 under the session, this is professor Farhad in which we would look at a CPA simulation or it's no more than an exercise, you will see an intermediate accounting course. So in this exercise or in the CPA simulation, you have to determine whether the lease is a finance lease or an operating lease. We have to prepare the journal entry for the less C for the less or determine the interest payment, determine the interest revenue. So basically, this is a comprehensive example. If you like my lectures, please like them and share them. Connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1,900 plus accounting, auditing, tax, finance, as well as Excel tutorials. I also have my website, farhadlectures.com. If you are studying for your CPA exam or they can intermediate accounting, but specifically if you are studying for your exam, I don't replace your backer. I don't replace your Wiley. I don't replace your Glyme or Sergeant or whatever course you are taking. I supplement those courses. I explain the material slower and in much more details than backer, Roger and other courses. The reason they don't do so, because that's not their job and a CPA course, they review the material with you. They assume you know it. They assume you already learned it in college and now they're reviewing it with you. They don't teach you. I teach you the material and oftentimes students fail the exam because they have not learned the material or they did learn it. But there's a time gap or they learn it, but there's some gaps in their knowledge. This is where my website comes into place and complete this gap, fill this gap, help you pass the exam. So I strongly suggest you check it out. Let's take a look at this exercise. Maggie's Medical Manufacturer, Maggie's Medical M&M manufactures compression plate that uses proprietary technology for fractures. Physician leasing, which is a leasing company, purchases the compression plate from Maggie's Medical for 2.2 million, 90,000 and leased it to Northeast Medical Group on January 1st, 2021. There's a lot of information here. Let's just make sure we have a good handle of what we're saying. We have three parties here. We have Maggie's Medical, which is the manufacturing group that manufacture this compression plates. That's fine. That's their product. In the middle, we have Physician Leasing, which is a leasing company, which is a finance company. And we have the users of this compression plate, which is the Northeast Medical Group. So what happened is this, Physician Leasing buys the material from the manufacturer, then leased it to the users. Those are the users that uses those compression plates. Okay. So those are the three parties. Let's take a look at the details. The quarterly lease payment, it seems it's a quarterly and that's important to notice on the exam, whether it's semi-annually or quarterly. Most likely on the CPA exam, it will be, it will be semi-annual, but you have to be careful, whether it's quarterly or semi-annually. The payments are 147,871 beginning of each period. That's important. It starts at the beginning of the period, not at the end of the period. Very important term. So here, if you got this wrong or if you read that wrong, that's it. You're done for the problem. You're done for that simulation. You're going to get all the answers incorrect. The lease terms are five years in here or what I did is the number of payments are giving. So the numbers of payment may not be giving. So if it says five years, you are paying quarterly, it means you have 20 payments. You have 20 quarters. The lease term is five years. Okay. No residual value and no purchase option. Okay. That's fine. The economic life of the asset is five years. The implicit interest rate and the less incremental borrowing rate is 16. That's fine. Fair value of the asset is 2,090,000. Okay. That's fair enough. This is what we are giving. We are giving all this information, but first you have to read it and you have to read it carefully because one piece of information that's missing here, it will throw you out. Now, based on this information that's given here, I can ask you literally 15 different multiple choice questions or I can give it to you in a form of assimilation, what we will do here. So how should this lease be classified by Northeast medical group and by the physician leasing? So they're basically asking us how should this group and this group treat this lease? Well, what are the leases? It's either going to be a finance lease or an operating lease for, for physician leasing. Let's take a look at what criteria do we go over? How do we analyze this information? Well, let's start. Do we have, there are five tests. The first one is, is the ownership of this equipment transferred at the end of the, at the end of the period? It doesn't tell us anything. So the transfer of ownership and the answer is no, there's no transfer of ownership of this medical equipment or of this compression plates to the Northeast medical group. So it failed this criteria, no transfer of ownership. Is there a purchase option, a bargain to be more specific, a bargain purchase option, it says here, there's no purchase option. So we failed the second test for the finance lease. So there is no transfer of the asset at the end of the life of the lease term, there is no bargain option price. Well, let's take a look at the third criteria, the lease term test. Well, the economic life of the asset is five years. This