 Hello and welcome to this session in which we would look at a CPA simulation or an exercise that could appear in intermediate accounting that deals with converting cash to a cruel. This topic is important and it's tested on the exam and the reason is simple. There's a practical reason for that. There's a good chance after you graduate from college, you're going to be working with a CPA firm. If you're studying for the CPA exam, it makes sense to work in a CPA firm. If you work in a CPA firm, most likely you are going to have small and medium clients that keep their books on cash basis and often times they will need to convert to a cruel. And basically this exercise would illustrate this concept, converting from cash to a cruel. And that's why this topic is extremely important on the CPA exam. Therefore, if you are a CPA candidate, I strongly suggest you take a look at my website, farhatlectures.com. I don't replace your CPA review course, whatever course you are taking. You can keep it. I can be a useful addition to your CPA review course. I can add 10 to 15 points to your grade by explaining the material differently, by showing you how to solve the problem differently. Not better, not worse, just differently and you may need that alternative explanation. Think of it as a backup explanation. Your risk is one month of subscription. Your potential return is passing the exam. And if not for anything, take a look at my website to find out how well or not well your university is doing on the CPA exam. And here's a list of all the courses that I cover, including intermediate accounting. Please connect with me on LinkedIn. If you haven't done so, connect with me on YouTube as well. And on LinkedIn, you can take a look at my recommendation. Students that use my system to pass the exam and see how they used it, please connect with me on Instagram and Facebook. So let's take a look at this exercise. Adam Lone Service Company maintains books on cash basis. However, the company recently borrowed 160,000 from a local bank. And the bank requires Adam to provide annual financial statement prepared on a cruel basis. And believe it or not, this is actually what happened in the real world. They come to you, small businesses, they went to the bank. The bank want a cruel financial statement. Their bookkeeper or these oftentimes they don't have a bookkeeper to just they keep their record on their bank statement. Now they need to or tax basis for that matter. Now they need to prepare financial statements. So what they do is you will take a look at the record. You will take a look at their cash disbursement, cash receipts. You will try to restructure their accounts payable, accounts receivable, their current liabilities and current assets to convert. So this is what we are giving. You are told or based on the record, cash collected from customers, 380,000. And usually it's either recorded under quid books or you can take a look at their bank statement and just add up all the deposits. And if they're all receipts from customers, you will know it's 380 cash paid. Again, you can look at their bank statement, salaries, supplies, rent, insurance, miscellaneous expenses. And under cash basis, they brought 380,000. They spent to they spent 270 their net operating cash flows 110,000. Now, now we're going to restructure their account receivable and their account payable as of the beginning of the year and as of the end of the year. And the account receivable, how do you know this? Basically, you will talk to the client and you'll ask them as of the beginning of the year, you might be saying, how did we end up with account receivable if it's cash basis? You just ask them, how many clients or what was the amount that was owed to you by clients? And they would say, well, at the beginning of the year, it was 38,000. And this is how we establish the beginning receivable. And you'll ask them as of the day, at the end of the year, how much do customers still owe you? They would say 30,000. And this is how you would restructure this. You'll ask them if they have any prepaid or if they prepay anything, supplies, how much supplies they had, how much supplies they have now, and any accrued liabilities. In addition to that, you learn that the bank loan is 6%. It was dated September 30th. And there is depreciation of 16,000 for the year. Now, what we're going to do, we're going to convert from cash to accrual. That's what we are going to do. Now, how do we convert from cash to accrual? Simply put, we're going to take each number on the income statement and determine what is the accrual amount of that number? What does that mean? Well, let's take a look at cash collected from customers. This is how much cash we actually collected. Now, we need to convert this number into revenue. Because what matters is how much of that cash that we receive is considered revenue. Now, how do we know whether this amount is revenue or not? We need to examine. We need to analyze the related account, the related balance sheet account, which is for revenue is account receivable. Therefore, we have to analyze account receivable. Simply put, here's what we are saying. If we restructure, I'm going to do it in two different ways. If we restructure account receivable, we started the year. We started the year with 38,000. And at the end of the year, we had 30,000. This is what our account receivable is showing. So account receivable went down. What does that mean? It means the customer paid us an additional $8,000 that has nothing to do with this year revenue. It has to do with prior year revenue. Why? Because my receivable went down. Simply put, let's restructure the whole thing. So let's assume I received $380,000 in cash. Therefore, I have to credit account receivable when I receive the cash, $380,000. What amount do I have here to make the entry balance? The amount is 372. Let me do it in a different color. 