 Hello, and welcome to the session in which you would look at this CPA exam simulation. And it's specifically a FAR accounting and reporting simulation. So how do you approach a CPA exam simulation on the exam day? Well the first thing you do, if you want to scroll down and take a look at what type of a simulation am I dealing with. So if we scroll down, we see I'm dealing with some journal entries. So that's the type of the simulation. Notice here there's an account name. I have to choose an account and I have to choose a debit amount and a credit amount. So the type of the simulation is journal entries. That's fine. The next thing I want to see is what is the topic of the journal entries. So I know it's a journal entries and I should be familiar. I should be comfortable with journal entries, especially if I'm using four hat lectures because this is what I do. I teach accounting from basics. So what is the topic of the journal entries? So let's read real quick. There's no exhibits in this. There's no exhibits in this simulation. On January 1st, Lex purchased equipment for 90,000. We're looking at a purchase of property, plant and equipment. This is what you should be thinking now. In addition to the purchase price, Lex paid $6,000 in sales tax, $1,600 in shipping cost, $3,000 in personnel training cost, $2,400 in installation cost. The equipment has an estimated salvage value of 10,000, total estimated life of 10. At this point, I don't have like, even if you don't read any further, I know we're talking about the cost of the equipment, either determine the cost or most likely there's a journal entry, either journalize the purchase of the, of this entry, the purchase of this asset or some sort of depreciation. That's what you should be thinking in your mind. Lex uses the straight line method depreciation and voila. We're looking at depreciation. So at this point, your stress level should go down, your confidence level should go up. I'm dealing with a, with the property, plant and equipment. We purchased one and there's some sort of depreciation. Let's see what they're asking. At this point, you should vary, you should be very, very comfortable. On January 1st, the estimated salvage value was revised to a total of five years from the date of the purchase and estimated salvage value was reduced to 5,000. So what happened also, the following year, they revised the useful life of the asset and they revised the salvage value. Again, I'm still dealing with property, plant and equipment. The equipment was sold for 55,000 July 1st, year three for the situation below record the appropriate journal entries. Great. I know what I'm dealing with. I purchased an asset. I'm going to might have to book depreciation. I might have to book the purchase of the asset. I might have to book the depreciation and I might have to book the disposal of it. I don't even know what I'm looking for. Okay? But this is basically what they are asking me. So let's go ahead and solve this simulation. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation, as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses, broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead. Start your free trial today. So let's look at more specific instruction to prepare each pre-quire journal entry. Look at those real quick. Click on the cell to figure out the name, enter the corresponding debit and credit. All the amount is automatically rounded to the nearest dollar. Not all row and the table might be needed and if no journal entry, no journal entry is needed. So the first question you are being asked, prepare the journal entry to record depreciation for year two. Okay. So they want the depreciation for year two. Now if they ask you for the depreciation for year one, well, it's basically a financial accounting question, really, really basic. Even for year two, I believe this simulation is a basic, only basic if you understand how property, plant and equipment works. And this is again, I cannot keep emphasizing this. This is what I actually teach you. So in order to compute the depreciation for year two, you need to compute the depreciation for year one. Why would I say this is simple? In my class, I can add two more complications to this simple exercise. Rather than January 1st, I can tell you the asset was purchased April 1st. For example, this is one. In this way, I will force you to do what's called a partial depreciation for year one. Also what I would do is rather than give you the straight line, which is an easy form of depreciation, I can give you the double declining balance. So I can add two complication to it. I can add more complication to it, but I will not. So let's go ahead and get started. So what would you do? The first thing you do is you need to determine the cost of the asset. When you buy an asset, you need to depreciate the asset. So what is the cost of this asset? Well, let's take a look at the cost. The first cost is the purchase cost. You purchase this asset for 90,000. So obviously the purchase cost is the main cost of the asset. What else? You purchase the cost. You paid $6,000 in sales tax. Is sales tax added to the cost? Of course it is because when you buy something, if you pay sales tax, you cannot purchase that something without paying the sales tax, therefore it's a necessary cost. Shipping cost. Can you buy something and not ship it and get it? No. It is a shipping cost is included because you need to have it and to have it, you need to do what? You need to ship it. So you cannot say it costs me 90,000. It costs you the sales tax too. It costs you the shipping cost as well. The shipping cost is $1,600, $1,600, $1,600. Now you incurred $3,000 in personnel training cost. Well, you're training your personnel to use the asset. Is this part of the cost of the asset? No, it's not. Because what happened if your employees are already trained? Do you have to incur this cost? No. Are you dealing with the asset itself? Is training cost getting the asset ready for its intended use? No, it's getting the employee ready to use the asset. So here's the trick here is training personnel cost is not cost of the asset. Let's switch to you paid $2,400 in installation cost. So notice