 Hello and welcome to this session. This is Professor Farhad and this session we're going to be looking at an actual CPA simulation that was released by the AI CPA. This is a far simulation. 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 1600 plus accounting, auditing, finance and tax lectures. This is a list of all the courses that I covered including CPA questions. On my website, you'll have access to additional material such as true, false, PowerPoint slides, notes, multiple choice and 2000 plus CPA questions. So let's take a look at this simulation. So this is what the simulation looked like. I'll have to tell you upfront the dissimulation. I believe it's comprehensive and it relies on two type of knowledge. It relies on your education knowledge. Basically, this is something you might see on a long exercise in your college or and or and some of the information you might see in the real world. So this simulation I considered, it's not difficult, but it's a challenging simulation because it combines both your college knowledge and your practice. So if you never practice accounting, you're going to find some of the information a little bit intimidating, but that's the point of going over the simulation is to make you better at approaching those simulations. So the first thing is you want to take a look at the simulation, read what's giving, just to get an idea what you are looking for. So we have Oak Company. It's preparing. Let's make it a little bigger. Oak Company is preparing its financial statements as of the year and December 31st, year five. Review the exhibits above to identify any adjustments required to draft the income statement for the year ended. So basically, now we're going to find out what this simulation is about. It's about the income statement and basically it's given here and we have to make some adjustments to the figures. Again, an intermediate accounting course. I know I teach intermediate accounting. I do have exercises like this, but you're going to see the information that's giving. It's more like from the real world, but it doesn't make a difference. It's not, it should not be intimidating once you get used to it. To adjust the draft income statement, enter the amount associated with the adjustment in column C. So basically we have to put something in column C, enter increases to revenues and expenses as positive, whole values and decreases as negative. Enter decreases to gain as positive, whole values and increases to gain as negative, whole value. So you have to be very careful. If no adjustment is needed for the financial statement line item, then leave the associated cell in the column C blank. That's fine. If multiple adjustment affect a single financial statement line, then enter the net amount of the adjustment. So maybe one adjustment might affect more than one line. Adjustment may not require some rows within the draft income statement. That's fine. Amount in column D and subtotal will automatically calculate. So the amount in D will automatically compute if you put an addition or a subtraction. So now you know what you want to do. You know what you are looking to do. First, real quick, look over the exhibit. First exhibit. Summary of year five result for segment B. Revenue, operating expenses, transactions or something about segment B. That's all you have to know for now. Let's look at this. This is the debt agreement memorandum. It seems we have some loan. The following summarizes the key terms of the debt arrangement entered into by Oak Corporation in National Bank January 1st, year five. We borrowed 10 million. Semi principal repayment of a million beginning July 1st, year five. The interest rate is variable. It's the six month library as quoted at the beginning of each semiannual plus 2.5. It's 2.5 plus library. Principal and interest payment, July and January. Maturity January 1st, year 10. National bank is Oak first and only lender. That's fine. So when we need something about the debt, we'll come back to this. Analytics definition. Here they're giving us analytics. That's fine. Just close it. Just a bunch of ratios. Email regarding pine corp sale contract. So let's look at the email. You want to scan it real quick. You may want to come back to it later. So we have an email. It says senior accountant. It's from the controller to the senior accountant. While working on year end closing, please consider the following new customer contract details. Oak enter into a contract with new customer pine to produce and deliver 20,000 product for pine. The total transaction price was 450. The shipping terms are FOB destination. Now controller. I spoke with the manager of the shipping department and I was told that the department shipped the 20,000 on December 31st to receive confirmation from the common carrier that pine receive all 20,000 product on January 2nd, year six. Based on this information and your email below, I recorded the following journal entry. Debit account receivable, credit revenue, debit cost of goods sold of 350 credit inventory. So this is what they did for this transaction. Okay. So we're just going to kind of close it for now and we'll come back to what we need. Now we know. Now this is the interest expense general ledger details. So this is the actual account record for the interest expense. We have the semi annual interest