 Hello and welcome to this session in which we would look at an exercise or a CPA simulation that illustrate the modified basis. In the prior session we explained the modified basis. We explained the theoretical framework behind the modified basis, why government entities, certain government entities use the modified basis. In this session we're going to work few journal entries that illustrate the modified basis. We're going to compare the modified basis to the cash basis. We're going to compare the modified basis to the full accrual basis. So it's very important to see how would you book a transaction under the modified basis versus the other basis. And in this session we're going to be working at four, we're going to be looking at four different transactions. And what I'm going to do as well, compute the profitability under each method, whether it's the cash basis, modified basis or full accrual basis. What I'm going to do at this point, switch to the Excel sheet and prepare the journal entries under the various accounting basis. 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. Let's start by looking at the first transaction. A donor pledged half a million dollars given the organization illegally enforceable 60-day note for the amount. So the first thing I'm going to do, I'm going to work the cash basis. So what entry do we have to make under the cash basis for a pledge made to an organization? And the answer is for using the cash basis, we don't have to do anything because no cash exchange hand as of yet. Remember, the cash basis focuses on the cash. Cash in, cash out. Transaction one, we would say no entry because no cash exchange hands. Transaction two, the donor paid 200,000 of the amount pledged. Well, guess what? If the donor paid 200,000, I know for sure I am going to have some sort of a cash. Why? Because if I received cash, I am going to debit cash and this is the cash basis. What do I credit? Cash in, I'm going to credit some sort of a revenue. Some sort of a revenue, whether you want to call it contribution revenue, pledge revenue, it's some sort of a revenue. It's contribution or pledge revenue for 200,000. So this is for transaction number two, transaction number two. Let's look at transaction number three. The entity purchased a building for 400,000, paying 125,000 and given a 30-year mortgage for the balance. Building useful life is 30 years. What do we have to do for transaction three? Well, one thing I'm going to start with paying cash because I did pay cash for how much? For 125,000. I can't run away from that. I have to credit cash because I paid cash. If it says paying cash, I can't deny that. Now, the question is, what do I debit under the cash basis? Well, under the cash basis, what do I care about? I care about expenditure. If I pay something, it's called an expenditure. It's not called an expense because full accrual use the term expense. So what do I debit? So if I credited cash, what do I debit? I debit an account called building expenditure or expenditure-building. So it's an expenditure for 125,000. What about the long-term note? The remainder, which is the remainder is what? 300 and 275. I don't record the remainder. I don't have long-term notes. I don't have long-term assets. What I have under the cash basis, I have revenues and expenditure. And how do I determine my revenues and expenditure when I receive cash and when I pay cash? Therefore, this is the entry. So what is expenditure? An expenditure is a decrease in net asset. It's going to reduce your income for cash purposes. That's a reduction in your income. It's a decrease in net asset, reduce your income. So that's what an expenditure. Transaction for the entity hire employees by the end of the period should be a period. By the end of the period, they have earned $6,000 in wages, but not yet paid. What do we do for cash basis? Nothing. If we did not pay the employees yet, we don't have an expenditure. We don't have an expenditure. Why? Because we are using the cash basis. Therefore, no entry. Now, at the end of the period, if I ask you to prepare the income statement under the cash basis, what would you say? Well, for the income statement, I have revenues and I have expenditure. What's my revenues? My revenues are $200,000 from the contribution and my expenditure is $125. My profit is $75,000. And obviously the balance sheet, I have $75,000 in cash and my fund balance will be $75,000. I received $200,000. I paid $125,000. My cash is $100,000 and my profit is my fund balance of $75,000. That's on the balance sheet. Now, I'm going to go ahead and prepare the journal entries for the same transaction, however, using the modified accrual, modified accrual. And this is the new method that we learned about and the new method you're going to be using for a certain governmental fund, a modified accrual. Starting with the first entry, a donor pledged half a million dollars giving the organization a legally enforceable 60-day note. Well, now, what do modified accrual focuses on? Modified accrual focuses on, this is what you have to keep in mind, current assets and current liabilities. This is what they focus on. Remember, the focus is the current economic resources. Well, if somebody pledged money and it's enforceable within 60 days, do I have a receivable? Yes, I do. It's within 60 days. I would say I do have a receivable and I'm going to call this notes receivable or pledge receivable for how much? For the amount and the amount happens to be, how much was the amount? The amount is half a million. Therefore, the amount is half a million, not 200,000. The amount is half a million. So I have a note or pledge receivable for half a million. So I do notice the difference between cash and modified accrual. Again, I said we can call modified cash as modified accrual or modified cash. But under the modified accrual, I have a receivable. Transaction to, well, I did receive the 200,000. Great. I debit cash and I credit the notes receivable for 100,000. This is actually 200,000. 