372. Let me do it in a different from a journal entry perspective. This is from a T account. So simply put, I restructured the T account and this is what it looks like. Well, if I received cash from a journal entry perspective, I say cash is $380,000. And this is the cash, $380,000. My receivable went down. That means I credited my receivable overall of $8,000. So what's left is revenue. And revenue must have been 372. Therefore, I'm going to start to prepare my financial statement. So first, we have the heading under the accrual basis. And service revenue is 372. So I took what's cash and I converted it into revenue. Now, the opposite would have been true. Simply put, if my receivable, if my account receivable went up, I would have took the cash. This is the shortcut plus the increase in account receivable. Here, I took the cash and I deducted the decrease in account receivable to arrive to revenue. So this is what happened. So I just converted cash collected from customers to service revenue. And this is what I'm going to be doing. I'm going to be taking each account separately and analyzing it. I'm going to look at, now we're going to look at our operating expenses. Starting with salaries, 186,000. What I do is, I will take a look at my accrual account or at my balance sheet account. And I want to determine whether I have any accrual for salary expense. There is no accrual. If there is no accrual, if this is the cash that I paid, simply put, it means that's the amount that I accrued. 186,000 from an accrual perspective and cash perspective, there is no change. Supplies, let's erase this and analyze supplies. Because we do have an account for supplies. So what happened to my supplies account? Let's restructure the T account. Let's look at the supplies account. Supplies starting the year with 1,600 ended up with 1,800. Well, I know that I have $200 more of supplies. Why? Because look, the overall, there was an increase of 200. There's an increase of 200. There's an increase of 200. What does that mean? It means of this amount of the 31,000 that I expensed, not all of it is supplies expense. Why? Because I paid, but it should be supplies. Well, let's restructure the entry. I paid cash credited 31,000 for supplies. And I know from my journal entry that supplies went up. So supplies, I need to debit supplies. I debit that supplies 200. This is how I know this. Well, it means supplies expense must have been 30,800. Again, let's go back to the T account here. My beginning balance is 1,600. And I recorded 31,000. It means I removed from my expenses, I removed from my supplies 31,000. I expensed this much. Well, if I take 1,600 minus 31,000, it's not equal to 1,800. It means I purchased an additional 200, which is showing. It means I purchased an additional 200. The difference between those two, because supplies went up, it means I did not consume it. Although I paid 31,000 in supplies, but I consumed $200 less. How did I know I consumed less? Because my supplies went up. My supplies asset went up. This is supplies expense. This is the expense account. Therefore, from an accrual perspective, I only expensed 30,800. 30,800. Let's take a look at rent. Now, the opposite would have been true. If supplies account went down, if the supplies account went down, it means I even paid more for supplies. It means if supplies account went down overall, it means I'll have to take 31,000. Plus, since my supplies account went down, it means I consumed more than I will add the difference if the difference was higher. It then would have been 31,200. Simply put, what I did here is I took the supplies and I deducted 200 because I used 200 less of supplies than I purchased. Although I purchased 31, but I only used 30,800 because my supplies went up. Let's take a look at, so we're done with supplies. Let's take a look at rent. Rent, it shows that I paid 15,000. It doesn't look that I have any account on the balance sheet, not prepaid rent or not rent payable. Therefore, rent expense is 15,000. Insurance is 12,000. Prepaid insurance, prepaid insurance started at zero. Prepaid insurance started at zero and I ended up with 2,600. So from a cash perspective, everything that I buy, I would say it's an expense because I'm a cash basis taxpayer. But what happened is my prepaid went up. Well, simply put, I did spend 12,000. I paid 12,000 in cash, but 2,600 of it, I still have. It means I have to reduce my insurance expense. Therefore, my insurance expense is 9,400. From a journal entry perspective, I paid cash 12,000. My prepaid account went up 2,600. It means the expense, the prepaid expense, the prepaid expense must have been 9,400. So this is how I figure out the insurance expense. Miscellaneous expense, I paid at 26,000. Here they're saying I have a liability. Be careful whether you are dealing with a liability account or an asset account. So when you are doing those converting cash to a cruel, be careful whether you are going from a cash to a cruel using an asset or a liability because it makes a huge difference. My miscellaneous