 Hello and welcome to this session in which we would look at CPA questions that deals with leases. Leases is a very important topic on the CPA exam. It's a major topic like pension, like the cash flow, like income tax, accounting for income taxes, governmental and consolidation, among other topics. But why leases is important and why do you have to be comfortable with leases before sitting on the exam? So here's how it works. When you sit down on the exam day and you are not sure, you thought, yeah, I may not get a lot of leases. Somebody told me that leases is not an important topic on the exam. Here's what's going to happen. The AI CPA software, they're going to throw at you a question about leases and that question could be easy to medium. And how do they determine whether that question is easy or medium? Well, hundreds, if thousands of students took the exam before and they answered that question. 80% of the students get this question right and you got this question wrong. And it's easy to medium question about leases. What is this? How is the software is going to react? It's going to say this candidate either answered that question incorrectly by mistake or this individual does not understand leases, which is a major topic on the exam. Then they will give you a second question about leases. You get it wrong. They'll give you a third question about leases. You get it wrong. Immediately you are heading to a grade below 75. The point I am trying to make here is you cannot take your chances on the CPA exam day. You have to be confident in all topics. And leases is one of these major topics. Not only leases, any topic you want to be competent because they can detect your weakness, the software will detect your weakness. And if they say you have weakness in major areas, you will fail the exam. So that's why I want to emphasize this point. But before I start, if you are, whether you are an accounting student, because this topic is covered in intermediate accounting or a CPA candidate, especially if you're a CPA candidate studying for the CPA exam, I strongly suggest you check out my website, farhatlectures.com. Now, you might have Becker, Roger, Wiley, Gleim, good for you. I'm really happy for you. You need to have those courses. I don't replace them. What I do is I can be a useful addition to your CPA course. I can add 10 to 15 points to your score by helping you understand the material better. I don't sell you, you know, air or snake oil. I sell you actual teaching knowledge. So I'm not selling you strategies or how to do things. I'm selling you the knowledge you need, the basic you need to do well on your CPA prep courses and at the end of the day, do well on the CPA exam. And here's my offer to you. You are risking $30. This is what you are risking. Invest $30. Try my system. You like it, keep it for the next month. If you don't like it, cancel. So your loss is $30. What is your potential gain? Your potential gain is passing the CPA exam. Are you willing to take that chance? That's up to you if you're studying for the CPA exam. Always, if not for anything, check out my website to determine how well is your university doing on the CPA exam on average? I have average score by university as well as section. If you are an accounting student, I have plenty of accounting courses and resources, connect with me on LinkedIn and check out what other people, other people mean successful candidate that they used my system along their CPA review course and they passed. Please like this recording and share it on YouTube, Twitter, Facebook, anywhere you can share it, connect with me on Instagram and Facebook. So let's take a look at the first question and a question like this, where you have a lot of data I can ask you to a lot of questions. So don't read the data first. See what you are being asked. You are being asked, what is the outstanding balance of the lease liability in Exton's June 30th balance sheet? Now, why do I ask you to read the question first? Because I can ask you 10 different MCQs about this question. So you want to know what you are looking for, because you could be buried, you could be spending five minutes just to kind of go over the data. Now you are focusing, you want to know what's the lease liability. West Goshen Tech sells computer system. West Goshen leases computer to Exton company on January 1st, 2021. The manufacturing cost of the computer is 19 million. So notice, the manufacturing cost of the computer, it's not really any way relevant to me because I'm looking for Exton. So this is basically out. Like it just, this is where you don't have to worry about this information because the cost of the manufacturer is not part of the question. This is a non-cancelable lease has the following term. The lease payment, that's important, 3,287,947. It's semi-annual twice a year. First payment January 1st, remaining payment on June and December. Each year through June 30th, 2025. The lease term is five years, 10 semi-annual payment, no residual value, no purchase option. Economic life of the equipment is five years, implicit interest rate. And let's see incremental borrowing rate, 9%. Fair value of the computer is of January 1st, 23 million. This is important. Okay, so let's start with this. So what are they asking us? They want to know Exton lease that equipment. What is their lease liability as of June 30th, 2021? And the dates here are extremely important, just in any problem, but especially with bonds and leases, extremely important. So you started the lease January 1st. Now, you are not giving the present value factor to find the present value of the payment, but you are giving the fair value of