 Hello, and welcome to this session. This is Professor Farhad. In this session, we would look at an actual CPA simulation that was released by the AI CPA. Those simulations are the real deal. Why it's the real deal? Because the CPA is administered by the AI CPA. And specifically, this simulation will cover BEC. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1,500 plus accounting, auditing finance and tax lectures. For example, for BEC, I have a whole course of managerial accounting, a whole course in cost accounting, a whole course in finance that applies to BEC. And I have hundreds of CPA questions that I work about BEC. On my website, you will find additional resources such as true, false, multiple choice, PowerPoint slides, notes about the BEC, and 2,000 plus CPA questions. I strongly suggest you visit my website. What I'm gonna do next is pull the simulation and we'll go over the simulation together. This way, I want you to build your tolerance and your familiarity with CPA simulation. Okay, let's take a look at this simulation. Once again, the simulations are no more than multiple choice questions in a different format. It's gonna be a lot of multiple choice question, more than one, but nevertheless, it's the same topics and the same thing that you learned in the multiple choice. So the first thing you wanna do is first read the simulation, read what's given real quick, just to get an idea. Now, without even reading, I can tell you, you'll need to compute the quick ratio, the total debt ratio, the times interest ratio, return on equity, but you wanna read what's required. So Oil Inc. a privately owned oil field services company borrowed from TH Bank in year five. The controller has asked you to calculate key matrices to determine compliance with loan covenants. And by the way, if you work in a CPA firm and you're preparing a review, most of the time, the sole purpose of the review is to compute those matrices and to determine whether they are not, the loan is in compliance. And when I was in practice, I did this a lot, maybe a lot mean four to five companies on a quarterly basis. So it's a lot throughout the year. The company generated 2,050,000 in cash flow from operating in year five. Use the information included in the exhibit above. So we have some exhibits, the table below for the year end of December 31st, year five, calculate the required financial matrices and identified in column A, which I already told you we have to do that and enter the associate respond rounder to two decimal spaces in column B. The information and analytics deficient exhibit must be used for any financial ratio. So simply put, they're telling us in the exhibit, they're giving us the ratios. In column C, select the option list provided to indicate whether each of the financial matrices calculated in column B is in compliance with the applicable provisions of the debt covenant and the loan, and the debt covenant and the loan covenant. We can look at the exhibit. So basically column C is basically yes or no. Are they in compliance or are they not in compliance? So the first thing look is the, look at the financial statement position, AKA the balance sheet. This is the balance sheet. That's fine. We're going to need this information. They're giving us a statement of operation, which is the income statement. We're going to need this. Remember, we're working with year five. Guess what? They are giving you the analytical, analytics definitions. They're giving you the ratios. You don't have to memorize anything for this problem. Now it doesn't mean you don't have to memorize them for the multiple choice, but happen for this problem they're giving you the ratio. So you need to know, you need to understand the ratio. So although they're given here, I'm not going to say that don't memorize them. I'm going to say understand them and be familiar with them. At least the most common ones, okay? But if you understand them, they're easy. And this is the bank loan covenant. And this is part of it. Okay, we have to read this carefully because this is what we need to do. TH Bank, the lender is pleased to enter into a loan agreement with oil company to provide financing for investment project. Clear enough, the terms of the loan agreement are documented separately. In the term sheets, the purpose for this letter is to disclose the loan governance pursuant to the loan agreement with TH Bank. Until the commitment have expired or been terminated and the loan principle interest in all fees payable has been paid in full. The company covenant and agrees as to itself and its subsidiaries will the lender that. So here are the terms of the agreement. The company will furnish the lender as soon as available in any event within 95 days after each of physical year of the company is audited financial statements, blah, blah, blah, all the financial statements. So you have to provide financial statements 95 days after the end of the fiscal year. Usually when I was in practice, they ask you like after every quarter. Most of the bank, they ask you, depending on the loan too. The loan is too large or too small. Well, yes, but