FAR CPA Exam Review Course 

Hello and welcome to Bisk CPA Review's coverage of financial accounting and reporting. My name is Bob Monette, and I will be your instructor for financial accounting and reporting. And let me say right off the bat, that financial accounting and reporting is what I would call a classic good news, bad news type of situation.

Let me give you the good news. The good news with financial accounting and reporting is that I think you'll find of the four parts of the CPA Exam. It is the part where you will be most comfortable with the material. I really believe that because after all. What you majored in is financial accounting and reporting you didn't major in auditing you didn't major in regulation.

You didn't major in business environment and concepts, whatever that is, right. You didn't make that wasn't your major, your major was financial accounting and reporting. So as I say of the four parts, I do think you'll find. That it is the part where you are the most comfortable with the material, the bad news.

And I know you'd rather not hear it, but the bad news with financial accounting and reporting is that it is simply a backbreaking amount of material. It just is of the four parts of the CPA Exam. It is, I think by far the most material that you're going to have to study. And of course, when you are faced with an CPA Exam that is covering this much material, all you can do.

The only strategy that works is take it a chapter at a time, taking a topic at a time, you know, slow down, master each topic, do the work, get the problems done. And take it slow and easy through all the material. Cause there is so much, in other words, it's almost as if you have to eat an elephant, that's really what it comes down to financial accounting reporting is you have to, you've been given an elephant that you have to eat.

Well, obviously you can't do it in one meal. So you got to break it up. Into little meals and then hopefully you can get through the elephant. And of course we're hoping that's what these classes are all about. That we break this up into manageable pieces now to give you an idea of exactly what they test in financial accounting and reporting.

Let me just quickly say that the official AICPA content specifications. That goes over. The detail of what's in the financial CPA Exam is in your book. If you have the Bisk book it's in appendix B I don't want to look at that right now, but when you get a chance to look at that, you'll find that the official content specification is not what I would call a model of clarity.

It really isn't you'll look at it. And it says, you have to know measurement. You have to know concepts. And I think most people come away from that going, what do I have to study? It's not as, it's not, as I say a real model of clarity. So I'm going to give you the content specification in a little different way, because you know, someone who teaches this as I do someone who's very close to this, how do I look at the content specification?

What is the way I think of it? Let me show you the way I think of it. First of all, we have to concentrate on, on four major areas. First balance sheet issues, issues around the balance sheet. Income statement issues, issues all around the income statement, statement of cash flows and consolidated financial statements.

I want you to think of those four areas, balance sheet issues, income statement, issues, statement of cash flows and consolidated financial statements. I promise you one way or another. Those four areas will make up approximately 60 to 70% of your grade. Every single CPA Exam. What I'm saying is it's make or break.

It's about 60 to 70% of your grade every single time. Now it's a lot of work. I'm not minimizing that it's, that covers a great deal of ground. We have a lot to say about those areas, but it's about 60 to 70% of your grade. Then you have the non-profit areas. First, governmental accounting, state, and local governmental accounting.

You can expect state and local governmental accounting to make up. Between eight and 12% of your grade, then there's O N P O S other nonprofit organizations, O N P O. When I talk about other nonprofit organizations, we're talking about private, not for profit hospitals or healthcare entities, private not-for-profit colleges, or universities, voluntary health and welfare organizations.

These are your other nonprofit organizations other than state local governments. And you can expect O N P O's to make up between eight and 12% of your grade in the FAR CPA Exam. Now that's officially what each one represents eight to 12%. But my perspective, if I were studying for this CPA Exam, I'd expect state local, governmental accounting to make up closer to.

12% of your grade, and I'd expect other nonprofit organizations to be closer to 8%. In other words, I'd expect non-profit in total to be about 20% of your grade with a little bit more emphasis on governmental accounting. And I say that because governmental accounting really is more complicated. This is just more they can ask.

So I think when it all shakes out, expect governmental accounting to be closer to 12% of the nonprofit organizations to be closer to the 8%. Usually it's about 20% of your grade. Now, if we add all that up, We're somewhere between 80 and 90% of your grade. And there's one final area. What I call miscellaneous financial accounting topics, miscellaneous financial accounting topics.

We'll make up somewhere between 10 to 20% of your grade. What do I mean by miscellaneous financial accounting topics? Well, there's a whole list of them. I'm not trying to give you a complete list, but things like partnership, accounting. Foreign operations, personal financial statements, ratio, analysis, earnings per share.

There's a whole list of miscellaneous financial accounting topics. And we'll those two, you know, we're going to cover everything and we'll go over all those miscellaneous topics as well. But you've got that final 10 to 20% of your grade and you can't ignore that. You know, every point is essential. It's a pass, fail CPA Exam.

So he can't really ignore anything, but that is how I see financial accounting and reporting. That's how the content specification breaks down in my mind. And of course I mentioned something like this because it's the way I like my students to think in other words from now on, because you're one of my students from now on, you know, when you're studying something you're thinking, do I really understand the impact on the balance sheet?

Do I really understand the impact on the income statement from this. And of course, do I understand how to do a statement of cash flows? Do I understand consolidate financial statements that you thinking in these terms? And as I say, the official content specification is independent space. So you can look that over when you get a chance, but this is basically the way I like my students to think.

Welcome back in this FAR CPA Review class. I want to begin our discussion of the asset side of the balance sheet. Let's start with cash. Now there's not a lot to study with cash, but there are a few things that you have to be careful about. First of all, what you put in a balance sheet under the heading cash must be money that is free and clear and available to be spent in current operations.

Please remember that's what cash is. Money that's free and clear and available to be spent in current operations. So, what do you have to be careful about in the exam? Well, if there's some reason you can't spend cash, you have to back that out, you know, watch out for a security deposit on a longterm project.

If you see a security deposit on a long-term project, you can't spend that. So you back it out, that's going to be on the balance sheet as you know, security deposits. But the point is it's not cash because it's not free and clear and available to be spent in current operations. You could see a bond sinking fund.

You know, when a company has bonds outstanding, they agree with their bond holders that every year they'll put so much cash in the hands of a trustee. So that 25 years from now, when the bonds mature, the investors know the cash will be there to pay, to pay them back. Well, the point is that if you have a bond sinking fund, the cash is in the hands of a trustee.

You have no ability to spend it. So it's not cash, it's not free and clear and available to be spent in current operations. So you have to back that out, you know, that's on the balance sheet as fond, sinking fund. It's not cash. Another one. You might see a compensating balance on a bank loan. I'm sure you know what that is.

A company has. A loan outstanding at a bank. Some banks make the company keep a certain minimum balance in their account. Well, if you have to keep a certain minimum balance in your account, it's not cash because it's not free and clear and available to be spent in current operations. So you have to back that out.

You know, that's really an investment it's on the balance sheet as an investment, but it's not a cash. So just always be careful. If there's some reason you can't spend cash. It doesn't belong in the cash balance. You have to back it out also in terms of cash, make sure you know, the three month rule, highly liquid securities certificates of deposit, treasury bills, any commercial paper with an original maturity of three months or less.

Again, certificates of deposit, treasury bills, any commercial paper with an original maturity of three months or less. If you see a security like that, you can treat it the same as cash. They called cash equivalents. Just keep it in your cash balance. Let me ask you a question. Let's say I have a six month CD.

It's going to mature in two weeks. Is that a cash equivalent? No, because the original maturity six months watch out for that. Remember the way the rule works, the original maturity has to be three months or less. Since the original maturity, six months, that's not cash. You know, that's an investment that is not cash.

The original maturity is three months or less highly liquid securities. You can put it in your cash balance, be treated as a cash equivalent. Now I will say that the primary thing, the CPA Exam hits with cash is bank reconciliations. Now I know that you've done bank reconciliations before in school. Once in a while in your own checking account every now and then, but I thought we should do a couple together just to get the sense of how the FAR CPA Exam comes at this.

So if you go to your viewers guide and look at question number one, apex, it says in preparing the August 31 bank reconciliation, apex has the following information and at the bottom they say. At August 31. What is the correct cash balance? In other words, they're asking you if you're doing a balance sheet on August 31, what is the correct amount to put in that balance sheet under the heading cash?

Well, let's work it out. We know the bank statement balance on August 31 is 18,000. Oh 50 1,850. That's the bank statement balance on August 31. Now let's go through these reconciling items. How about the posits and transit? We worried about that. Sure. What are those? Those are deposits that we've put in the bank.

We've added it in our check register, but it's in transit still. Hasn't shown up in the bank statement yet it's in transit. So we're going to have to add that in. So we're going to add in the deposit and transit 3002 50. How about return of the customer's check? The 600 worry about that? No. Why not?

Because we started with bank balance. Don't forget that we started with bank balance. We started with the bank statement and the return check would be included in the bank statement. The bank has already backed it out. Don't forget your starting point here. If you started with bank statement, the bank would have taken that return checkout already.

Don't worry about it. How about outstanding checks? Of course, these are checks. We've written them. We've mailed them. They just haven't cleared the bank yet. So we'll subtract. The outstanding checks, 2007 50. How about the bank service charge? No, cause we started with bank statement. The bank service charge would be reflected in the bank statements already been backed out.

So if you add it up, comes out to 18,005 50 in the answer is a, that is the correct bank balance. That is the correct cash balance on our balance sheet on August 31st. And that's a good question because. When you do your homework, you'll see that the same things come up again and again, in these questions, the posits and transit outstanding checks, returned checks, bank service, fees, interest.

And again, in this case, I wouldn't worry about bank service fees interest, because I started with bank statement, things like bank service fees, interest are in the bank state. So you do a couple of those. I think you'll be okay. Let's look at one. That's a little different number two. The following information pertains to gray company, December 31, we know the checkbook balance 12.

We know the bank statement balance 18, I'm sorry, 16,000. It says a check was drawn on grays accounts payable to a vendor. They didn't record a December 31, but not mailed until January 10 of the following year. The bottom they ask. In Gray's December 31 year, three balance sheet, what would be reported as cash?

So they're asking if we do a balance sheet, December 31 year three, what's the correct amount to put in that balance sheet under the heading cash? Well, I like this question because it's not a lengthy question, but there's enough here to make you think. And of course, that's the last thing you want to do with the date of the, on the day of the exam.

When you take the exam, you'd love to do think you have it all down cold. You're not gonna have to really think about anything, but this question does make you think doesn't it. Don't you have to think about that. If I'm going to work out the correct cash balance in the year three balance sheet, what's my starting point.

Should I start with checkbook or should I start with bank balance? In other words, you had to think theoretically. What is the correct starting point to work out the correct balance in cash? Do I start with checkbook or do I start with bank balance theoretically, because did you notice if I start with the 12, if I start with the 12,000 there's answers there for me, if I start with the 16,000, this answer's there for me.

So I had to think about which one I start with. Theoretically, what's theoretically stronger checkbook. Bank statement. Definitely check book. Now, why, why is checkbook where you should begin here? If you're given both, you have to decide between the two. Why is checkbook stronger? Think about this for a minute.

What are some major things that are missing from bank statement? Anything. It could be huge deposits in transit. There could be a lot of outstanding checks. I hope you see that that's the problem with bank statement. That could be a lot of outstanding checks. There could be huge deposits in transit. Think about your checkbook for it.

Think about your checkbook for a minute, your own personal checkbook. Shouldn't short checkbook, at least recognize all shouldn't it reflect all the deposits you've made all the jacks you've drawn. I mean, you know, I've messed up, but you know what I mean? Assuming you're functioning fairly well. Your checkbook should reflect all the deposits you've made.

All the checks you've drawn. The problem with bank statement is there could be a lot of outstanding checks that could be huge deposits in transit. Now checkbook's not perfect. What's missing from checkbook interest bank, service fees, return checks, but they tend to be in material. So. Suffice it to say that anytime you given a choice, you should start with checkbook.

All right. So we're going to start with the 12,000. Now we have something to think about. A check was drawn on grays accounts, payable to a vendor dated and recorded December 31 what's what's recorded mean booked. It was booked. In other words, On December 31, they debit accounts payable, 1800. They credited cash 1800.

It was booked. But now what happened now? I don't know. They stick it in a drawer. They don't mail it till January 10th. Unbelievable. They, you know, they went to quite a new year's party. You know, they went, they went off, went to some incredible new year's party. They don't get back to the office till January 10th and they mail it.

Well, here's what they way they're making you think about if I don't get back from the new year's party, it'll January 10th and I don't mail it till January 10th. Should I have it back? If you think you, should you pick B if you don't think you should. Hey, that's where we are. Isn't it. So how do you get from a to B?

Well, you take out a coin. You flip it? No. You have to think it through. Should I add it back or not? Yes. You add it back. The answer is B, but why? You know why? Because if you didn't mail that check till January 10th, then on December 31, that cash was free and clear and available to be spent in current operations.

That's the thinking here. You didn't mail that till January 10th and on December 31, that cash was free and clear. And available to be spent in current operations. Yes. You add it back. And if this is bothering you, some students resist this. Look at it this way. If I were the auditor on this job, what adjusting entry would I make my client do?

I'd say, well, you didn't mail it to January 10th. So debit cash, put the cash back 1800 and credit accounts payable. 1800. The liability goes back on the books also. It's really it's it's the issue was cutoff. Isn't it? It's really proper cutoff, December 31, you had the cash. So you'd make your client debit cash 1800, put the cash back and the payable would go back on the books as well.

Same problem. What if, same thing I draw our check. I recorded, I dated December 31 and I'm driving home from my new year's party. I find the. The bill in my pocket, I haven't mailed it yet. So I stopped at a mailbox. I put it in the mailbox at five past midnight on new year's Eve. How about this? I date it recorded December 31, driving home from the new year's party, stopping at mailbox because I'm always thinking of my job.

I'm always thinking of my employer first. So I stopped at a mailbox and I put it in the mailbox five past midnight. On new year's Eve, add it back. Yes. Yes. Add it back. Because on December 31, the cash was free and clear and available to be spent in current operations. And I thought, Bob that's so ridiculous.

Remember, this is CPA Examworld. It's its own little self-contained world. So if they say it wasn't mailed until January 1st, January 2nd, you add it back because on December 31, the cash is free and clear and available to be spent in current operations. The issue was cut proper cutoff

let's move on from cash. And let's talk about accounts receivable. Now the primary thing that the CPA Exam tests with accounts receivable is accounting for bad debts. Now, as I'm sure you remember, there are two approaches. To accounting for bad debts. There's the direct write-off method. And there is the allowance method.

Let's start with the direct write-off method. Under the direct write-off method. A company makes no entry for bad debts until a customer actually defaults. That's what we mean by the direct write-off method where. A company will make no entry for bad debts. They do nothing for bad debts until something happens until the customer defaults.

And when the customer defaults the account is written off at that point, let me illustrate, let's say in 2011, a company makes a $900 sale on account. So we assume they'd make their normal entry. They would debit accounts receivable 900 and credit sales, 900. We assume they'd make their normal entry. Now we'll assume that they haven't collected a dime on this account.

In 2011, 2012, 2013. Finally, in 2014, they decide to give up their collection effort. Maybe the customer's declared bankruptcy. Maybe they've left the country. The exam's not going to give you lots of detail. The point is that in 2014, they've decided to give up their collection effort. Here's the point about the direct write-off method.

In my example, there would have been no entry for bad debts in 2011, 2012, 2013, but in 2014, when they give up their collection effort, they'll debit bad debt expense, 900, take that expense to the income statement and credit accounts receivable 900 right off that account. That's the direct write-off method where you do nothing for bad debts until a customer actually defaults.

And when the customer defaults the account is written off at that point. Now, before we leave the direct write-off method, you see why theoretically, it's not a good method. It's extremely weak, theoretically, because of the matching concept. Remember on an income statement, our objective is to match current revenues with current expenses.

We're not really doing that here. In my example, are we. When I do my 2014 income statement. In my example, when I do my 2014 income statement, don't I end up matching 2014 sales with an expense. I really incurred back in 2011. I didn't know it at the time, but that's the problem. I ended up matching 2014 sales with an expense that was really incurred back in 2011.

From a theoretical standpoint, the direct write-off method is very weak. You can only use the direct write-off method. When bad debt expense is an immaterial item on the income statement. I'll say that again. You can only use the direct write-off method for bad debts when your bad debt expense is an immaterial item on the income statement.

And you know what I'm going to say next. If your bad debt expenses are a material item on the income statement, the company is required to use the allowance method of accounting for bad debts. So if a company's bad debt expenses are a material item on the income statement. The company is required to use the allowance method of accounting for bad debts.

And we will look at the allowance method in our next class. I'll see you then

welcome back. As we said in our last class, if a company is bad, that expenses are a material item on the income statement, they are required to use the allowance method of accounting for bad debts in the allowance method. We're going to estimate the accounts that we think will go bad. And we're going to set up provision on our balance sheet, on allowance, on our balance on sheet for the accounts that we think will go bad.

So it's a very different approach, the allowance method, because now we estimate the accounts we think will go bad and set up an allowance on our balance sheet for the accounts we think will go bad. Now, before we look at some problems, I will tell you that there's one thing. That a lot of students forget in the CPA Exam on allowance for bad debts.

A lot of students forget that there are two approaches to the allowance method. There is an income statement approach, and there is a balance sheet approach. You have to remember that there's an income statement approach, and there's a balance sheet approach to the allowance method. Let's look at a question in the viewers guide question number one at January 1st.

Of the current year J company had a credit balance of 260,000 in, in its allowance for uncollectible accounts. Based on past experience, 2% of credit sales have been uncollectable during the year. Jammin wrote off 325,000 of uncollectable accounts, credit sales for the year, total 9 million in the December 31 year end balance sheet.

At what amount. Would jam and report as allowance for uncollectible accounts. Well, you may already be thinking this way, but an excellent approach to allowance for bad debt questions is to set up a T account for the allowance account. You can do that. You get one of these in the tasks do, and you scrap paper just right away, put it to your countdown for the allowance method and work it through.

So we'll set up a T account for the allowance method, and we know that. They started January 1st with the $260,000 credit balance in allowance for bad debts. Normally the allowance account has a credit balance and they started January one with the $260,000 credit balance in allowance for bad debts.

During the year, they wrote off $325,000 of bad debts. So just mentally think about the entry. When an account goes bad, we debit the allowance account. Don't debit, bad debt expense. In the allowance method. When an account goes bad debit, you have a provision on allowance for accounts that go bad. So when accounts go bad, you debit allowance for bad debts.

In this case, 325,000. And you would credit the individual accounts receivable 325,000. Now notice after those write-offs. Now the balance in the allowance account is a $65,000 debit balance. Right now, the balance in the allowance account. After that activity. He has a $65,000 debit balance. Now go back to the question they say, based on past experience, 2% of credit sales tend to go bad.

That 2% of credit sales tells you what they're basing their estimate on the income statement. This is the income statement approach. You have to notice that notice they base their estimate on 2% of credit sales, any time. You know, you, you, you estimate, you know, 1% of gross sales tend to go bad. 3% of net sales tend to go bad.

4% of credit sales tend to go bad. You're basing your estimate on the income statement. Now listen carefully. When you base your estimate on the income statement, it does not matter. It does not matter. There's a $65,000 debit balance in allowance for bad debts. That'll have no bearing on your adjusting entry for bad debts every year.

You just take 2% of credit sales. I'll say that again. When you base your estimate on the income statement. It does not matter. There's a $65,000 debit balance and allows that debt. It doesn't matter whether there's a debit balance or credit balance in allowance for bad debts every year. You just take 2% of credit sales.

So when I get to December 31, I'm going to take 2% of their credit sales, 9 million, and I'm going to debit bad debt expense, 180,000. And I'm going to credit allowance for bad debts, 180,000. And when I put that credit into allowance for bad debts, 180,000, that brings the allowance. To now a credit of 115,000, and that's what they wanted.

They wanted the balance in the allowance account. After the adjustment, it's answer a 115,000, but I want you to remember that when you base your estimate on the income statement, when it's the income statement approach, every year, you just take 2% of credit sales and whether there's a debit or credit balance in the allowance account before the adjusting entry, that won't have an effect on your adjusting entry.

It's just 2% of credit sales. Now, compare that with question number two. Hall's allowance. Collectable accounts had a credit balance of 24,000, December 31st of the previous year. So we'll sit down a T account and we know the allowance account had a $24,000 credit balance during the year they wrote off 96,000 of uncollectable accounts.

So again, you kind of do that mentally. They would have debited the allowance, 96,000 credit, the individual accounts receivable 96,000. Right off those accounts. After that activity, there's now a $72,000 debit balance in allowance for bad debts. Isn't there there's a $72,000 debit balance based on an aging of receivables.

It indicates a hundred thousand dollars allowance for bad debts is required at December 31. Of the current year. So notice that based on an aging notice. Now our estimate is based on an analysis of the balance sheet on aging of the receivables on the balance sheet, this is the balance sheet approach. I hope you see that difference.

It's it's not like the last question where 2% of credit sales, 1% of gross sales, 3% of net sales tend to go bad. That's the income statement approach. We're basing our estimate on the income statement here. We're basing our estimate on an aging of receivables and analysis of receivables on analysis of the balance sheet.

This is the balance sheet approach. So based on that aging, based on the analysis of the balance sheet, they say that they are required to have a a hundred thousand dollars allowance for bad debts. So your job in the balance sheet approach. Is to adjust the allowance account, which required balance. So what I have to do here is debit bad debt expense, 172,000 credit allowance for bad debts, 172,000.

And that'll bring the allowance account from a $72,000 debit balance to a hundred thousand dollars credit balance. Aging says I need, I hope you see the date difference in the balance sheet approach. You have to consider whether there's a debit or credit balance. In the allowance account before you adjust the allowance account to which required balance, that's the difference.

You're adjusting the allowance account to what's required balance, whatever the aging says you need. So in the ask me at the bottom, what is their uncollectible accounts expense for the year? What's the expense on the income statement? He would be answer a, the 172,000. You can't go in that exam and not know the difference between the income statement approach and the balance sheet approach to allowance for bad debts.

In fact, you know, when a student sits in that exam and they get a multiple choice on allowance for bad debts, and their first thought is, wait a minute, are they using the income statement approach or the balance sheet approach? That's somebody who's prepared. That's someone who's going to immediately break that question down because you know what the CPA Exam does.

Sometimes it'll be the income statement approach. Sometimes it'll be the balance sheet approach. And if you're not clear on that difference, it's going to get you messed up something else that you have to think about in the allowance method. Let's say that a company does use the allowance methods to account for bad debts.

And let's say that they've written off a $2,000 account is bad. Okay. They've written off a $2,000 account is bad. So we assume. They would make their normal entry. They would debit allowance for bad debts, 2000 credit accounts receivable 2000. Now let's assume two, three years go by and you go to your mailbox and the check is in the mailbox.

In other words, what if you collect on account you've written off. the CPA Exam likes this little wrinkles. You have to be aware of it. What have you using new Alan's method? You've written off an account as bad debit allowance, 2000 credit accounts receivable, 2000, you know, five years go by, go to the mailbox.

The check is there. What if you collect an account that you wrote off? Well, there's more than one way you can handle this, but here's a very simple way of handling this. If you collect on account that you've written off, always start by reversing. The entry that you made when you wrote it off, just start by reversing the empty that you made when you wrote it off in the first place.

So now I debit accounts receivable. I re-establish the account credit allowance for bad debts. Then I just record the payment like any other payment I'll debit cash, 2000 and credit accounts receivable, 2000. That'll always work for you. Reverse the entry that you made when you wrote it off debit accounts, receivable credit, the allowance account.

That re-establishes the account and then record the payment like any other payment debit cash credit accounts receivable, 2000 reverse record. The payment reverse record. The payment always works. Let's take a look at question. Number three. Inge is determined that the net real double value of it's accounts receivable at December 31 based on an aging of receivables.

Was 325,000. They give us additional information. We know that the allowance account January one was 30,000. They wrote off 18,000 of bad debts. Notice uncollectable accounts recovered during the year 2004 the year. What was the uncollectable accounts expense? What was the expense on the income statement?

Let's work it through with the T account. We'll set up a T account for allowance for bad debts. Didn't they start the year with a. $30,000 credit balance in allowance for bad debts. That was their starting point. During the year they wrote off 18,000 of bad debts. So let's mentally put that in. They would have debited the allowance count eight, 18,000 credit.

The individual accounts receivable 18,000. Now they throw in uncollectable accounts recovered. What are you gonna do with that? Remember reverse record the payment reverse record the payment. You start just kind of mentally do it. By reversing the entry that they made when they wrote it off. So now I debit accounts receivable.

