 Hello and welcome to the session in which we would look at this CPA exam simulation that's covered on the financial accounting and reporting exam. The first thing you do when you look at a simulation is what type of a simulation am I dealing with? I'll scroll down. What I'm looking for is some type of drop-down menu, yes and no, and I have to input some figures. I have to compute some figures and put some figures. Good. I should not be intimidated by this. Second thing you do is what is the topic of the simulation because the simulation topics are topics that are covered on the CPA multiple choice covered through the blueprint. Let's read real quick. What is the main topic of the simulation? RAF company is reviewing the accounting and disclosure requirement for its significant guarantees, commitment, and contingencies, including litigation as of December 31st, year three. Right there, it looks like this is the topic of the simulation so far. The financial statements are expected to be available and to be issued on February 10th, year four. Use the information in the exhibits above to determine the amount, if any, to recognize and whether disclosure is required in RAF financial statement as of and for the year ended, year three. Unless otherwise specified, assume that no amount related to these guarantees, commitment, and contingencies, including litigation, have been recognized. So nothing has been recognized. That's it. I know what is the topic is all about. Now I can go ahead and get started. 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. I am not going to look at any exhibit unless I know this exhibit will help me. So in other words, don't waste your time looking at exhibits now. Why not? Well, because let's take a look at what we are told. Contingent copyright infringement, starting with copyright infringement. Do we need to disclose the copyright infringement? And yes or no? And do we need to basically book an asset or a liability? Usually, we're booking liabilities. And remember, liabilities make sure they're in parentheses. Copyright infringement. Now I have, what do I look for this information? Well, I have one, two, three, four, five exhibits. Would I look for it in the letter of credit? No. Would I look for it about email regarding letter of credit? No. Would I look for it about email regarding loan guarantees? No. Copyright infringement, it's not going to be a state, a letter from the state and health and safety agency. So I'm going to look, I'm going to look at the letter from an outside console to RAV, a general console. Click on this letter. Let's see what's in that letter. Well, that's a lot of information in that letter. I'm hope I'm going to find something about the copyright infringement. This is how I'm, how I am, how I am approaching this. So this is from the outside console to our console. The following is an update on four matters for which we were retained to represent RAV. This is the outside console. There are four matters. So we know this letter is going to have four different things. RAV is a defendant in 6 million copyright infringement lawsuit brought by beach in October year three. RAV has offered 1.5 million to settle the lawsuit, but they counter offer a 5 million. The case is not expected to go to trial and we believe that the loss is probable. There's a good chance we're going to lose. That's why basically we offered 1.5. As of the date of this letter, negotiations are ongoing, although we cannot determine the exact amount of loss, we believe that the reasonable estimate of the loss is between 2 and 5 million. No amount within that range is more likely outcome than any other amount. That's my answer for this copyright, copyright infringement. Do I have to disclose it? For sure I have to disclose it. Do I have to book a liability? Yes, I have to book a liability. Why? Because it's probable and I can estimate a number. And what's the number? Is it 2 million? Is it 5 million? Since it's between 2 and 5 and no number is more likely than the other, gaps as you can go with the 2 million because no number is more likely than another. So it could be 2, it could be 5, but we don't know the percentages. Therefore we can go with 2. That's it. This is done. Do I have to disclose? Of course I have to disclose. Do I have a liability for this? Of course I do. And the liability is remember 2 million, it's a liability, it's in parentheses. Done. Loan guarantee. Okay, do I have to disclose a loan guarantee? And if so, do I have a liability? Loan guarantee. Let me take a look at this legal counsel real quick later, make sure there's anything about this loan guarantee. There's a product liability here real quick. I'm looking at this real quick. Some water damage, state something from the state health and safety agency. Based on our review, we believe that will be subject to a penalty. That's fine. None of it, none of this about the about the loan guarantee. Well, there is an email regarding the loan guarantee right there. I missed it. Click on the loan guarantee email. Let's see what's in that email. From the controller to the accounting manager, we just received a notice from Birch Company and unrelated third party with respect to the loan guarantee we provided for the company. At the inception of the guarantee, you recognize $150,000 liability for this guarantee. It looks like we're going to be responsible for this. Now from the CFO of Birch Company to the controller, RAV has fully guaranteed an outstanding loan of half a million from Sunnytown Bank. Due to our deteriorating financial condition, we were unable to repay the loan, which was due on December 31, year three on January 15, year four, Sunnytown Bank deliver us a notice of default in accordance with the terms of our loan as a result of our default on the loan and our inability to pay it's probable that Sunnytown Bank will require you to perform as a guarantor. Please let us know if you have any questions. Very nice letter from them, right? In simple English, RAV guaranteed the loan of another company. Once you guarantee the loan of another company, hold on a second, whether that company is going to default or not, it's the answer is always yes. So if you guarantee the loan of another company, you always have to disclose it. Now whether you have to book a liability or not, that's a different story. This is what we have to determine now. And the answer is yes, if it's a probable, it's clearly probable. We're responsible. We're on the hook for that loan. RAV is on the hook. Therefore, they have to record the liability for the full amount of half a million for half a million. Okay. And accept property insurance claim. Let's go back here. Property insurance claim. It's not loan guarantee. It's not line of credit. I believe I saw on the letter for the legal console, there was something about property insurance claim. And it's right here. We have an insurance claim on October 15th. Let's take a look at this. One of RAV's facilities