 Hello and welcome to the session. This is Professor Farhad in which we would look at this CPA simulation that you can see something like this on the CPA exam. This simulation deals with purchases inventory and how the effect cost of goods sold and their income assets like liabilities retained earning for two consecutive years, 2021 and 2022. As always, before we start, 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 1,900 plus accounting, auditing, tax, finance, as well as Excel tutorials. If you like my lectures, please like them and share them. Look, if you're listening to me, if they benefit you, it means they might benefit other people, share the wealth on my website, farhadlectures.com is where I have additional resources for CPA candidate. I do not replace your becker, your Roger, your Glyne or your Wiley. I can't replace them. I don't have that ability, but what I can do, I can supplement I can make you understand the material better. I can fill the gaps. I can fill what you missed in college or what you forgot since you left school. So your CPA course will make more sense and you will take advantage of the teaching style of Becker, Roger, Wiley and Glyne. So I strongly suggest you check out my website for additional resources that's going to make your life much, much easier. Now, before we look at this simulation, I just want to let you know, I can ask you, this is as a multiple choice question, rather than a simulation and I can give you this as a multiple choice question. I can ask you 14 different multiple choice questions. Notice for every year I can ask you something to find something for me. So notice this is a multiple choice questions, but we turn it into a simulation. Well, hold on a second. This does not look like a simulation on the exam. I see documents. Well, let me show you how I'm going to turn it into a task based simulation with documents. An examination of the records of Adam Company revealed that goods costing one thousand were received on December 31st, 2021. Rather than giving you the statement, I can give you a receiving report showing you that we received a thousand dollar worth of goods. How about that? Same thing. The purchase invoice for these goods was not received till January 4th, 2022. I can show you a purchase invoice and I stamped received January 4th, 2022. How about that? At that time, the purchase and the related liability were recorded. I can show you the accounting record and show you that the debit and the credit, you know, debit purchases, credit liability were not recorded until 2022. So notice, I already gave you three different documents, and those are three different statements given to you. Adam Company incorrectly executed the cost of the goods from its December 31st inventory rather than December 31st, 2021. So rather than telling you this, I can show you an email communication between the accounting supervisor and the receiving department or between the accountant supervisor and an employee and accountant and telling you this is what happened rather than giving you the statement. So those are additional two documents. OK. And the question is indicate whether the following statements were understated, overstated or not stated for 2021, 2022. So notice how this could be a multiple choice with 14 different questions. A simulation with just a paragraph simulation, or I can give you five or six different documents and confuse you. But we're all asking about the same thing. So as long as you understand, as long as you can follow my explanation, once they give you a question, you'll be comfortable with it. Now, how can you understand the concept? Go to Farhat Lectures because the CPA prep course, they don't teach you. That's not that's not their job. Their job is not to teach you. You're supposed to have learned this in college if you did. And if you if you forgot about it or if you did not or the college failed to teach you in any of these situation, this is where I can complement and fill out those gaps in your education and in the time gap between your education and your test prep. Let's get started first purchases. Sometime I'll do 2021, 2022. Sometime if it makes sense, I'll go in order purchases. Well, guess what? Did we count the purchases in 2021? No. So what happened to purchases? Purchases were understated, obviously, because they were not counted. Well, if they were not counted in 2021, what year were they counted in? They were counted in 2022. They were shifted to 2022. So what happened to purchases in 2022? We shifted something to them. They were overstated. Inventory December 31st, 2021. What happened to inventory on December 31st, 2021? Let's think about it. How what happened with inventory? You count inventory. So if you count inventory, are you going to find this $1,000 that you actually have? Are you going to are you going to count it? And the answer is you will not count it. Why? Because on your December 31st, 2021, incorrectly executed the cost of the goods, they were not included within your inventory. They're just telling you this in the problem, they are not included. Therefore, it is understated. You were told in the problem that it was executed, executed. So when it was counted, when you counted it, it was not there. Cost of goods sold. Now, this is important to understand how cost of goods sold work. Well, without me mentioning here, we are using the periodic inventory system. What does it mean? We are using the periodic inventory system. It means what we do at the end of the year, we count our ending inventory to determine our cost of goods sold. And there is a particular formula that we will use in order to count ending a cost of goods sold. And what's that formula? You need to be familiar with this formula. All CPA firms, they emphasize this formula. And basically, we're going to take beginning inventory. And we're going to add purchases. Then we're going to subtract ending inventory. Okay. When we count ending inventory. So let's assume for the sake of illustration, we're talking about 2021. For the sake of illustration, our beginning inventory was 100,000. Our purchases, which executed that $1,000 was 400,000. And our inventory, when we counted the inventory, we only have $50,000 based on the count. We did not count this additional 1,000 purchase because it was executed. Okay. Now, 100,000 plus 400,000, 100,000 plus 400,000 equal to 500,000 minus 50,000 of ending inventory, we have cost of goods sold a $450,000. This is what happened. This is what happened. Now, let's assume we properly counted this inventory. Let's assume we properly counted this inventory. So this is the correct beginning inventory will not change. We would still have 100,000 