payment. One is 187 500 and one is 181 68 750. So the total interest expense is 356 250. That's fine. We can close it. We have research and development account. So we have the opening balance was zero engineering cost to develop specification for prototype material consume. You want to read those because they're giving it to you for a reason. They don't give you anything for no reason. So you want to make sure you read it. Material consume to develop a prototype market research. Just scan them. Scan them real quick. We'll come back to them later. And additional information. The following list provide information for oak and for the year ended December 31st. We're given the live or rate the six month live or rate. Okay. That's that's what we are giving as information. That's good. Once we are dealing with the interest will come back and we'll dig through it. So all what we did now is we look at the information that's given. So now we are ready to start to make the adjustments based on the information. So you know what information you are giving and you know where to look for the information. So let's go ahead and scroll down to the income statement. And it seems here we might have to make an adjustment about revenue in cost of good. So how do I do this? Because here they're giving you a number. It means you might. It doesn't have to. But you might. Now remember there was a sale. There was a sale transaction with regarding pine email regarding pine corporation. Let's go back to that. Let's go back to that transaction and see what we are giving and what are we supposed to do? Okay. So oak entered into a contract with a new customer to produce and deliver 20,000. The total transaction. It was FOB destination. All right. So here's what we did. We shipped it. We shipped the product December 31st, year five. Okay. And we recorded the following account receivable debit credit revenue debit cost of good sold credit inventory. So simply put, we recorded the transaction. Did we do the right thing? If we did the right thing, then there's nothing there's nothing we can do. There's nothing to do because that's the only information we're giving about revenue and cost. If it's not, then we have to do something. Is this, do we have to do anything here? And the answer is yes. It's a simple, do it destiny about a very simple concept and accounting. And that's FOB destination versus FOB shipping. If it's FOB destination, if it's FOB destination, you did not really complete the sale until the product was received by the customer. When did the product was received by the customer? The product was received January 2nd, year six. It means this sale cannot be recorded December 31st, year five. That's all that's to it. It looks intimidating. It's a lot of information. Well, guess what? We cannot book this transaction. What does that mean? It means we have to reduce our revenue by 450, reduce our cost by 450. Obviously, we have to also reduce account receivable and inventory, but we are not giving the balance sheet here. So what does that mean from as far as we are concerned as this exercise? As far as we are concerned, we have to reduce revenue by 450,000 because the sale was FOB destination. It was not our sale and the cost of goods sold has to be reduced by 350 because we increased our cost. Now, this revenue and sales will be booked in the following year. But for this year, we have to back out the revenue. We have to back out the sale. This is basically what we needed to do. And it's all based on the concept. Do you know what FOB destination is? FOB destination, you did not really complete the transaction until you deliver it. You deliver the product. So the inventory is yours until you deliver it. Well, we did not deliver it until year six. Therefore, year five, it cannot be considered revenue and we cannot remove the inventory from our books. That's it. So we adjusted revenue and cost of goods sold. And I don't believe there's anything about revenue and cost of goods sold. Here, they're asking us about the general and administrative expenses. And they'll tell us about research and development and sales and marketing. So they're giving us three expenses and we might have to adjust them. Now, what did you see information about those accounts? Well, research and development, we saw information about this account here. So let's take a look at this because everything else has to do with the other thing is interest. So we have other information about interest, but this is not what we are doing now. So here's what we are told. This is the R&D expense account. They're giving you basically the ledger for this. 128 year five, engineering cost to develop specification for a prototype. Is this research and development cost? Yes, it is. Material consumed to develop a prototype for project A. Is this research and development? It is. Market research to evaluate the potential sales price. So here we go. Now you have to understand R&D, R&D, research and development. It's when you are researching, actually doing some work to find a new way of, a new way, a new idea, a new product. Marketing cost, market research to evaluate potential sales is not R&D. What does that mean? It means we need to back out this number out of research and development. So this number cannot be in research and development. This number 215 is basically marketing, sales and marketing. So it should not be there. Third-party contract service provided to test the prototype. That's research and development, 502. We don't have to do anything about this one. Recognition of year five salaries for R&D personnel. Well, R&D personnel, that's research and development. Recognition of year five corporate accounting and finance salaries is this research and development. That's not research and development. So what we find out here, there are two numbers. The 215, we need to get it out of the research and development account. And the 183, I need to get it out of the research and development account. Simply put, I need to back out of the research and development account, the total of these two figures. What does that mean? It means if I go back here, so it's 183 plus 215. So I'm just going to go 183 plus 215, 398. Simply put, from R&D, I have to back out 398,000 because they don't belong there. Okay? Negative. I have to back them out. That means negative. I back them out of there. I have to put them somewhere else. Where do I put them? Well, remember, the marketing, we had the marketing of 215. The marketing goes under sales and marketing. So of that amount, 215 goes under sales and marketing. Basically, this is a reclassification. And 183 was for something else. Let me go back. I forgot what was it about. Accounting and finance services. And 183 goes into accounting and services. So basically what I did, I reclassified 398,000 out of the research and development and into general and administrative and sales and marketing. And all what you needed to do is know the definition of R&D. The knowing those two expenses should not be there. So that's why they gave you this list. When they give you something scanned at first, but when they're asking you to kind of adjust R&D, you have to look at this. So you have to read it and understand those two should not be there. So we're done with this. We're done with this. Gain on disposal. We have a gain on disposal of 300,000. And they're saying we might have to make an adjustment here. Gain on disposal. Let's see. Summary. Let's see what do we have here. Deep pressure. Notice here. Summary two. Summary year five. Result from segment B. So this is a result of segment. Let's see. Additional information. Oh, October 26th. Notice here. Oak sold segment B, a major line of business that represents the strategic shift in the company's operation. This is the keyword and recognize a pre-tax gain of 300,000. Is this how we deal? Is this how we book a transaction such as selling a major line of business? No, this is not a gain. This is a discontinued of operation. So it should not be as a gain. It should not be as a gain. So what does that mean? It means this 300,000 here should not be here. This is not a gain. So what is it if it's not a gain? Well, that's a discontinued operation. So first of all, I have to take it out of here. So 300,000 positive. So I can take it. So I can, oops, not 3,300,000. So I can net this out. There is no gain. And I have to, where do I have to put it? I have to put it under discontinued operation. So if I take it out of there, it has to go somewhere else because I took that gain. It has to go somewhere else. Well, here I have a gain on discontinued operation from another party. I'm going to increase that gain by 300,000. And remember, they told you to put the gain as negative. So the gain goes here. So the 300,000 also emits classification. It came out of the gain account. Let me just close this. It came out of this account and it went into this account. And remember, the gain has to be a negative for the instruction. So that's that. So interest expense, they recorded interest expense of 356,250 and it's based on this computation. No, not this computation. Where do we have the interest expense? I believe we had the interest expense general ledger. Let me take a look at it. Now, this is the debt memorandum, the information. I believe they gave us the interest, oh, research and development, interest expense, general ledger details. So this is how they come up with the interest expense. They're saying interest expense is 356,250. So the question is, is this the correct interest expense? Because here they're telling you, you might have, let me show you here, 356,250. Do you have to make an adjustment for that? So simply put, what you have to do is you have to recompute the interest. If the interest is supposed to be 356,250, you don't touch it. It's good to go. If it's something else other than 356,250, then you have to do something about it. So what do you have to do? You have to kind of compute, compute the interest expense. All right. So let's take a look at what we have here. That, that, that arrangement. So we borrowed, we borrowed $10 million. And we made the first semi-annual principal payment. So we made a principal payment on, on, on July 1st, year 5 of a million, of a million. So we borrowed 10, we're down to 9 million. Variable six-month labor escorted at the beginning of each period plus 2, plus 2.5. So let's find out what should be our interest expense for the first six months, because this is what we are giving. So it's 2.5 plus LIBOR. So at the beginning of the period, January 1st, January 1st, it's 1.25. What does that mean? It means you're going to take, you're going to take your balance