 and welcome to the session. This is Professor Farhad in which we'd look at a CPA simulation that deals with accounting principles and assumptions. Many students, they ignore this concept because an accounting you usually are dealing with numbers. One, two, five, 26. Well, accounting principles and assumptions are basically theory and students doesn't think understanding the theory is important. Well, I have to tell you otherwise, understanding the theory behind the accounting record, behind the what we do in journal entries will help you understand those journal entries much, much easier. And that's the purpose for this session is to work through an exercise to help you understand why we do things in a certain way based on certain accounting principles and assumption. As I told you, this is basically it's going to look like a CPA simulation, but this topic is covered in my intermediate accounting. The difference between what I offer and a CPA review course is I explain, I teach you the material rather than just reviewing it. I don't assume you know it. I don't make that assumption. 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 1,700 plus accounting, auditing, tax, finance, as well as Excel tutorials. If you do like my lectures, please like them, share them. If they benefit you, it means they might benefit other people. Connect with me on Instagram. On my website, as I just stated, I have additional resources, especially if you're studying for your intermediate accounting courses or your CPA exam. If you want to increase your score as well as other courses, including finance, if you want to increase your score by then to 15% on your CPA exam, I strongly suggest you check out my website. So we have a list of principles and assumptions and based on this list, we're going to be selecting answers for certain scenarios, which principle or assumption will apply. Let's take a look at the first one. Fair value changes are not recognized in the accounting record. So they're telling you fair value changes are not recognized, although sometime fair value changes are recognized. But when fair value changes are not recognized, what does that mean? Well, first of all, do you know what fair value is? Fair value changes? Well, fair value changes, that means you have either an asset or a liability, either an asset or a liability. And for asset, you might have, let's look at assets, you might have land, you might have property, plant and equipment, you might have investment. You might also have liabilities. And what are the liabilities? You could have bonds that you issued, you could have no payable loans. So those are the liabilities. Now, what is fair value? When you are measuring things at fair value, it means if your land goes up in value or if your land goes down in value, you have to recognize what's called an unrealized gain or loss. Why do you have to recognize unrealized gain or loss? Because you are using fair value because your land went up, you have not sold it, it's unrealized, you have to adjust it. Same thing with your property, plant and equipment, if they went up or down in value. Matter of fact, for you as GAP, we don't do this. So fair value are not recognized. But if you have an investment, if you have an investment, and we will talk about investments later on, actually, I do have them on my YouTube talking about investments, investments, they do use fair value adjustments. Okay, but the question is, fair value adjustments are not fair value changes are not recognized in the accounting record. What is this principle? Well, it's a measurement principle. So we have five and we have six. It's a measurement principle. And if they're not recognized, it means we are used historical costs. Therefore, for the fair value, number five, it's a measurement principle. And specifically, we're using historical costs. Let's take a look at the second scenario. Financial information is presented so that investors will not be misled. So we're not misleading investors. So is it economic entity? Is it going concern? Is it monetary? I would say it's when you tell the investors everything not misleading them, you are using the full disclosure principle. Full disclosure means tell the investors as much information as possible, so you don't mislead them. They know all the information. Let's take a look at this question. Intangible assets are amortized over period benefited. What does that mean? It means you have an asset. It's an intangible asset. And what you do with this intangible asset, you expense it. You amortize it. Amortize is an expense. You expense it over the period, whatever period it benefit. What is that based on what? Why do you expense it? It's based on what? Well, it's based on something called the matching principle. You're matching the benefit. You're matching the benefit of the asset to the period. It benefits. It's the matching principle. And the matching principle, we don't have it in this list, but we have the expense recognition principle, which is the same as the matching. So when we say expense recognition, it means you are matching expenses to the period in which they benefit. An example is taken an intangible asset and amortize it just or taken a property, plant, and equipment and depreciating the asset. That's the matching or the expense recognition principle. Therefore, the answer is seven. Let's take a look at scenario D. Agricultural companies use fair value purposes for valuing crops. Now, if you are an agricultural company and you do have crops and you're extracting that crops and that crops has an active market, what does that mean? Let's assume you are in the business of corn. So you plant corn and you extract, not extract, what you will do is you sell that corn in an active market. As soon as you take the corn from the field, as soon as you collect the corn, you do have an active market in the corn because you can sell it at any time. So you can do, you can value it at fair value. Why? Because there's an active market for it. What does that mean? It's a measurement principle, but the measurement principle here is fair value. So it's a measurement principle but you are using the fair value. So it's measurement principle fair value. Why can you do that for agricultural companies? Because generally speaking, the same thing with coffee. There's an active market for coffee. There's an active market for corn. There's an active market for wheat. All of those, they have active market. Let's take a look at this scenario E. Each enterprise is kept as a unit distinct from its owner or owners. What does that mean? And hopefully, this is one of the principles that you learn in financial accounting 101. It means the business and the owners are two separate entities. We account for them separately. Well, this is based on the economic entity principle or the economic entity assumption. It means the business and the owners are two separate entities, two separate entities. Let's take a look at F. All significant balance sheet event are disclosed. Well, we're talking about disclosure. Disclosure means telling the users as much information as possible. What is that? What is that principle? When do you tell the users as much information as possible? It's a full disclosure principle. You're telling them as much as possible. Revenue is recorded when the product is delivered. What does that mean? Well, we