the difference between training cost and installation cost. In both costs, you are paying for employees. You are paying for someone. You might have hired outside service or you might use your employee to install the asset. Why do we include the installation cost? Because you cannot get this asset ready unless you install it. It's getting the asset ready for its intended use. Training personnel cost, it's getting the employees ready to train the asset. So what do you include in the cost? Any cost necessary to get the asset ready for its intended use. So training personnel is training the employee to use it, not part of the cost. So if we add $90,000 plus $6,400 plus $1,600 plus $2,400, we get to a nice surrounding number of $100,000 and hopefully this will be a hint for you. This is the cost of the asset. So now we determine the cost. We did not answer the question because the question is figure out the depreciation for year two. Well, an order in year two is easy to find. Year two would have been, let's see, let's see if there was no revision, how would we do it? So if there was no revision to this asset, we would take $100,000, there's a salvage value of $10,000 equal to $90,000. This is the depreciable amount because we have to deduct the salvage value. $90,000, the original asset useful life is $10,000, therefore $9,000 per year. So the entry would have been for year one, the entry would have been for year one, depreciation expense $9,000, accumulated depreciation $9,000. This is for year one and this is the correct entry. Now if there was no revision to the life of the asset, year two would have been easy. Year two would have been the same. But what happened is in year two, the asset life was revised. The asset life was revised and as a result because the asset life was revised, we have to change the, quote, the cost of the asset because basically now we have a different starting cost which is a different book value and the salvage value was used. So when you revise the asset, you are simply dealing with a new asset, what do I mean by a new asset? You are simply dealing with a new book value, new salvage value. So what's the book value of the asset as of the beginning of year two? Well you started with the asset of, you started with an asset that has a cost of $100,000. In year one, you took out $9,000 in depreciation, therefore your book value as of the beginning of the revision of this asset is $91,000. So now what you do, this is basically in quote your new cost, $91,000. Now to compute the depreciation for year two, you're going to take $91,000, same thing, same formula that they used for year one except now you have a, I'm going to put the salvage value in a different color, you have a different salvage value. The salvage value is rather than 10, let me just fix this because my 10 is acting up, so we're talking of an asset of $91,000, let me just make this bigger, maybe this will help, $91,000, not 910, $91,000 minus, let me change the color, minus $5,000 of a new salvage value, therefore if I take $91,000 minus $5,000, I'm dealing with an asset of $86,000 depreciable asset. This is my new depreciable amount. Now I'm going to take this new depreciable amount divided by the useful life of the asset went from 10 to 5, I already used up one year, what I'm left is with 4, so I'm going to divide this $86,000 by 4 and I'm going to get a number of $21,500 and this will be my depreciation for year two. Notice, if the depreciation for year two was not changed, it would have been the same as year one, since it was changed, they increased the depreciation. How did they increase the depreciation expense? They reduced the life of the asset, they reduced its salvage value, you have more depreciation. So the first question was, book the depreciation for year two, again here you have to know depreciation inside out and the entry is debit depreciation expense, credit accumulated depreciation, that's the entry, and the amount is $21,500, $21,500. Now what else would you need to know about this depreciation problem? Well, you need to know that it's a straight line, which is easy, because in year three prepare to record the journal entry sale for year three. Now remember, we sold the asset and I have to be very careful, July 1st, year three, July 1st, year three for $55,000. Let's go back to my work papers here and here's what happened. In year one, we took depreciation of $9,000. In year two, we took depreciation of $21,500. In year three, if we did not sell the asset, in year three we did not sell the asset, we took depreciation of $21,500. However, in year three, this is the depreciation expense, this is the depreciation expense. Now why am I mentioning this, why am I emphasizing this point? In order to sell the asset, you have to know the book value. So in year three, since we did not keep the asset, so we only kept it till July, therefore we had it January, February, March, April, May and June. So July 1st, we sold it, we have to divide this by two, $21,500 divided by two will give us $10,750. Now simply put, in year three, we debit depreciation expense $10,750, credit accumulated depreciation right before we sell it $10,750. So the first thing you want to make sure, you want to make sure your depreciation is up to date. Okay, now let's add up how much accumulated depreciation we have, why? Because you have to compute the book value of the asset when you sell it. That's the first thing you need to do, you have to compute the book value. What's the book value? Equal to the cost of the asset minus accumulated depreciation. So the cost of the asset is $100,000. What is the accumulated depreciation? It's $9,000, oops, it's $9,000 for year one, $9,000 for year one, I'm going to break it down here for you again, plus $21,500 for year two plus $10,750 for year three, which is for the partial year. So if I add this up, $9,000, $9,000, I keep putting $91,000 plus $21,500 plus $10,750 will give me $41,250 of total accumulated depreciation. Now if I take $100,000 minus, let me change the color here, minus $41,250, I will have, let me see, $100,000 minus $41,250, I have a book value of $58,750, now this is my book value when I sold it, okay? Now let's prepare the journal