was, let's get the calculator here, your balance was $10 million. Clear the tape. You had, you had $10 million. Okay. Then you're going to multiply it by 2.5 plus 1.25, 3.75, 0.0375, oops, 10 million times 0.0375. That's equal to 375,000. And we're going to multiply this by 0.5 because that's four-six months. So $187,500 for the first six months. Let's see if it's $187,500. So let me go back to that interest expense, $187,500. So the first month they computed properly. Okay. Now we have to do the, we have to compute the second six month, not the first month. The first six month is computed properly. Now what happened is this, after we made our first payment, we used to have 10 million worth of, worth of that. Remember we made the interest payment. Then we said we paid a million down. We paid a million down. So our balance is 9 million. Now again, we have to compute the interest expense. What's the interest expense for the second six month? Well, it's 2.5 plus LIBOR went up to 1.5. So 2.5 plus 1.5 equal to 4% times 0.04. That's equal to 360,000, but we're only computed this for six months times 0.5. That's 180,000. Well, it's supposed to be 180,000 based on my computation. They're recorded at $168,750. I have to make an adjustment. I have to increase my interest expense by the difference. So $180 minus $168,750, $11,250. What does that mean? It means I have to increase my interest expense by $11,250. So I'm going to go down here to my interest expense and increase my interest expense by $11,250. So that's my interest expense. That's my interest expense. Now I have to, it seems here, maybe I have to do something about my income tax expense slash income tax benefit, which is C15. Well, what happened is this. Here's what happened. I increased my, simply put, I made adjustments, I made adjustments especially for my revenues and cost of goods sold. Those were actual adjustments. My gain was readjusted. I'm sorry, my gain was reclassified. I increased my interest expense. So all in all, now my income from continuing operation before income taxes is $411,250. Now I need to find out what's my tax rate. My tax rate is 20%. So what I'm going to have to do, I'm going to have to take, let me clear the tape. I have to compute my, my adjustments basically for $11,250 times .2. That's $82,250. So that's my income basically is reduced by that much. It's reduced by that much. My income is reduced. Why? Because remember, I had the gain and that gain is gone. Yeah, $300,000 gain, but that gain is gone. I was taxed on that. Now I'm no longer taxed on that. Therefore, I have to reduce it. Overall, my income tax expense by $82,250. Okay. Now what's going to happen that $300,000 will be, you know, that I removed it from the gain. It's going to go down and it's going to be taxed again somewhere else. But the point is I'm done with my income tax adjustment. I did my gain from disposal. Now income tax or benefit on the discontinued operation. Look, you had the gain. You had the gain $300,000 gain. Well, you have to pay taxes on that gain. How much is the taxes? 20%. Well, guess what? Then you have income tax expense. And hopefully you know this 300,000 times 20% is 60,000. Let me just show you what I'm going to do. I'm going to multiply 300,000 times 0.2 times 0.2 equal to 60,000. So I'm going to have to, let me clear it again. I have $300,000 gain from this continued operation. It has to be reported net of tax. So I have to pay taxes of 60,000. I have to pay tax of 60,000. That's an increase to my expenses. That's 60,000. Now my gain net of tax is 240. Why? Because I had a gain of 300,000. But I had to pay taxes of 60,000. Now what else do I have left? Basically, I did everything because this is computed and that income is computed. So basically, I'm done with the income statement. That's basically what I'm supposed to do. Now additional information here, you can find information about the tax. Let me see where you got the information. Oak effective income tax rate is 20%. So I just want to know where I got the tax information from. Now we're not done with this. We're not done with this. You're going to have to compute the total assets and the total liabilities. So you have a little bit of work on the balance sheet now. Use the information in table above in the analytics definition exhibit to determine the effects on oak's total assets and liabilities. Enter increases of total assets and total liabilities as positive whole numbers and decreases as negative. If no adjustments, the total assets or liabilities then leave the cell blank. So don't put anything. Amount in cell D2 and D3 would calculate automatically. That's good. I don't have to do the computation. I just have to input the number in D4. Enter the return on asset then applying any required adjustment to total assets and total liabilities as a percentage round to the two decimal point. So what did it change in my total asset? So when I did all these adjustments, did my total asset change? And the answer is yes. Remember my account receivable. I reduced my revenue. I also reduced my receivable and my cost of good soul to simply put here's what happened for my. Let me get the calculator here. When I removed 450 of revenue, when I removed 450 of revenues, I also removed 450 of assets. So I have, I removed 450 minus. So I removed that much from my assets, but I