Re-establish the account I credit the allowance. Got let's put that in the T account. I credit the allowance count 2000 and then I record the payment like any other payment, but here's the point after all that activity, there's now a $14,000 credit balance in allowance for bad debt. Now, is this an income statement approach?

Or a balance sheet approach right now I have a $14,000 credit balance and allows for bad debts after all that activity. And my question to you is, are they using an income statement approach to the allowance method or a balance sheet approach? You're right. It's balance sheet because they've, they base their, their estimate on an aging of receivables on analysis of the balance sheet on analysis of the receivables.

This is the balance sheet approach that you had to notice two cases. Two key pieces of information. Did you notice their gross accounts receivable at December 31, total 350,000, but based on an aging, they only expect to net three 25. Do you see that key information? Their gross accounts receivable at December 31, 350,000, based on an aging, they expect the net realizable value.

They only expect to net three 25. So if you only expect to net three 25, how much of an allowance for bad debts? Do they think they need 25,000? So your job in the balance sheet approach is to adjust the allowance count to that's required to that required balance. Since they already have 14,000 in allowance with bad debts, we're going to debit bad debt expense, 11,000.

The answer is B. They wanted the expense on the income statement. We're going to debit bad debt expense, 11,000 credit allowance for bad debts, 11,000. And that brings the allowance from 14,000 up to 25,000, which my aging says. I'm required to have that's the balance sheet approach and the balance sheet approach to the allowance method.

You have to consider whether there's a debit or credit balance in allowance for bad debts before you make your adjusting entry, because in the balance sheet approach, your job is to adjust the allowance account to what's needed balance. Yes. Make sure you're comfortable with the difference between the income statement approach and the balance sheet approach to allowance for bad debts.

Now. Staying on accounts receivable for another minute. There's a couple of terms related to receivables that you may see in the exam. And I want to make sure, you know, what they're about. the FAR CPA Exam could mention that a company has pledged their receivables. If a company pledges, their accounts receivable, all they're doing is using their receivables as security for a loan.

So that's what it means to pledge your receivables. You are using your receivables. As security for a loan. And of course the big thing to remember about pledging receivables is that's a required footnote shareholders. Other interested parties are going to have to know that if you've pledged your receivables as security for a loan, that must be disclosed.

That's a required footnote. As I say, shareholders and other interested parties have to know that you've done that with your receivables. So that's a required footnote. What if they say that a company has factored their receivables? Without recourse. If a company factors they receivables, what they're doing is they are selling their receivables to a factor.

And when they say without recourse, that means what if the customers don't pay their bill? Whose problem is that? That's the factors problem. The factor has no recourse to come after the company for additional funds. In other words, The sale is final. That's what it means when you see without recourse, it really means the sale is fine.

As I said, if the customers don't pay their bill, that's the factors probably the, the, the factory has to collect the receivables. That's the sale is final. Now it's the factors problem. So the factor has to collect the receivables and if they can't get the money, they have no recourse to come after the company for additional funds.

So, because the sale is fine without recourse, just treat it as a sale debit cash. For whatever the factor pays you, credit accounts receivable for their book value and you'll show gain or loss on sale. It's almost always lost because you have to get it. You'll only get a discounted price. So it's simply debit cash credit, the receivables for their book value and debit loss on sale.

And like I say, without recourse just means sale is final. Now, one of the possibility, what if the CPA Exam says a company has factored their receivables? With recourse or they could say they've assigned their receivables with recourse really very much the same thing. The fact that their receivables with recourse or they assign their receivables with recourse.

What do you think with recourse means with recourse means that if the people don't pay their bills, if the receivables are uncollectable, it's the company's problem, not the factors. Now the factor has recourse to come after the company for additional funds. When you factor with recourse or you assign with recourse, Who's going to collect the receivables, the company, not the factor company keeps the receivables.

The company collects the receivables. And as I say, if they can't collect the receivables, the factory has recourse to come after the company for additional funds. So because the company, the seller is going to keep the receivables and collect them. All they do is debit. Accounts receivable, factored or accounts receivable assigned and credit accounts receivable.

In other words, on their balance sheet, they separate the accounts receivable they've factored or signed from all their other receivables tends to be, you know, a few of the large ones. That's what it tends to be. You know, if you will, they're large receivables. So you'll debit accounts, receivable, factored, or debit accounts receivable, assigned credit accounts receivable that separates those large receivables that you factored, and then you debit cash and credit notes payable.

In other words, When you factor with recourse or assign with recourse, it's really another example of using your receivables as security to get alone. So only the difference is when you're picking out specific large receivables. So you would debit accounts receivable, factored, or assigned credit accounts receivable, and then debit cash, credit notes payable.

And then as the company collects the receivables, they pay off the note with interest. I'm not trying to get into every entry you'd see here, cause you'd see entries where they pay off the note with interest, but that's what happened. Now they collect the receivables and as they collect the receivables, they pay back the note with interest.

Don't fall behind, keep up with your homework. I'll see you next time. Okay.

Welcome back in this FAR CPA Review class. We're going to talk about non-interest bearing notes. And I think, you know that if you're in the exam, And you see the phrase non-interest bearing note, you know, this, something wrong because notes are supposed to bear interest. Remember accounts receivable, accounts payable do not bear interest, but notes receivable notes payable are supposed to bear interest.

So as I say, you see that phrase, non-interest bearing note, you know, this something wrong. And the bottom line is this. When you see a non-interest bearing note, your job is to impute or infer the interest that must be in that note. That's what you have to do. You have to impute or infer the interest. That must be in the note.

Let's go to a problem. Number one says on January one, year five. Eliya sold. I want to circle that word sold notice in this problem. We're on the seller side. In these problems, you could be on the seller side, you could be on the buyer side, we're on the seller side, eel you sold a building which had a carrying amount of 350,000 receiving $125,000 down payment.

And as additional consideration, a $400,000 is the phrase non-interest bearing note due January one, year eight. Now, like I say, you're in the exam. The minute you see that phrase, non-interest bearing note, you know, there's a problem. Cause notes are supposed to bear interest. Then they say there was no established exchange price to the building.

What does that mean? Well, if there was no established exchange price for the building, we don't know what's cash price. We don't know what it would sell for in cash. So what do we use the discounted present value of the payments read on. It says the prevailing rate of interest for note of this type 10% present value of a dollar or 10% for three periods, 0.75, what amount of interest income would be included in Ilias income statement.

Now, before we solve it, you see why I answer a, is there because some people are going to sit in the CPA Exam and God, they're just trying to trick me. It's a non-interest bearing note. There is no interest, but we know it's more complicated than that because our job is to impute or infer the interest that must be in this note.

Let's do a couple of entries. Let's go back to January one, year five, if I'm Ilya, what entry did I make when I sold the building? Well, you know that if I'm Ilya. I would have debited cash for the 125,000 because there wasn't a cash down payment. Right. So it's a good place to start. We know that he'll use going to debit cash 125,000.

Now listen to me carefully, the key to non-interest bearing notes is to remember to record the note. At it's discounted present value. That's the key here. You must record the note at its discounted present value. They said that the per the prevailing rate of interest for note of this type is 10%, right.

And they said present value of a dollar or a 10% for three periods, 0.75. So I'm going to take that factor 0.7, five times the face amount of the note 400,000. And if I'm Eliya, I'm going to debit note receivable for 300,000, it's discounted present value. If I'm Eliya, I'm going to credit the building for its carrying value.

That's in the first sentence, 350,000 and notice Eliya credits gain on sale. 75,000 to Eylea, there was a $75,000 gain on sale. Now, if you look at the entry that we just did, they said in this problem, this was a non-interest bearing note, right? Let me ask you in your opinion. Is there any interest in this note?

Yes. How much, how much interest precisely is in this note? A hundred thousand. Why? Because a promise to pay me 400,003 years from now is worth 300,000 today. Why am I getting that extra a hundred thousand? Because I'm willing to wait three years. We call that interest. We impute, we infer the interest. That must be in the note.

Now let's go ahead a year. Let's say it's now December 31 year five. What adjustment do we make? Well, when you're doing interest adjustments, the key is to use the carrying value of the note, not the face value. I'm going to take the carrying value of the note 300,000, not face value, carrying value, 300,000 times the interest rate, 10%.

And if I'm Eliya, I'm going to debit note receivable 30,000 and credit interest income, 30,000. The answer is B C. If you're Ilia your job. Is to amortize the discount in the note, the difference between the face amount of the note, 400,000 and it's discounted present value 300,000 Eylea has to discount.

Yulia has to amortize that hundred thousand dollar discount. Again, the difference between the face amount of the note, 400,000 and it's discounted present value of 300,000 Delia has to amortize that a hundred thousand dollars discount to interest income over the life of the note, using the effect of interest method.

Let's go ahead another year. Let's say it's December 31 year six, same entry. Isn't it? No. When you get to December 31, year six is the interest rates still 10%. Yes. That's not going to change as you go from payment to payment to payment, the effect of interest rate stays 10%. That is a one-time determination, and it's not going to change over the life of the note.

But what has changed be careful is carrying value because of our adjustment back on December 31, year five. Now the carrying value of the note is 330,000 times 10%. So Isla will debit note receivable, 33,000 credit interest income, 33,000 the following year. And I have to show you that because the CPA Exam could ask you for the interest for the second year.

Be careful. Now let's do the same problem from the buyer side. Remember whether you're the buyer or the seller you have to impute or infer the interest that must be in this note. Let's look at it from the buyer's side. If you're the buyer back on January one, year five, you're going to credit notes payable for it's discounted, present value.

You're going to say, well, the going rate of interest for note of this type is 10% present value of a dollar. 10 present value of a dollar 10% for three periods, 0.75. You take that factor 0.7, five times the face amount of the note, 400,000. And you're going to credit notes payable for it's discounted present value 300,000.

You're going to credit cash for the down payment, 125,000. And you debit the building 425,000. Like I say, the key to non-interest bearing notes. Is to record the note at it's discounted present value. Now let's go ahead a year. What happens? Well, if you're the buyer, you're going to take the difference between the face amount of the note, 400,000 and it's discounted present value 300,000.

The buyer is going to take that a hundred thousand dollar discount and amortize that to interest expense over the life of the note, using that effective interest method. So we get to December 31 year five. What interest adjustment does the buyer make? Member work with the carrying value of the note, not the face value, take the carrying value.

The note 300,000 times the interest rate, 10% and the buyer's going to debit interest expense 30,000 credit notes payable 30,000. What happens if you go to December 31 year six, the interest rate is still 10%. The carrying value is changed because of your adjustment back. On December 31 year five. Now the carrying value notice 330,000 times 10%.

So the buyer will debit interest expense 33,000 credit notes payable 33,000. Whether you are the buyer or the seller. When you see a non-interest bearing note, you have to impute, you have to infer the interest. That must be in that note. Let's do the next two questions. It's a set on January 2nd. M sold.

Once you circle the word sold, run the seller side here M sold equipment with a carrying amount of 480,000 in exchange for a $600,000. They use the phrase non-interest bearing note due January one, January 2nd, year five, there was no established exchange price for the equipment. You know what that means?

If there was no established exchange price, we don't know what's cash price. So we're going to use the discounted present value of the payments. The prevailing rate of interest for note of this type is 10%. Present value of a dollar 10% for three periods. Point seven five. Let's put the entry down. What entry would am have made back on January 2nd?

Well, as I said, the key to non-interest bearing notes. Is to remember to record the note at it's discounted present value. So if you're M you're going to debit note receivable for it's discounted present value, we know the going rate of interest for note of this type is 10%. We know present value of a dollar, a 10% for three periods, 0.75.

We're going to take that factor 0.75 times the face amount of the note, 600,000. We're going to debit note receivable 450,000. It's discounted, present value. We're going to credit the equipment for its carrying value for the 90,000. And notice there's a loss on sale debit loss on sale 30,000. So we can answer the second question in the set.

Second question in the set says in M's near to income statement, what amount would be reported as gain or loss on sale of the machinery? Well, you know, the answer is a, there's a $30,000 loss on sale. Now the first question says in AMS year, two income statement. What would be interested in come, you know, what's going to happen am has to take the difference between the face amount of the note, 600,000 and it's discounted present value.

Four 50 M has to take that $150,000 discount and amortize it to interest income over the life of the note. So when M gets December 31 year two, what is I'm going to do remember work with the carrying value? The note not face value am is going to take the carrying value of the note 450,000. Times the interest rate, 10%, Emma's going to debit note receivable 45,000 credit interest income, 45,000.

And the answer to the first question is B the interest income on the income statement is 45,000 answer be the loss on sale of machinery. And the next question is answer a 30,000. Let's do another question. Next one on January 1st, year eight. Male exchanged equipment for a $200,000. There's the phrase non-interest bearing note due January 1st year 11, the prevailing rate of interest for note of this type is 10% present value of a dollar 10% for three periods, 0.75.

What amount of interest revenue would be in the year nine income statement? Well, let's do the entries back on January one, year eight, when mill makes that sale. Remember the secret here. Is to always record the note at it's discounted present value. So we know that the going rate of interest for note of this type is 10%.

And we know that present value of a dollar or a 10% for three periods is 0.7, five. We're going to take that factor 0.7, five times the face amount of the note, 200,000. And if you're male, you're going to debit note receivable for it's discounted present value 150,000. And I'm assuming that mill just credit sales 150,000.

I don't know the carrying value of the equipment, but the point is. We're not going to let mil record this as a $200,000 sale. We're not going to let mil overstate their sales. The sale is 150,000. The rest is interest. We don't care that the lawyer set it up. We don't care what the note says that it's, noninterest, non-interest bearing that we're not going to let mill overstate their sales and the rest is interest.

All right, now let's carry it through. If you're male, you get to December 31 year eight. What are you going to do? You're going to take the going rate of interest for note of this type 10% times, the carrying value of the note, which is 150,000, you're going to debit note receivable 15,000, and you're going to credit interest income, 15,000 and notice that's the answer.

B B would be fine if they wanted interest income for year eight, they want it for year nine. So let's carry it out to year nine. When you get to December 31 year nine, the interest rate is still 10%. The carrying value has changed. Because of your adjustment back on December 31 year eight. Now the carrying value of the note is 165,000 times, 10%.

So mill will debit note receivable, 16,500 credit interest income, 16,500. And the answer is C. So watch out for that second year. Let's do another problem on December 30th. Chang sold run the seller side here, sold a machine to door in exchange for a non-interest bearing note. There's the phrase again, requiring 10 equal annual payments of $10,000.

So for the first time we're dealing with an annuity, you know what that is a series of equal periodic payments over a specified number of periods DOR made the first payment notice right away on December 30th. The market rate of interest with similar notes is 8%. They give us present value factors. And at the bottom they say in the December 31 balance sheet, what would Chang report as note receivable?

Let's do an entry here. If you're Chang on December 30th. When does Chang get the first $10,000 right away? Notice Chang gets the first 10,000 on December 30th, the first day. So that's not a bad place to start. Shang is going to debit cash 10,000. Now if you're Chang, remember with non-interest bearing notes, the critical thing is to record the note at its discounted present value.

I don't need the first table present value of a dollar. Just X that out to just trying to get you down the wrong path. I want present value of an ordinary annuity. At 8%, but what bothers some people is I don't want the factor for 10 periods. I want the factor for nine. You might want to circle the 6.25.

Why do I want the fact for nine periods? Because I already received the first 10,000, the discounted present value. The first payment is 10,000. My job is to discount the other nine payments. So I hope you see why I want the factor for nine periods. Not 10. Again, I already received the first payment. My job is to discount the other night.

So I'm going to take that factor 6.25 times the equal payments, 10,000. And if you're chatting, you're going to debit note receivable for 62,500. And if you're chanting, you're going to credit sales 72,500. So when they ask us at the bottom in the December 31 balance sheet, at what amount would Chang report for this note receivable?

You know, the answer is C. Because the note should be reported at its discounted present value 62, five, but notice from that entry, if they wanted the sale for Chang it's 72 five, not 62 five. If you see the entry, it makes perfect sense because they got, they could have the same question in the CPA Exam and say, what's the sale for Chang?

A lot of people think the sale is 62 five, no, it's 72 five. And as I say, if you look at the entry, it makes perfect sense. Now, besides non-interest bearing notes, you also have to be careful when there's a note that does have interest, but it's too much, or it's too little watch out for unreasonable interest.

So again, you also have to be careful besides looking out for a non-interest bearing note. We know we can't allow that if there's a non-interest bearing note, we have to impute, we have to infer the interest. That must be in the note. But not only can we not allow a non-interest bearing note, we can't allow a note that has unreasonable interest, a note that does have interest, but it's too much.

It's too little. You got to watch out for unreasonable interest score to a problem. Next problem says on December 31 year one jet received two. $10,000 notes receivable from customers in exchange for services rendered. So right away, this problem is more complicated because there are two notes to think about.

Jet is receiving two notes in exchange for services on both notes. Interest is calculated on the outstanding principal balance at the annual rate of 3% and notice everything's payable at maturity. There are no periodic payments of any kind. So both notes, bear interest at 3%, then it says the note from heart made on the customer trade terms is doing nine months.

The note for max is doing five years. The market rate for similar notes is 8% stop right there for a second. Do you see how I know I'm dealing with unreasonable interest? Why? Because both notes from customers, bear interest at 3%, what's a fair rate of interest for these kinds of notes, 8%. So there is interest.

But it's not enough. It's unreasonable. Then they give us present value factors. At 8%, we know present value of a dollar 8% to a nine months, which is 0.9 44 and present value of dollar 8% to in five years, which is 0.6, eight Oh, bottom. It says at what amounts. So should these two notes receivable be reported in jets December 31 year one balance sheet?

Well, obviously we're going to handle these notes separately and I want to start. With the note from heart and to kind of get you into this thinking, let me show you what jet wants to do. See if this makes sense. If I'm jet and I get this $10,000 note from heart for services, I don't want to worry about the 3%, the 8%.

Why are you accountants worry about this? I don't want to worry about the 3% and the 8%. I just want to have a simple, uncomplicated life. If I'm jet, I want a debit note receivable, 10,000 and credit sales, 10,000. You see what I'm saying? Jack, doesn't want to worry about the 3% and the 8%. That's ridiculous.

I want to have a simple, uncomplicated life. If I'm jet. When I get that note from heart, I want to debit note receivable, 10,000 credit sales, 10,000. In other words, as far as Jetta is concerned, that's a $10,000 sale. Now here's the question. Because hearts note bears interest at 3%, but a fair rate of interest for this kind of note is 8% can jet handle hearts note that way.

Yes, yes. Jet Ken. Why it's to P it's a picky area. Why? Because remember when a note is made under customary trade terms, if I know is made under customary trade terms, And is due in less than a year. That's the critical point here? The note from heart is doing nine months. If a note is made under customary trade terms and is due in less than a year, the note from hearts doing nine months, there's no requirement to impute interest on that note.

If a note is made on the customary trade terms and is doing less than a year, there's no requirement to impute interest on that note. So the note from heart. Can just be recorded by jet as a $10,000 note. So if you look at the answers, it's gotta be C or D because the note from heart can just get recorded as a $10,000 note with a $10,000 sale.

Now, obviously the note for max is more complicated, why it's doing five years and that's why I love this question. And you should love it too. I know you don't, but you should love this question. It's a great review question because this question. Shows you everything you've got to remember for the CPA exam about unreasonable interest.

It shows you this little rule about what if it's less than a year and now what do you do if it's more than a year? Here's the point. If you see on reasonable interest, do more than a year out, here's what you have to do again, if you see unreasonable interest due more than a year out your first step, every time.

Work out the maturity value of the note let's together. Let's get the maturity value of this note. I'm going to take the $10,000 note from max. It bears interest at 3%. Doesn't it? So what is that? That's $300 of interest too. Every year for five years. Let me summarize five years from now. What does max promised jet max has promised jet.

Five years from now $10,000 principal plus 1500 of interest. The maturity value of the note is $11,500. Again, I took the $10,000 note for max. It bears interest at 3%. That's $300 of interest every year for five years, which comes out to 1500. So my point is five years from now. What max has promised yet is $10,000 principle, 1500 of interest.

The maturity value of the note is $11,500. I'm going to take that maturity value 11 five and discounted back to today at a fair rate of interest, which is 8%. That's a fair rate of interest for note of this type. So let's get our factor. We want present value of a dollar 8% for five years. The factor is 0.6, eight.

Oh, I'm gonna take that factor. Point six, eight Oh times the maturity value 11 five. That comes out to 7,008 20. The entry that jet would make for the second note, the note for max debit note receivable for its discounted present value 7,008 20 and credit sales 7,008 20. The point is we're not going to let jet overstate their sales, the sale for jet on the sale to max.

The sale for jet is not 10,000. It's 7,008 20. The rest is interest. We don't care. The lawyers drew it up. We don't care that it was drawn up as a 3% note. A fair rate of interest for this kind of note is 8%. So for the second note, Chet would debit note receivable for its discounted present value 7,008 20.

So the answer is D we're going to, we're going to report the note from heart at 10,000 it's customary trade terms due in less than a year. We don't impute interest, but the note from max. Should be recorded at its discounted present value, which is 7,008 20. So debit note receivable, 7,008, 20 and credit sales, 7,008 20.

The sale for jet for the sale to max is not 10,000. It's 7,008 20, and the rest is interest. We impute. We infer there's more interest here than 3%. It's really eight. See you in the next class. Don't fall behind. Keep up with your work. I'll see you in the next class.

Welcome back in this FAR CPA Review class. We're going to begin our discussion on how to account for inventory. And as I'm sure you remember from college, this is a fairly large topic. And I want to try at the beginning to kind of knock this down to size. So you might find this helps when you're in the exam. You get any question.

About accounting for inventory. Try to remember that. Any question on accounting for inventory one way or another has to fall into one of three topics. Topic. Number one is costing the original costing of merchandise topic. Number two is measurement the measuring of inventory. And then topic number three is the big one, and that is valuation.

And in these classes, when I say valuation, I'm talking about the proper valuation of the ending inventory. Let's start with costing now, as I'm sure, you know, the primary basis of accounting for inventory is historical costs, but here's the question. The historical cost for merchandise includes exactly what well, what you're dealing with here is a rule.

So let me say it. The basic rule is this. That over and above the cash price you pay for merchandise over and above the cash price you pay for merchandise. You must capitalize to inventory all the costs you incur to bring that merchandise into a condition and location for sale. That's known as the condition and location for sale rule because that's the rule we follow.

That over and above the cash price you pay for merchandise, which is obvious, obviously that gets capitalized inventory, but we also capitalize to inventory all the costs we incur to bring that merchandise. Into a condition and location for sale. So examples, you're going to capitalize to inventory.

Purchasing costs, handling costs, warehousing costs, insurance during transit. And don't forget freight in transportation in is part of the cost of merchandise. Not frayed out. Don't make that sloppy mistake frayed out. Is a selling expense. It belongs below gross profit, but as I say to inventory over and above the cash price, you pay for merchandise.

We're going to capitalize purchasing and handling and. Insurance during transit and warehousing costs and freight in transportation in all these costs are capitalized to the inventory account because they are all costs. We incur to get that merchandise into a condition and location for sale. Now stay with me on this point while it is true that the primary basis of accounting for inventory is historical costs.

Never forget that ultimately inventory is carried on a company's balance sheet at its original cost or its market value. Whatever's lower for inventory. We have to apply lower of cost or market because inventory ultimately will be carried on the balance sheet at its original cost or its market value.

Whatever's lower. So that's what I want to get into next. How do we apply the concept of lower of cost of market to inventory? Well, I'll tell you what makes this complicated normally in accounting, when we say market, we mean replacement costs generally. That's true. When we say market, we mean replacement costs, but not necessarily with inventory because when you're applying lower of cost of market to inventory, there's a ceiling.

And market can never be higher than the ceiling. And there's also a floor and market can never be below the floor. And that's what makes this more involved. So let me give you some definitions, cause you have to know these definitions. Let's start with the ceiling. As I say, market can never be higher than the ceiling.

The ceiling is called net realizable value and it is defined as the selling price minus. The normal costs to complete and sell the item again, the ceiling is called net realizable value and it is defined as the selling price minus the normal costs to complete and sell the item minus normal disposal costs.

That's the ceiling selling price minus normal disposal costs the normal costs to complete and sell the item. And as I say, market can never be higher than that amount. Now what's the floor and there's no fancy name for the floor. It's just called the floor. The bottom. The floor is defined as that ceiling net realizable value minus a normal gross profit on sale.