purchases rather than 100,000. We're going to have, we would have 410,000. Well, as a result, if we added the purchase, we're going to assume we're going to count the inventory. Now, therefore, we're going to have 51,000 of inventory. Therefore, 100,000 plus, sorry, 1,000, not 410, that's 401. So 100,000 plus 400 and 1,000 minus 51,000, guess what? It's going to give me also 400 and 50,000. So notice cost of goods sold was not affected either or because what I did is when I added the purchases, I also added it to my ending inventory. So I added the purchases and as a result, it's going to be taken from ending inventory. It's as simple as that. Now, if you're saying, hold on a second. So it's the same thing. Yes, it's the same thing because the purchases increase cost of goods sold, ending inventory reduce cost of goods sold. So as you increase the one, the other one will decrease cost of goods sold, the net effect will be zero on cost of goods sold. Now, if there is no effect on cost of goods sold, it'll be easy to know the effect on income, no effect on income. If we know no effect on income, we're going to be easy. We're going to be no effect on retained earnings, no effect on retained earnings. So notice cost of goods sold is not affected whether you included certain purchases or not because when you include them, you're going to include them in ending inventory when you don't include them. You don't include them in ending inventory. And here they were executed. The cost was executed from inventory. They were executed. Okay. Now, let's look at 2022. 2022. What happened to ending inventory in 2022? The best way is to also use an example. Keep on going with this example. Now, obviously on the exam day, you don't have that much time, but you want to understand the concept. That's why I'm taking my time and explaining the concept. In 2022, here's what's going to happen in 2022. You're going to have, now we're going to move to 2022. You're going to have beginning inventory. And let's assume we're going to start with this when you made the error. When you made the error, your beginning inventory will be $50,000 because you made the error. Now, what's going to happen? Your purchases, you're going to have an additional 1000 in purchases plus our purchases. And for that year, for 2022, we made 300 in total. The purchase is supposed to be 300. But since we missed that invoice, now the purchase is 301. Now, we count ending inventory. Now, we're going to count ending inventory. And as a result, I'm going to make this simple. We counted ending inventory and it's 51,000. Okay. So now, 350 plus 301 equal to 351 minus 51 equal to cost of goods sold of 300, 351 minus 51 equal to 300,000. Okay. Let's move on to if we did not make the error. So let's move up here. And what happened if we did not make the error? If we did not make the error, now we're going to look in there. If we did not make the error, this column right here, our beginning inventory, when we start 2022, it will be 51,000. Our purchases would only be 300,000. Because this 1000, this additional 1000, now it's included in beginning inventory was properly counted in the prior year. Now, ending inventory, when we count ending inventory, we still have 51,000. Because this additional 1000 went down there. It was counted. Therefore, 51 plus 300 is 351 minus 51 equal to 300,000. What you need to understand from all of this is purchases in a periodic inventory system does not affect cost of goods sold. It's going to affect other things we're going to see in a moment, but not cost of goods sold. Why? Because purchases and ending inventory, they offset each other. Therefore, let's do cost of goods sold first. Not affected, net income not affected, retained earnings, not affected. Okay. Now we did not answer inventory December 31st, 2022. Well, look, I don't have to answer this question. Look at the answers. It was 2022, 51,000, 2021, and 2022, I'm sorry, 2022, when it was correct, 51,000 was incorrect, 51,000. Therefore, for 2022, the inventory is not affected because it's not affected. It's whether we did it correctly or incorrectly. We, we counted the inventory properly. So the inventory itself is proper for 2022, for 2022. Now, let's look at assets. Let's look at assets. What happened to our assets in 2021? Well, I should have did this when I did inventory. If inventory is underreported, inventory is an asset. Asset is underreported, right? Same thing for 2022. Inventory is an asset. Is asset, if not affected, if I'm sorry, if inventory is not affected, assets are not affected as well. So this is the effect on 2022. Let's look at liabilities. What happened to liabilities? What happened to liabilities? Well, for 2021, we had a liability. We had a legitimate liability, but it was not reported. Therefore, it's underreported. What happened to 2022? In 2022, we account for all the liabilities. So what happened? Whatever was not accounted in 2021, it moved to 2022 and basically was counted properly because remember liabilities, they are continuous. They, you know, they're permanent account in a sense that if it was not counted, it will be counted in 2022, then paid, then it's gone. So not affected for 2022. So notice in all of this, and all of this, if you notice, and that's a, you know, the only thing that was that affected 2022 is purchases. That's all what you need to know. It was overreported. The other accounts, they were not affected. The other accounts were not affected. Something it's, you want to memorize maybe? Or you want to understand 2021? Once you understand 2021, you will understand 2022. This is what I offer you. I offer you detailed explanation with examples versus a CPA course where they go over this real quick, like, you know, you, you and Anne, or they don't even go through this to just show you this real quick without going into details. Now, after you understand this, if they want to go real fast, you can keep up with them. If they want to give you a mnemonic, you can, you can take that mnemonic as long as you understand the material. And that's what I do. So again, I'm going to invite you to visit farhatlectures.com for additional resources for your CPA exam or intermediate accounting or whatever, whether other, whether you are taking any other accounting course. CPA exam is very important for your career. It's extremely important. It's a couple of years worth of investment and money and time that's going to pay dividend for two to three decades. It's going to determine where you live, what car you drive, who's your partner, and many other factors. So take it seriously. It's only temporary. The pain is temporary, but the gain is permanent. Good luck and study hard.