is the economic life of the asset. Let me highlight this. The economic life is five years and the lease term is five years as well. So here we have to ask ourselves, is the lease term for a major part of the remaining economic life of the asset? Well, guess what? The lease term is 100% of the life of the asset. Guess what? We passed, all what we have to do is pass one of the test, one of the test and whoops, sorry, go back. We have to pass one of those tests and this is, we passed the lease term test, which is the life and the, the economic, the lease term is 100% of the economic life of the asset. All what it has to be is the, is a major part of the life of the asset. It's 100%. Therefore the answer is yes. Therefore we know this is a finance lease. This is, we're going to, we're going to be treating this as a finance lease. Now the other criteria is the present value. So if we compute the present value payments for this lease, if we did compute those present value payment, would they be equal to a substantial part of the fair value? Well, let's, let's do so. Let's, let's go through this. We already know it's a finance lease. So this is an extra step basically. So what you do is you take the payments 147,871 and you multiply them by the present value factor, the present value factor. And here we have to be very careful. The present value factor, you have to use the period N equal to N equal to 20. We have 20 periods and the interest rate equal to 16. Well, not right. 16 divided by four. 16 divided by four equal to 4%. Just as we took five years times four to get to the 20, we'll take the interest rate, which is 16% divided by four. Therefore N equal to 20, I equal to 4%. I equal to 4%. Again, we took five years multiplied by four. We'll take the interest rate and we'll divide by four. Because why are we doing all these adjustments? Because it's a quarterly lease payment, not semi-annual. If it was semi-annual, the number of payments will be 10 N equal to 10. And I will be equal to 8%. Now we're going to go to the table and see what factor do we use. Now on the exam, they might give you the tables. Most likely they will give you the tables on the exams. You just have to be careful which table to choose, which table to choose. So in this situation, you'll have to choose the beginning of the period table, the beginning of the period table. Let's take a look at the table just to make sure we cover all our basis. For this example, I make it simple. So I'm giving you only one table. And that table is the present value of an annuity do. Remember, this is an annuity do. Why is it an annuity do? As I told you, the payments are at the beginning of the period. So simply put, make sure you're on the right table or if you are not given the right table, if you're just giving a sample of them, make sure to use the proper one N equal to 20. Remember, we said N equal to 20 and I equal to 4%. So we're going to meet at 14.13394. 14.13394. Therefore, we're going to take 147,871 times 14.13394. And that's going to give us 2,090,000. So the present value of the payment equal to 2,090,000. And guess what? The fair value equal to 2,090,000. So again, we met another criteria for this lease to be a finance lease. We only need to meet one criteria. We already met the lease life. But here, does the present value of the payments, if we add them all together equal or exceed a substantial or of the underlying asset? It used to be 90%. Now they said, does it exceed the substantial? If it's more than 90%, it's substantially. It's 100%. So it's definitely a finance lease. And the third question is alternative use. We don't even have to go through the alternative use test. We know this is a finance lease. So simply put, what we say is for the Northeast manufacturing, this is a finance lease, this is a finance lease. And for the for the physician leasing, this is a sales type lease. Since it's since it's a finance, it's going to be a sales type lease because they use the same criteria. Now, prepare the appropriate journal entries for both the user, the Northeast Medical Group and the leasing from the beginning of the lease through the second rental payment April through the second rental payment April 1st, 2021. So simply put the first regular payment or the second payment because we make the first payment immediately. Adjusting entries are recorded at the end of the year. Okay. So again, we agree it's a, it's a finance lease. So we're going to, what I'm going to do, I'm going to do the entries back to back for the less C and the less sort. This way you see how things are going from the less C's perspective. What we have is we find the present value of the payment and we already find out that the present value of the payment are 2,090,000. Therefore we debit the right of use asset and we credit a liability. So for the less C, which is the, the, the medical group, the Northeast Medical Group, they will debit an asset called right of use lease, 2,090,000, the present value. And they will credit lease payable 2,090,000. What would the less sort have? Well, if they, if they make a sale, they simply, they have, they're going to have a receivable, they're going to have, they're going to have a receivable of 2,090,000 and they will credit equipment of 2,090,000. So notice the, they have a receivable, I'm sorry, they have a receivable, they have a payable, an asset, basically they, they remove the asset, they put the asset on the