deliver the product. We perform our service. We recognize revenue. What is that principle? It's called the revenue recognition principle. The revenue recognition principle. All important aspects of a bond and venture are presented in the financial statements. Well, under what principle do we present everything that we need to present about a bond or about anything else? Well, I would say full disclosure principle. You are presenting everything. What's the rationale for accrual accounting? So what is accrual accounting? Simply put, what is the rationale for accrual accounting? Why do we use accrual accounting? Well, accrual accounting is what? If somebody asks, what is accrual accounting? Accrual accounting means recognize revenue when earned, recognize expenses when incurred. That's the two most, you know, that's the shortest way I can explain accrual accounting. That means recognize revenue. Basically, an example of accrual accounting. Actually, we have two examples so far here. If we look at G, G is accrual accounting. And if we look at C, C is accrual accounting. So C and G are accrual accounting. Why? Because we recognize the expense when it incurred and recognize the revenue when we generate the revenue. Therefore, the rationale for accrual accounting is both the expense recognition as well as the revenue recognition. This is basically accrual accounting. The use of consolidated financial statement is justified under what? So what is consolidated financial statements? You may not know this if you haven't took advanced accounting, but consolidated financial statements is when you take separate companies and you can put them all in one, you consolidate them, you combine them all into a parent company. So here's what you do. Think about the Gap Store. The Gap Store owns the Gap Store, owns Old Navy, and I believe they own Banana Republic. Now, what happened at the end of the day, at the end of the year, Gap, Old Navy, and Banana Republic, all three companies, they get consolidated into the Gap Store. So we account for them separately, then we consolidate them. That's okay, as long as we account for them separately. This is the entity economic entity principle. This is based on each company is accounted for separately, but it can be consolidated under what company, but remember, each one is accounted for separately. We don't mix them. Reporting must be done at a defined time interval. It means you have to report quarterly or annually, usually if it's a publicly traded company is one, two, three, and the last quarter is the annual. So those are the four quarterly based on what assumption? Well, we have an accountant called something called the periodicity principle or the periodicity assumption. It means the life of the company has to be broken down into artificial period. And the period could be quarterly, monthly, daily, daily, it's not used semi-annually or quarterly. Quarterly is very, is very common for public traded companies, not common, it's mandatory for publicly traded companies. An allowance for doubtful account is established. What does that mean an allowance for doubtful account is established? It means when you have a count receivable, you have to deduct the allowance. Allowance, it means if you have a receivable of 100,000 and you think 5,000 will be in collectible, you would report the receivable at 95,000. Now, what, what is that principle? What are we using here? We are, we're measuring a count receivable 95,000. Now the question becomes, is this a historical cost measurement or fair value? Well, actually it's neither. It's a measurement principle, but it's a measurement principle called net realizable value. It means how much you can collect. It's a measurement principle. Here's what you need to understand in measurement, in measurement principle. We have two extremes. We have cost and we have fair value and we have in between. In between will be net realizable value and we have other than net realizable value. Net realizable value is a way to measure an asset. It means how much are we, are we going to collect from this asset? It's not really fair value. If I have, if you have to choose on the CPA exam, you would choose historical cost. So it's net realizable value, but the measurement we're going to choose is historical cost. Although it's called net realizable value or cash realizable value. Sometimes they call it cash. It means how much cash you expect to receive from your receivable. That's how we measure receivable because we use the allowance. Allowance, it means how much we cannot collect. Goodwill is recorded only at the time of purchase. So when we, when we record goodwill, we only do that when we purchase the goodwill. Well, what does that mean? We're measuring the goodwill. When we purchase it, we measure it. So it's a measurement. Do we measure it at cost or do we measure it at fair value? And here's what you need to know. At the time of the purchase, always, always, always, we use cost. Now, certain asset eventually will be reported at fair value. It means we could bring them up or down, but initially you have to understand this. Every time you purchase something, it's always recorded at cost. And sometimes it stays at cost like land will stay at cost forever unless we have, unless we have an impairment. Other assets, we use fair value like investments initially at cost and we adjust them to fair value up and down. A company charges its sales commission cost to expense. It means when we have it, when we have a sales commission, we charge it to expense. If you see the word expense, it means you should be looking at something to do with expenses. Well, expense here is expense recognition principle, expense recognition principle or matching. Or matching. Remember, I told you that we're not, we're not giving this, I'm not giving you this principle, but the matching principle is the same as expense recognition. And I like the matching principle more for the scenario because what happened is when your salespeople earn, earn their say, earn their commission, we expense it. When do they earn it is when they generate revenue. So we are matching revenues with expenses too. That's why I like it. But it's basically based on the, to insert this question, the expense recognition, it means the expense incurred, you record it. When did it incurred is when they performed, when they performed, when did they perform is when they, when they earned their sales, you expense the commission. When they not, not earned their sales, when they generated sales, it means they, they generated sales, it means you have to expense their commission. Okay. But again, it's part of the matching principle. They make sales because of that, they generated expense, we match the expense to the sale. So it's the matching principle. As always, I would like to remind you to record, to like this recording, share it with others. If you think they benefit and always, I would like to remind you to visit my website, farhatlectures.com for additional explanation about topics such as these in my intermediate accounting, as well as my other courses. If you're studying for the exam, you want to improve your grade, check out my website. The CPA exam is a lifetime investment, you don't want to shortchange yourself. Good luck, study hard and shortly stay safe, especially if you are still living through the coronavirus.