 in which you would look at a CPA exam simulation that covers the auditing and attestation exam. The first thing you wanna do when you look at a simulation is what am I expected to do? Well, if I look at the simulation, if I just browse it real quick, it looks like I need to learn about the impact on the current ratio, whether it's an increase or decrease something's happening and the impact on profit margin. Also, it looks like I'm gonna have to prepare one, two, three adjusting entries. Great, not bad at all. If I understand my current ratio, if I understand my profit margin, that should not be an issue whatsoever. It should take me a few minutes to complete this section. And the adjusting entries, I need to know my adjusting entries inside out while preparing for the exam. And this is what we do at Farhat Lectures, teach you adjusting entries. So before we proceed any further, I have a public announcement about my company, Farhat Lectures.com. Farhat Accounting Lectures is a supplemental educational tool that's gonna 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 go ahead and get started. An engagement team is performing the audit of the financial statement of Griffin Company for the year-end December 31st, year seven. The first task, the senior accountant has identified three misstatements that have been carried forward into the summary of proposed adjustments. The right here, one, two, three. Determine the impact of the identified misstatement on the financial statement below. So basically, what's the impact of this adjustment on the current ratio? What's the impact of this adjustment on the profit margin? For each one, identified whether it's a decrease on this ratio, an increase, or no impact on this ratio. Okay, let's go ahead and get started. Starting with, oh, yeah, hello, Asad. I asked him, I'll give you the gerorot, of course, the gerorot that she could not find it. No, usually she's in charge of that department. Oh, no worries. The first entry, we debited payroll expense and we credited accrued payroll. Okay, what is the impact on the current ratio? Well, let's think about it for a moment. What is the current ratio? Do we know the current ratio? Now, if you don't know what the current ratio is, then you can't answer that question. Current ratio is current assets divided by current liability. Actually, you don't have to know it because the ratio is given to you in analytics definition. If you click here, if you click here, you will find out that what the current ratio is, current assets divided by current liabilities. It should be given to you. And let's take a look at it because this way you don't have to sweat it out, current assets divided by current liabilities. So now, what do I need to do? I need to kind of, don't try to guess. You say, okay, it's my current assets are, if I have 10 divided by five equal to two. What happened? What happened here is accrued payroll went up. It means my accrued liability went up. What happened if I have 10 divided by, let's make it eight? What's 10 divided by eight? All what I did is I increased the denominator that's gonna give me 1.25. So if I increase this, my current ratio will go down. Therefore, the impact is a decrease on the current ratio because my numerator denominator went up, which is accrued payroll is a liability. What's the impact on the profit margin that's pretty straightforward? If my expenses are going up, my profit margin is going down. It's pretty straightforward. Depreciation expense. Well, if my expense going up, my profit margin going down. I'm done with this part as well. Now, what's the impact of this ratio at the current ratio? Well, depreciation expense, we already analyzed that an expense would reduce income. What about accumulated depreciation? Well, accumulated depreciation is a contra asset. It's listed with long-term assets, property, plant and equipment. It has no impact on current asset and no impact on current liabilities. Therefore, there's no impact on the current ratio from this proposed adjustment. This adjustment, prepaid insurance was debited, insurance expense was credited. So notice here, if we are reducing expenses, what is the impact on the profit margin? It's the opposite. Our profit margin will go up because in the prior two, expenses were going up, profit margin was going down. Now expenses are going down. We are crediting expenses. Now we're adding to the prepaid insurance. Prepaid insurance is a current asset. So the opposite here. Here we are increasing the current asset. So if we go from current asset from 10 divided by five, let's make the current asset two additional dollars in current liabilities, 12 divided by five, that's gonna be more than two. It's 2.4. Therefore, the current ratio will go up. Again, this should take you a few minutes. As long as you understand what the current ratio is, as long as you understand what the profit margin is, you don't even have to understand it. The ratio even given to you, it's even given to you. You just have to know how to analyze this. I would say this part of the simulation, it's easier than any multiple choice I can put together. Each one of those impact I can take this exercise and I would say a company XYZ accrued $72,000 of accrued expenses of accrued payroll. What's the effect of that on current ratio? What's the effect of that on the profit margin? Same thing here, a company booked a depreciation expense of 125, what is the impact on current ratio? I'll give you multiple choice. This is what I keep, that's why I keep saying, simulations is more than a multiple choice framed differently, framed differently. So let's take a look at these adjusting entries. This is task two. The engagement manager has requested that the summary of the proposed audit adjustment started by the senior accountant be updated for any additional misstatement identified. Notice I didn't even look at my exhibits yet. Use the information in the exhibits above to determine the adjusting journal entries. So don't waste your time, like you finished task one without looking at the exhibit. That's why don't look at the exhibit unless you know what you want to look for. To prepare the journal entries, they'll tell you what to do. Click on a cell in the account column and select the account, enter the corresponding debit and credit in the associate column. All amount automatically rounded to the nearest dollar. Not all rows in the table will be needed. So I don't know, it looks like I need three adjusting entries. I have no clue what I'm doing here. So now I'm gonna look at the exhibits. Starting with my debt restructuring email. So I have one, technically I have two exhibits, the audit work paper and the debt restructuring email. I'm gonna start with this one. See if I can figure out an adjusting entry from here. It's from the audit manager at Firm Company to the senior auditor at Firm Company. The subject is debt restructuring with Compass Bank. The senior auditor Griffin, which is a client, has refinanced its credit facility. I reviewed the loan agreement, said this happens on December 28th, year seven. The maturity of the loan was extended from September year eight to December year 14. The entire 3.4 million of the balance was classified as current as of December 31st, year seven. So it looks like they had a loan, they refinanced the loan, but right now the loan is classified as current, which now it's incorrect. It's incorrect because now the loan is going to year 14. The loan principle is stable with a quarterly installment of 225 and the first payment is due in March. Determine the impact on the financial statements. Simply put, here's what's happening. Griffin have a loan of 3.4 million. Now here's what happened. The loan was current as of September. So when they refinanced, it seems that maybe the whole balance was due, but now the refinance and the refinance 3.4. And this loan is a current liability, still current liability, but this loan now goes to year 14. So it's no longer, it's no longer a current liability. So what do I have to do then? If it's a current liability, I have to reclassify it into long-term liability, but remember, any long-term liability debt is part of it current, part of it short-term. How do you do this? If you have a loan, 3.4, some of it will be current and some of it will be current debt and some of it will be long-term debt. The current debt is the long-term, the current debt will be current debt of long-term and the long-term will be long-term net of short-term. So how do I determine of the 3.4 million? Which one of it is current? Which one of it is long-term? Well, simply put, I have to look at the year, what year are we dealing with here? What year are we dealing with here? Year eight. So we're looking at year eight, going from year eight, going forward, going from year eight, going forward, okay? So we have year eight, year nine. The next year, the next 12 months, whatever payments are due the next 12 months, those will be current, those will be current. What am I told here? I'm told that a quarterly payment of 225 is due, quarterly payments. How many payments do we have per year? If it's quarterly, it's four. 225 times four, this means 900,000 should be current and the remainder, so 3.4 million, so we have 3.4 million of which 900,000 is current, 2.5 million is long-term, 2.5 million is long-term. But right now, all the debt is current. So what do I need to do? If all the debt is current, I need to back it out. I need to back out the loan from the current and make it back out the loan from the current section. It means I have to debit the current portion of long-term debt. I have to back out of the year, 2.5 million because I already have 3.4, and I have to, wherever I backed out, I'm gonna have to take it to the long-term debt, should be long-term debt net of short-term, but that's only thing, long-term debt. So I took out 900,000 of the short-term and I placed into the long-term 2.5 million. Let me show you, you might be saying how did that really happen? Let me show you from a T-account perspective what this all would look like because it's important to see that. So from a T-account, I had 2.5 million in the current portion, and what I did is I, sorry, I had 3.4 million in the current portion, and I debited this balance, 2.5 million. Therefore, my ending balance is 900,000. I did not have anything in the long-term, so I debited the current and I