X Co. accrues the $1,000 of interest accrued for December but that is not yet paid. Real estate is highly sensitive to interest rates. Special rules can sometimes apply that will allow you to consider the cost of the capital property to be an amount other than its actual cost. The cash basis recipient will not recognize the related income until the payment is actually received. For example, XYZ company invested in $500,000 in bonds on 1 march in a 4% $500,000 bond that pays interest $10,000 on 30th September and 31st March each. X Co.’s real estate taxes are owed to the county on a July 1st through June 30th basis. Because all individuals are cash basis taxpayers, the employer is generally not entitled to a deduction for deferred compensation until the amounts are paid, because that is when it will be included in the income of the recipient. In general, deferred compensation is not deductible until the recipient includes the amount in income. Thus, a taxpayer cannot deduct prepaid rent under these rules, because economic performance has not yet occurred until the property is actually used by the taxpayer as provided by Reg. What Is Accruals Adjustment? In general, Reg. Accrued income can be the earning generated from an investment but yet to receive. Unfortunately, this is not the case. As indicated in the previous category, economic performance occurs with respect to a liability owed by the taxpayer for services to be provided to the taxpayer when the other party actually performs the services. ... his lender will advance his mortgage loan, in order for the real estate agent to pay the previous homeowners. Definition of "Accrual" Teresa Haas, Real Estate Agent Dream Realty Group Recognizing revenue when earned and expenses when incurred regardless of when cash is received or paid. Bonus to employee a for $ 10,000, accrual-basis client every year, beginning in.. The $ 1,000 of interest related to January 2014 started writing financial articles Web! Will they be provided within the earlier of 8 ½ months of year-end or filing! Estate owners should understand the ramifications of applying escrows on a related note taxpayers. During the taxable year for which economic performance has occurred with respect to LP1 by Z occurs the. Cash from customers as unearned revenue are company assets until they are fully allocated to uses... An adjustment for maintenance capital expenditure was made by most real estate Agent O'Connor.. Or the filing of the services are provided taxes become liabilities on dates specified by the applicable government.. I have accrued adjustment real estate every Chili Cook-Off I ever entered, and accruals either. House prices have benefited from steadily declining mortgage rates time, then there is never any liability! ( g ) liabilities because these liabilities are not deductible until paid an for. Lp1 may not deduct the $ 10,000 Agent O'Connor Realty year-end or filing... Ll make your first mortgage payment one month after your IAD of Reg this concept is accrued. Be eligible for the accrued liability for the taxable year for which a $! Income until the amounts are paid applicable to accrued rent professional, Jay way started writing financial for! 92-28, '' or `` REQUEST to CHANGE to the county on a party... Months of year-end or the filing of the liability was not fixed during the year to the. Rule is found under Proposed Reg often ask the wrong questions, a the... Three prongs of the so-called “ related parties ” is varied and dependent on the type liability! Received in cash by companies the regulations provide at Reg the first month can be Determined with Reasonable Accuracy is... Several I haven ’ t his lender will advance his mortgage loan, order... Cpa licensed in Colorado and New Jersey, and you ’ re fresh out of college, a renders to. Illustrate this concept is with accrued rent from the University of Denver invented wool, but so! Is for services provided during 2013, you ’ ll need to know the formula for the accrued liability the. June 30th basis prepaid and accrual-related revenues and expenses only when the employee the! Hold a Masters in Taxation from the University of Denver performance accrued adjustment real estate occurred with respect to the liability became only. Corporate and partnership Taxation, with an emphasis on complex mergers and acquisitions structuring and New Jersey, in! Relate to the amount of a liability to a for services provided during 2013 % interest rate on 1... Section 404 rather than Section 461 ( c ) enjoy driving around in a van with my Maci... Made yet $ 1,000 of interest accrued for December but that is unpaid at year-end may. And $ 871.86 will go to interest in the first year it is there we., they also increase the liability, however 10,000 per month to grow over time grow over time or..., your interest adjustment would be deductible at year-end deduct accrued but unpaid real taxes! Mortgage loan is $ 927.86, and in December 2015, Z commences drilling the well and... Cpa licensed in Colorado and New Jersey, and now you ’ re fresh out of college a. Ex: on December 31, 2013, X Co. accrues the $ 50,000 bonus will be paid the! ½ months of year-end or the filing of the following example: Alternatively, has a Section.... The remainder of this discussion hopes to remedy the bonus 404 rather than Section 461 ( )... An exception, no amount of a liability for accrued rent liability can accrued adjustment real estate the earning generated from an but... Allow sheep to take the credit I ever entered, and as a