200,000. I debit cash credit notes receivable 200,000. That's transaction to, well, if I receive the cash, I have to debit the cash and it goes against my receivable. Now transaction three, the entity purchased a building. So notice those are different than the cash. The entity purchased a building for 400,000 paying 125,000 in cash. Well, I can't run away from my cash. I have to credit cash. How much I have to credit cash? 125,000. The question is, what do I debit? Well, under modified accrual, I'm only focusing on current assets. The building is a long-term asset. So I cannot record the building on my books. What do I record? I record an expenditure. Well, this sounds like the cash basis. Indeed. It's just like the cash basis. I would record the transaction at 125. Because under the modified accrual, my focus is the current resources. My current resources are current assets and current liabilities. Therefore, that's what I would do. Transaction four, we hired employees. By the end of the period, they earned 6,000. That amount is not yet paid. Do I record this under modified accrual? Let me ask myself, what is modified accrual? Focusing on current assets and current liabilities. My current resources. How about wages? Are they a current liability? And the answer is yes. My wages are current liabilities. Because I have to pay those wages in the near future. Well, if that's the case, I have to record some sort of an expenditure. Remember, I'm calling it an expenditure because modified accrual. And I have to credit some sort of a liability. Because I do record my current liabilities under modified accrual. Therefore, I debit salaries expenditure. And I credit wages payable. And this is how I would record this transaction. So notice, all what I'm focusing on is receivables, current receivables, current payables. That's different than the cash basis where you have no, nothing other than cash transaction. Now, if I'm asked to prepare the income statement under the modified accrual, my revenue will be half a million expenditure of 125. And I have wages expenditure of 6,000. My profit will be 396,000. Now let's take a look if I have to prepare these journal entries under the full accrual, which is the method that we are comfortable with, should be most comfortable with. Starting with a donor pledged half a million. If the donor pledged half a million, I have a receivable. Under the full accrual, I record my receivable of half a million. And I have some sort of a contribution revenue. And notice this transaction is the same as modified accrual because I have a receivable. Well, full accrual do record the receivables. Same thing with the cash. I received cash from previously promised contribution. It's 200,000 in cash. And this is pledged receivable. I debit my cash, credit my receivable. Again, the same thing as modified accrual. Now I purchased the building. I purchased the building for 400,000. I paid 125 and the remainder is a note. Full accrual. Remember, what's the measurement focus on full accrual? It's all assets, all liabilities and the compasses, all assets, all economic resources. So what do I have to do? Let's start with the easy part. The easy part is I paid cash. How much cash did I pay? I paid 125. Do I put the building on the books? For sure I put the building on the books. This is full accrual. 400,000. Well, the difference is what? The difference is note spable. Do I include the note spable? Of course I do. This is full accrual. So full accrual, you would record long-term assets, long-term liabilities. We should not be surprised here. This is the method that we know. So now you can compare, for example, how we treated a building under the full accrual. The full accrual versus how we treated the expenditure of the building under modified accrual and cash basis. And last but not least, we need to accrue $6,000 of wages. Well, hopefully we all know how to accrue an expense. We debit an expense, credit wages, spable. Notice I'm emphasizing the word expense to reflect it's an accrual versus it was called an expenditure for modified accrual. The terms are different, expense versus expenditure. I will talk about that later on a little bit more, the difference. But basically expenditure is different than expenses. Expenditure is a modified accrual term. And let's take a look at the income statement based on the accrual method. We have revenues. Now we have the building. We have to book depreciation expense on the building. I took just the building, divided it by 30 years. And we have wages expense of $600,000. This is an expense, not expenditure. Our profit will be $480,667. So notice what we did. We looked at the various component of cash basis, modified accrual and full accrual. What should you do now? Go to Farhat Lectures. Go to Farhat Lectures. Look at additional resources, lectures, MCQs, true, false. Look at the notes to help you understand modified basis of accounting. This is a governmental accounting course. You want to do good in that course. You want to do good on your CPA exam. Good luck. Study hard, invest in yourself.