credited 2.5 million in the long-term. Therefore, this is the debit, this is the credit. Now the balance is 900,000 short-term, 2.5 million long-term. So I fixed this issue. I fixed this issue. And basically this email gave me a journal entry. I'm looking for two more journal entries. I'm gonna take a look at my auditing work paper or audit work papers. So it's, the work paper is about service revenue. December 31st, prepared by the staff on 124 to ascertain whether service revenue recognized during year seven is complete and accurate in all material respect to the financial statement as a whole. So here's what happened, we have the name of the customer and we have tick marks. A, we have tick mark, C, B. Okay, so we have the tick mark. So what's A? A per review of contract invoice and service records, we calculated the amount of revenue earned and verified that the revenue was recognized in the current period. Well, if that's the case, anything that's A, there's not much I can do about it. Okay, C, what is C? Per review of the 50,000 contract and invoice service for the period December 15, year seven through January 14th, year eight and should be recognized equally between year seven and year eight based on the terms of the contract. Hold on a second. I have a contract of 50,000 and I'm being told this contract here from Globe because the contract goes from, it's a split between two period. December 15, year seven through January 14, year eight. If that's the case, why do I have the whole thing in revenue here? This means I should have only 25,000 in revenue. So just telling me exactly what to do. All what I need to do now is back out, remove how much of revenue. I have to remove 25,000 of revenue and that revenue becomes what? Becomes unearned revenue. I have to back out that amount. I have to back it out. How to back out revenue? What's the adjusting entry? I'm gonna have to debit revenue itself because I am removing $25,000 from revenue. How do you do that? You debit revenue. You debit revenue. So what is the revenue account here? I'm gonna debit revenue and I'm gonna credit unearned revenue. Accrued vacation allowance. Okay, I don't have unearned revenue. Well, then the next thing is contract liability. It means I still have a contract liability of 25,000. That's the closest thing. I would love to have love to see contract rather than contract revenue, unearned revenue. But this is what contract revenue is. It's basically unearned revenue. So I did not earned half of the contract. So where's the contract? I used it already. So let me just debit here revenue. Debit revenue. The revenue is debit and the credit is contract liability. So 25,000 out of revenue and goes into the balance sheet as a liability. Again, pretty straightforward adjusting entry. It looks weird. It looks intimidating, but that's basically what it boils down to. And what's my point? My point is don't be intimidated by journal entries. Not journal entries. Don't be intimidated by CPA simulations. So Ash, A, A, A, B, we have a B here. Chestnut ink. What's the deal here? C, per review of the $50,000 contract. No, B, not CB. Per review of the contract and service record, service was finalized in invoice as of December 31st, year seven. That's good. Per review of the ledger detail, the receivable balance was recorded in the unbilled receivable. No, if we invoice them, it cannot be unbilled. It's an account receivable. So this is unbilled receivable. So what do we have to do? We have to remove it from the unbilled and make it a bill receivable, make it a receivable. Make it a receivable. It's not unbilled, it's billed. We are told it's billed. Why is it in the unbilled? Therefore, what do we have to do? We have to make a third adjusting entry and that's debiting account receivable because it was unbilled receivable. 75,000, we have to add it to the receivable and credit unbilled receivable because they debited unbilled receivable and they credited revenue. Well, it's not unbilled, it is billed. So credit unbilled receivable of 75,000. So notice here, all what we did in this simulation is look at the effect of an adjustment on ratios and prepare three adjusting entries that I believe they are pretty much straightforward. We do those adjusting entries in accounting one-on-one, not even in intermediate accounting. You would learn about reclassifying the debt from short-term to long-term. The second adjusting entry is accruing, I'm sorry, removing revenue from unearned revenue, sorry, reducing revenue and making it unearned revenue revenue that you have not earned and the third one is basically a mistake, basically removing the unbilled receivable and debited the receivable because the revenue was already there. Once again, at the end of this recording, CPA exam simulation should not be intimidating to you. I know it's easier said and done. How do you gain more confidence? You understand the concept and this is how far-hat lectures can help you. Once you understand how to do adjustments, once you understand the current ratio, the profit margin, then a simulation like this would look easy, although at the beginning it might look intimidating. Good luck, study hard, I'm always here for you and stay safe.