entry, how we sell it. Well you can start with the easy part, you can start with the hard part, let me start with the easy part. The first thing I do is I get rid of the asset. I have an equipment, I have a piece of equipment with a book value of $100,000, I get rid of it, equipment, I credit the equipment. So if you credit the equipment, you have to debit accumulated depreciation, why? Because accumulated depreciation is, is the asset, is how much asset, how much of asset you have, how much of, what do I mean by this? You have to debit accumulated depreciation, in other words how much of the asset to get rid of. If you get rid of the asset, you have to get rid of, it's accumulated depreciation. Because I already booked depreciation expense, so I can have two entries, I already booked depreciation expense, therefore I am going to debit accumulated depreciation for a total of $41,250 because I sold the asset, I got rid of the asset. Now you're going to see I can break this into two different entries, I will show you this in a moment, okay? So I, I debited accumulated depreciation $41,000, $41,250, okay, I got rid of the asset. Let's start with the easy part now. Well, this is easy, well easy, also easy part. Easy is debit cash, I received cash of $55,000, okay? So I received cash $55,000, I recorded the cash debit, I got rid of the asset, I got rid of its accumulated depreciation. What am I left with? I am left with what? I am left with computing the gain or the loss on this asset. Is it a gain or is it a loss? Well, it's a loss. Why? The book value was $58,750 and that's why I had to compute the book value and I received $58,000, $55,000, therefore I have a loss of, sorry my, my pen keep on acting up, I'll show you this on the, I'll show you the journal entries. The loss is $3,750, I debit a loss on the equipment and this will be the journal entry. So let me show you how you will do it on the exam day. Now on the exam day, let me tell you, because you could have this as two different entries, because you could have it as two different entries, I don't know how they will grade it, but basically let's me start with cash, I'll start, okay? I received cash, I would say cash is the easiest one, so if you're, if you're strapped on time, actually there are few easy entries, you debit cash. I would also credit, I would also credit, I'm gonna credit here, I will also credit the equipment because you are getting rid of the equipment, I will credit the equipment $100,000 because this was the original cost, okay? Those are like the easy part. Now what else do I have to do? I have to credit accumulated depreciation and what I did in my example using my method, I'll tell you why I said using my method, in my example I debited accumulated depreciation $41,250, I debited accumulated depreciation $41,250, okay? I had a loss of, a loss of, a loss of, a loss of $3,750, now this is a correct journal entry, but I mean this is correct. Now the fear here is the system might, may or may not consider this correct, why? Because they said prepare the journal entry to record year three and any necessary adjustment. What do we mean by necessary adjustment? The necessary adjustment, do you remember at the beginning when I started the sale, I said I had to book my depreciation expense of $10,750 to bring my asset up to date. So what could be also a correct journal entry? You would have to debit the depreciation expense $10,750, okay? And you'd have to reduce accumulated depreciation to $30,500 to $30,500, okay? So this would be also a correct entry, okay? So again, the AI CPA would recommend that you show them depreciation expense separately. The reason I showed you accumulated depreciation because the way I, if you're taking my class I would say bring your depreciation up to date and sell the asset. Well if I asked you to bring the depreciation up to date you would have to debit depreciation expense $10,750, credit accumulated depreciation $10,750. If I do this, this is also correct. This is what the AI CPA want, but I showed you how would I do it if I did it in one shot. Now don't ask me which one is correct. Well it seems here that they want the necessary adjustment. Actually the proper way is to book depreciation expense, credit accumulated depreciation. I would say the most accurate way, okay, is to do what I did. Do two entries. First book depreciation expense, then book what I showed you here because you already booked accumulated depreciation. So you would put two entries. Which one is correct? This is the solution that they gave. I don't know which one is correct. Maybe both are correct. Maybe if you do the other one, also the software will accept as a correct answer. Am I sure about this? No, I'm not because no one knows because how they grade the AI CPA exam questions is basically a black box. To summarize, again, I would say this is a simple straight forward exercise. Literally I give this exercise literally in my financial accounting 101, which is my freshman accounting class. So when someone tells me simulations are difficult, no they're not. I'm sorry, you're not prepared well. You don't understand the topic. The only thing tricky in this topic, the only thing tricky is this 3000 personnel cost. So let me tell you something. If you included this 3000 personnel training cost within the cost, your depreciation would be incorrect and everything else will be incorrect. Well they might give you credit for depreciation expense, accumulated depreciation for the account that you used, but they will not give you credit for this because this answer will be incorrect. Also obviously once the depreciation is incorrect, everything else will be incorrect. Now the cash, hopefully you will get it right. Everything else will be incorrect. If you use the right amount, then you would have to know whether it's a loss or a gain too. You don't know. The point is, is don't panic, do your best. Simulations, they're not a threat to you. You're a threat to them, okay? And in a sense that you can manage this, especially if you are using far hot lectures. You use my property, plant and equipment lesson. This is easy peasy lemon squeezy. Good luck everyone. Stay safe. I'm always here for you.