sustained significant water damage. At your request, we conducted the property insurance carrier to check on the status of the 2.5 million claim that RAV filed. So that's what they did. The outside counsel did that on December 27th, year three, the property insurance carrier acknowledged that the loss to be covered by the insurance policy is so good. So we're covered. However, the property insurance carrier stated that its adjuster is still reviewing the claim and does not expect it to settle until March year four. So they accepted the claim, basically said, don't worry. This event is covered by your insurance, but we cannot give you an answer yet. The property insurance carrier further indicated that any payment is subject to a deductible of 125. That's fine. Do we disclose this? No reason not to. We can disclose this. It's basically a contingent gain because we're going to be receiving some money from the insurance company. Do we book any asset? Do we book any receivable? And the answer is no, no, you don't. You don't book anything there. And the reason you don't book anything there is because gain contingencies, you cannot book them. You want to disclose them? That's fine. Especially if you disclose the event. You want to let the users know that you have an insurance claim pending and you're in good shape. That building is covered, but you don't book how much you're going to be getting. Wait until you get it. Conservatism. Five, penalty from state health and safety agency. Now I saw in that letter, I saw there was a letter from the state health and safety agency. And in the lawyer's letter, I saw something about this. So since that lawyer's letter is open, let me go down and take a look at what the outside council is saying. On November 28th, year three, the state health and safety agency completed its inspection of the facilities, noting several violations. Based on our review of the agency filing, we believe that you'll be subject to a penalty up to 175. That's what the outside, our outside council is saying. But before we make a decision on that, let's take a look at what the letter from the health and state agency is saying. Since we have this additional information, this letter is February 5th. This letter serves as a notice that you are being assessed the fine of 150. Well, our lawyer kind of, they went over the estimate related to a violation of the state health and safety codes that were identified on November 28th. Yes, this is what the lawyer was discussing. Our follow-up inspection indicated that the violation were appropriately remediated and there were no outstanding code violation. That's good. We complied. Now, do we have a contingencies to disclose about? Of course we do. Of course we do. Now, do we have to book an amount? Of course we do. Even the lawyer told us it's going to be 175. But now since we have the letter and we have the exact number, we're only going to book 150. That's fine. That's 150. Oops. Remember, it's a liability. It's negative. Okay. Product liability lawsuit. I believe the letter, that lawyer's letter, has something about the product liability lawsuit. So let's take a look at it. Product liability lawsuit. Let's close the state agency. Product liability lawsuit on September 15th, year three. Product liability lawsuit was brought against our company by a customer who sustained injuries while using our product. As of the date of this letter, we have completed our initial discovery and we believe the lawsuit is without merit. Good. That's easy. Given that the lawsuit lacks merit, we believe that the possibility that Rev will require to pay any amount is remote. What do we know about contingencies if it's remote and the case is without a merit? Companies get sued all the time. They ignore it. Do we have to disclose anything about this? No, we don't. We don't have to disclose. We don't have to book anything. We don't have to book anything. Why? Because it's without merit. We believe it's without merit. There is no liability to book. There is no liability to book. We don't even have to disclose it. It's like, it's a non-existing event. Letter of credit. Well, letter of credit, we have, I believe, two documents. Now, one document, actually two. Letter of credit. Let's see what this letter of credit is all about. This is from Megabank. Issued 1231 expiration a year later. Issued by Megabank. The company is our obligation. Beneficiary is supply company. Amount available. So, the bank may represent this letter of credit upon providing the following documentation within 21 days of the purchase. So, basically, this is a letter from the bank telling us we have a letter of credit of 1.5 million. Oh, that's great. It's good to have a letter of credit of 1.5 million. That's from the bank, but there is something else. You want to check everything. Email regarding letter of credit. Let's see what that email is about. From the Treasury Manager to the Purchasing Manager. Per your request, Megabank issued 1.5 million level of credit for the purchase from supply of raw material that are expected to be received February. So, they're telling us, look, we're telling the Purchasing Manager, go ahead and make the purchase. We have the letter of credit. Now, what do we have to do? Do we have to disclose if we have a letter of credit? Yes, we do. If you have a letter of credit, you just disclose. You have a letter of credit from the ABC bank or whatever bank, and it's for that amount 1.5 million. Do we have a liability on that letter of credit? No, we don't. We don't have any liability because it's just a letter of credit, and it's issued to us, and we can use it. That's all what's to it. It's like a credit card balance that we can use. So, this is how you would approach a simulation like this one. Look, I'm not disclosing anything about the exam, but this is an AI CPA simulation. So, I'm telling you, they're telling you, you could see something like this on the exam, and I know many students do say that they receive questions about contingent liabilities. So, don't worry what the simulation would look like. Worry about how to answer questions about contingent liabilities. If it's probable and you can estimate the amount, you have to book it. If it's not probable, you have to disclose it. If it's possible, you disclose it. If it's remote, you don't do anything. That's what you need to know to answer the questions for this, what looks like an intimidating CPA simulation. At the end, I'm going to remind you to stay calm, to stay confident. Farhad Lectures can help you understand the concept which are tested on the CPA simulation. You cannot prepare for a particular simulation, but what you can do is you can learn the material so any simulation they throw at you, you can learn the type of the simulation and the material so anything that they throw at you, you'll be good to go. Notice we didn't even use a calculator in all of this. Good luck, study hard. I'm always here for you and stay safe.