also added back to my inventory 350. Why? Because I debited inventory when I credit the cost of goods. So simply put my assets went down 100,000 because I removed 450 and added 350. My assets went down 100,000. So for this adjustments overall, my assets went down. For this one, this one, and this one, those were reclassification. All what happened is I took the expenses out of here and put them in here. So there's nothing, there's no effect on my assets. There's no effect on my liabilities. Gain on the disposal, practically the same thing except that it's going to affect my income tax, but gain on the disposal doesn't really affect anything for my assets. Basically also reclassification. Interest expense, well I added more interest expense. I'm going to debit interest expense credit liability, which is going to affect my liability. Income tax benefit, same thing. It's not going to affect my asset. I don't have any benefit. Gain from discontinued operations was reclassification. And this has to do with the discontinued operation, the income tax expense or benefit. So practically all what happened is my assets went down by 100,000 because I removed that. I removed 450 of receivable, but I also added back 350 of inventory. So the net effect is reduction of my assets of 100,000. Now what happened to my liabilities is my interest, I had an adjustment to my interest expense. My interest expense went up. So my interest expense went up. What else happened? My interest expense went up. My income tax benefit, I had benefit here, went down because I saved money. Then my income tax expense went up again. So simply put, it mostly has to do with interest expense, mostly has to do with interest expense. I'm sorry, interest and taxes. So I added 11,250 of interest expense, which in turn added 11,250 of liabilities because the entries you debit interest expense, you credit interest liability. So I added 11,250 of liabilities. Then income tax expense went down. So basically my liabilities went down. That's going to be a minus 82,250. 82,250. That's minus 71,000. Then income tax expense went up, which is debit income tax expense credit income tax liability. I added 60,000 of liabilities. So it's interest expense and income tax expense, which is under corresponding liability. So overall, 11,000 reduction in my liabilities, 11,000 reduction in my liabilities. So it's the liabilities is minus 11,000. So simply put, this is basically my final year end assets, final year end liabilities, and those are year four assets and year four liabilities. That's what we are giving. That's what we are giving. Now the question becomes compute return on asset. So how do you compute return on asset? That's the question. Well, return on asset, let's see how we'll have to be very careful because they're giving us the analytic analytics definition, analytics definition, return on asset. Let's take a look at return on asset. Return on asset is net income divided by the average total asset. So we have net income. We have the new net income. We use this net income. So our net income is 1,311,250. And we're going to take net income and we compute net income based on the average asset. What is the average asset? It's year one plus year two divided by two. So let's take a look and compute this figure. So let's find the average first. Let's clear the tape. So we have year one 45,025,000 plus 44,975. Let me do it again. Clear the tape. Okay. 45,025,000 plus 44,975,000. 90,000,000 divide this number by two. And the average asset is 45,000,000. Now I'm going to take 13,000,000 which is my net income, my adjusted net income, my new net income. So return on asset. And why do you compute by the, why do you divide by the average? Because the income statement is a period number. It's for the whole period. And the balance sheet is a point of time. That's why you have to compute both. You have to make sure you're using the beginning and the end of the year because that income covers the beginning all the way till the end of the year. So the so the denominator has to cover the same period. So 1,311,000 divided by 45,000,000. That's equal to 2.91. Therefore the ends 2.93, 2.91. So return on asset is 2.91. And here they're giving you the format percentage. That's fine. 2.91%. As I said, this, I would say this simulation, I would say it's challenging. Yes, it is. It's, it's, it includes both knowledge from your college studies. And you have to be familiar with, because in college, we don't give you those general ledgers. Those general ledger, you will see them in the real world. That's why I believe it's challenging. Also, the general ledger here, or unless you took an accounting information system, which is not all, all colleges offer accounting information system. So you have to know how to read the information that you are giving. So overall, the material, the contact is not difficult. The contact is straightforward and easy. But the way the information is presented is, is difficult. So what's the point I'm trying to make is you got to get yourself familiarized with those simulations. So they don't intimidate you. One way to do it is to be very familiar with the information. And the way to do it is to go to my website, subscribe to my CPA lessons. It's an investment in your career. I can help you study hard and good luck. And I'm always here to help.