That's the floor. It is defined as that ceiling, that realizable value minus a normal gross profit on sale. You're going to have to know those definitions. So of those definitions in mind, let's do some problems. If you look in your viewers guide, you'll see several problems set up. Let's go to product a.

Notice the historical cost is $2 and 50 cents a unit. The replacement cost is $2 and 60 cents a unit. The normal selling price is $4. A unit. The normal disposal costs a dollar, a unit, and the normal gross profit is 70 cents per unit. Let's apply lower of cost of market to these products. Now here's the basic process.

We follow calculate the ceiling. Calculate the floor. Then we calculate market. Then we apply lower of cost or markets. Let's follow that down. Let's calculate the ceiling net realizable value. We know the ceiling is defined as that selling price $4 a unit minus the normal disposal costs of a dollar. I hope we can agree that the ceiling net realizable value would be $3.

$4 minus one. Now the floor, we would be defined as that net realizable value $3 a unit minus our normal gross profit on sales. 70 cents. The floor would be $2 and 30 cents a unit. So we've calculated the ceiling. We've calculated the floor. Now, how do you get market to figure out market? You look at three numbers.

You look at the replacement costs $2 and 60 cents a unit, the ceiling, which is $3 a unit and the floor, which is $2 and 30 cents a unit. And just remember whatever numbers in the middle that is your market. Just remember middle number is always market. That's just a fast way to remember this. Look at those three numbers.

The replacement costs the ceiling and the floor, whatever numbers in the middle. That is your market. Obviously the number in the middle here is $2 and 60 cents a unit. The replacement cost. That's the number in the middle. Between $2 and 30 cents the floor and $3. The ceiling, the middle number here is $2 and 60 cents.

That's your market then your final step for it is the lower of cost, which is $2 and 50 cents a unit or market, which I now know is two 60. I stay at cost because it's lower. That's your last step. You see the steps calculate the ceiling, calculate the floor, calculate market calculate lower of cost or market.

Let's do product. Number two. The historical cost is $6. A unit replacement cost is $5 and 25 cents a unit. The selling price is $8 and 50 cents. Normal disposal costs are $3 and 50 cents. Gross profit is 80 cents per unit. Let's apply a lower cost to market first, what do we do? Calculate the ceiling. The ceiling net realizable value is defined as the selling price, $8 and 50 cents minus the normal disposable cost of $3 and 50 cents.

A unit let's agree that net realizable value is $5. A unit. The floor would be that $5 net realizable value. Minus the 80 cents. Gross profit on sale. The floor would be $4 and 20 cents. All right. What's step three, step three. You look at three numbers. Remember the threes go together. When you get to step three, I look at three numbers.

I look at replacement costs, $5 and 25 cents a unit, the ceiling, $5, a unit, the floor, $4 and 20 cents. What is in the middle? The five, the ceiling is in the middle here. That is your market. Middle number is always your market in those three numbers. Whatever number is in the middle, that is your market. All right, so now our last step for.

We say it's the lower of cost, $6, a unit historical cost or market, which I now know is five. I would use $5 a unit. I use whatever numbers, lower calculate the ceiling, calculate the floor, calculate market calculate lower of cost or market. You say, well, Bob, isn't there a shortcut. This is it. This is the shortcut.

It's the fastest way and how to do these. All right. So we agree that in problem, number two, here, that. Cost is $6. A unit market is five. So I'm going to use five. What's my journal entry. You know, me, I never liked to get too far from journal entries. What's the journal entry here? Well, let's say I've got a hundred thousand units in my ending inventory.

Aren't I writing my inventory down $1 per unit, because cost is $6. A unit market is five. I'm going to write it down a dollar per unit. I would take a dollar times the a hundred thousand units in my ending inventory. And I would debit and inventory loss, a hundred thousand dollars. That a hundred thousand dollars inventory loss would go to my income statement.

And I'd credit inventory, a hundred thousand I'm writing inventory down to market. Let's do product three or product C. Historical cost is $10. A unit replacement cost is $9. A unit selling prices. 15 disposal costs are $2. Normal gross profit is $3 and 50 cents. Let's go through the steps, calculate the ceiling, calculate the floor, calculate market calculate lower of cost or market.

All right. So we know the ceiling is that selling price $15 a unit minus the normal disposal costs the normal cost to complete and sell the item $2. Let's agree that net realizable value was $13 a unit. The floor is defined as that ceiling $13 a unit minus a normal gross profit on sale. $3 and 50 cents.

What's a great. The floor is $9 and 50 cents a unit. What? Step three, look at three numbers. Right? Step three, you look at three numbers. Look at replacement costs, $9 a unit, the floor, $9 and 50 cents a unit, the ceiling, which is $13 a unit. What's the number in the middle, the floor. The floor is in the middle.

So the middle numbers, your market, my market here is $9 and 50 cents per unit. That's my market. Now my fourth step is to say it is the lower of cost, which is $10 a unit or market, which I now know is nine 50. I use nine 50 because it's lower. Whatever number is lower, lower of cost or market. If he can stand at one more.

How about product floor? You getting used to this yet? I know you are. Let's look at product. Number four. Historical cost is $150. A unit replacement cost is $175 a unit. The selling price is 200. The disposal costs are 10 and the gross profit is $80 a unit. Let's apply a lower cost to market. What's step one, calculate the ceiling.

I'm going to take the selling price. $200 a unit minus normal disposable costs of 10. Can we agree? Net realizable value is $190 per unit. What's the floor. Take that ceiling one 90 minus normal profit on sale. 80. Can we agree? The floor is one 10. What? Step three. Look at three numbers. Right. I look at replacement costs 175, the ceiling, one 90 the floor, one 10.

What number is in the middle? One 75 is in the middle. The replacement cost is market here. And then step four. What's your last step? It's to say it's the lower of cost, which is $150, a unit historical cost or market, which I now know is replacement cost one 75. I just stay at cost one 50 because it's lower.

All right. So that's topic number one. The original costing merchant. Next we know that the primary basis of accounting for inventory is historical costs, but ultimately inventory is carried on the balance sheet at its original cost or its market value. Whatever's lower, never go into that exam without knowing how to apply lower of cost or market to your inventory.

Let me just show you one multiple choice on this, that. Does drive people crazy. If you look at multiple choice, number one, it says the original cost of an inventory item is below net realizable value, but above net realizable value less than normal profit margin. The inventory's replacement cost is below net realizable value.

That's normal. The margin onto the lower of cost of Margaret rule inventory would be valued at. And I don't know if you see what they're trying to do to you here, but. In a question like this, what they're hoping to do is kind of sit in the CPA Exam and go, okay, it's above this, it's below this. It's between this and end up staring at this for five minutes and you don't have time.

And I'm sure you're ahead of me. What is the, what is the way you should approach this question rather than sit in that exam and golf? It's above this. It's below this it's between this and, and stare at it. Make up numbers. This question becomes a lot easier. If you make up numbers now. You are in control, make the numbers as simple as you, as you, as you want to work with them.

The only limitation is your numbers have to fit the facts. Let's make up some numbers. They said the original cost let's make that $10 a unit I'm in control here. I want to make the numbers as easy as I can to work with. So the original cost, which I'll make $10 a unit is below net realizable value. So I'll make that realizable value.

15 that's fits. But original cost is above net. Realizable value, less a normal profit margin. It's above the floor. So, so the 10 has to be above the floor. I'll make the floor five, make my number. I have to make my numbers fit the facts. Then it says the replacement cost is below net realizable value, less normal profit margin.

So replacement costs is below the floor. Let's make replacement costs anything below five, make it two. All right. So my numbers fit the facts. Now, what do I do? I just solve it like a number problem. I look at three numbers. I look at replacement costs to the floor. Five, the ceiling, the ceiling is 15.

What's the number in the middle, the floor five. That's my market, whatever number is in the middle. And those three numbers, middle numbers, always market. So my market is five. The floor. Then my last step is to say it is the lower of cost, which is $10 a unit, which, or Micah, which I now know I now, and it was the floor five.

I use five, I use the floor. So the answer is date. This inventory will be carried at net realizable value, less than normal profit margin. It would be carried at the floor. I just want to show you that the question like this, don't play their game. Don't sit in that example. It's above this. It's below this and let five minutes go by, make up numbers, have the numbers fit the facts.

Then you just solve it like a number of problem. And you'll find. That greatly simplifies a problem like that. Let's move on to the second topic, which is measurement the proper measuring of inventory. Now, when they talk about measurement of inventory, there are basically two pure systems. It's either going to be a periodic system or a perpetual system.

And I want to make sure you see the difference in a periodic inventory system. What that basically means is that the company does use a purchases account. That's what a periodic system really needs that the company does use a purchases account. So as they go through the accounting period, every time they purchase merchandise, they debit purchases, they credit accounts payable.

The company uses a purchases account. That's what a periodic system means. So as they go through. The accounting period. Every time they purchase merchandise, they're going to debit purchases, credit accounts payable. So then when they get to the end of the accounting period, they're going to know their total purchases for the period because they kept track of them because they kept track of them.

And when you add your total purchases to your beginning inventory, that gives you what, the goods that were available for sale, then. Periodically, which is where the name comes from. You go in your warehouse, you take a physical count and you find out two things you find out what's their ending inventory.

And when you subtract and the inventory from what was available, that gives you the cost of the goods that you sold. I think you see why they call this a periodic system because in a periodic system, you're finding out two critical pieces of information, ending inventory and cost of goods sold.

Periodically. That's why it's called a periodic system because you're finding out those two essential pieces of information, ending inventory and cost of goods sold periodically now in a perpetual inventory system. What that essentially means is that the company does not use a purchases account in a perpetual system.

The company does not use. A purchases account. So as they go through the accounting period, every time they purchase merchandise, they debit inventory. There's no purchases account. When they purchase merchandise, they debit inventory and they credit accounts payable. Then when they make a sale, they make two entries.

Not only will they debit accounts, receivable, credit sales, that's the entry any company would make, but then they make a second entry where they debit cost of goods sold for the cost of the merchandise shipped. And credit inventory. So you see what's going on here. If every time I purchased merchandise, I debit inventory and every time I make a sale, I credit inventory.

Don't I end up with a perpetual running total of my inventory balance. I also end up with a perpetual running total of my cost of goods sold. That is a perpetual system. Let me ask you a question in a perpetual system. Would you ever have to take a physical count? Yes, you would it inventory accounting, it's impossible to get away from a physical count.

Eventually you have to verify the records. Why? Because of breakage theft, spoilage shoplifting, we call it shrinkage because of shrinkage, even in a perpetual system, you know, once in a while, You have to take a physical account to verify the records. And of course, if you're a publicly traded company at year end, you have to take a physical count.

We know that, but you have to anyway, take a physical count at some point because of breakage theft, spoiled shoplifting shortages in accounting, we call that shrinkage. So even in a perpetual system, at some point, you'll have to take a physical account to verify the records, but. That deals with the second topic, which is measurement.

So we've talked about the original cost of the merchandise. We've talked about measuring merchandise and in our next class, we'll get into the biggest topic of all. And that is valuation. And as I said in these classes, when we say valuation, we're talking about the proper valuation of the ending inventory, and we'll get into that in the next class.

See you then.

Welcome back in this FAR CPA Review class, we're going to continue our discussion on the accounting for inventory. And what we have to get into is valuation the proper valuation of the ending inventory. Well, as you know, one way to place a value on ending inventory is specific identification where you go through your warehouse.

Item by item. And you specifically identify the cost of each piece of merchandise. That's on hand. That is specific identification, where again, you go through your warehouse, painstakingly item by item, and you specifically identify the cost of each piece of merchandise that you and your enduring inventory that is a perfectly acceptable way of valuation.

A perfectly acceptable way to place a value on ending inventory, specific identification. However, what has to be said about specific identification is that it's time consuming. It's expensive. Of course it may not be practical, especially for interim financial statements. And it might even be impossible.

Just think about this for a minute. When would specific identification be impossible? Well, what if the ending inventory was destroyed in a fire, a flood, something like that? Well, now specific identification is impossible. Let me get to my point. My point is that we have to have other methods of estimating the value of ending inventory without specific identification, because specific identification is time consuming.

It's expensive, it's impractical in many cases, and it might even be impossible. So that's what we have to get into. Now. We're going to look at different methods of estimating the value of ending inventory without using specific identification. And the first method I want to get into is the gross profit method.

Now we're going to use the gross profit method to estimate the value of ending inventory, primarily in interim financial statements. That's where you'll see it. Again, we can use the gross profit method to estimate the value of ending inventory. Primarily in interim financial statements, we can also use the gross profit method to estimate the value of ending inventory.

When ending inventory has been destroyed in a fire, a flood, something like that can be used there as well. Now, before we get into actually how you do the method. I want to review something first. I want to make sure that all of my students know the difference between a gross profit percentage and a markup on cost percentage.

Because if you confuse these percentages, it can really get you messed up in a problem like this. So let me just take a minute and make sure that you're crystal clear on the difference between a gross profit percentage. And a markup on cost percentage because they're not the same thing. And I want to make sure you see the difference.

Let me just give you a very simple example. Let's say that I'm a corporation and I only sell one thing. I sell video cameras. That's all I sell. And let's say that video cameras cost me $1,000 each. And let's say that I use. A 25% markup on cost. All right. So I only sell video cameras. This, the video cameras cost me $1,000 each and I use a 25% markup on cost.

And let's say this year, I just sold one. So it's been a banner year. I just sold one. Well, let's talk about this. If I use a 25% markup on cost, that only means one thing. I sell merchandise at 125% of what it costs me. That's what that's all that percentage means. If a company uses a 25% markup on costs, it means they sell merchandise at 125% of what it costs them.

So let's think about little income statement here. The video cameras cost me a thousand dollars each. I only sold one. So we know cost of goods sold would be a thousand. And if I use a 25% markup on cost, we know that I sell merchandise at 125% of what it costs me. So my sales would be 1000, 250, 125% of a thousand sales would be 1002 50.

And notice this. If my sales are 1002 50 cost of goods sold a thousand, I made $250 gross profit. And if you make $250 gross profit over. 1002 50 sale, my gross profit percentage. My gross margin is 20%. So they're not the same thing at all. This company uses a 25% markup on cost, but they've gross profit margin.

Their gross margin is 20%. Now, you know what that 20% means when you see gross margins, 20%, it means 20% of sales is gross profit. If I take 20% of the sales, 1002 50, it gets me back to gross profit, two 50. And I also notice this if. Gross profit percentage is 20% of sales. I know cost of goods sold is 80% of sales.

If I take 80% of my sales, 1002 50, it gets me back to cost a good sold a thousand. That's always a function of a hundred. If gross margin is 20% of sales, I know cost of goods sold is 80% of sales. That's always a function of a hundred. And what I'm leading to is a shortcut because I think this helps a lot.

I want to make sure that my students, when they're in the exam, they could quickly convert. From a markup on cost percentage to gross profit, the cost of goods sold. This is a handy thing to be able to do in the CPA Exam quickly. So let me just give a little shortcut now, make sure this is clear. When are you going to use my shortcut?

You're gonna use my shortcut. If the CPA Exam gives you a mock-up on cost percentage, but you want to know gross profit cost, a good soul. Here's the shortcut. Just take the markup and divide by 100. Plus the markup again, you simply take the markup. And divide by 100, plus the markup. All right, so let's deploy.

Let me show you what I need. If I'm in the CPA Exam and they say a company uses a 25% markup on cost. I'm going to take the mock-up 25 over a hundred. Plus the markup one 25 25. Over one 25 is one fifth, one fifth of sales would be gross. Profit four-fifths would be cost of goods sold. It's very quick. Let's do another one.

What if I'm in the exam? And they say a company uses a 50% markup on cost. What am I going to do? Well, if it was a 50% markup on cost, I'm going to take 50 over what? A hundred plus 50 50 over one 50 is one third. Just use fractions. I know one third of sales sales would be gross. Profit. Two thirds of sales would be cost of goods sold.

You just can't do it faster. Let's do another one. You're in the CPA Exam and they say a company uses a 20% markup on cost. Well, if they use a 20% markup on cost, I'm going to take the markup 20. Over 120, which is one sixth 20 over one 20 is one sixth. I know that one sixth of sales would be gross. Profit five sixth of sales would be cost of goods sold.

It's a very quick thing to be able to do. If you give a mock-up on cost, you can quickly figure out cost of goods sold and gross profit. All right. So with that in mind, let's do a little problem on the gross profit method. If you look in the viewer's guide, you'll see a problem. This company's beginning inventory was $200,000.

The purchases during the year 450,000 sales during the year 500,000. And you can see what we're told this company does use a 25% markup on cost and their ending inventory was destroyed in a fire. Well, if the ending inventory was destroyed in a fire and the ending inventory is destroyed in a fire, and I've got to figure out ending inventory, what am I going to do?

Right. If they're ending inventories destroyed in a fire. And I've got to figure out ending inventory. What am I going to do? Well, here's where you use the gross profit method. And I think the best way to understand this is use the skeleton, the cost of goods sold. It's certainly something you work with all the time, and if you don't have it absolutely memorized yet, you certainly will.

What's the skeleton, the cost of goods sold. We know it's beginning inventory plus purchases equals goods available for sale. Less ending inventory equals cost of goods sold. So let's fill it in as far as we can in this problem. Do we know beginning inventory, we do. It's 200,000. It's given, do we know the purchases during the year?

Yes. 450,000 that was given. So we know goods available for sale 650,000. That's all given, do I know ending inventory? No, it was destroyed in a fire. How about cost of goods sold? Do I know cost of goods sold? No, but I can figure it out. Can I figure out cost of goods sold? Let me ask you a question. If this company uses a 25% markup on cost isn't cost of goods sold 75%.

I hope you with me, if this company uses a twenty-five percent markup on cost isn't cost of good sold 75%. No, it's not. No, it's not. That's a mistake. A lot of students make. That's treating that 20%, 25% like a gross profit margin. It's not, it's a mock-up on cost percentage. How do I go from a mock-up on cost percentage to gross margin member?

Take the mock-up 25 over one 25. We know 25 over one 25 is one fifth, one fifth of sales. One fifth of 500,000 would be gross. Profit four-fifths. Of sales 400,000 would be cost a good soul. So now I can put that in, I know, cost of goods sold would be 400,000. I'll go over that again. If I take the of 25, over 125 that's one fifth, one fifth of my sales would be gross profit or a hundred thousand.

One 50 500,000 four-fifths of 500,000 will be cost of good soul of 400,000. So if I know goods available for sale is 650,000 that was given and cost of goods sold is 400,000 and the inventory had to have a value of 250,000. See, this is a way of estimating the value of ending inventory without using specific identification.

So the FAR CPA Exam could ask you what's the fire loss. If the inventory was totally destroyed in a fire, what's your fire loss. It's 250,000. That's the value of ending inventory immediately before the fire, or if you've got uninsurance recovery back out, if you've got a hundred thousand from the insurance will, then it's the 250,000 minus your insurance recovery, a hundred thousand.

Now you fire losses 150,000, but it's, it's a way of estimating the value. Then an inventory in this case, 250,000 without using. Specific identification. And as I said, this is primarily used in interim financial statements, but you can also use the gross profit method to figure out the value of ending inventory.

If it's been destroyed in a fire or flood, something like that. Now of course, another way to estimate the value of ending inventory with, without using specific identification is to make an assumption about the way inventory costs are flowing. And there's basically three. It's either going to be first in first out or last in first out or weighted average, let's talk about first in, first out or FIFO, you know that when a company chooses a first in first out cost flow assumption, they are assuming that the first merchandise purchased is the first to be sold.

First in first out first merchandise purchase is the first to be sold first in, first out. Well, here's the question. What is the impact on the financial statements? Well, think about it. If I'm going to assume that the first merchandise purchased is the first to be sold. Won't my older merchandise prices be in cost of goods, sold on the income statement.

First in, first out, my older merchandise prices will be in cost of goods, sold on the income statement. My most recent merchandise prices will be an inventory on the balance sheet. That's the impact on the statements. So let's analyze the statements. How do we feel about the income statement? Well, not that good, because we're saying first in, first out, all the merchandise prices are in cost of goods, sold on the income statement.

And now on my income statement, I have a slight problem. Now I'm matching current revenues with older merchandise prices and they may not be relevant anymore. You could always, you could be in a period of dramatically changing merchandise prices. That's the argument, whether it's inflation or deflation, you could be in a period of dramatically changing merchandise prices.

And that's the problem with FIFO Pfeifle on the income statement is ends up matching current revenues with older merchandise prices. And as I say, they may not be relevant anymore. First in first out, causes a distortion in the matching concept. Now how about the balance sheet? Well, the balance sheet, we feel pretty good because in inventory, on the balance sheet, you have your most recent merchandise prices.

So your balance sheet does reflect the current financial resources that you do have invested in merchandise. And this all makes a lot of sense. When you remember the bottom line, the bottom line is  is a balance sheet approach. You've got to remember that Pfeifle is a balance sheet method. Why? Because of the recent prices were on the balance sheet, the balance sheet does reflect the type of current financial resources.

That the company has invested in merchandise. And as I say, if you want to attack, Five-O, you'd go to the income statement. Cost of goods sold on the income statement is made up of older merchandise prices. They may not be relevant anymore. There's a distortion in the matching concept because under the matching concept, our objective is to match current revenues with current expenses.

Well, we're not doing that with FIFO. With FIFA, we're matching current revenues with older merchandise prices is a distortion in the matching concept. But as I say, It all makes perfect sense. When you keep in mind that  is a balance sheet approach. Now  last in first out is really in every way, the opposite of FIFO.

When you assume a last in first out cost flow, you are assuming that the last merchandise purchased is the first to be sold. If you're assuming that the last merchandise purchased is the first to be sold. Now your most recent merchandise prices are in cost of goods. Sold. On the income statement, all the merchandise prices are on the balance sheet and inventory.

So let's analyze it. If it's last in first out, if my most recent merchandise prices are in cost of goods sold on the income statement, the income statement is very well served by lifeboat because when, when we use light though, on our income statement, we are matching current revenues with current merchandise prices.

The income statement is very well-served by lifeboat. And of course, if you want to attack life, Oh, you go to the balance sheet. The problem with life O is inventory on the balance sheet is made up of older merchandise prices. They may not be relevant anymore. Again, the company could be in a period of hyperinflation or hyper deflation.

And the problem is that inventory on the balance sheet is made up of older merchandise prices and they may not be relevant anymore. And in fact with life, Oh, what, what ends up happening is you end up with a base that stays on your balance sheet that just gets older and older and older and more and more out of date.

And it'll get to the point where your balance sheet does not reflect in any way, the type of current financial resources that the company really has invested in merchandise. And this all makes a lot of sense. When you keep in mind that life O is an income statement approach. See, that is the essential difference.

FIFO is a balance sheet method. Why? Because the recent prices are on the balance sheet. YPO is an income statement method. Why? Because the recent prices are on the income statement. Make sure you remember that basic difference. FIFO is a balance sheet approach. Why? Because the recent prices are on the balance sheet.

Lightfoot is an income statement approach. Why? Because the recent prices are on the income statement. We just show you one way. They could test that principle. Look at multiple choice. Number one. A company decided to change the inventory valuation method from FIFO to life, or they're going from FIFO to life out in a period of rising prices.

Notice it is a period of inflation. What was the result of the effect? What was the result of the change? On ending inventory and also net income. So if you go from  in a period of changing prices, what is the effect on ending inventory? What is the effect on net income? Well, let's start with ending inventory.

If I go from Five-O to life or what's happening to the balance sheet, aren't I going from? Aren't I going from? New price. Number five was a balance sheet approach. The recent prices were on the balance sheet. So aren't I going from new prices, which are higher. It's a period of rising prices. Aren't I going from new prices on the balance sheet, FIFO to old prices on the balance sheet life O which are lower inventory is going down.

You want decreased under the first column. If I go from five foot of life though, rising prices. That's what happens to the balance sheet because I'm going from. Recent prices on the balance sheet, which are higher to older prices on the balance sheet, which are lower inventory is going down. How about the effect on that income what's happening to cost of goods.

Sold will under FIFO, older prices are in cost of goods sold they're lower. So aren't I going from lower prices in cost of goods sold under FIFO to life aware newer prices are in cost of goods, all which are higher cost of goods sold is going up. Net income is going down. You want answer C decrease under both.

Let's do that again. The effect on that income. Well, if I go from five for life on I going from old prices in cost of goods sold, which a lower to new prices and cost of consult, which are higher. So cost to consult is going up. Net income is going down. Remember that essential difference. Viper is a balance sheet approach because the recent prices were on the balance sheet.