the computer. We're going to be using the fair value of the computer. Simply put, as of January 1st, 2021, you have a lease liability. You have a lease liability of 23 million. And this is immediately January 1st. Also what happened immediately on January 1st, you made your first payment. You made your first payment. What does that mean? You made your first payment. You are going to reduce your lease liability by the payment. And you made a payment of 3,287,947. Now, you want to know what is your balance right after this lease payment. Once again, why am I doing this? Because you made the lease payment immediately. Therefore, I have to reduce my balance. So there is no interest involved in this payment. So I started with 23 million. I made a payment of 3,287,947. And that's going to give me a balance of 19 million, 19 million, 712,053 dollars. And this is one of the answers. But that's not what they're asking us. If they ask you, what is the balance as of January 1st, 2021, that will be the answer. But that's not the answer. So immediately, I will take this one out. Immediately, I take C out as well. Notice, I went down to 50-50. I don't even do anything yet. I know it's not going to be the fair value of the equipment because I'm going to be making a payment later on. So immediately, you could have take out C. It cannot be the balance as of June 30. And right after my first payment, my balance went down. It cannot be D. So now I'm down to 50-50. If I have to guess, you can guess at this point. But don't guess. You can work this question real easily. Well, what happened is this was January 1st. Now, by June 30, you're going to be making another payment. How much is the payment? The payment is 3,287,947. The payment is fixed. What's going to happen on that date when you make the payment, you are going to split the payment into two components. One component, sorry, will be interest. And one component will be for the liability for the principal. So one component is interest. The other one is for the principal or against the liability itself. Now, how do I know which one is the principal? Which one is the liability? This is why I had to compute this balance first, the 19,712,53. So that's my balance as of the beginning of this period. And the interest rate I am being charged is 9%. So that's going to give me interest component of 1,074,085 dollars. So simply put, of this payment, the interest is 1,074,085 dollars. And the remaining must be the liability reduction, which is 1,513,000. Let me just, you do the computation here. So 3,287,947,3,287,947 dollars minus the interest component, 1,074,085 dollars. What I'm left with is 1,513,862. So this is going to, again, so what's the entry? Simply put, the entry is going to be, you debit the liability, 1,513,862. You credit interest expense, 1,774,085 dollars. And you credit cash for the amount, 3,287,947. So now I'm going to be reducing my liability again by this amount, 1,513,862. Now this is the answer, whatever I get here. So all I have to do is do this computation. And after this computation, the answer will be 18,18,198,191. So that's basically how you do this. Remember, the payment is broken down into interest and into liability. First, you compute your interest. Then whatever's left is for the liability, for the principal amount. But this question, they could have asked me, what is my interest component? For example, they could have asked me, what is the interest component as of the state? It will be this amount. They could ask me, what is the balance as of December 31st after the second payment? Then you have to make a second payment. And they could ask me, what is the total interest expense for the year? You have to add up both interest expense. So they can ask you a lot of questions about problem like this. Make sure you are comfortable with the lease topic. Let's take a look at this question. Let's keep the calculator. What is the effective annual interest rate? So they're giving us a problem and they're asking us, what's the effective annual interest rate? Now you may not see something like this on the exam exactly like this, but you want to make sure you are comfortable with the lease schedule. Because I mean, they could give you a lease schedule. I'm sure they can't. But I'm not sure they ask you, what is the effective interest rate? But you want to make sure you understand how to compute this. Because if you know how to compute this, then you know how to compute interest expense. If you know how to compute interest expense, as we saw a minute ago, you know how to compute the principal. So it's very important to have a good understanding about everything. Refer to the following lease amortization schedule, the 10 payments that are made annually starting with the beginning of the lease. Title does not transfer to the less C and there is no purchase option or guarantee residual value. The asset has expected life of 12 years. The lease is non-cancellable. What is the annual effective interest rate? That's what they want us to know. What is the effective annual interest rate? So how much am I being charged an interest? Well, how do I know this? Well, I am giving my cash payment. That's not really helpful because remember the cash payment, the cash payment, the 12,000, the cash payment will be split between interests and the liability or the lease principal. So the first payment is made immediately. It's all goes toward the principal. The second payment, 12,000 here. Well, I noticed that $6,911 is interest and 5,089 is principal or decreasing in the balance. What does that mean? Well, if I paid $6,911 over a balance of $69,108, all what I have to find out now is divide those two numbers, $6,911 divided by $69,108. And that's going to give me my interest is around 10%. 