they need those financial statements. A, 1.2. The company will not permit a quick ratio less than 1.5. The company will not permit a total debt ratio to exceed 0.8 so that that ratio cannot exceed 0.8. The company will not permit the operating cash flow ratio calculated as the ratio of cash flow from operating to ending liabilities to be less than 0.2. So telling exactly how you would need to compute this. The company will not permit the interest earned ratio calculated as the ratio of income before interest and expenses, which is EBIT, to interest expense to be less than 10. So you have to keep the times interest earned above 10. The company will not permit the return on equity to be less than 0.1. And we're gonna see how we compute the return on equity. The company will not permit profit margin to be less than 0.05. And the profit margin cannot be less than 5%. So we are, okay, we are giving what we need to do. Basically now we're gonna compute the quick ratio. Once again, you don't have to remember how to compute the quick ratio, but you need to know. The quick ratio are the quick assets divided by current liabilities. So let's take a look. So here we go. The quick ratio is, let's see what the quick ratio is, current, quick ratio is quick assets, which is cash and cash equivalent, short-term marketable securities and receivable divided by current liabilities. So simply put, we have to look at the balance sheet, the statement of financial position. So we look at the statement of financial position and look, we're looking at year five. Okay, be careful because we're computing for year five. So we take cash and cash equivalent plus account receivable. That's it. We don't include inventory. We don't include prepaid and we don't have short-term investments. So simply put, we are going to take cash and cash equivalent. So you pull your calculator real quick. You will take cash and cash equivalent, 2,570,000 plus 3,300,000. This is your current ratio. I'm sorry, those are your quick assets and divide them by current liabilities. Current liabilities is given as 5,000,000 divided by 5,230,000. And the ratio is 1.12, so we're done with the first ratio. That's it. You are giving everything, you just have to put it together. It doesn't get any easier than this. Now 1.12, round to two decimal point, except. Now we need to determine whether this ratio is in compliance or not. And this is where the hand-twisting start gets into place in the real world. So there we go. The quick ratio cannot be less than 1.5. We're in violation of the debt covenant, okay? So select an option. No, we are not in compliance. We are in violation, which is not good. And you know what happened in the real world? I'll tell you what happened because I dealt with this a lot. One company's in particular. They will go back and ask you to recompute, to look into the current assets and the current liability. See if you have too many liabilities somewhere. But this is basically the quick ratio. The second ratio is the debt ratio. Once again, the good thing is you don't have to you don't have to remember it, but it's total liabilities divided by total asset. Something you have to know, okay? So total liabilities, so since the balance sheet is open, we have, we should have total liabilities. Total liabilities, remember, total liabilities. So total liabilities, 25,810 divided by total asset, 45,930. I think we should be in good shape for this, but you don't, you know, in good shape. It means we are in compliance, but let's, they want the number exactly. So clear your tape and you're gonna take liabilities, 25,810, I don't need the three zeros, divided by total asset, 45,930, oops, divide by 45,930, and that's gonna give us 0.49, that I do this right, total liabilities, 25 million divided by total asset, up 25, not 22. Okay, let's, I made a mistake. You have to be careful, 25,810 divided by 45,930, 0.5619, 0.56, 0.56. So 0.56 is the answer. Are we in compliance? Well, I think it's 0.8. So it has to be less than 0.8, I remember this. So we are in compliance, we say yes for this. Now we need to compute the times interest earned. Well, this ratio is EBIT, earning before interest and taxes, so we don't need the financial position divided by interest expense. So let's go back to see if EBIT is giving. So let's look at the statement of operation. We are giving, again, you're working with year five. So you are giving interest expense, you are giving taxes, you are giving net income. So simply put, EBIT is not given clearly. Actually, let's see. We are giving income before taxes, now, right here. So this income here, income from operation, is income before interest expense and before taxes. So this is EBIT right there. EBIT is, EBIT, sorry, give me one second please. My son just removed his, his, his headphone. Sorry about that, just my son took his headsets out. Now let's back, back on. Okay, so this is EBIT, earning before interest. You're not going to see this on the CPA exam for sure, right? So this is EBIT, earnings before interest and taxes divided by interest expense, and let's do this, get the calculator and let's see