Life was an income statement approach because the recent prices are on the income statement, cost of goods sold. That is the essential difference. Now there's also weighted average. Here's the formula for a weighted average cost per unit to get away to the average cost per unit, you take cost of goods available for sale, and you divide by the number of units available for sale.

That's the formula. That's how you figure out a way that average cost per unit is it is cost of goods available for sale, and you divide that by the number of units that were available for sale. Let me just make up some numbers. If my cost of goods available for sale, total $120,000. And I had 10,000 units available for sale.

Then my weighted average cost per unit is $12, right? If my cost of goods available for sales, $120,000, and I had 10,000 units that were available for sale divide by 10,000 units. My weighted average cost per unit would be $12 South at year end. I have 2000 units in my ending inventory. Times $12. My ending inventory would be valued at $24,000, 2000 units, times $12.

My ending inventory would be valued at $24,000. That would be the proper valuation of the ending inventory under weighted average. Now I'll tell you what I worry about. Don't be one of those students that confuses a weighted average with a moving average. Let's do a moving average. Let's say we start on January one and I have a thousand units in my ending inventory.

Excuse me, January one. I have a thousand units in my beginning inventory valued at $6 each. So my beginning inventory is valued at $6,000. All right, then let's say on January 17th, we purchase another 200 units for $12 each. Well, think about it. That's a $2,400 purchase. Add that to the 6,000 in my beginning inventory.

Now I have $8,400 invested in inventory. I've got what? A thousand plus 200 1200 units on hand take 8,400 divided by 1200 units. My weighted average cost per unit as of January 17, it's $7 per unit. See, that's the key to a moving average. The key to a moving average is every time you purchase units, you strike a new weighted average cost per unit on that day.

So that if on January 23rd, I sell 500 units. If on January 23rd, we sell 500 units. They get costed out of that unit price, $7. So inventory would drop $3,500. So our inventory just dropped from 8,400 down 3,500. I now have 4,900 invested in inventory, but as I say, the key to a moving average is every time you purchase units, you strike a new way.

That average cost per unit on that day, what happens on February 6th? If I buy 300 more units for $9 each well, if I buy. 300 more units for $9. Each that's a $2,700 purchase. Right? Add that to the 4,900. I had invested in inventory. Now I've got $7,600 invested in inventory, right? 7,600. How many units do I have?

Well, I had 1200 units, right? I sold 500 that left me with 700. Then I just bought 300. I have a thousand units on hand. Take the $7,600. I have invested in inventory divided by a thousand units. And what does that tell you? My weighted average cost per unit as of February 6th is $7 and 60 cents a unit. As I say, the key to a moving average is every time you purchase units, you strike a new way.

That average cost per unit on that day. Let me ask you this. See if you can fill in this blank, I'm going to use our moving average. With what type of inventory system that's right. A perpetual system. See, I would use a moving average with a perpetual inventory system. I would use a simple way to average with a periodic system.

So remember that basic relationship you'd use a moving average. If you have a perpetual inventory system, you would use a simple way to average. If it is a periodic system, we'll continue our discussion on the valuation of inventory in our next class. Keep studying.

Welcome back in this FAR CPA Review class. We're going to continue our discussion on the proper valuation of ending inventory, because there are two more valuation methods that you need to know about. We're going to start with the retail method. Now the retail method is used by retailers. Just imagine a huge retailer like Walmart, you know that Walmart has.

Thousands tens of thousands of products on the shelves all bought at different prices. So specific identification is just not practical, especially for interim financial statement purposes. This is the sort of company that would use the retail method. Now, before we look at a problem, there's something you have to be aware of.

There are two essential pieces to this puzzle. If you're going to solve any problem on the retail method, there were two things you have to have. Number one, you have to know the cost to retail ratio. That's number one, you're going to have to know the cost to retail ratio. And number two, you have to know ending inventory at retail.

Those are the two critical pieces of this puzzle to solve any retail problem. You have to know the cost of retail ratio, the cost of retail percentage, and. Ending inventory at retail. Let's go to a problem. If you look at question number one, it says Dean company uses the retail method to estimate inventory for interim financial statement purposes, data relating to the computation of inventory.

July 31 are as follows and you see the kind of information they give you in a problem like this. We know the beginning inventory. February one at cost. And at retail, we know the purchases at costs and at retail, we know the markups. We know the markdowns, we know the shoplifting losses and we know the sales.

Then it says at the bottom, and this is a mouthful. It says under the approximate lower of average cost or market retail method, let's go over that again. Under the approximate lower of average cost or market retail method, I'm going to give you another name for this. This is usually called conventional retail, which is a lot easier.

But when you see average, lower of cost of market retail, it's another name for conventional retail, which is what the CPA Exam almost always asks. So it's just conventional retail. What is Dean's estimated inventory, July 31. All right. So let's back up. As I said, there are two essential pieces to this puzzle.

What's the first thing we need the cost to retail ratio. Let me give you the formula. Here's the formula for the cost to retail ratio, to figure out the cost of retail ratio in the numerator. We want goods available for sale at costs. Again, in a numerator. We want goods available for sale at cost, and then the divisor we want goods available for sale at retail.

That's how you figure out the cost of retail ratio by taking goods available for sale at cost and divide by goods available for sale at retail. So let's figure it out. Let's figure out goods available for sale at costs. Go to the cost column. We're going to take beginning inventory at cost 180,000 plus purchases at cost 1,000,020 thousand.

Just draw a line there, added up. Can we agree that goods available for sale at cost comes out to 1 million, $200,000, 180,000 plus 1,000,020 thousand goods available for sale at cost would be 1 million. 200,000 now what's goods available for sale at retail, you might wanna just put a little check Mark next to each number.

I say, we're going to pick up the beginning inventory at retail 250,000 plus purchases at retail. 1,575,000. Plus the mock ups. Of 175,000. Ignore the markdowns. I'll say why in a moment. So add up to 50 plus 1,000,005 75, plus one 75 goods available for sale at retail comes out to 2 million. So now we have what we need.

If I take goods available for sale at costs 1 million, 200,000, and I divide by goods available for sale at retail, 2 million, my cost of retail ratio. My cost of retail percentage is 60%. So I've got that. That's the first essential thing I need that cost to retail ratio here at 60%. Now I've got to pause and talk about something.

They call this lower of average cost or market retail or conventional retail. And it's something you have to be aware of. Anytime the CPA Exam says the phrase lower of cost or market in any retail problem. Again, anytime the CPA Exam says the phrase. Lower of cost or market in any retail problem. It always means the same thing.

Put the Mark ups, not the markdowns in the ratio. It's what it means when you see lower cost to market in any retail question, what they're telling you to do is put the markups, not the markdowns in the ratio. So if you play around with it, what you'd see is if I put the mock ups. Not the markdowns in the divisor.

Remember the markdowns would be a minus. And when you put the markups, not the markdowns in that divisor, in our ratio, it suppresses the ratio. It makes it a little lower. It's trying to approximate lower of cost to market. But as I say, the good news is anytime they say lower of cost of market and any retail question, that's what they're telling you to do.

Put the markups, not the markdowns and the ratio. All right. So we have our cost of retail percentage. Our cost of retail ratio is 60%. Now what's the other piece of the puzzle. I need ending inventory at retail. Now I know goods available at retail in my divisor here. 2 million. How do I figure out ending inventory at retail?

It's a fairly easy thing for a retailer to figure out back out what you sold. 1,000,705 back out breakage theft, spoil at shoplifting, any kind of shrinkage, 20,000. You do Mack back out the markdowns. You don't ignore the markdowns. They just not in the ratio. Anytime they say lower cost of market in a retail question, those markdowns are ignored in the ratio, but I now have to figure them in.

So back out what you sold 1,000,705 back out the Mark Downs, 125,000 back out the shrinkage, the shoplifting loss is 20,000 and your ending inventory at retail comes out to 150,000. Now your last step is to say, If my ending inventory at retail is 150,000 and my cost of retail ratio is 60%. What's ending inventory at cost 60% of 150,090,000.

Answer a it's a way of estimating the cost of what's on the shelves. If ending inventory at retail is 150,000, which is a fairly easy number for a retailer to figure out. And my cost to retail percentage is 60% well costs. My ending inventory at cost. It'd be about. 60% of 150,000, about 90,000. Now there's one more method that you have to be aware of.

And I know you're going to like it. It's dollar value lifeboat, some companies rather than count physical units, some companies, they don't want to count physical units in inventory. What they count instead is dollars. In other words, when a company uses dollar value, life vote. One us dollar invested in inventory is one unit of inventory to them.

That's how they look at it. That one us dollar invested in inventory is one unit of inventory to them. They don't, they don't count physical units. They count dollars. Now you're going to see that this method really isn't that bad, except you have to worry about inflation. The problem is the dollar changes because of inflation.

And you have to factor that in as well. Let's go to a problem. Let's go to the acute company. It says the acute company manufactures a single product on December 31 year 10, acute adopted the dollar value life. Oh, inventory method. Then they say the inventory on that date using dollar value. Life was determined to be 300,000.

You might want to circle that 300,000 and label it. That's called the light bulb base. When you start dollar value life. Oh. You have $300,000 invested in inventory. And again, you want to label that that's the life of base and it's something else you should write down. I think you ought to put in your notes, the base, your index is always one base.

Your index is always 1.00. So your job in this approach is to keep track of inflation. Since the base year, you always start with a clean slate. The base, your index is always 1.0 because your job in this approach is to keep track of inflation since the base year. So we know what the base, your index. Is 1.00 now notice a year goes by.

At the end of year 11, we now have 363,000 invested in inventory. But notice the price index is now 1.1 that tells you there's been 10% inflation since the base year, another year. It goes by at the end of year 12, they have 420,000 invested in inventory. Notice. Now the index is 1.2 that tells you there's been 20% inflation since the base year that at the end of the year 13, they have 430,000.

Invested in inventory, but now the index is 1.25. There's been 25% inflation since the base year. Now I'm going to show you the steps here that really aren't that bad. You just have to be a little patient. You'll see what I mean. You just get used to it. So let's do year 11 a year goes by we're at December 31 year 11.

We now have 363,000 current dollars invested in inventory. That's what they keep track of. What do we have invested in inventory? 363,000 current dollars. The problem is there's been 10% inflation since the base year. Right now, our index is 1.1. Here we go. Step one, you always divide by the price index.

Always divide by the price index to get back, to base your dollars. So I'm going to take that 363,000 divided by 1.1, in terms of base your dollars, that comes out to 330,000. I just took the 363,000 divided by 1.1, you always divide by the price index to get back, to base your dollars. And as I say, if you divide that 363,000 by 1.1, in terms of base your dollars, that comes out to 330,000.

Now listen, how many base your dollars were invested last year? That's right. The base 300,000. So in real terms, when we pull the inflation out, we have more invested in inventory this year than we did last year. What we added this year is a $30,000 layer. You have to be able to find that layer. All right.

Now here's the most important schedule. What would we take to the balance sheet at as inventory at the end of year 11? What are you going to take the balance sheet as inventory? At the end of year 11. Well, you've got your base 300,000. That's not touched, but now you've added a year 11 a layer. You've added a year, 11 year 11 layer of 30,000 times 1.1 that comes up to 33,000 C in dollar value life.

Though, each layer is valued at its own index. I've got to take the 30,000 times 1.1. I've added a $33,000 layer because in dollar value life, every layer is valued at its own index. Why. Because if I did add inventory, I added this year's dollars. I can't add last year's dollars. It's not physically possible.

I always had this year's dollars. So what I did this year is that 33,000 year $11 to what I already had, what I'll take to the balance sheet for my inventory at the end of year 11 is 333,000. That is the proper valuation of the ending inventory under dollar value life. Oh, let's do another year. See if you get.

More comfortable with it. Now another year goes by it's December 31 year 12. We now have 420,000 current dollars invested in inventory. But the problem is. There's been 20% inflation since the base year. Notice my index is now 1.2. So how do I start? Remember I always divide by the price index to get back to base your dollars.

So I'm going to take that 420,000 divide by 1.2, in terms of base your dollars, that comes out to 350,000. If I take 420,000 divided by 1.2, that comes out to 350,000. Now, careful how many base your dollars were invested last year? 330,000. So in real terms, I've added another $20,000 layer. Be careful don't some students go back to the base.

No, I always look at how many base your dollars were invested. Last year, last year I had 330,000 base your dollars this year. I have three of them, 50,000 base your dollar. So in real terms, when I pull the inflation out, I've added another $20,000 layer. You've gotta be able to find that layer, but now the most important schedule.

What do I take to my balance sheet for inventory at the end of year 12? Well, I've got my base 300,000. That's not touched. I've got my year 11 layer of 33,000. Haven't touched that. But now what I've added is a year 12 layer of 20,000 times 1.2. Every layer is valued at its own index, because if I did add inventory, I added this year's dollars.

I can't add old dollars. It's not physically possible. What I did this year is at 24,000 that's 20,000 times 1.2. I added 24,000 current dollars to what I already had. So what I'll take to the balance sheet for my inventory at the end of year 12 is 357,300 plus 33 plus 24, 357,000. That is the proper valuation of the ending inventory under dollar value lifeboat.

How about one more year? Can you stand it? Let's do another year. We now another year goes by it's December 31 year 13. We now have 430,000 current dollars invested in inventory. But the problem is our index is 1.25 that tells us there has been 25% inflation since the base year. So how do I start? That's right.

I always divide by the price index. To get back to base your dollar. So I'm going to start off here by taking that 430,000 divide by 1.25, in terms of base your dollars, that comes out to 344,344,000. I'd be careful how many base your dollars were invested last year, three 50. So in real terms, inventory's gone down 6,000 based dollars.

That's why I had to do a problem. This involved. Because I had to show you what happens if inventory goes down, as long as it keeps going up, you're adding layers. And hopefully you're getting more comfortable with that. But what if inventory goes down because now we have 344,000 face your dollars invested in inventory.

Last year, it was three 50. Inventory has gone down 6,000 base dollars. Now listen carefully. This is why it's called dollar value life. Oh, I want you to notice this is not just called the dollar value method. It's called dollar value life. Oh, do you know why it's called dollar value life though? Because the life aspect comes in when inventory goes down, if inventory ever goes down, listen, the last layer you added is the first one you begin to cost out.

Last layer added is the first one you begin to cost out last in. First out. That's why it's dollar value LIBO. Cause if inventory ever goes down, the last layer you added is the first one you'd be going to cost out. So now together, let's think about this. What would I take to my balance sheet for inventory at the end of year 13?

Well, I've got my base, right? 300,000. I haven't touched that. I've got my year 11 layer. That's still there. 33,000. I haven't touched that, but my year 12 layer. That used to be 20,000 base, your dollars dropped 6,000 to 14,000 base. Your dollars times 1.2, every layer is valued at its own index. So that layer is now valued at 16,800.

So what do I take to my balance sheet at the end of year 13, 300 plus 33 plus 16, eight, 349,800. That is the proper valuation of the ending inventory under dollar value LIFO. I hope you followed that anytime inventory goes down, last layer added is the first one. He began the cost out last in, first out.

So as I say that year 12 layer that used to be 20,000 based dollars dropped six to 14,000 base. Your dollars times 1.2 it's own index. That layer is now valued at 16 eight. So, what I take to the balance sheet at the end of year 13 would be my base 300,000 plus my year 11 layer, 33,000, plus my year 12 layer, which is now 68, 349,800.

That is the proper valuation of the ending inventory under dollar value life. Oh, now what we just did, that is a simulation that's much more than a multiple choice, but I wanted to show you what a simulation would be like on dollar value life, because it makes a good simulation. And if he got a simulation on dollar value life, or they would, they might take you into a year where inventory goes down, but let me show you the same thing in a multiple choice.

If you look at multiple choice, number two, multiple trace. Number two says on January one year one, Paul adopted the dollar value LIFO inventory method. PO's entire inventory consists of a single pool inventory data for year one and two are as follows. So notice the day they adopt a dollar value life.

That is January one, year one, they had $150,000 invested in inventory. What's that? That's your life? Oh, bass right now. Are you goes by at December 31 year one. They now have 220,000. Current dollars invested in inventory, but the problem is there's been 10% inflation since the base year. Notice the index is now 1.1.

So you know what to do. You always divide by the price index to get back to base your dollars. And if you take that 220,000 divided by 1.1, in terms of base your dollars, that comes out to 200,000, they did that for you. How many base your dollars were invested last year? One 50. So you've added a $50,000 layer.

So what would you take to the balance sheet at the end of year one? You've got your base 150,000. Hasn't been touched, but you've added your year. One layer of 50,000 times 1.1, right? Every layer is valued and its own index. What you did in year one is add 55,000 current dollars to your base, which already had.

So what we'll take to the balance sheet at the end of year, one would be a hundred to end. Which excuse me would be 205,001 50 plus 55, 205,000. That would be the proper valuation of the ending inventory under dollar value life. Oh, now they don't want the ending of a story at the end of year one. They want it at the end of year two.

So let's go ahead. Another year we get to December 31 year two, we now have 276,000 current dollars invested in inventory, but the problem is there's been 20% inflation since the base year. Now the index is 1.2. So you know what I do, I always divide by the price index to get back to base your dollar. So I'm going to take that 276,000 divided by 1.2, in terms of base your dollars, that comes out to 230,000.

They did that for you. How many base your dollars were invested last year? 200,000. So they added another $30,000 layer. So let's do the main thing we have to do. What is the proper valuation of the ending inventory at the end of year two? What do I take to the balance sheet? As my inventory at the end of year two, well, I've got my base 150,000.

Haven't touched that I've got my year one layer of 55,000. Haven't touched that, but now I've added a year to layer of 30,000 times 1.2 in dollar value. Life Oak. Every layer is valued at its own index because when I add to inventory, I add current dollars can add old dollars. What I did in year two is add 36,000 current dollars to what I already had.

So what I take to my balance sheet for my inventory at the end of year two will be one 50 plus 55 plus 36, 241,000 answers. See? So that's what the same thing looks like in a multiple choice, but you can't go in the CPA Exam and not know dollar value life though, because it does make good multiple choice.

And it certainly makes a good simulation. I hope you're working on your problems. You're keeping up. You're not falling behind. That's always what I hope. And I'll look to see you in the next class.

Yeah, welcome back in this FAR CPA Review class. We're going to begin our discussion of fixed assets. And you know that when we say fixed assets, we're talking about land and buildings and machinery and equipment and furniture and fixtures, but to be more precise, remember that fixed assets represent capital expenditures, meaning these are expenditures that benefit.

More than one accounting period, fixed assets always represent capital expenditures expenditures that benefit more than one accounting period. That's where the word capitalized comes from as opposed to what a revenue expenditure, a revenue expenditure only benefits the current period. You pay your telephone bill.

That's a revenue expenditure only benefits the current period. But as I say, fixed assets represent capital expenditures and that's where the word capitalize comes from. Now. You're going to find that. Fixed assets will not be one of the more difficult areas in the course. I'm sure you feel that way and it's true, but don't think the CPA Exam doesn't test fixed assets.

They do. And in fact, there's a number of things they can get into with fixed assets. The first thing they get into with fixed assets is this, what costs should we capitalize to fixed asset accounts? Over and above the cash price you pay for the asset, which is obvious, but over and above the cash price you pay for the asset, what costs should be capitalized to fixed asset accounts?

Well, there is a rule. The rule is that for fixed assets, we must capitalize all the costs we incur to bring that fixed asset into a condition and location for use. That's known as the condition and location for use rule. It's almost like inventory where an inventory we capitalize. All the costs. We incur to bring inventory into a condition and location for sale, right?

With fixed assets, we capitalize all the costs. We incur to bring the fixed asset into a condition and location for use. So let's think about this. How about machinery and equipment? What costs would we capitalize to machinery and equipment accounts over and above the cash price you pay for the machinery and equipment, which is obvious?

Well, For machinery and equipment, we would capitalize freight charges, installation, charges, insurance during transit. And don't forget this one. If there's a testing period, if there's a testing period, before you put machinery and equipment into production, all the costs that you incurred during the testing period would be capitalized to the machinery and equipment account.

How about land? What costs do we capitalize to a land account over and above the cash price you pay for the land? Well, for land, you're going to capitalize attorney's fees. Be careful they could call it title search. Also, you're gonna capitalize grading the land, clearing the land, draining the land, surveying the land is a lot of them.

So again, for land, you're going to capitalize attorney's fees, title, search. Grading clearing, draining, surveying the land. And now, since we're on land is one that like you to think about one, the FAR CPA Exam always likes to get into, let's say a company buys a piece of land and on the land, there's an old unwanted building.

And what the company is going to do is destroy the old building and construct a new building. So that's the plan. The land has an old unwanted building and the company plans to destroy the old building. And construct a new building. Here's what the CPA Exam would ask you. The cost of destroying that old building minus anything you get for scrap that's usually thrown in.

But again, the question is the cost of destroying that old building minus anything you get for scrap. What do you do with that cost via capitalize it to the land account or the new building? It is land. Why? Because the cost of this during that old building is a cost you incurred to get there, land in a condition for use really a straight application of the rule, because the cost of destroying that old building is a cost that you incur to get the land in a condition for use.

Definitely go to the land account. How about buildings? What costs he capitalized to a building account over and above the cash price you pay for the building? Well, for buildings, you're going to capitalize building permits. Architects fees, engineering fees, again for buildings, you're going to capitalize building permits, architects fees, engineering fees.

And there's one more thing I want to talk about with buildings and that is capitalized interest. Here's the point. If a company borrows money to construct a building or really any asset I want to emphasize that capitalized interest does not just apply to buildings. It applies to any asset. You are constructing for your own use.

I'll say it again. Capitalized interest applies to any asset that you are constructing for your own use, but realistically in the exam, I think it would be on a building, but I'll make my point. If a company, borrows money to construct a building or any asset, they must capitalize interest during the period of construction.

That's the requirement that you must capitalize interest. During the period of construction. Let me give you an example. Let's say a company, for example, borrows $10 million at 10% interest to finance the construction of a building. So a company borrows $10 million at 10% interest to finance the construction of a building.

And let's say that their construction costs for year one. $6 million and those costs were incurred evenly through the year. So the construction costs for year one, $6 million, and those costs were incurred evenly through the year. What they would ask you in the CPA Exam is what is capitalized interest for the year?

Well, a lot of students would sit in the CPA Exam and go and say, well, I'm going to take the interest rate 10% times the borrowing 10 million. Wouldn't capitalize interest be a million. No, it's not that simple. Some students would say, well, I'll take the interest rate. 10% times the construction costs 6 million and say, well, capitalized interest is 600,000.

That doesn't work either. There are those attempting answers, but there is a little trick to this, you know, there would be here's the requirement. A company must capitalize interest on average expenditures. And that's that, it's that little word average that a lot of students overlook because that's the requirement that we must capitalize interest on average expenditures.

And here's a shortcut, as long as the construction costs are incurred evenly through the year. And I think realistically in the exam, they probably would be. As long as the construction costs were incurred evenly through the year, then you just divide by two. If you divide by two, that'll give you an estimate of your average expenditures.

So because the $6 million of construction costs, they said were incurred evenly. I'm going to divide by two. My average expenditures would be 3 million times. The interest rate, 10% capitalized interest would be. 300,000. That's the capitalized interest. 300,000. So again, as long as the construction costs are incurred evenly, then you just divide by two.

And that'll give you an estimate of your average expenditures. What if the construction costs were not incurred evenly? Well, let me just give you an example. Let's take let's, let's take the same project. Now we get into year two. I want you to recognize that when we get into year two, the $6 million of borrowed money that we had in the project in year one.

Would carry over and be invested all through year two. Notice always what I'm dealing with is not the borrowing notice. I'm not deal notice off in this in, in both years. I haven't just looked at the borrowing, the 10 million that I borrowed. No, you do deal with the construction costs because that's the argument that you now have $6 million of borrowed money in this project.

So you don't look at the borrowing. You do look. At the construction cost, because that is the basic argument that we now have $6 million of borrowed money in this project. But as I say, if it's incurred evenly to figure out average expenditures, you divide by two, that gives you the 3 million times, 10% gives us.

It gives us the 300,000 of capitalized interest for the first year. But when you get into the second year, I want you to recognize that that $6 million of borrowed money that we had in the project in year one. Would still be invested in year two and would be invested all through year two for all 12 months.