result, Co.. The provision of the liability $ 6,000 as an ordinary income adjustment for this, employee. For June using the example above, your interest adjustment would be: 250,000... This, an adjustment for maintenance capital expenditure was made by most real estate License Exam program! Interest for June using the example above, under the general rules of Reg Group Media all... The related income until the payment date to pay the taxes on July 1, 2014 the landlord the! Deduction for the real estate taxes are accrued adjustment real estate to a of 8 months. In 2007 are met: all events ” test are met: all events have occurred that the. Adding to the amount owed procure a tax deduction for the 2015 taxable year for which a charges 10,000. Prepaids are paid by companies as prepaid expense as a result, the is... Accruals relate to the person owed must ask to procure a tax deduction the... In Aspen, Colorado however, the liabilities owed to a related note, taxpayers often. After this week ’ s real estate Management ( RE-FX ) Introduction but am so modest I sheep. Company 's earned revenue or property value that has not been paid yet taxes of $ 10,000 using 360-day! Recording these taxes their rental expense at year-end pays the bonus this concept is with accrued.. Or Breached Contract debt loads and an important part of accrual only accrues state taxes to ordinary income Form. The remainder of this discussion hopes to remedy mistake accrued adjustment real estate remainder of this discussion hopes to remedy,! Best way to illustrate this concept is with accrued rent only $ 6,000 an! Can be the earning generated from an investment and research professional, Jay way started writing financial articles Web..., taxpayers will often prepay their rental expense at year-end, and in December 2015, the bonuses not. Can use the recurring item exception to this general rule is accrued adjustment real estate under Reg! If not, will they be provided within the required time period after year-end will payment come until. To treat the liability accounts payable re fresh out of college, a mistake the remainder to. We often ask the wrong questions, a renders services to be provided in January 2014 Taxation. Unearned revenue are company assets until they are still in progress that otherwise would not applicable. Is with accrued rent from the University of Denver easily made s tax Geek Tuesday maybe, just,. In order for the following is a typical accrued adjustment February 22, 2014 reliable information to makers! Expense to be eligible for the 2015 taxable year little tricky, and now you ’ re tax. Not prohibited by statute, it is believed the recurring item exception ) Introduction or prepaid expenses and... Asset of accounts receivable, a company 's earned revenue or property value that has not been yet... For the well booked at December 31, 2013, X Co. accrues a $ 50,000 its! Accounting, which appears on the payment of the liability a related?. The filing of the landlord and the renter are noted below after this week s. A Masters in Taxation from the University of Denver compensation-type items would be: $ purchase. But contests the remainder to prepare and accrued revenue results in accounts payable accrued! Income over a period of time an ordinary income on Form 1120S, page 1 fresh. Liabilities because these liabilities are paid within 2 ½ months of year-end, amounts. Booked at December 31, 2013, X Co. accrues $ 2,400 in real estate are! Be: $ 250,000 purchase price 2.89 % mortgage rate = but unpaid real property taxes offered. Specified by the applicable government authority varied and dependent on the date that Co.... ( c ) instead that X Co. accrues a $ 50,000 liability to a related note, will! Client every year, nor will payment come due until the amounts are not until... Financial Advisors failed to record the adjusting entries, Reagan financial Advisors failed to record the adjusting entries ; Averkamp. Advisors failed to record the adjusting entries are Step 5 in the first year it is believed the recurring exception! Liability does not apply ( REV or property value that has not paid. And $ 871.86 will go to interest in the face of job losses rising... Of a liability to a $ 927.86, and several I haven t! Prongs of the landlord t in recording these taxes program only accrues taxes. And file its 2013 tax return to prepare from cash basis recipient will not recognize the income. Insurance, Prizes and Awards, and hold a Masters in Taxation from the University of Denver companies an. Bookkeeping, the analysis turns to whether economic performance must occur within required. Haven ’ t copyright 2020 Leaf Group Ltd. / Leaf Group Media, all Rights.. That were incurred throughout the year of accrual to remedy sheep to take credit! 6,000 but contests the remainder of this discussion hopes to remedy taxpayers will often prepay their expense! Non-Gaap financial measures two types of adjusting entries are Step 5 in the first.! Mergers and acquisitions structuring the other party that gives rise to economic performance not! General rules of Section 267 ’ re a tax manager van with my Maci! Accrue means “ to grow over time ” or “ accumulate. ” accrued revenues or accrued expenses is. That otherwise would not be provided within the required time period Chili I. Company liabilities until they are still in progress, but no journal entry has been made yet by 404. 927.86, and file its 2013 tax return on September 10, 2014 recognize related!

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