10.00028, 10%. And this is my interest. So my interest for this problem is 10%. Why? Well, I have my interest expense. Well, if I paid that much interest expense on this balance, well, my interest cost is 10%, implicitly is 10%. Let's take a look at this question. What is the total effective interest paid over the term of the lease? Basically the same thing, except a different question about this topic. Well, hold on a second. This is a lot of numbers. How do I know how much interest I paid? Well, let's start with my balance. What is my outstanding balance? I owe $75,939. That's my liability. Okay, that's good. Then of that liability, how much did I actually pay? Well, I made 10 payments of $12,000. So I made payments of $120,000. Those are my total payments. My balance is $75,939. So the difference between those must be my interest. So immediately what you can do in this problem, immediately you can eliminate the 120. You could eliminate the 75. So you're down to 50, 50. And I don't even have to use my calculator. If I'm subtracting 120 from 75, it cannot be 63. So my answer must be 44,062. And that's my answer. It's the difference between what I paid in total and what my loan balance is. What my loan balance is. So I paid 120,000. I owe $75,939 for the lease. The remaining must be, okay, let's take a look at this problem. What's the outstanding balance after payment nine? So this is payment nine and they're asking us, what should be the balance after payment nine? Now, hopefully you know that after payment 10, the balance is zero. So the balance here is zero. This is easy if they ask you this. But this is what they could do on the exam. On the exam, they can start by giving you this intimidated data and they ask you, what is the balance after payment 10? Okay, and if you don't know that the balance is zero after payment 10, then immediately the AI CPA software will say this CPA candidate don't understand the leases. Well, what does that mean? It means you're heading toward a grade below 75. Let me give you this on a personal level example. If I gave you this question on my exam in my classroom and I told you, what is my, what's your balance after payment 10? And if you don't know that the balance is zero, you should not pass my course. Not because I'm harsh because you don't understand leases. And this is what happened on the exam day. If they notice, you don't understand this concept, then forget about it. You should not be a CPA as of yet. What you should do, sign up for hatlectures.com and this guy will help you pass, right? Of course. So this is what that's what I'm saying. You have to understand everything. So what is the outstanding balance here in this right here in this area? So what's the prior outstanding balance? The prior outstanding balance is 17,125. Then you made a payment of 10,000. Well, remember the payment part of it, it's gonna be interest, part of it, it's gonna be principle. So if we can find the principle component, we're gonna take the principle component and deduct it from this prior balance and this will be our answer. Well, we don't know what's the principle component. Can we find out the principle component? Of course, we're gonna take the outstanding balance multiplied by some interest rate to find out the interest component first, to find the interest component here. Well, I'm not giving the interest. Can I find the interest component? I sure can. It's 6,091 if I take my one of my interest expense divided by the prior balance, I will find out that I am being charged 11%. Well, now it's easier 11%. So I'm gonna take 0.11 times 17,125 and that's gonna be 1,883 of interest, 1,883. Let's make it 84. So of this $10,000, 1,884 is what? Is expense, therefore if I take the difference between this and the remainder of the payment, 8,016, 8,016 is the principle. Now, I find out what I need to find out. I'm gonna take 8,016, so, and find the difference between that and the prior balance. And the prior balance should be 17,125 and that's gonna give us a balance of $9,00. $9,009 and the answer is this. Now, if I made one more payment, now my balance is $9,009, if I made one more payment of 17,000, I'm sorry, if I made one more payment, now the balance is 9,900 times 11% times 0.11. So my interest expense, 990, my interest expense will be 990 for the payment 10 and my remaining balance from this payment will be, voila, $9,009, $9,009 and the prior balance was $9,009 and my remaining balance will be zero. There we go, so I showed you after year nine and after year 10, but you don't wanna do year 10, you don't wanna waste your time. If they ask you what is year 10 is, well, say this is a two-second question if they ask you what is the balance in year 10, it should be zero because the balance at the end of the life of the lease or the bond, once you amortize everything, the balance should be zero, you pay that off, okay? The balance should be zero. Now, again, at the end of this recording, I'm gonna ask you to like this recording and I invite you again to check out my website, farhatlectures.com. Again, I'm gonna give you this challenge. Are you willing to try my website for $30? Okay, it's gonna supplement your courses and I have lessons that goes with your courses to find out if you can get that extra 10 to 15 points that pass your exam. So simply put, the CPA exam will pay you dividend for years to come, 20, 30, 40 years. Are you willing to try $30 to find out whether you can get there? That's all what I'm offering you. Anyhow, good luck, study hard and of course, stay safe.