So that would be another 6 million invested for the entire year of year two, all 12 months, times the interest rate, 10%, that would be $600,000 of capitalized interest. What if they added that the company incurred another 1 million, $200,000? What if they incurred another 1 million, 200,000. Of construction costs on April 1st.

Well, if they incurred another 1,200,000 of construction costs on April 1st notice, now it's not evenly. All right. That's what I want to show you. What if the construction costs are not even well, they incur another 1 million, 200,000 of construction costs on April 1st. Well, that borrowed money has been in the project for nine months.

So you're gonna have to give it a weight of nine twelves. So you're gonna have to take the interest rate. 10% times a million, two of construction costs. That's 120,000 of interest times nine twelves, give it a weight of nine twelves. That's 90,000 of capital. . What if they incur another 1,200,000 of construction costs on October 1st?

Well, that borrowed money has been in the project for three months. Give it a weight of three twelves or a quarter. So take 10% of a million, two that's 120,000. Times a weight of a quarter. That's another 30,000 of capitalized interest. So what's the capitalized interest for the second year, 600,000 plus 90,000 plus 30 720,000.

So I just want to show you that, that if the construction costs not incurred evenly through the year, that's easy. Just divide by two. Well, if it's not incurred evenly through the year, what you have to do is wait the borrowed money. By how many months it's been in the project, I have to wait the interest.

By how many months it's been in the project. I'm not sure the CPA Exam would do that, but just to show you in case it came up, but generally as long as the construction costs are incurred evenly, you just divide by two. That gives you an estimate of your average expenditures, times the interest rate, and that'll give you capitalized interest.

Let's look at a question. Number one, number one says a company's constructing an asset for its own use construction began in the previous year. Asset is being financed entirely with a specific new borrowing construction expenditures were made last year. And this year at the end of each quarter, the total amount of interest costs that would be capitalized in the current year should be determined by applying.

The interest rate on this specific new borrowing to what? Well, you know, it's not a, or D we don't just apply the interest rate to total expenditures. Now it is average expenditures, but what you have to think about is whether it's B or C, would it be the interest rate times, be the average expenditures for the asset for both years, or see the average expenditures just for the current year.

And it is B it's for both years. It's the same as in my example, that the $6 million of borrowed money that was in the project in the first year would carry over and be invested for all 12 months of the second year. That's why you have to consider both. So that's why the answer is B. They're not see, you'd have to consider the average accumulated expenditures for both years, because if you think of my problem, that's really what I had to do in the second year.

Take the $6 million of borrowed money from year one. It would be invested all through year two. It has to be considered in the second year as well. In addition to the borrowed money you put in the project in the second year. So you do have to consider both years. And that's what they're getting at. What I want to get into next is something the CPA Exam loves.

And that is how do we handle an improvement to a fixed asset? And I think, you know, what the issue is when we make an improvement to a fixed asset, do we capitalize it or do we expense it? the CPA Exam loves this. This tough little area, you make an improvements. We'll fix that set. Should you capitalize that improvement or should you expense that improvement?

Well, I want to start with some terminology, cause sometimes in the CPA Exam it'll come down to terms, watch out for these terms. Betterment's what's an example of a betterment putting a new roof on a building. Just remember betterments are always capitalized. My point is if the CPA Exam calls something a betterment, you don't argue with it.

Betterments are always capitalized. As I say, sometimes in the exam, sometimes it comes down to terms. So if they call it a betterment, you don't argue with it. Betterments are always capitalized. Another category you have to be careful about additions, extensions, or enlargements additions, extensions, or enlargements.

An example would be putting a new wing on your building. Additions, extensions, enlargements, always capitalized. My point again is if the CPA Exam calls something an addition, if they call something an extension, if they call something an enlargement, you don't argue with it. It's capitalized. One more category.

Watch out for extraordinary repairs. An example would be putting new motors and all your machines. Overhauling, a machine extraordinary repairs are always capitalized. Again, my point is if the CPA Exam calls something. On extraordinary repair. You don't argue with it. You capitalize it right now. If you, with me, I'm trying to draw a distinction between extraordinary repairs and what.

Ordinary repairs and maintenance. You know, this ordinary repairs and maintenance, you paint something, you replace a gear. You'll find when you do your homework, they get very picky, but ordinary repairs and maintenance, you replace a gear that's expensed, but extraordinary repairs would be capitalized. Now, the reason you have to be careful about this area is you'll see in your homework, they get very picky.

So I'm going to give you a rule and my rule should answer anything. They dream up. Just remember this, we must capitalize any improvement that does any one of four things. If an improvement does any one of four things you don't just automatically capitalize it let's go over the four. Number one, if the improvement extends the useful life of the asset, capitalize it.

That's. Number one, if an improvement extends the useful life of the asset, capitalize it. Number two, or number two or number two. If an improvement increases the number of units produced by the asset capitalize it that's. Number two, if an improvement increases the number of units produced by the asset, capitalize it, or, or number three, if an improvement increases the quality of the units produced by the asset, capitalize it.

So if an improvement extends the useful life of the asset or increases the number of units produced by the asset or increases the efficiency of the asset, capitalize it, or one more. Number four, if the improvement increases the efficiency of the asset, capitalize it. If the improvement increases the efficiency of the asset.

Capitalize it, those are the four and a quick way to remember the four, just remember queen Q E N. Remember queen, you got all four Q if quality is increased, E if it extends life, the other E if efficiencies increase or N number of units produced increased, that's a quick way to remember it. You see queen that's an answer.

Anything they dream up. If Q qualities increase, he extends life. The other aid efficiencies increase, or N number of units produced is increased. If an improvement does any one of those four things capitalize it. And of course, if an improvement does not do any one of those four things, you expensive. As I say, hopefully that would answer anything.

They dream up. Let's look at question number two, they say on July one, one of Rod's delivery vans was destroyed in an accident on that date, the vans carrying them out. Was 2,500 then on July 15th, rod received and recorded a $700 invoice for a new engine installed back in may. Well, that's an extraordinary repair should have been capitalized.

So that would bring the carrying value to the band. If we capitalize that extraordinary repair up to 3,200, another 300 invoice was received for various repairs. Well that's ordinary repairs and maintenance should be expensed in August. Rudd received. A $3,500 payment from their insurance policy on the van.

And it says, what amount would run report as gain a loss on that disposal of the van? Well, I just think about the entry. When they get 3,500 from the insurance company, they're going to debit cash 3,500. They're going to credit the van for it's carrying them out, which would be 3,200. Cause we'd capitalize the new engine of 700.

And the gain would be a credit of 300 and the answer is B. And just one thing you want to be aware of that would be an example of a gain from an involuntary conversion. You didn't mean to do it. The van was destroyed in an accident. It was involuntary that's again from an involuntary conversion, as opposed to what you go out, you sold the van at a game that would be voluntary.

But I just want to mention to you that gap doesn't care gap doesn't care, whether gains or losses or voluntary involuntary gains and losses have to be on the income statement. Let's talk about how you handle impairments to long lived assets or intangibles. If the FAR CPA Exam gets into impairments to long lived assets or intangibles.

You've got to remember that long lived assets and intangibles are divided into three categories. There are three categories. Here we go. Number one, there are long lived assets or intangibles you're holding for use long lived assets or intangibles held for use. Now here's the question. How do you know if a long lived asset or intangible that's being held for use?

How do you know it's impaired it's impaired? Anytime the carrying value on the books is greater than its fair value. Then, you know, it's impaired. If the carrying value on the books is greater than its fair value, that asset is impaired. So what do you do? You debit a loss, take a loss to the income statement up and continuing operations and you credit the asset.

You write the asset down to fair value. That's what you're supposed to do. It's impaired. So you take a loss to the income statement and credit the asset. Write it down to fair value. Now what we've done, we've written the asset down to fair value. That fair value becomes the new basis for that asset. And we depreciate that new basis over its remaining life prospective only nothing retroactive.

So you don't go back to prior periods. No, we take a loss to the income statement, write the asset down to fair value and that fair value. That's the new basis for the asset. That's it. That's its new carrying value and that new carrying value would be re would be depreciated. Over the assets remaining.

Like you don't touch prior periods. What if the asset recovers in value? We don't re we don't record that recovery is not recorded right now. The second category would be long lived assets or intangibles held for sale. Well, what's held for sale. Held for sale means sale is probable within 12 months. So that's the second category, long lived assets, orange tangibles held for sale.

And again, held for sale means. That sale is probable within 12 months. Now, the question's the same. How do you know if along with asset or an intangible you're holding for sale? How do you know it's impaired it's impaired? If the carrying value on the books is greater than the selling price. If the carrying value on the books is greater than its selling price minus.

Any cost you incur to get rid of it, any cost to sell. In other words, if the carrying value on the books is greater than what you'd net out of the sale, it's impaired. If the carrying value on the books is greater than the selling price minus any cost to sell, if the carrying value in the books is greater than what you would net out of the sale it's impaired.

So what do you do? You debit a loss, take a loss to the income statement up in continuing operations. You'd write the asset down to fair value credit. The asset and depreciation stops. Depreciation stops. Now, there is a third category. The third category would be long lived assets or intangibles held for disposal other than by sale.

That's the third category, long lived assets or intangibles held for disposal other than by sale. What do I mean by other than by sale? They caught intend to abandon the asset distributed to owners exchange the asset. So that's another possibility. You could have long lived assets or intangibles held for disposal other than by sale and other than by sale, we mean they could intend to abandon the asset distributed to owners, exchange it.

And as a simple rule, if you see long lived assets or intangibles held for disposal, other than by sale, though, simple rule is treated as held for use. Just treat it as held for use until they dispose of it. So you just go right back to the notes on held for use, and you'll be fine because that's the rule.

Just treat that asset is held for use until it is disposed of. I hope you're not falling behind. I always hope that that you're doing the work, keeping up with it, getting those problems done, learning from the problems you get wrong, especially when you have to focus in on and I'll see you in the next class.

Welcome back in this FAR CPA Review class, we're going to continue our discussion on fixed assets. And what I want to get into next is how we handle a problem where companies exchange fixed assets. I'm sure you've seen these type of problems before where companies exchange a delivery truck for some computers or.

Machinery for our equipment. How do we handle these problems? Well, how we handle exchanges of assets? All depends on one thing. Does the exchange have commercial substance? That's the issue? Does the exchange have commercial substance now? What does commercial substance mean? It means that as a result of the exchange, as a result of the exchange, the cash flows of the companies involved will change significantly.

In terms of risk score, timing, or amount. Again, commercial substance means that as a result of the exchange, the cash flows of the companies involved will change significantly in terms of risk or in terms of timing or amount that is commercial substance. Now, when an exchange does have commercial substance, if it does have commercial substance, we have to use what they call the fair value approach.

Let's do an example. Let's say that in an exchange that does have commercial substance, and I think the CPA Exam will more than likely just tell you. And in an exchange that does have commercial substance, a and B exchange assets, and a gave up an old asset with a book value of 6,000 and a fair value of 20,000.

Al's who has to pay 4,000 cash in exchange for new assets. So in an exchange that does have commercial substance, Eddie gives up an old asset with a book value of 6,000, a fair value of 20,000. He has to pay 4,000 cash also in exchange for new asset. Let's think about the entry a would make here. We know that when an exchange does have commercial substance.

You have to use the fair value approach. And what does that mean? It means that a has to record the new asset at its fair value. Now here's what the CPA Exam gets into. How does a no, the fair value, the new asset? Well, the rule is use the fair value of what you're receiving or the fair value of what you're sacrificing.

Whichever is more clearly evident to figure out the fair value of the new asset. Use the fair value of what you're receiving or the fair value of what you're sacrificing. Whichever is more clearly evident noticing this problem. He doesn't know the fair value of the new asset. So AI has to look at the fair value of what they're giving up to acquire the new asset.

And through that, we'll infer the fair value of the new asset. What is a giving up? A's giving up an old asset with a fair value of 20,000, but that's not enough. A it has to kick in 4,000 cash. Isn't a giving up 24,000 in value to acquire that new asset. So we infer the new asset must be worth 24,000. So eight is going to debit the new asset 24,000.

It's the fair value approach. And they asked to record that new asset at fair value. Now, AI is going to credit the old asset for its book value 6,000. And you're going to find that never changes, always credit. The old asset for its book value 6,000 a is going to credit cash 4,000. Hey is paying cash and notice the entry doesn't balance.

Hey, he's going to credit gain on the exchange 14,000. Cause I want you to know when an exchange does have commercial substance, you record the new asset at its fair market value and you recognize gains or losses gains or losses whatever's indicated by the exchange. So here a would credit gain on the exchange 14,000, because when an exchange has commercial substance, you record the new asset at its fair value and recognize gains or losses.

Whatever's indicated by the exchange. Let's do another problem. In an exchange that does have commercial substance a gives up an old asset with a book value of 6,000, a fair value of 20,000, a receives a new asset and also a receives 8,000 cash. So now a is receiving cash. So what entry would they make? A, is going to debit cash because a is receiving cash a is going to debit cash 8,000 a is going to credit the old asset, always for its book value 6,000.

So what do we know? We know when an exchange does have commercial substance. Hey has to use the fair value approach. And you know what that means a has to record the new asset at its fair value. How do you get the fair value, the new asset, look at the fair value of what you're receiving or the fair value of what you're sacrificing.

Whichever's more clearly evident. Well, here what's more clearly evident is the fair value. When a is giving up since a is giving up an old asset that has a fair value of 20,000. Then we infer that that a must be receiving 20,000 in value again, because a is giving up an old asset that's worth 20,000. We have to infer that a must be receiving 20,000 in value.

So since he got 8,000 cash, the new asset debit, new asset for the other 12,000. See, you're inferring. You have to infer in this case, the fair value of the new asset, we have to infer that they must be receiving 20,000 in value. So since 80 received 8,000 cash, the other 12,000 must be. The fair value, the new asset.

So debit the new assets, 12,000 and credit gain on the exchange 14,000. We know when an exchange has commercial substance, you record the new asset at its fair value and you recognize gains or losses. Whatever's indicated by the exchange. And there is a $14,000 gain indicated by the exchange here. Let's do another one in an exchange that does have commercial substance.

A gives up an old asset with a book value of 6,000 and a fair value of 1000 in exchange for new asset. That's the problem? Well, we know when an exchange has commercial substance, we have to use the fair value approach. And you know what that means. It means that a has to record the new asset at its fair value.

How do you get the fair value of the new asset? Well, you look at the fair value of what you're receiving or the fair value of what you're sacrificing. Whichever is more clearly evident. Use the fair value of what you're receiving or the fair value of what you're sacrificing. Whichever's more clearly evident.

What's more clearly evident. Here is the fair value of what AI is giving up since a is giving up an old asset that's worth. And we have to infer that a must be receiving a thousand in value. So we're going to debit new the new asset for just $1,000 credit. The old asset for its book value 6,000 notice that never changes.

You always credit the old asset for its book value. I need a $5,000 debit to balance the entry out. That's a loss on the exchange because we know when an exchange has commercial substance, we record the new asset at its fair value and we recognize gains or losses. Whatever's indicated by the exchange.

Let's do a problem. Number one says in an exchange with commercial substance, and as I said, I think more than likely the CPA Exam will make it very clear whether an exchange. Has commercial substance or not in an exchange with commercial substance, they traded equipment with an original cost of a hundred thousand accumulated depreciation of 40,000 for a similar piece of equipment.

And by the way, we don't care whether it's similar or dissimilar, all that matters is does the exchange have commercial substance? And this does, and notice they gut here. They gave you the fair value. The new asset, the productive equipment has a fair value of 120,000. In addition, They received 30,000 in cash in connection with the exchange, what would be vase carrying them out for the equipment received in the exchange?

We'll think about the entry they would make. They said the exchange has commercial substance. It does. So we have to use the fair value approach, you know, in the fair value approach a or in this case, VA has to record the new asset at its fair value. So let's think about the entry that VA would make here.

They is receiving cash. So they is going to debit cash 30,000. And because the exchange has commercial substance, they will record the new equipment at its fair value. They gave you the fair value of the new equipment. Remember, use the fair value of what you're receiving or the fair value of what you're sacrificing.

Whichever is more clearly evident. What's clearly evident. Here is the fair value. What Bay is receiving. 120,000. So they will debit the new asset for 120,000 Fe would credit the old asset for its book value Bay is going to credit the old asset for its original cost. A hundred thousand debit accumulated depreciation, 40,000.

You see what I'm doing? They is really credit in the old asset for its carrying value is book value 60,000, but I'm just doing it more formally where we credit the old asset for its original cost, a hundred thousand debit accumulated depreciation, 40,000. Now the entry doesn't balance, I need a $90,000 credit to balance the entry out.

That is the gain on the exchange. And it is recognized because we know when an exchange does have commercial substance, we recognize gains or losses. Whatever's indicated by the exchange. Now here, what did they ask for? They want to know Veys carrying them out for the equipment received. It would be fair value.

Answer date 120,000. All right. Now let's talk about an exchange that is lacking in commercial substance. When an exchange of assets is lacking in commercial substance. We don't use the fair value approach. We use the book value approach again, when an exchange is lacking in commercial substance, when an exchange does not have commercial substance, we don't use the fair value approach.

We use the book value approach. What is the book value approach onto the book value approach? You record the new at the book value of the old. Plus any cash paid record the new at the book value of the old plus any cash paid. And if there's any gain indicated, generally speaking, it's ignored. That's the book value approach.

You simply record the new at the book value of the old plus any cash paid. And if there's a gain indicated generally speaking, it's ignored. Let's do a problem in an exchange without any commercial substance with no commercial substance. Notice a gives up an old asset. With a book value of 10,000 and a fair value of 18,000 a has to pay 2000 cash in exchange for new asset.

So what entry would they make here? Well, because the exchange does not have commercial substance here's what a would do a would credit cash, 2000 credit, the old asset for its book value, 10,000 and debit the new for 12,000 a would simply record the new at the book value of the old 10 plus any cash paid to.

It would record the new asset at 12,000. And if there's a gain indicated and there is here because the all that, so it has a fair value of 18,000. There is a gain indicated here, but generally speaking, it is ignored.

Now how about this situation? What if a. In an exchange that does not have commercial substance now in an exchange that does not have commercial substance, what is a gives up an old asset with a book value of 10,000 and a fair value of 2000 in exchange for new asset? Again, in an exchange that does not have commercial substance does not.

It's lacking commercial substance, a gives up an old asset with a book value of 10,000 and a fair value of 2000 in exchange for new assets. What would you do? Well, this is a little different. Normally when an exchange is lacking in commercial substance, we just record the new at the book value the old plus any cash paid, but here you wouldn't do that because there's a loss indicated notice in this case, I would record the new at fair value.

I would debit the new asset for 2000. It's fair value credit, the old asset for its book value 10,000, that never changes. And I would debit a loss 8,000. Losses are always recorded. Losses are never ignored. You always record a loss. So even though the exchange is lacking in commercial substance, you can't ignore that you have a loss losses are never ignored.

Losses are always recorded. So in this case, I would debit the new for its fair value. 2000. I would credit the old for its book value 10,000 and I would record, I would debit the loss 8,000. When there's a loss indicated, even though the exchange lacks commercial substance, there, you would record the new at fair value because losses are never ignored.

Losses are always recorded, but generally you don't worry about a gain when an exchange lax, commercial substance, you just record the new at the book value the old plus any cash paid, but I have to show you an exception to that as well. Let's do problem. Number two, they say in an exchange without commercial substance.

Yola and Xero exchange ownership of 25 forklifts Yola paid zero 30,000 to compensate for a difference in the value of the forklifts. On the date of the exchange here, they give us the cost and market value. Notice the forklifts have a cost to Yola of a hundred thousand and a market price of 120,000.

Xero's forklifts have a cost is out of 126,000 and a market value of 150,000. And remember zero also got 30,000 cash in Zara's income statement. What amount of gain would be reported from this exchange? Now you see why I answer a, is there a, is there because it's tempting to sit in the CPA Exam and say, well, they said the exchange lacks commercial substance.

It does not have commercial substance. So I ignore gains, but there's an exception unless this cash received and Xero did receive cashier cash received is considered to be a partial realization of the gain. So you've got to walk out, even though the exchange lacks commercial substance, you've got to watch out if this cash received because cash received is considered to be a partial realization of the gain.

Let me show you the entry that Xero would make Xero is going to debit cash 30,000. Zara will credit the old forklifts for their book value, the carrying value of 126,000, that never changes. But now we have to do a little side calculation. What is the game indicated for Xero here? What's our receiving Zara is, is receiving new forklifts with a fair value of 120,000.

Think what Xero is receiving Zara was receiving new forklifts with a fair value of 120,000, but that's not all. Xero is also receiving 30,000 cash. So the total market value of all the considerations hours receiving is one 20 plus 30, 150,000. Now what's the book value. What Zara is giving up 126,000, the book value of the old forklifts.

So there is a $24,000 gain indicated for Xero. Now you strike a ratio. You say since 30,000, over one 50, since 20% of the consideration. Xero is receiving is the form of, is in the form of cash. Again, since 30,000, over one 50, since 20% of the consideration that Zara was receiving is in the form of cash.

Xero does have to recognize 20% of that $24,000 gain indicated or 4,800. So Xero back to our entry would credit gain 4,800 cash received. It's considered to be a partial realization of the game. So because 20% of the considerations are, is receiving is in the form of cash. Xero does have to recognize 20% of that 24,000 old gain indicated.

So we're going to credit gain on the exchange 4,800. And notice Zara will debit the new forklifts. It's a plug for a hundred thousand 800. That would be the carrying value of the new forklifts, a hundred thousand 800. You really have to plug that in. So it's good to know the entry cause they could ask you that.

But here they said, what's the gain on the exchange. It's not a, it is B. Because even though the exchange is lacking in commercial substance, and normally when it's lacking commercial substance, you don't worry about gains. Unless this cash receipt cash received then would be considered to be a partial realization of the game, keep studying, and I'll look to see you in the next class.

Welcome back in this FAR CPA Review class. We're going to look at how they could test fixed assets with a simulation and hopefully. You've already done this simulation before coming to this class. If not, you should shut the class down. Do the simulation first, get all your answers before we go through it together. You always learn much more.

That way. Let's take a look at this. They say during 2012, Sloan began a project to construct new corporate headquarters Sloan purchase land with an existing building, the 750,000. The land was valued at 700,000 building was valued at 50 Sloan planned to demolish the old building construct a new office building on the site for each item one through six, we have to select whether it would be L classified as land.

Don't appreciate B classifies building and depreciate or E expense. Number one, the purchase of the land for 700,000 will clearly we purchase the purchase price of the land would be classified as land. Land is not depreciated. That would be letter L of course, number two, interest of 147,000 on construction financing incurred after the completion on the construction.

Well, towards what they're referring to here is capitalized interest. Should we capitalize? The 147,000 to the building will remember. We capitalize interest during the period of construction. That's the requirement that we always capitalize interest during the period of construction. Notice this interest incurred after completion on the construction.

So it would be E expense. It was after the construction three interest of 186,000. On construction financing paid during the construction. You capitalize that to the building that's letter B. We capitalize interest during the period of construction for any asset that a corporation is constructing for its own use, not just buildings, any asset that the company is constructing for its own use, but that would be capitalized to the building account letter B.

How about the purchase of the building? For 50,000 that's clearly be right? No, no. That building was on the site. Our plan is to destroy the old building, construct a new one. And remember we're supposed to capitalize to fixed assets, all the costs we incur to bring an asset into a condition and location for use and destroying this old building.

This $50,000 building is a cost we're incurring to get the land in a condition for use that's letter L because destroying that old building is a cost. We incur to get the land in a condition for use that's capitalized to land, not to let her L okay. How about number five? The 18,500 payment of delinquent real estate tax assumed by Sloan.

On the purchase that would go to land also because we capitalize all the costs we incur to get that land in a condition for use all the costs we incur to get an asset into a condition or location for use that would go to land as well. The $12,000 liability insurance premium during the construction period.

Number six, what do we do with that? Well, isn't that a cost we're incurring to get the building in a condition for use that's liability insurance during the construction period. Hey, that's a cost that we've incurred to get the building in a condition for use that would go to be the building. And we would appreciate it.

How about number seven, the 65,000 costs of raising the existing building while the cost of destroying the old building. The cost of destroying that old building is a cost. We incurred to get the land in a condition for use. So buying that old building that we're not going to use destroying the old building that we're not going to use.

These are costs we had to incur to get the land in a condition for use that would go to the land account. And of course the moving expenses number eight would just be expense letter E in the next section. Items nine through 14, represent expenditures, vice loan, forgiveness for goods held for resale and for equipment, we've got to decide for each expense.