expense, it means I paid 26,000. However, my liabilities, my accrued liabilities that are related to this account, that are related to this account, showing that I went from 3,000 to 4,000. It means my liabilities went up by 1,000. What does that mean? When my liabilities goes up, it means I am not paying for something. It means I am not paying. It means I am expensing something but I am not paying for it. One more time, what does that mean? It means I did from a cash. This is the cash account. This is the cash number. The cash number I paid 26,000 in cash. In addition to that, I accrued another 1,000. It means my expense is 26 plus 1,000. It means my expense is 27. And the reason I add the expense because this is, I add the 1,000 because my liabilities went up. When your liabilities goes up, it means you are recording an expense because every time you accrue an expense, you debit an expense and you credit a liability. Here, what's happening is you increased your liabilities by 1,000. It means you increased your expenses by 1,000 but notice this expense is not cash. That's why it's not showing with the 26. Therefore, when I convert, I have to add this additional 1,000. And if you wanna see it from a journal entry perspective, I credited cash 26,000. I credited accrued liabilities 1,000 because it went up by 1,000. Notice it went from three to four. Therefore, the miscellaneous expense to balance is 27,000. And this is how I end up with 27,000. This is how I end up with 27,000. So be careful whether you are dealing with a liability or an asset. Okay, be careful because it makes a huge difference. And that's why converting from cash to accrued, you have to understand your liabilities, how your liabilities work and how your asset work. Let me give you a shortcut. But if you really want to learn this, you gotta really understand the cash flow statement. Every time your assets go up, every time your assets go up, from a cash flow perspective, it means your cash is going down because to acquire asset, you have to consume cash. Every time your assets, when you are using your assets, I'm assuming here other than cash because we are dealing with cash, when your assets goes down, it means you are not using cash. It means your cash flow is not being, I'm sorry, your cash flow is up. When your asset goes down, when your account receivable goes down, it means you are collecting money. When your supplies goes down, it means you are using supplies without spending the cash now. When your prepaid goes down, it means you are using your prepaid without paying cash now, okay? This is for assets. For liabilities, it's the opposite. When your liabilities go up, it means from a cash flow perspective, your cash flow goes up. So when your liability goes up, like accrued liabilities here, when your accrued liabilities goes up, it means you are not spending cash. You're gonna have to pay it later, but for now, it's an increase in your cash. You are not paying cash. You are using other people's money to record your expenses like here. You are using your expense in a thousand, but you're not paying it. Now, when your liabilities goes down, what does that mean? When your liabilities goes down, it means you are paying off your liabilities. Therefore, it's your cash is going down. Your cash is going down. So you have to understand this relationship extremely well, extremely well. Okay, let's keep going. So also the company had depreciation of the equipment of 16,000. Therefore, we booked depreciation. Then total operating expenses is 284,200. Now we're gonna take service revenue minus operating expenses. We'll give us operating income. Now we still have to deal with the loan, okay? Now remember, the loan is not part of the operating expenses. The loan is part of other expenses, not operating expenses. Therefore, we have to compute the interest on that loan. The interest on that loan, well, how do we compute the interest? We took the loan in September. So we have end of September, be careful. So we have October, November, December. We borrowed money for three months. And the interest rate on this money was 6%. As a result, it's gonna be 2,400 the interest expense. Therefore, interest expense is 2,400. Now we can find that income, 84,400. We're ignoring taxes here obviously for the sake of this example. So what we did is we took cash disbursement and we convert them into accrual. We convert them into accrual figures, accrual figures. Again, this number is extremely important for your CPA exam, this type of question. Why? Because on the exam, you are expected to know how to convert from cash to accrual. I can help you understand this. On my website, I have explanation, examples, but to understand this, my suggestion is to understand the cash flow statement first, because that's gonna give you a comprehensive review, then go back and view cash to accrual. Okay, that's my advice to you. But it doesn't mean I cannot teach you the cash to accrual, right, from the get go. And I do so in my recording. I do say, and I would say, I'm teaching you this and you will use it for your cash flow. Many students, they find it easier to start with the cash flow and go back to cash to accrual. It's up to you how you would use it. Make sure you understand it, both ways, how to go from cash to accrual and from accrual to cash. Okay, because the cash flow statement is you're gonna take your accrual and convert back to cash. Anyhow, stay safe, good luck, and study hard for the exam.