what we have. And I think we should be in good shape. It's going to be more than 10 because it's more than 10. So 4,320 divided by 260. If you're going to not use the zeros, not use them for both. So we're 16.6153, 16.62. So the answer will be 16.616.2 and we're in good shape. We are in good shape. Yes, we are in compliance because it has to be more than 10, okay? Now we need to compute return on equity, return on equity. Every time you hear the word return, it's net income. Every time you hear the word on, it means divide. And every time you hear the word equity, duh, it's equity. But you have to be very careful when you compute return on equity. Why? Because return on equity, the numerator is an income statement account and the denominator is a balance sheet account. What does that mean? It means when you divide an income statement account by the balance sheet account, you have to be careful because the income statement is a number that represent the whole year. So notice the income statement is 2,730,000 but this number is generated throughout the whole year. So it's for a period of time. When you divide an income statement number by a balance sheet number, the balance sheet number is only a point in time. So let's keep this open. Let's get the statement of financial position here. Let's look at total equity. So total equity is 20 million for year five, 20 million, 120, 17 million, 739, 700, 17 million, 390,004 year two. What we have to do because it's a balance sheet account, we have to find the average. Simply put, we have to find the average. So first let's find the average, clear your tape, find the average, 20 million. I'm not gonna use the three zeros, 20 million, 120, plus 17,390, that's 37,510, divide that by two and that's your average. You wanna write it down in case, 18,755. Now I'm gonna take net income which is 2,730, 2,730, again I'm not using the last three zeros divided by 18,755 which is the average equity. And that's gonna give me 14.55, you get around it, it's gonna be 15%. I don't remember what the requirement for this, but it's 0.1, 0.1, 0.15. I need to know what's the, I don't memorize that number. So let's go back to the loan covenant here and return on equity is a requirement for that. Yes, cannot be less than 0.1, we're in good shape. So we return on equity is 0.15. So we are in compliance here as well. Operating cash flow. Remember what they said, they said operating cash flow is cash flow from operation divided by current liabilities. And I believe cash flow from operating was given to us right here. I believe it was giving someplace clearly, not here. Oh, right here. Cash flow from operation is 2 million and 50,000 and we have current liabilities. It means how much do we have cash flow from operating that we could cover current liabilities? Current liabilities are current liabilities. Current liabilities are total current liabilities, 5 million, 230,000. So simply put I'm gonna take cash flow from operation 2 million and 50,000 divided by 5,230,000, which is current liabilities. And that's gonna give me 0.3919, which is 0.39, 0.39, 0.39, which is 39. It means from our cash from operation can cover 39% of our current liabilities. And what's the requirement for this? Let's take a look at the requirement. The company to see operating cash flow cannot be, cannot be less than 1.2. Wow, we're in trouble here, right? We're in trouble here. The client is in trouble. So yes, it is way less than 1.2, which is that's a lot. I mean, I believe in the real world, this is a big burden to overcome. It means from cash from operation has to cover your liabilities 1.2 times. Wow, that's a high ratio to meet, okay? So they're failing in this rate. No, they're not in compliance. They're not in compliance. They're failing here, so no. So they're not in compliance. And the last one is profit margin. It has to be, it cannot be less than 5% 0.05. And profit margin is net income divided by sales. You need to know this, net income. Again, it's given. You don't have to memorize this, but the point is you gotta know it. If you don't know what profit margin is or net profit margin, well, it's the bottom line divided by the top line to determine for every dollar in sales, how much do you keep in profit? So let's find out. Think it's close, 2,730 divided by 39,500. That's 0.69113, almost 0.07, so it's 7%. So the profit margin is 0.07, whoops, 0.07. Are we in compliance? Yes, we are, because it's more than 0.5. So simply put, as you can see, this VEC simulation, I consider to a great degree easy, straightforward easy simulation. Although at the beginning it might look intimidating, it might look, you have so many things to look at, but it boils down to ratios. If you know your ratios, you don't even have to know them. They even, they gave you. Just you need to know how to put them together and stay calm and don't panic, and that's all what's to it. Again, I would like to remind you to go to my website. I have a lot of lessons, exercises, practices about ratios, explanation. Subscribe, you study once for your CPA exam. I'm here to help you. Good luck and invest in your career.