Do we capitalize it or just expensive? How about freight charges paid for goods held for resale? Well, remember for inventory, we capitalize to inventory all the costs we incur to get the inventory in a condition and location for sale. Right. We capitalized the inventory, all the costs we incur to get that inventory into a condition and location for sale.

So freight in transportation in would be C capitalized to the inventory account. It's a cost we incurred to get the inventory in a condition and location for sale. Same thing with number 10 in transit insurance. That's a cost we incurred. To get the inventory in a condition and location for sale. We'd capitalize that to the inventory account.

Let her see how bout 11 interest on a note payable for goods held for resale that's expensive. We don't capitalize interest on inventory. No, we capitalize interest for any asset we're constructing for our own use. Interest incurred during the period of construction in an asset we're constructing for our own use.

We don't capitalize interest to the inventory account. Number 12 installation costs on the equipment that would be capitalized to the equipment account because for equipment, we capitalize all the costs we incur to get the fixed asset in a condition and location for use. So the installation charges would be capitalized to the equipment account.

The next one, number 13 testing. If there's a testing period that's C capitalized to the equipment account and then 14, the cost of a current year service contract on equipment. While the service year contract that's expensed, let her eat. And then finally in this simulation. Items 15 to 18. We have to do some depreciation calculations.

They say on January 2nd, 2012, Sloan purchased a manufacturing machine for 864,000 machine has an eight year life, 144,000 salvage value and Sloan expects to manufacture 1,800,000 units over the life of the machine.

Calculate depreciation expense for 2013, under these four approaches, let's start with straight line, you know, straight line. You thought I'm going to count. If I'm going to calculate depreciation and a straight line for this machine, I'm going to take the cost 864,000. Of course, I'd back out the salvage straight-line consider salvage.

So take off the salvage of 144,000. So that's 720,000 and I divide by eight straight line years, the estimate of useful life. And what I'll do in straight line is take $90,000 depreciation every year for eight years. So what's the depreciation expense for 2013 on a straight line. Of course, the answer 90,000 number 16.

How about double declining balance while never double declining balance is literally. What it tells you it is it's double the straight line rate times and ever declining balance. What's the straight line rate. Well, if it's an eight year life, then each year I'm going to depreciate one eight or 12.5% and double the current balance.

I would double that to two eights or 25%. It's double the straight line rate. All right. So in 2012, I would have taken double the straight line rate instead of one eighth, two eight, two eights. Or 25% times 864,000. This method, you don't back out the salvage. So it would just be 25% of 864,000. So in 2012, we would have taken $216,000 depreciation, but they don't want the depreciation for 2012.

They want the depreciation for 2013. What happens in 2013? Well, in 2013, it's still 25% double the straight line rate. But the balance has declined. Take the original cost of the machine. 864,000 minus the accumulated depreciation 216,000. Now the carrying value of the machine is 648,000 times 25%. So for 2013, we would take 162,000 of depreciation.

Twenty-five percent of 648,000 double the straight line rate times the balance has declined to 648,000. The answer would be 162,000 of depreciation for 2013, under double declining balance. Number 17. How about that? How many years digits? What I remember in some of the year's digits, what we do is add up the digits of the useful life.

This is an eight year life. So I would add up one plus two plus three plus four plus five plus six plus seven plus eight, which you have to put 36. Now you may remember from our classes. I hope you don't sit there and add up digits. Remember the shortcut and times and plus one over two. So the shortcut with adding them digits is take the useful life.

Eight times eight plus one eight times nine is 72. Over two is 36. It's quick. If it's 10 ten-year life, 10 times 11 is 110. Over two is 55. It's quick. All right. So eight times nine is 72. Over two is 36. We add up the digits of the useful life. Now what happens in 2012, we would have taken eight 30, six of what?

864,000 or 720,000. Do you back out salvage a lot of students aren't sure. Yes, you do. Some of these digits would back out salvage. So in 2012 it was, and we would take $160,000 depreciation, but they don't want it for 2012, 2013. What happens in 2013, in 2013, it would be seven 30, six of 720,000 or 140,000.

So the answer is 140,000. And then finally, number 18, the units of production approach. Well in the units of production approach, we would take the cost of the machine 864,000. Yes, we back out the salvage. So that's 720,000 and we divide by the 1,800,000 units. We estimate the machine will produce over its life.

And what you do in this approach is take 40 cents of depreciation for every unit produced this year. Do we know the units produced in 2013? Yes. It's given 300 and 300,000. So it's 40 cents a depreciation for every unit produced. They produced 300,000 units. In 2013, they would take $120,000 depreciation in 2013 in the units of production approach.

I hope you did well on that simulation, as I say, it's just one way they might hit fixed assets as a simulation. I'll look to see you next time. Welcome back in this FAR CPA Review course, we're going to begin our discussion of a very important topic, a very heavily tested topic. And that is how to account for bonds. And let me say right off the bat, that if there is a secret to bonds, it is knowing all the basic entries that you make with bonds.

Because what you're going to find is that if you know all the basic entries that you make with bonds, there isn't any bond question. You can't break down one way or another. In other words, no matter what sort of complications they throw at you one way or another all bond questions, come back to these basic entries.

So it's a good place to start. So what we're going to do in this FAR CPA Review course, we're going to go right to a problem. And I'm going to use this one problem to cover a lot of ground. Let's go to the viewer's guide. Look at the first problem. It says on January 2nd of the current year, West issued. What'd you circle the word issue.

I want you to notice right away that in this problem, we are on the issue side. As you're going to see with bonds, sometimes in the exam, you can have a problem on the issue side, sometimes in the exam, you've got to have a problem on the investment side. It's important to keep in mind. What side of the transaction you're on here?

We're on the issue side. West issued 9%. I circled that 9%. Listen, very carefully. There is an interest rate that is printed right on the face of the bond certificate. It's called the stated rate of interest that's printed right on the face of the bond certificate in the amount of 500,000. Let's stop right there.

If it's $500,000 worth of bonds. There must be 500 bonds because in the CPA exam, bonds are always in denominations of a thousand. In other words, one bond equals one, $1,000 debt. So we must be talking about 500, $1,000 bonds, which mature in 10 years. So the 10 year bonds, the bonds were issued. Notice at a discount, they sold $500,000 worth of bonds for 469,500.

A little discount. Why? Because they want the bonds to yield 10% notice they want the bonds to yield a little more than the stated rate. 10%. Now, listen, carefully get used to this idea when bonds sell at a discount, there's always effectively more interest. Remember that when you see a discount, you know, there's effectively more interest and remember for both sides.

Now, why am I saying for both sides? Because if I'm the issuing company, a discount means there's effectively more interest expense. If I'm the investor company, a discount means there's effectively more interest income, but at discount always means more interest to both sides. And I'll just say that that's the sort of thing.

If you can, if you can just get to the point where that's automatic, that anytime you see a discount, you know, there's more interest more than the stated rate. Effectively, there's more interest. If I'm the issuing company, there's effectively more interest expense. If I'm the investor company, there's effectively more interest income, but a discount always means more interest.

And that's the sort of thing. If you get that down, Pat, it'll help you. You can start eliminating answers. You have to, if the minute you see a discount, you know, there's more interest you work a lot faster. Let's read on. It says interest is paid annually. Notice on December 31 West uses the effective interest method.

To amortize the bond discount in the June 30th, current year balance sheet. What amount would West report for bonds payable? And I'd like you to circle the word report. And we'll talk about it in a little bit. All right. Now, as I say, what I want to go over with this problem are the basics entries that you make with bonds.

So let's go back to January 2nd. If I'm West, if I'm the issuing company, what entry did I make when I issued the bond? Well, if I'm West on January 2nd, you know, I'm going to debit cash for what I collected 469,500. But remember, I'm going to credit bonds payable, always for the face amount of the debt. I'm going to credit bonds payable for 500,000.

And there's an example of something that's never going to change. I don't care what they throw at you. The account bonds payable is always credited for the face amount of the debt. So I'm going to credit bonds payable, 500,000, and then to balance the entry out, I'm going to debit. Discount on bonds, 30,500.

Now that we have that entry down, that's the entry that Westwood have made back on January 2nd. When West issue the bonds. Now that we have that entry, I want to talk about some terminology. We both know that the face amount of the bonds is 500,000. That's the debt on its face. If you had the certificates on the face, it adds up to $500,000 worth of debt.

But the critical question in the CPA Exam is as of January 2nd, what is the carrying value of the bonds? This is a very important definition. Remember, the carrying value of bonds is defined as the face amount, plus any unamortized premium or minus any unamortized discount. I'll say that again, the carrying value of bonds is defined as the face amount.

Plus any unamortized premium it's plus any unamortized premium or minus any unamortized discount. So, can we agree if I use that definition as of January 2nd, the carrying value of the bonds would be the face amount, 500,000 minus the discount, 30,500. Let's agree that the carrying value of the bonds on January 2nd is 469,500.

And let me just quickly say that. Partly what caring value is all about is they want to make sure that you, as a student, understand how this debt is carried in the balance sheet. The point is this debt is not carried in the balance sheet as a liability of 500,000. No it's carried in the balance sheet as a liability of 469,500.

Why? Because in the balance sheet, the discount or premium is presented as part of the debt. It's part of the debt. So right now, this has carried on the balance sheet as a liability of 469,500. And as I say, that's partly what carrying value is driving hat. Now let's go back to this question. The bottom it says in the June 30th, current year balance sheet, at what amount would West report for bonds payable?

Well, a lot of students would go for answer D in other words, they sit in the CPA Exam and say, well, Bob said, bonds, payables, always at face value. I remember Bob said that like, it was an absolute bonds. Payables always had face. The answer is D all right. Now the why is it not D why doesn't that work? Well, let me say this.

It might make you feel better. D would be fine if they had asked what's the balance in the account. Bonds payable. Let me say that again. If they had asked what is the balance in the account? Bonds payable. No question. It's answer D they didn't ask that. What did they ask? Well, the word I had you circle was rapport.

They want to know how you report the debt. And remember debt is reported in the balance sheet at the face amount, 500,000 minus the discount, 30,500. So you're back to carrying value again. That's why that word is important. How is debt reported in the financial statements at the face plus any unamortized premium or minus any unamortized discount?

That word is important there. They want to know how it's reported. Now another point. These bonds were issued on January 2nd. When are we doing financial statements? June 30th, right? We're doing a balance sheet on June 30th, six months later. Let me ask you another question. Do these bonds pay interest annually or semi-annually or they set annually on December 31.

So, you know, a lot of students do a lot of students sit in the CPA Exam and say, well, the bonds pay interest annually on December 31. But we're doing a balance sheet six months later on June 30th. If we're doing a balance sheet, six months later, interest is paid annually. There hasn't been any interest adjustments yet.

So why isn't the answer? A why isn't the debt still reported at the face 500,000 minus the discount? 30,500. Why isn't it still as of June 30th reported as a liability of 469,500. There hasn't been any interest adjustments, interest is paid annually. You know why that doesn't work, that doesn't work because it doesn't matter how they pay the interest on June 30th, you'd make your recruit rules.

So don't forget that. So it can't be answered. DIA, can't be answer a, because again, it doesn't matter how they pay the interest annually on June 30th, we'd have to make our cruelty. So what we're going to get into now are interested adjustments and. I want to start with straight line amortization of the discount.

I know they said that West is using the effective interest method to amortize the discount. But I want to show you a straight line. So let's assume now it's June 30th of the current year, but now let's assume it's straight line amortization of the discount for you. Any time you have to make an interest adjustment with a bond.

I think you should always start. With an absolute something that the CPA Exam can't play around with it. You know what that is? The actual interest check. They send out the actual interest check they send out is always calculated the same way. There's no way the FAR CPA Exam can play around with it. So let's get the formula down.

Remember the actual interest check that is sent out is always based on the stated rate of interest printed on the bond. Times face value. Remember that formula stated, time-space stated, time-space stated times face. That'll always get you the check they send out. So let's work it out. I'm going to take the stated rate printed on the bond, which is 9%.

But for six months, remember it's June 30th. It's going to be four and a half percent times face value, 500,000. They're going to credit interest payable. 22,500. Why don't I credit cash that's right, because it's not paid till year end, December 31. I'm a June 30th making my accruals. Now make no mistake.

Make no mistake about this. If you credit cash, you get the same answer, but you never know what the CPA Exam is going to test. And it's actually a credit to interest payable. 22,500 interest check is always stated rate 9%, but for six months, Would be four and a half percent times face value, 500,000. That gives me the check.

They send out, we're going to credit interest payable, 22,500. Now, if I'm going to use straight line amortization of the discount, how do I look at it? Well, don't I know these a 10 year bonds don't they mature in 10 years. Isn't that 26 month periods. So in straight line, I would take that $30,500 discount divided by 26 month period.

And I would credit discount 1005, 25. I would take $1,525 of discount amortization. And I would have an interest expense, 24,825. That's the adjustment that I would make now a nice thing about straight line. What you're going to love about straight line is that we're going to make the same interest adjustment every six months like clockwork for the next 10 years, you got to love that about straight line.

That's what happens with straight line? You make the same interest adjustment like clockwork every six months for the next 10 years. Same entry again and again, and again now, obviously we're not going to do all those entries, just busy work, but that's what you would do with straight line. Make the same adjustment every six months for the next 10 years.

Now another point very important. Remember this? Amortization of a discount, always increases carrying value. Remember amortization of a discount always increases carrying value on both sides, whether you're the issuing company or the investor company will look at the investor company later. But whether you're the issuing company or the investor company, amortization of a discount always increases carrying value on both sides.

So if you look back at this entry, Because I credit a discount 1005 25, because I took $1,525 of discount. Amortization carrying value would rise by 1005 25. So what's just happened. Carrying value has gone from the old carrying value, four 69, five up 1005 25 to answer. See, I think if I were you, I would write next to answer.

Say straight line. If, if this had been straight line, the answer would be C. But of course we're not doing straight line, but if they want a straight line, the answer would be C. Now the debt is reported on June 30th as a liability, a 470,000, excuse me, 471,000. Oh 25. If it's straight line. And as I say, the great thing with straight line is you make the same adjustment every six months for the next 10 years.

So think about this. If amortization of a discount always increases carrying value. Won't carrying value. Go up 1005, 25 every six months. I make the same adjustment every six months for the next 10 years. So 10 years from now, when the bonds mature, what's the carrying value of the debt 500,000. What's the last entry.

The issuing company makes debit bonds payable, 500,000 credit cash, 500,000. Remember it's a debt. At maturity, you've got to pay off the face amount of the debt. I don't care whether you sell bonds at a discount or a premium at maturity, you've got to pay off the face amount of the debt. So that's what happens.

Carrying value keeps rising 1005, 25, every six months. So 10 years from now, when the bonds mature, the carrying value of the debt is 500,000. And the last entry of the issuing company makes, is debit bonds payable, 500,000 credit cash, 500,000. And that's the whole cycle. That's straight line. Now, as you know, In this problem, they're not using straight line.

They're using the effective interest method of amortization. So let's go to the effect of interest method of amortization. Before we do calculations, I want to make a point. I want you to know before we begin that the CPA exam has more questions about the effective interest method of amortization than any other single thing about bonds.

It's not all they ask, but you've got to know how important this is. The CPA exam has more questions on the effective interest method of amortization than any other single thing about bonds. So you have to get this down really well. So let me start by asking you a question. When you see the effect of interest method of amortization, would that have any effect on the entry that was made back on January 2nd?

No. So you might just wanna put in your notes, Andrea, on January 2nd, same, no effect on that entry on January 2nd would be identical. All that's affected. When you see the effect of interest method, our interest calculations. So now let's go to June 30th of the current year. Let's make our interest adjustment, but now let's assume it is the effective interest method of amortization.

And I have another note for you. You've got to remember this formula, just remember this under the effective interest method of amortization, the way you calculate your interest is you multiply. The effective yield of the bond, not the stated rate, the effect of yield of the bond times carrying value. And this is why carrying value is so critical because to calculate your interest.

Now, I've got to take the effect of yield of the bond of the stated rate times, carrying value, not face value. All right. So let's work it out. When I get to June 30th of the current year, how do I figure out my interest expense? I'm going to take the effect of yield of the bond, which is 10%, but for six months would be 5% times carrying value for 69 five.

I'm going to debit interest expense 20 3004 75. How about the interest check? That's not affected the interest check I send out is stated time-space. So I'm still going to credit interest payable for. The stated rate printed on the bond 9%, but for six months would be four and a half percent. Time-space 500,000.

I'm still going to credit interest payable, 22,500. Now, while we're looking at this entry, do you see why the CPA Exam loves to test this so much? Because that's what you have to keep straight. The interest expense is the effect of yield of the bond 10%. But for six months would be 5% times carrying value four 69, five, but that has no effect at all on the check that goes out interest check that goes out of state at times face the state of rate, which is 9%, but for six months would be four and a half percent times.

Phase 500,000 interest payable is still 20, 25. Now the entry doesn't balance. I need a credit of $975 to balance the entry out. That's the amortization of the discount for the first six months. And there's no other way to get it. It's a plug. It's the difference between the expense and the interest check.

It's why entries help you a lot, because so often than the exam, they want the amortization for the year and then the effect of interest method. That amortization is a plug. It's the difference between the expense and the interest check. And there's no other way to get that. All right. So what's happening to carrying value.

Don't we know. That amortization of a discount always increases carrying value. So carrying value has gone from four 69, five up nine 75 to answer B the answer is B. All right, now let's go ahead. Another six months. What happens on December 31 same entry? No. Think, think it through with me when you get to December 31, will the effective yield still be 10%.

Yes, that's not going to change. As you go from payment to payment to payment, the effect of yield is not going to change. That's a one-time determination and it's not going to change over the life of the bonds. What does change carrying value because of our adjustment back on June 30th. Now the carrying value is answer B four hundred and seventy thousand five hundred and seventy thousand four 75 times 5%.

We're going to debit interest expense 20 3005, 24. But as you know, that has no bearing on the check that goes out the interest check that goes out as stated times face. So I'm going to take the state rate printed on the bond, which is 9%, but for six months would be four and a half percent. Time-space 500,000.

We're going to credit interest payable. 22,500 interest checks not affected entry doesn't balance. Does it? I need a credit of 1,024, one Oh two for the balance of the entry out. That's the amortization for the last six months. So credit discount, 1,824. There's no other way to get that number. It's the difference between the expense and the interest check, which is why entries help you a lot.

Now stay with me. I hope you understand that if they had asked me what's the amortization of the discount for the year, I would have no choice. But to put both entries down, add up nine 75 plus 1,024. And there's no other way in the universe to get that answer. I'll say it again. If they had asked me for the amortization for the year, I would have no choice, but to put both entries down, add up nine 75 plus 1,024.

And there's not another way to get that answer. You've got to know the effective interest method of amortization. All right now, right now, what's the balance and interest payable, 45,000. So on December 31, we send out the interest check for six months, excuse me. We sent out the interest check for the year it's paid annually.

So we will debit interest payable, 45,000 and credit cash, 45,000. Make sure you're comfortable with the effective interest method of amortization. And we will do more. With the effective interest method of amortization in our next class, we'll continue with our discussion on bonds and you haven't seen the end of the effective interest method yet.

I looked to see you then

welcome back in this FAR CPA Review course. We're going to continue our discussion on how to account for bonds. And you remember, in our last class, we talked about how to do interest calculations on a bond. Under straight line under the effect of interest method. Let's go back to that, but now let's make it a premium. If you look at the first problem, it says on may one year, two bolt issued again, notice, run the issue side.

As I said, in our last class with bonds in the CPA exam, you could have a problem on the issue side. You can have a problem on the investment side. You have to notice that we're on the issue side, the issue 11% notice that that's the rate printed on the bonds. That's the stated rate. The issue of 11% bonds in the face amount of a million let's stop right there.

There must be a thousand bonds because in the exam, bonds are always in denominations of a thousand. So if it's a million dollars worth of debt, it must be a thousand $1,000 bonds. They mature on may one year 12. Notice that 10 year bonds, they go from may one year two to may, one year 12, the 10 year bonds, the bonds were issued to yield 10% notice they want the bonds.

To yield a little less than the stated rate, 10% resulting in a bond premium of 62,000. Here's what I want you to remember when bonds sell at a premium there's effectively less interest for both sides, less than the stated rate. That's always what a premium means for both sides, less interest. I say both sides because if I'm the issuing company, a premium means there's effectively less interest expense.

If I'm the investor company, a premium means there's effectively less interest in gum, but a premium always means less interest for both sides, less than the stated rate bolt uses the effective interest method to amortize. The bond premium interest is paid semi-annually on November one and may one.

Notice we're doing a balance sheet, October 31 year two in the October 31 year two balance sheet. What is the unamortized bond premium? Let's do some entries. Let's go back to may one year two, if I'm bold. And I issue these bonds, you know, I'm going to debit cash for what I collect 1,000,060 2000. I'm going to credit bonds payable, always for the face amount of the debt, a million, and I'm going to credit premium on bonds.

62,000. That's the entry bolt would have made when bolt issued the debt. Now, while we are looking at that entry, let's go back to terminology. As of may one year two, what's the face amount of the debt, a million what's the carrying value of the debt. It's defined as the face amount, a million plus plus any unamortized premium 62,000.

Let's agree that as of may, one year to the carrying value of the bonds, Is 1,000,060 2000. And I remind you that what really, what that's about is to make sure that a student understands how the debt is carried in the financial statements. And that's the point. This debt is not carried in the financial statements as a liability of a million.

No, it's carried on the balance sheet as a liability of 1,000,060 2000, because remember discount or premium is presented in the balance sheet as part of the debt, let's do interest calculations. We're doing a balance sheet on October 31 year two, let's start with straight line amortization of the premium.

As I said, in our last class, when you go to make an interest adjustment on a bond. I think it's good to start with something they can't change. And that is the check that goes out. The actual interest check they send out is always stated time-space every time. So I'm going to take the state of rate printed on the bond 11%, but for six months would be five and a half percent.

Time-space a million. We know the interest check is going to be 55,000. What do I credit interest payable? 55,000 not cash because it's not paid till tomorrow morning, November one. We're on October 31 making our accruals. So we would credit interest payable, 55,000. That's the, that's the check that goes out.

It's always stated times face. Now, if this is straight line amortization of the premium, why do we know? We know these are 10 year bonds. They go from a one year two to may, one year 12, isn't that 26 month periods. So in straight line, I would take that $62,000 premium divided by 26 month periods. And I would debit premium 3,100.

I would take $3,100 of premium amortization. And I would debit interest expense 51,900. And as we said in our last class, which you've got to love about straight line is you're going to make the same adjustment every six months like clockwork for the next 10 years. Now what's happening to carrying value.

Remember. Amortization of a premium, always decreases carrying value on both sides. We'll look at the investor side later, but I want you to remember that amortization of a premium always decreases carrying value on both sides. And when, if you just memorize that you worked so much faster, amortization or premium just keeps decreasing carrying value.

So think about it. What's happened to this premium. They asked him this question. In the October 31 year two balance sheet, what is unamortized premium? Well, the premium just went from 62,000 down 3,100 to answer C you might just want to write next to answer C straight line. If this had been straight line now on amortized premium would be 58,900 answers.

See, but as I say, amortization of a premium always decreases. The carrying value of the debt. So think about that for a minute. If I'm going to make the same interest adjustment every six months for the next 10 years, Karen value is going to keep going down 30 (130) 100-3100. So 10 years from now, when the bonds mature, what's the carrying value of the debt.

What's the carrying value of the bonds, a million, and what's the last entry. The issuing company makes, you know, debit, bonds payable, a million credit cash, a million it's a debt. It's a debt security. At maturity, you've got to pay back the face amount of the debt. I don't care whether you sell bonds at a discount or premium at maturity, you've got to pay off the face amount of the debt.

So we would debit bonds, payable, a million credit cash, a million that's the whole cycle. All right. Now in this problem, they're not using straight line. They using the effective interest method of amortization. Let me start with the question. Would the effect of interest method of amortization have any bearing on the entry that we made back on may one year two?

No. Just remember the entry on may one year two, when they issued the bonds would still be the same. All that's impacted by this are interest calculations. So let's do it. It's October 31 year two. Now it is the effective interest method of amortization. While remember under the effect of interest method to calculate your interest, you multiply the effect of yield of the bond.