box. Notice kind of the mirror image of each other. Then remember, we make the first payment immediately on January 1st, 2021, immediately what's going to happen, we're going to credit cash, the medical group will credit cash, 147,871. They will write a check for that amount and they will reduce their liability, 147,871. Now you have to be very careful as soon as this happened, remember, you're going to have to reduce your liability when you compute your interest, which we'll see this in a moment. The less sort the physicians leasing, they're going to receive the cash, debit cash and they would reduce the receivable. They would reduce the receivable. This is, notice this is on the same date that they signed the contract, they make the first payment. Now they're going to make a payment on April 1st, 2021, which is the first payment. What's going to happen is this, when we make this payment, remember the balance for both was 2,090,000, then there was a payment made immediately of 147,871. Therefore, the interest will be based on this balance. When we compute the interest, whether it's the interest expense or the interest revenue, it will be based on this balance. Therefore, we're going to take 2,090,000 minus 147,871 times 4%, the quarterly interest rate payment. So the interest component is 77,681. Therefore, the less C will credit cash, the less C will have to pay in cash 147,871,871 is missing, 871. And what's going to happen, this payment, it's going to be split between interest expense, which we computed here, and the remaining will be least payable toward the principal. Now for the less sort, it's going to be the same thing. There's an error here. It's going to be the same thing. Cash is 147,871. The interest revenue is the same 70,000. I'm sorry. The interest revenue is 77,000. I made an error here. I don't know why somehow when I was doing it in Excel, I put the formula 77,685. And the least receivable is 186. Notice they're the mirror image of each other. They paid cash, they receive the cash. They reduce the receivable, they reduce their payable. They record the interest expense, they record the interest revenue, all for the same amount. So this is the less C and the less sort. Now, if you know how to do this interest payment, and obviously you can, you know how to do subsequent interest payments, simply put what's going to happen in subsequent interest payment, your balance here, whatever that balance here will be reduced by 70,186. And this will be your new balance where you apply the interest expense and the interest revenue computation. Okay. So be careful, keep track of your interest. Let's take a look at the third assumption. Assume that the Northeast Medical Group leased the compression plate directly from the manufacturer. So they did not go through the leasing company, which produces the machine. Obviously, the Maggies manufacturing produced the machine. It cost them 1.8 million. Prepare the entries for the manufacturing from the beginning of the lease through the second lease payment. Now, we're going to be doing accounting for Maggies Medical, the manufacturing company. Well, here, they basically, they sold it. How much did they sold it for? They sold it for 2 million and 90,000. So they're going to debit a receivable, debit a receivable for this amount, which is a lease receivable, but simply put debit a receivable credit sales for 2.09 million, 2.09 million. Then the cost is 1.8. They will debit cost of goods sold. They will debit cost of goods sold 1.8 million. And they removed the equipment. They sold it. They removed it. So this is the entry for the manufacturing company. The debit receivable credit sales, the cost of goods sold credit inventory, not inventory, inventory equipment. Now they receive the first payment immediately, very, very straightforward. They notice the same day they receive the payment. They will debit cash and they would reduce the receivable. Then they would receive a payment April 1st, 21. Then they will debit cash for that amount. Same thing. They would have interest revenue and they would reduce their lease receivable. So this is basically this. Again, what can the CPA exam do? AI CPA, they can ask you, what is the balance of the lease after the first payment or what's the balance of the lease after the second payment or how much interest expense was incurred year one? They can ask you so many, I mean, based on this problem, I can ask you so many different multiple choice questions. Every journal entry here, I can pick something and ask you, you know, how much was the lease receivable? You know, as of the end of the year or how much was the lease receivable after the second payment? So you have to know what are they asking you about? What are they asking you about? As always, I'm going to ask you to like this recording and most importantly, I'm going to remind you to visit my website. If you're studying for your CPA exam, don't short change yourself. My subscription is minimal for what you get. It's practically free. It's practically free for the amount of value that you get in the CPA investment is a lifetime, 20 to 30 year, if not 40 year investment. People are a little longer. It's going to pay dividend for life. Get it behind you. It's those two years that you need to focus on, invest a little bit of money to get it out of the way. I'm always here to support you. Study hard, stay safe. That's the most important thing, actually. Good luck.