Not the stated rate, the effect of yield, which is 10%, but for six months would be 5% times carrying value, 1,000,060 2000. We're going to debit interest expense, 53,100. That's the effective yield of the bond 10%. But for six months would be 5% times carrying value, 1,000,060 2000. We're going to debit interest expense for 53,100.

But as you know, that has no bearing on the check that goes out. Interest check that goes out of state of time-space stated rate 11%, but for six months would be five and a half percent times face a million was still going to credit interest payable, 55,000, the entry doesn't balance. I need a debit of 1900 to balance the entry out.

What is that? That is the amortization of the premium for the first six months. So I debit premium 1900 and it's a plug. It's the difference between the expense and the interest check. That's why entries help you so much. Because if they want that amortization get the entry down. So when they asked me in this problem in the October 31 year, two balance sheet, what is the unamortized bond premium?

Well, it was 62,000. It's gone down 1900 to answer B we've answered the question. Let's go to the investment side. Let's go to the second problem. It says on July one year six Fox purchased, you might want to circle the word purchase notice. Now we're on the investment side with bonds. You could be on the issue side.

You could be on the investment side. Fox purchased 400 of the thousand dollar face amount of 8% bonds of day corporation. So notice that 8%. That's the stated rate. That's printed right on the bonds and notice that if you're Fox, you bought $400,000 worth of bonds at a discount. You purchase those bonds for three 69, to why?

Because you want them to yield a little bit more. You want them to yield 10%. Remember we sat in our last class when bonds sell at a discount, there's effectively more interest for both sides, always more effectively than the stated rate. If I'm the issuing company, there's effectively more interest expense.

If I'm the investor company, there's effectively more interest income, but when you see a discount, you know, there's effectively more interest than the stated rate. The bonds mature July one year 11, the five-year bonds pay interest semi-annually on January one in July. One Fox uses the effective interest method of amortization.

The bonds are appropriately recorded as a long-term investment, the bonds would be reported on Fox's December 31 year six balance sheet at let's do a couple of entries. Let's go back to July one year six. If I'm Fox, if I'm the investor company, when I buy those bonds, I'm going to debit investment in bonds.

For what they cost me 369,200. And I'm going to credit cash 369,200. That's my entry on July one year six. When I invest in those bonds, I'm going to debit investment in bonds for 369,200. And I'm going to credit cash 369,200. Notice if you're the investor, you probably will not set up a separate discount account.

I wouldn't, I wouldn't do that. You know, some. College textbooks might take the time to do that. I think it just slows you down. In other words, the way the investor looks at it, they just record all investments at their costs. I wouldn't set up a separate discount account for the investor. You could, there's nothing wrong with it.

And as I say, some college textbooks would take the time to do that, but really the way to look at it, they just record all their investments. It costs. All right, now let's go to December 31 year six, and let's say it's straight line amortization of the discount. Start with straight line. Well, as always.

Let's start with the actual interest check that Fox has gone to collect. Remember, Fox is the invest or here. Well, to work out the actual interest check, they're going to collect that stated time space. So I'm going to take the stated rate printed on the bond, which is 8%, but for six months would be 4%.

Time-space 400,000. If I'm Fox, I'm going to debit interest receivable, 16,000. And again, I don't debit cash. It's not collected till tomorrow morning, January one. I'm at December 31 making my accruals. So I would debit interest receivable 16,000. Now, if this is straight line, how do I look at it? Well, even though the invest door does not set up a separate discount account, the discount is there.

There's a $30,800 discount here. The difference between phase 400,000 and what they paid three 69 too. There's a $30,800 discount here. And in straight line, I'm going to say, well, they're five-year bonds. They go from July one year six till July one year 11. If they're five-year bonds, that's 10, six month periods.

So I'm going to take that discount. 30,800 divided by 10, six month periods. I'm going to take three thousand eight hundred eighty three thousand eight hundred eighty of discount. Amortization. What do I debit? Well, there's no discount account. So I just debit investment in bonds. 3,880 and I credit interest income, 19,880.

And the great thing about it, straight line, you're going to make the same adjustment every six months for the next five years. And we, what else do we know? We know amortization of a discount always increases carrying value. So notice the carrying value of investment bonds keeps going up three thousand eight hundred eighty three thousand two hundred eighty every six months.

So five years from now, when the bonds mature, what's the last entry the investor makes. Debit cash. 400,000. They get their money back. Remember they are owed this money. So when the bonds mature, the investor will debit cash 400,000 credit investment bonds, 400,000. And that's the whole cycle notice. We're always advertising towards face.

So Karen value would just keep going up 3000, no hundred 80 every six months for the next five years. So five years from now, when the bonds mature carrying value of investment bonds is 400,000 last entry. The investor makes debit cash 400,000. They get their money back credit, investment bonds, 400,000.

That's the whole cycle. All right, now we know in this problem, we're not using the straight line method. We're using the effective interest method of amortization. Now, you know, when you see the effect of interest, method of amortization, that doesn't affect the entry. That was made on July one year six.

That entry is the same all that's affected our interest calculations. So let's go to December 31 year six. It's now the effective interest method of amortization. Well, you know, the interest check's not affected. If you're Fox, you're still going to debit interest receivable. For the stated rate printed on the bond 8%, but for six months would be 4%.

Time-space 400,000. You still going to debit interest receivable, 16,000. Infrastructure's not affected, but to work out the income you are end for that six months to work out the income you earn for that six months, you've got to take the effective yield of the bond. Which is 10%, but for six months would be 5% times carrying value, three 69 to you're going to credit interest income, 18,460.

That's the income you earn by taking the effect of yield of the bond, which is 10%. But for six months, we'll be 5% times carrying value, three 69 to you're going to credit interest income, 18,004 60 entry doesn't balance. Does it. I need a debit of 2004 60 to balance the entry out. That's the amortization for the six months.

There is no discount account. So just debit investment in bonds, 2004 60. So when they ask us in the October 31 year, two balance sheet, what amount would, what amount,

excuse me. In the December 31 year six balance sheet, the bonds would be reported on Fox's balance sheet and how much? Well, the investment bonds was at three 69, too. And it's gone up 2000 for 60 amortization of a discount, always increases Gehring value on both sides. So Karen value's has gone up 2004 60 to answer C three 71, six 60.

The answer is C. Now the investment bonds is on Fox's balance sheet at three 71, six 60. Cause Karen value has gone up 2000 for 60. And remember that amortization is a plug. It's the difference between. The interest check and the income you weren't, it's a plug really no other way to get it, which is why entries helped you so much.

Now, another point I should mention, remember that we have said in another class that held to maturity securities must be accounted for at amortized costs. When they said that Fox appropriately recorded this investment as a long-term investment. Presumably they mean held to maturity. I think they should specify, but it means held to maturity.

Remember held to maturity investments must be accounted for under amortized costs. Just so you know, this is amortized cost notice there's the straight line approach to amortize costs. There's the effective interest approach to amortize cost held maturity investments must be accountable under amortized costs.

That's what we're applying here. This is amortized costs. There's the straight line approach to amortized costs. There's the effect of interest approach to amortize cost. All right. Now, if you look in your viewers guide, there are three more questions here that have to be done. Questions three, four, and five.

I want you to get those questions done before you come to the next class. It's very important. Do these three questions before you come to the next class and I'll look to see you then.

Yeah, welcome back. Now you remember that in our last class, I asked you to do three questions before coming to this class and let's start by going through those three questions in the first question. Webb, I want you to think about a couple of things as you begin the question, what is the face amount of the debt?

A hundred thousand. When you begin, what's the carrying value of the debt? 105,000. What's the stated rate of interest printed on the bonds. 7%. What's the effect of yield six. The point I'm making is this, that once you get comfortable with bonds, and I know you might not be there yet, but when you, when you study this and get more comfortable with bonds, somebody who has studied bonds, they have all those concepts sorted out.

When they look at the question. They're in the exam. They look at this question, they go, Oh, I see the face amount of the debt is a hundred thousand caring values. One Oh five, the state of rate printed on the bonds 7%. But the effect of yield is six. All those concepts have sorted out. And once again, what is being tested here is the effective interest method of amortization.

Now the carrying value back on June 30th, year two was 105,000. They want to know the unamortized premium, June 30th, year three. So to solve this, you had to think about the adjusting entry that you'd make for interest June 30th, year three. Well, let's work it out. We know under the effective interest method, the way you calculate your interest expense for that year is by taking the effective yield of the bonds.

6% times carrying value, 105,000. You're going to debit interest expense 6,300. But as you know, that has no bearing on the check that goes out. The actual interest check that goes out is stated times face. So to figure out the interest check, I take the stated rate, which is 7% times face amount, a hundred thousand.

The interest check here is 7,000 and you could credit cash 7,000. It is paid. The point is the entry doesn't balance. I need a $700 debit to balance the entry out. Debit premium seven debit premium 700. That's the amortization of the premium for that yearly period. So when they ask us at the bottom, what is the unamortized premium in the June 30th year three balance sheet?

Well, it was 5,000 because face amount of the debt was a hundred thousand carrying value was 105,000 a year ago. So we know that a year ago, the unamortized premium was 5,000. It's gone down 700 to answer C 4,300. In the next question, they want to know how would amortization of a discount affect two things?

How would it, how would it affect the carrying amount of the bond and how would it affect net income? Now I have a question for you here. You're in the exam. You have this question. My question is in this question, are we on the issue side? Are we on the investor side? Or can't tell, I want you to think about that for a minute in this little innocent looking question.

Are we on the issue side, the investor side, or no way to know definitely the issue side. How do I know that says bonds payable the liability. They said, how would amortization but discount on bonds payable? So it's the liability run the issue side. That's where we are here. Now, this question really refers to two concepts that we went over in our first class on this, and just see if they ring a bell first.

What does amortization of a discount always do? The carrying value increase, always increase, right? Amortization of a discount always increases carrying value. Now another point, remember, we sat in our first class that if a bond sells at a discount, There's effectively more interest for both sides. That's what it is.

Count always means effectively more than the stated rate. So think about it if on the issue side, and I know I am, because it says bonds payable, a discount means there's effectively more interest what expense. And if the expense is more, the income is decreased and the answer is a. I discount always means effectively more interest.

And if on the issue side, and I know I am, cause it says bonds payable, there's effectively more interest expense. And if the expenses are more, the income has decreased and that gets you to answer a, you've got to think it through. Step-by-step stay on this question a second. Let's make it the investor side.

Same answer. Isn't it. If I make it, the investor is not the same answer. You know, Bob, I don't trust you as far as I can throw you. Well let's work. Let's work it out. If I'm the investor, what does amortization of a discount do to carrying value? Is it still increased? Yes. If I'm the investor, amortization of a discount still increases carrying value, but if I'm the investor, a discount means there's effectively more interest income.

And the answer is B you might want to just put your own study right next to B investor. See that's where this comes down to. It's a, if it's the issuer B, if it's the investor, you gotta be careful in that exam to know what side you're on. Let me ask you this. When somebody had this question in the CPA exam, there was one word that was the big word.

They had a notice. What was it? Payable? It's a little subtle. Isn't it? Big thing you had a notice. There was bonds payable. So, you know, the side you're on. Cause the side you're on. If it's bonds payable, it's the liability. I'm on the issue side. Cause it affects my answer. Look at number three. Look at the next question.

Look at the next question. It is same idea. How would amortization of a premium on bonds payable run the issue side here. It's the liability effect, the carrying value of the bond and effect net income. Well, how does amortization of a premium always affect carrying value? Decrease? Remember amortization of a premium, always decreases carrying value on both sides.

And you might remember that when a bond sells at a premium, there's effectively less interest for both sides, less than the stated rate. So if I'm the issuing side, and I know I am because it's bonds payable, a premium means there's effectively less interest expense. And if the expenses are less, the income is increased and the answer is D.

Now, if I make that investor side, right? Same question. If I make it the investor side, Hey, amortization of a premium still decreases carrying value. But if I'm the investor, a premium means there's effectively less interest in calm. And the answer is C when it comes down to see if it's the investor D if it's the issuer, be careful what side you're on key to this question is the word payable.

Because if you know, you're dealing with a liability, you know that you're on the issue side. So make sure you watch out for that. Now, I want you to imagine for a minute that I'm out in the marketplace and I'm selling a Monette company, 10% bond. Okay. I'm out, I'm out in the world and I'm trying to sell a Monette company, 10% bond.

That's my stated rate. That's printed right on the bond 10%. But when I get out in the world, I find that companies just like mine are paying 15% interest on their debt. That's the prevailing market rate of interest for debt like mine 15%. Well, you know, what's going to happen if I'm my stated rate is 10%.

But everybody else was paying 15%. Nobody's going to want my bond. So I'm going to have to drop the price. I'm going to have to sell it at a discount, but understand what happens. I'm going to have to drop my, the price of my bond. How far, exactly to the point, not a penny, more, not a penny, less with the effective yield of my bond would be 15%.

That's what I'm going to have to do. I'm going to have to discount my bond. So it yields exactly 15% the prevailing market rate of interest. You know, how, how do you do that? How do you figure out what the discount on a 10% bond should be? So the yield is exactly 15%, you know, let's say I'm out in the world and I have a Monette company, 10% bond.

And I find the companies just like mine are paying 5% interest on their debt. That's the prevailing market rate 5%. Well, now everybody wants my bond. So the price rises, I sell it at a premium. And the price of my bond is going to rise exactly to the point, not a penny, more, not a penny, less with the effective yield of my bond would be 5% the prevailing market rate of interest.

So here's what the CPA Exam gets into. How would you know how far to discount the price of a 10% bond? So it yields exactly 15% or my other example, how would you know how far to increase the price of a 10% bond? So the effect of yield is only 5%. How do you work out what the discount or premium should be?

What we're going to get into now is how the market price of a bond is determined how the market price of a bond is determined. Well, the answer is it's all done with present value tables, and I want to give you a little rule here, and I always tell my students, if you can just remember this rule, it'll take you through any problem on how the market price of bonds is determined.

Just remember the rule, the rule is use present value of a dollar table on the principal. Present value of an annuity table on the interest. Again, you want to use present value of a dollar table on the principle, present value of an annuity table on the interest. Let's go to a problem. You look at the next problem.

It says on January one year seven Dean company issue ten-year bonds with a face of a million and a stated interest rate of 8%. So that's printed on the bond. You're stuck with that. That's printed on the bonds. 8% stated rate payable per year. Semi-annually you might want to circle that word.

Semi-annually that's key word here on July one and January one, the bonds was sold to yield 10, so they want the bonds to yield a little more, 10%, a little more than the stated rate. They give us present value factors. And at the bottom it says, what is the total issue price of these bonds? All right. So I'm hoping my students are in the CPA Exam and they are at Bob said.

Use present value of a dollar table on the principle, right? That's the first part of my rule use present value of a dollar table on the principle. Now, assuming you knew my rule, they still tried to mess you up. Didn't they, if you look at it, they gave you two present value of dollar tables. They gave you present value of a dollar for 10 periods of 10%, which is 0.3, eight, six, and present value of a dollar 20 periods of 5%, which is three, seven, seven.

Which one are we going to use? You circle that three 77. We're going to use the three 77 now why I'm sure you see it, but just to make sure we're together. When I see that word semi-annually that's key word here. When I see the word semi-annually it means whatever I charge my investors for these bonds, they have to yield 5% every six months for 20 periods of six months.

Each not yield 10% for 10 annual periods. Again. When I see the word semi-annual it tells me that whatever I charge my investors for these bonds, they have to yield 5% every six months for 20 periods of six months. Each not yield 10% for 10 annual periods. What if they'd set annual, if they'd set annual I'd use three, eight, six, you might just want for your own studying right next to three eight, six, the word annual they'd said annual I'd use three, eight, six, but they said semi-annual saw I use three 77.

So here's my first calculation. I'm going to take the million dollars principal. Times 0.37, seven, that discounts to 377,000. Now I know from experience that the next part is the hardest part. What's the next part of my rule. Say you was present value of an annuity table on the interest. You know what you have to remember here.

The actual interest checks, they send out, represent an annuity. Because won't the interest checks be a series of equal periodic payments over a specified number of periods. That's what you have to get used to that the actual interest checks they're going to send out do represent an annuity because they were a series of equal periodic payments over a specified number of periods.

Now stop and think what's the interest check always based on stated time space. So let's work out the interest chap. I'm going to take the stated rate printed on the bond. 8%, but for six months would be 4% times face a million. Let's agree that if all goes according to plan, we're going to send out 40,000 of interest every six months for the next 10 years.

Isn't that a series of equal periodic payments over a specified number of periods. It's representing an annuity, those interest checks. Now, what factor do I need? 6.14 or five or 12.462. You circle that 12.4662. Because when I see that word semi-annual I want a semi-annual yield. So whatever I charge my investors for these bonds, they have to yield 5% every six months for 20 periods of six months eats six months each.

And let me just say, if they'd set annual, it would be 6.14 or five. So you might want to just in your, for your own studying right next to 6.1, four or five, the word annual, but here at semi-annual. So I'm going to take that annuity 40,000. The interest checks represent an annuity times 12.462, that discounts the four 98, four 80.

Add it up, add up 377,000 plus four 98, 480. These bonds would sell for eight 75, four 80. And the answer is a, you have to know how to do that. Let me show you the same thing without numbers. Just a theoretical question. Look at the next question. The market price of a bond issued at a discount is the present value of the principal amount at the market rate of interest.

Let me just, let me have you think of this. Is it going to be plus or less? Present value of interest. They said the market price of a bond issued at a discount is the present value. The principal, is it going to be plus or less present value of interest it's plus it's not less. You remember the basic, the cap, the basic formula is present value principle plus present by vendor.

It's not less, so it can't be a or B, but here's what you got to think about is this C plus the present value of interest payments at the market rate of interest or D. Plus the present value of interest payments at the rate stated on the bond, it is C it's plus the present value of interest payments at the market rate of interest.

Do you see what they're being? What they're, what they're getting at here? Yes. I need the rates stated on the bond to figure out equal payments. I need the rates stated on the bond to work out the annuity, the 40,000, but I'm going to discount both that principle and the interest at whatever I want it to yield, which is the market rate of interest.

I can't sell my bond. If it doesn't yield the market rate of interest, people won't buy my bond. If it doesn't yield the market rate of interest. So that's what they're getting at there. Yeah. I need the rates stated on the bond to figure out the annuity, the equal payments to 40,000, but I'm going to discount both the principal and those equal payments at whatever I want it to yield, which is the market rate of interest.

That's what I want my bond to yield the market rate of interest, because if my bond does not yield the market rate of interest, people won't buy my bond. The answer is C. Now that was a discount, right? What if I make it a premium same answer? Yes. It doesn't matter here. It wouldn't matter whether it's discount or premium.

This is always how the market price of a bond is determined. Its present value of a dollar table on the principal, present value of an annuity table on the interest at whatever you want the bond to yield. If you want the bond to yield more than the stated rate. It's going to be a discount. If you want the bond to yield less than the stated rate is going to be a premium, but that's always how the market price of a bond is determined.

Its present value of a dollar table and the principle plus present value of an annuity table on the interest at whatever you want the bond to yield. If I want the bond to yield more than the state of rate's going to be a discount. If I want it, the bond to yield less than the state of rate, it's going to be a premium.

Let's look at the next question. The following information pertains to camps, issuance of bonds. July one year one, the total face amount of the debt, 800,000, the ten-year bonds, the stated rate printed on the bond. 6% interest is paid annually and they want the bonds to yield 9% and they say, what is the issue?

Price notice? What is the issue price for each thousand dollar bond? Now this problem is a little different. In the sense that they want us to work out the market price of each individual bond, but let's agree. I don't care if they want the market price of each individual bond or the market price of a whole bond issue.

It comes back to the same thing. It's present value of a dollar table on the principal, present value of an annuity table on the interest at whatever you want the bonds to yield. So let's work it out. The principal amount here is 800,000. Now the stated rate is 6%. I want it to yield nines. Let's get the factor.

I want present value of a dollar 10 periods at 9%. The factor is 0.4 to two. And again, here it is annual interest. So I want a present value of a dollar 10 periods at 9% 0.4, two two. So I'm going to take the $800,000 a principal times 0.422, that discounts to 337,600, 337,600. Now I still say the next part of my rule seems to bother some students.

What's the next part of my rule, say, use present value of an annuity table on the interest, which you have to get used to is that the actual interest checks they're going to send out do represent an annuity because they are, they are a series of equal periodic payments over a specified number of periods.

So, you know, this what's the, what's the interest check always based on state of time-space. So I'm going to take the stated rate printed on the bonds. 6% times the phase 800,000. Can we agree if all goes according to plan? Aren't we going to send out 48,000 of interest every year for the next 10 years.

Isn't that a series of equal periodic payments over a specified number of periods that represents an annuity. Let's get our factor. I want present value of an annuity, 10 periods at 9%. What I want it to yield 6.418. I'm going to take that factor. 6.418 times equal payments 48,000. That discounts to three Oh eight Oh 64.

308,000. Oh 64. Now, if you add up the present value of the principle 337,600, plus the present value of interest 308,864, it adds up to 645,664. These bonds you're going to sell $800,000 worth of bonds for $645,664. Cause you want them to yield 9%. Now they want the market price for each bond. So let's work that out.

That's just taking the $645,664. You're going to sell the bond issue. Four divide by how many bonds? 800. There must be 800 bonds, $801,000 bonds. If you divide by 800 bonds, each bond would sell for eight Oh seven Oh eight, $807 and 8 cents. The answer is C. You have to know how to do those. Keep studying.

I'll look to see you in the next class and we'll do more with bonds. See you then.

Yeah, welcome back in this FAR CPA Review course. We're going to do a simulation on bonds. Let's take a look at it. It says on January 2nd, 2011, North company issued bonds payable with a face amount of 480,000 at a discount. So, you know, the face amount of the debt for an 80,000 and the bonds were sold at a discount. We don't know what the discount was.

The bonds are due in 10 years, interest is paid semi-annually on June 30th and December 31 on June 30th, 2011. And on December 31, 2011 North made the semi-annual interest payments recorded the interest expense and the amortization on the bond discount. We have to fill in one through seven. We're given a schedule.

We have seven boxes that we have to fill in. From this list of possible answers. So where do we start? Well, notice that the first box we have to fill in, it's not the first question, but the first box they're asking, what would be the carrying value? The carrying amount January 2nd, at the very beginning, when they issue the bonds, we know the face amount was 480,000.

What was the carrying amount? Well, did you notice this? You'll get the next line down on June 30th when they made the first interest payment. We know they debit interest expense 18,000. That's given we know they took 3,600 of amortization on the discount. We know it's a discount, so let's go back to our class on this belt.

We know that amortization of a discount always increases carrying value. So with that amortization carrying value. Notice what up to the new carrying value of three 63, six. So think about it. If we took $3,600 of amortization on the discount and now carrying value is three 63, six, and we know amortization of a discount always increases carrying value than the carrying value.

Back on January 2nd, must've been 360,000, so we can fill in our first, our first box. The answer. Number three is 360,000 because amortization of the discount increases the carrying value. We took 3,600 of amortization on the discount on June 30th and now the new carrying value was three 63, three 63 six.

So back on January 2nd, carrying value had to be 3,600 less 360,000. Now let's reconstruct this. Now we can figure out what the original entry would have been to issue the bonds. Don't we know the face amount of the bonds was 480,000. So don't, we know they would have credited bonds payable, 480,000. We know they would have debited the discount for 120,000 because we know the carrying value back on January 2nd was 360,000.

And how do we define carrying value? The face amount of the bonds minus any unamortized discount or plus any unamortized premium? That's the definition of caring value, the face amount of the debt minus any unamortized discount or plus any unamortized premium here, we're dealing with a discount. So if they credited bonds payable, 480,000, the face amount of the debt, they must have debit a discount, 120,000, because we know from answering question number three, that box, the carrying value is 360,000.

When they issued the bonds back on January 2nd. So they must have debit and cash to finish the entry for 360,000. That's the entry they must've made when they issued the bonds. Now let's go down to the next line on June 30th, we know they debit interest expense, 18,000. Let's reconstruct the entry on June 30th.

They would have debit interest expense, 18,000. That's given. We know they would have credited the discount for the amortization 3,600 it's given. And we'll just plug this in. They must've credited cash 14,400. You can just plug that in or not. Look at your plug it in. Notice the cash payment on December 31 was 14 four.

Well then the cash payment on June 30th has to be 14, four. That's always the same interest check is always the same. Every June 30th, every December 31, like clockwork. So you could have done it that way also, but that's the entry they must've made record interest on June 30th, debit interest expense, 18,000 given credit discount, 3,600 given.

And then we plugged our credit to cash 14, four, which would have been the same credit to cash that we've already been given on December 31, credit to cash is always the same. So now we can answer question number two, the cash payment, June 30th, 14,400. And can't we answer question number one now. What's the  discount.

Well, we know from reconstructing the original entry, when they credited bonds payable, debit and cash, 360,000, they dividend on the amortized discount, 120,000. The unamortized discount started at 120,000 since they took 3,600 of amortization. That discount has gone down from 120,000, down 3,600. Cause the amortization now the unamortized discount.

Is 116,400. So that answers question number one, 116,400. That's the unimmunized discount. After the 3,600 of amortization discounts gone from 120,000 down 3,600 to one 16 four. Can we figure out now question number four, the state rate on the bonds. What's the stated rate printed on the bond? Well, don't we know that the stated rate printed on the bonds times face.

Always gives you the actual interest check. They send out, we know the actual interest check they send out. Every time is 14,400 looking at the cash column. So if I take that cash, they send out every time, 14, four, and I divide by the face amount of the bonds, 480,000. That comes out to 3%. Again, just take the cash payment, 14, four divided by the face amount of the bonds, four to 80,000.

That comes up to 3%. But remember that's for six months. That's every six months. So the stated rate printed on the bonds must be 3%, every six months, 6% for the year. It's 6% on an annual basis. The answer is 6%. The answer to question number four is 6%. That must be the stated rate printed on the bonds because that's how the interest check is always calculated, stated time-space value.

You know, that can I figure out the effective rate? Well, look at your interest expense on June 30th, they gave it to you 18,000. How do they get the interest expense will under the effect of interest approach? The way I get that expense, it's the effect of yield of the bond, not the stated rate, the effect of yield times, carrying value.

So how did I get that 18,000 interest expense on June 30th? It was the effect of yield times, the carrying value. It was the carrying value 360,000. So the question is.

What times 360,000 would give you 18,000. If you take that 18,000, the interest expense over the carrying value, three 60 comes out to 5%. That's how they got the 18,000. The effective yield. Must've been 5%. That's 18,000, over three 60 over the carrying value when they started. You take that effective yield 5% times three 68.

You'll get that 18,000. But remember that's for six months on an annual basis, it will be 5% times, two, 10%. So the answer to question number five is 10%. Now we still have two more questions, six and seven. Can we figure out the interest expense December 31, the amortization of the discount. December 31.

Sure. Weekend. Now all we have to do to finish. This is the adjusting entry for interest on December 31. What's going to happen on December 31. Well, we know they're going to credit cash, 14,400. That's given how are they going to get their interest expense for the year? Are they going to take the effective yield of the bond, which is 10%, but for six months, it'd be 5% times the new carrying value, which is three 60, three, six.

They gave you that. The way they're going to get their expense on December 31 is by taking the effective yield of the bond, which is 10%. We know that now, but for six months would be 5% times the new carrying value, which they gave you three 63, six, they're going to debit interest expense, 18,001 80. So we can, we can fill a number six interest expense, December 31, 18,001 80, and then.

You simply need a credit of 3007 80 to balance the entry out. It's a plug really no other way to get it. That's the amortization of the discount for the last six months at December 31. So credit discount, 3,780. And that answers question number seven, 3007 80. I think the simulation shows you a couple of things.

It shows you that bonds make a great simulation and it also shows you. That journal entries help you a lot, even when they don't ask for them, you have scrap paper in that exam use it. They didn't ask for entries here. And yet the way to approach this was to go to your scrap paper and start doing an analysis.

What was the entry on June 30th? What was the entry on December 31 start filling it in and the clouds start to clear. Don't forget to do entries a lot of times not exam. If you get stuck on something, if you start to do an entry, what do you debit? What do you credit? The clouds start to clear. Don't forget.

Journal entries are your friend, your very close friend. Use them. I'll see you next class.

Welcome back in this FAR CPA Review course. I want to continue our discussion of bonds. And what I want to get into next with bonds is something the CPA Exam loves and that is bonds. That are issued between interest States. Here's the big thing to remember. Anytime bonds are sold between interstates. You always assume in that exam, that the seller of the bonds will charge the buyer for accrued interest up to the date of sale.

That's always the assumption in the CPA Exam that the seller of the bonds will charge the buyers for accrued interest up to the date of sale. Let me give you an example. Let's say on September 1st, a company sells $10,000 of 6% bonds at a hundred at par the bonds pay interest semi-annually on June 30th and December 31.

So notice the bonds pay interest semi-annually on June 30th and December 31, but they sold the bonds on September one. They sold the bonds between interest States. As I say, in a problem like this, you're going to assume that the seller of the bonds would always charge the buyers for accrued interest from when to when, what are the dates don't mess up the dates, the way this calculation goes.

It always goes from the last time interest was paid in this case, June 30th, up to the date of sale, September one. So you, the buyers in this problem would be charged accrued interest for July and August. You see why it's those? Two month months from the last time interest was paid June 30th, up to the date of sale.

September one, you, the buyers will be charged accrued interest for a July and August. Now we'll just work out the math together. It's very simple. If we take 6% of 10,000 that's $600 of interest for a full year, we're talking $50 a month. Let's do a couple of entries. What entry would the issuing company make on September one?

Well, on September one, the issuing company sells $10,000 worth of bonds at par. They're going to get $10,000 cash for the bonds, but they also charge the buyers for two months of accrued interest, July and August. That's $50 a month, not a hundred dollars. So the, if you're the issuing company, you're going to debit cash for 10,100.

Notice if you're the issuing company, you're collecting an extra, a hundred dollars cash because you're charging the buyers for accrued interest for July and August. Now, you know, you're going to credit bonds payable for the face amount of the debt 10,000. That really never changes. And what the, what the issuing company does is credit interest payable, a hundred.

Why interest payable, because they're going to pay it back. You see the way this works. Yes. They charge interest up to the date of sale, but they owe it back to you. How are they going to give it, how are they going to give this money back to the investors? Well, they're going to send every investor a six month interest check.

They're not going to worry about, well, you've only owned the bonds for four months. No, they chart the way the system works. You, you are you as the investor, you're charged interest up to the date of sale, and then you get a six month interest check like everybody else. So they owe it back to you. So notice the issuing company credits interest payable, a hundred.

What is the investor do? Well, if you're the investor on September one, you're going to debit investment in bonds 10,000, but you're going to credit cash 10,100. You, the investor, you are charged an extra, a hundred dollars cash because you bought the bonds between interstates. They're going to charge you interest for July and August $50 a month.

So notice I credit cash 10,100, an extra hundred dollars cash. And of course the buyer debits interest receivable, a hundred. Because they're going to get it back. So if you're the investor, you handle it through interest receivable. So this is all handled through interest payable and interest receivable.

Let's go to December 31. What happens on December 31? Well, if you're the issuing company on December 31, you're going to send out everybody in six months interest Jack. So you're going to send this investor a six month interest. Jack, six months, times $50. Each wind company is going to credit cash 300. Now what's their interest expense.

Notice they've only incurred an interest expense for four months, September, October, November, December four months, times $50. You're going to debit interest expense 200. They've only occurred in expense since September 1st, right? They've only borrowed the money since September 1st. So debit interest expense for September, October, November, December times, $50, 200.

And now they debit that interest to payable. They set up back on September one for a hundred. If you're the investor company you're going to debit cash 300. Notice you get a six month interest check. Like everybody else. Yes. They charged you an extra a hundred dollars because you bought the bonds between interstates, but you get it right back.

You get a full six month interest check. So you're going to debit cash for 300, but you've only earned interest income for four months. Right. September, October, November, December times $50, you're going to credit interest income 200. And now you feel the investor, you credit that interest receivable that you set up back on September one for a hundred.

So just remember that you see bonds between interest rates, it's really all handled through interest receivable and interest payable. The obvious point is, and I know you, you know this without me saying it. Is that you see bond questions in that exam? Be careful about dates, always watch out for dates.

You know that generally about the financial exam, you're always careful about dates, but it's particularly true with bond questions. Now there's another thing the CPA Exam loves to hit with bonds, one of their favorite topics, and that is how you determine a gain or loss. That's a gain or a loss on early retirement of debt.

Early retirement of bonds. You have to know how to do this, to get us into this. We'll go right to a problem. And your viewers guide. Let's go to question number one. We'll read this together. There's a lot of facts in here on January 1st year one Fox issued a thousand of its 10% thousand dollars bonds for 1,000,040 thousand.

Stop right there for a second. Notice right off the bat. That they issued a million dollars worth of bonds for 1,000,040 thousand. So notice originally there was a $40,000 premium. You had to notice that. So there was a 40,000 old premium. The bonds were to mature January 1st, year 11. So the 10 year bonds, but were callable at one Oh one anytime after December 31 year four.

Let's talk about this for a second. What is Caldwell me? When you see bonds are callable, it means. That anytime the company wants. In this case after year four, anytime the company wants, they can call the bonds in and retire them at 101% of face value. That's what you're telling me. Anytime this company wants to have a year four, they can call the bonds and then retire them at a hundred.

And 1% of face value will read on interest is payable. Semi-annually on July 1st, January one on July 1st year six. That's the key date on July 1st year six Fox called all of the bonds and retired. The bond premium was amortized on the straight line basis before income taxes. What is Fox's gain or loss in year six from this early extinguishment of debt.

Now there's a number of ways you could solve this, but you know, me, I love journal entries and I think that a journal entry is the way to go here. I think a journal entry really helps you organize this. Like nothing else will. So let's, let's stop and think if you're Fox, if you're the retiring company, what entry are you forced to make here?

If you really do an enter your own, you almost forced the answer, whatever you forced to make. Well, we'll do it together. If I'm Fox aren't I retiring a million dollars worth of bonds. So a logical place to start. If I'm taking a million dollars worth of bonds off my balance sheet, I'm going to debit bonds, payable, a million.

You're going to find this entry makes a lot of sense. I'm getting the debt off my balance sheet. So I'm going to debit bonds payable a million. Now they said they called the bonds in anytime they want at 101% of face value. So I'm going to take 101% of a million. They must've credited cash, 1,000,010 thousand.

That's the cash. They paid out to retire the bonds to get the bonds back. So credit cash, 1,000,010 thousand. Let's just pause and talk about this for a second. Why are they doing this? Why did Fox decide to retire these bonds? What has PR they didn't get into all this detail, but I'm asking you to think about this.

What has probably happened? What has probably happened is interest rates have come down. Right. Interest rates have plummeted. So you know what Fox is doing. They don't give us all this information, but no doubt. Fox is issuing new bonds at a lower interest rate and using that cash to retire these old bonds, it's probably what's happening.

In other words, it's a refinancing, but as I said, the CPA Exam loves this. All right. So we know they're going to debit bonds, payable, a million, get up, get that debt off the balance sheet. We know they're going to credit cash for the call price, 1,000,010 thousand. Now listen carefully. The next part is the trickiest part.

The next part is where people mess up. And I don't want you to mess up on this don't we know that originally they sold these bonds at a $40,000 premium, right. Don't we know that they amortize the premium on a straight line basis. True. Now, how many years have gone by here? Well, they issue the bonds January 1st year one, they retired the bonds July 1st year sips.

So what's gone by here. All of your one, all of your, to all of your three, all of you don't be shamed. You use your fingers, all of your one, all of your, to all of your three, all of you for all of your five and half in year six, haven't five and a half years gone by. So let's work it out. If there's a $40,000 premium.

They use the straight line basis to, to amortize the premium. These are ten-year bonds. They go from January 1st year one to January 1st, year 11, I take the $40,000 premium divide by 10 straight line years. Aren't they amortizing 4,000 of that premium. Every year I took the $40,000 premium divide by 10 straight line years.

We know they're amortizing 4,000 of that premium every year. How many years have gone by five and a half multiply by five and a half. If you multiply 4,000 by five and a half haven't they amortized 22,000 of that $40,000 premium they've advertised 22,000 of that 40,000 old premium. So what does that tell you?

It tells you that the balance in an amortize premium, that's what I'm after the balance in unamortized premium is 18,000. So in my entry, I'm going to debit on amortized premium 18,000. See, this is the point when you retire debt, you must also retire any on advertised discount or premium that's related to that debt.

Doesn't that make sense? You can't, you can't report on your balance sheet discount or premium that relates to debt that doesn't exist anymore. I'm sure you see, it's very logical that if you retire bonds, you must also retire any unamortized discount or premium related to that debt. All these items come off your balance sheet.

So since they've advertised 22,000 of that $40,000 premium, the balance in unamortized premium is 18,000. I've got to get that off my balance sheet. So I'm going to debit unamortized premium 18,000. Now, if you get the entry to this point, now it's a plug. I simply need an $8,000 credit to balance the entry out.

That is the gain on retirement bonds. You can plug it. And one of the reasons I like an entry is, you know, if you need a debit to balance the entry out, it's a loss and retirement. If you need a credit, it's a gain. A lot of times students, they just do the numbers. They aren't a hundred percent sure whether it's a gain or loss will an entry makes it obvious you need a debit to balance the entry out.

It's a loss in retirement. Need a credit. It's a gain on retirement here. We have an $8,000 gain on retirement and the answer is yes. Now another thing the CPA Exam likes to get into is bond issue costs. Remember it's expensive to issue debt. It's expensive to issue bonds. There are costs involved. What are your bond issue costs?

The bond issue costs are basically printing the bond. Engraving legal fees related to the bond issue, accounting fees related to the bond issue and underwriters fees. That's pretty much it. These are your bond issue, costs printing, engraving, legal fees, accounting fees, underwriters fees. These are your bond issue costs.

Now a couple of things in the exam. You always assume. That bond issue costs are paid in cash upfront. Make that assumption. You see bond issue costs. You assume the company paid the bond issue costs in cash upfront. In other words, when you see a company issues, bonds, and their bond issue costs involved, well, not only do you make the normal entry when they issue the bonds, just make your normal entry for that.

But there's a separate entry where they debit bond issue costs and credit cash. Just do it as a separate entry. Just think of it as a separate entry. They pay the bond issue costs in cash upfront. So there'd be a separate entry where they debit bond, issue costs and credit cash. Now you'll notice if I make that entry, I have set up an account called bond issue costs.

What happens to it? Well, that account bond issue costs. That is a balance sheet account. It goes down under other assets. That's where it is, but it's a balance sheet accounts put down under other assets. And those bond issue costs will be deferred and amortized to expense over the term of the bonds.

That's what happens to them. The bond issue costs are a balance sheet account put under other assets and the bond issue costs are deferred charge and they're deferred and amortized to expense over the life of the bonds over the term of the bonds. Now, if they're immaterial, you could expense them the first year, but remember in the exam, you assume materiality.

You know, only treat something in the CPA exam as immaterial. When they say this is immaterial. If they're silent, you assume it's material. So the bond issue costs will be deferred and amortized to expense over the life of the bonds. And I bring this up because when you retire bond, you also retire any unamortized issue costs related to the bonds.

So please keep that in mind, when you retire bods, you must retire from that balance sheet, any unamortized discount premium or issue costs related to that bond issue. All these items come off your balance sheet. So watch out for the bond issue costs. Let's do another problem. And your viewers guide number two on January 1st year 13, heart redeemed its 15 year bonds.

$500,000 par at one Oh two. Stop right there. Why don't we start our entry? I know you want to, if they're, if they're retiring $500,000 of bonds from the balance sheet, don't we know they're going to debit bonds payable, 500,000. Right. You've got to get the debt off your balance sheet and they got the bonds back at one Oh two.

So what's the cash they paid out to get the bonds back 102% of face value, 102% of 500,000. We know they're going to credit cash 510,000. Nice. Just get the, if you started debit bonds payable, 500,000 credit cash, 510,000. Now, you know, this is where the problem gets difficult. The bonds were originally issued January 1st year one at 98.

Stopped right there. If they were originally issued at 98, doesn't that mean there was a 2% discount take 2% of 500,000. Keep in mind. Originally there was a $10,000 discount, 2% of 500,000 with a maturity date of January 1st, year 16. So we know they're 15 year bonds. They go from January 1st year one to January 1st, year 16, they have 15 year bond.

The bond issue costs late into the transaction with 20,000. So we have bond issue cost here of 20,000. There's a lot going on in this question. This event is considered unusual in nature, unusual in occurrence for heart. Alright, so it's unusual. It's infrequent. So if there is any gain or loss here, it meets the criteria.

It's going to be extraordinary. Heart amortizes discounts, premiums, and issue costs using the straight line method. What amount of extraordinary loss would heart recognize on the redemption of these bonds? They want to know the extraordinary loss. Well, let's work it out. Let's finish our entry. We know we've debit bonds payable for 500,000.

We know with credited cash, 510,000. Now we have to work out what the balance in an advertised discount, the balance in unamortized issue costs. Then we can figure out in this case, the loss, all right, let's start with a discount. You do this with me. Wasn't the original discount. 2%. They sold the bonds at 98.

There was an original discount of 2% of 500,000 or 10,000. Now they're amortizing the discount on the straight line approach, straight line. Right now, these are 15 year bonds. They go from January 1st year one to January 1st, year 16. They have 15 year bonds. How much time has passed 12 years because we issued the bonds January 1st in year one where retiring the bonds January 1st year, 13, 12 years have passed.

So I would do a ratio since 12 of the 15 years have passed. That's 80%, 12 or 15 is 80% since 80% of the time has passed. Presumably in straight line, they've amortized 80% of that discount they've advertised through straight line, 80% of that $10,000 discount. So the balance in on the advertised discount is 20% or 2000.

So I'm going to credit in my entry on the advertised discount, 2000, I've got to get that discount off my balance sheet. 12 to 15 years have passed. 80% of the time has passed. So in straight line, you've amortized 80% of that discount. So the balance in unamortized discount is 20% or 2000. So credit on amortized discount, 2000 same thing with the issue costs.

We advertise them on the straight line basis. Since 12 of the 15 years have passed. 80% of the time is passed through straight line. They would have amortized 80% of those issue costs. So the balance in unamortized issue costs, maybe you want an amortized portion on advertised issue costs 20% or 4,000.

So I'm going to credit on amortized issue costs 4,000. And now it's a plug. I need a $16,000 debit to balance the entry out. That's a loss and retirement bonds. We know it's extraordinary because it's both unusual and infrequent. And the answer is a notice that the $8,000 gain on Fox, they said nothing.

You assume that's just an ordinary gain, but if they go out of their way to say it's unusual and infrequent, of course it is extraordinary and extraordinary loss for heart. And the answer is a, you get a question like this in the exam, do an entry. The answer will pop out for you. You can force it. I'll see you in the next class.

Welcome back in this FAR CPA Review course. We're going to continue our discussion of how you account for bonds. And what I want to get into next are bonds that are issued with stock purchase warrants. Let me give you a definition, a stock purchase warrant. Is just like a stock option. You just think of it as a stock option.

It allows the holder to purchase so many shares of stock within a certain period of time at a certain fixed price called the option price or the exercise price. So if you're holding stock warrants, you can buy shares at a certain fixed price called the option price or the exercise price. And here's the point.

Sometimes companies will issue bonds. And they'll have stock warrants attached to their bond. All right. Now, why did they do this? The reason why a company would attach warrants to their bonds is first of all, makes the bonds more attractive. It makes the bonds more marketable, which makes sense. Also it tends to hold down interest rates.

In other words, rather than give you. The prevailing market rate of interest, rather than give you a high rate of interest. I give you a pitiful rate of interest, but to get you to buy my bonds, I throw in some stock options. So it tends to hold down interest rates as well. Because again, rather than give you the prevailing market rate of interest, I give you much less.

I give you a pitiful rate of interest, but to get you to buy my bonds, I throw in some stock warrants. So that's how the that's how these are used now. Before we go to a problem. I want you to know that if you get a problem in the FAR CPA Exam on stock warrants, the key to everything you do in that problem depends on whether the warrants are detachable or non detachable.

That's the key to how you handle warrants? Are they detachable or are they non-attachment? Let me explain when warrants are detachable. You can separate the warrants from the bond, trade them as a separate security. The bottom line is when Warren's already catchable, the warrants will have their own market price.

The warrants can be separated from the bond traded as a separate security. And as I say, the bottom line is when warrants already attachable the warrants have their own market price. There are separate security trading with their own market price. Now, when warrants are non detachable, you know what it means.

The warrants and the bond can never be separated. So if I sell the bond, I have to sell the warrants with the bond. I can never sell, sell the warrants by themselves. The warrants are not going to have their own market price. If I sell the bond, I've got to sell the warrants with the bond. If I exercise the warrants and I buy stock, remember they stock options.

If I exercise the warrants and I buy stock and then non attachable, I've got to turn the bonds in the bonds will be legally retired. Because when the non attachable, the warrants and the bond can never be separated. So that's always what you're looking for. Are they detachable or are they non detachable?

Let's go to a problem. It says on December 30, one of the current year, MOS issued a million dollars of 11% bonds at one Oh nine. Each thousand dollar bond was issued with 50. Detachable, you might want to circle that word. That's what I'm looking for. Each bond has 50 detachable warrants. Remember this stock options in each warrant allows the holder to purchase one share of $5 par stock at $25.

So they like stock options. They are stock options. You can buy every everyone you have allows you to buy one share of $5 par stock at a fixed price, $25 a share. Now let me ask you this. How many bonds are there here? Well, if it's a million dollars worth of debt, And bonds are always in denominations of a thousand.

It must be a thousand bonds. It says immediately after issuance, the market value of each warrant was $4. Now really circle that $4. That's you're always looking for that. I'll say it again. When warrants are detachable, what does it mean? The warrants can be separated from the bond traded as a separate security.

And the bottom line is when warrants are detachable, the warrants will have their own market price. And the has got to give that to you. So always anytime you see detachable warrants, you're looking for that. What are the warrants trading for? Because there's no way you could come up with that. the CPA Exam is got to give you that.

So we're looking for that $4. It says at the bottom on December 31, what amount would Moss record as discount or premium on the bonds? Well, let me show you what Moss would do if the warrants were non detachable, let me start with non detachable. If the warrants were non detachable, Moscow goes out and sells a million dollars worth of bonds at one Oh nine.

So we know Moss would debit cash for what they collected 1,000,090 thousand. Right. We know MOS would credit bonds payable, always for the face amount of the debt, a million. And what Moss would do is credit premium on bonds, 90,000. Notice the normal entry and notice that's answer B. You might want to write next to answer, be non detachable.

Here's the main point. When warrants are non detachable, the issuing company just treats the problem as if they issued one security debt, just bonds. And the warrants are ignored. You know, basically non detachable warrants are ignored, but I'll say it again. The basic theory here is when warrants are non detachable, the issuing company treats the problem as if they went out and issued just one security, jus bonds, just a debt security, and the warrants are ignored.

I centrally non detachable warrants are ignored. So as I say, if the warrants were non detachable here, the answer would be B, but they are a detachable. So here is the calculation. We know there's a thousand bonds here, right? It's a million dollars worth of debt. Bonds were always in denominations of a thousand.

So we know there's a thousand bonds. How many detachable warrants are on every bond? 50. So here's our calculation. We're going to take a thousand bonds times 50. We know there are 50,000 warrants in total. What are the warrants trading for $4 each. So take the 50,000 warrants in total times $4 that comes out to $200,000.

Now let's do the entry again. I'm Moss. I go out and sell a million dollars worth of bonds at one Oh nine. So we know we're going to debit cash, 1,000,090 thousand. We know we're going to credit bonds payable, always for the face amount of the debt. A million never changes, but here's the point when warrants are detachable, the issuing company is going to treat the problem as if they went out and issued two separate securities bonds and warrants, a debt security, and an equity security.

So. If your MOS, you have to allocate some of the proceeds coming in to the warrant feature. So we know there are a thousand bonds. There are 50 to tax with Lawrence on every bond. So there are 50,000 warrants in total that trading before dollars each. So in this entry, we're going to credit additional paid-in capital from warrants, 200,000.

Notice if your MOS, you have to allocate some of the proceeds coming in to the warrant feature. Cause there were separate security. So if you're Moss, you're going to credit additional paid-in capital from warrants 200,000. Now I know you can plug this next number and you will you'll end up plugging it.

But I want you to see the theory here. If your mosque, how much cash did you collect 1,000,090 thousand, did all that cash come in for your bonds? No, we just proved that 200,000 of that cash really came in for the warrants. So what did you sell your bonds for 1,000,090 minus 200,000. You really sold the bonds for 890,000.

In other words, the bonds really sold at a discount. So debit discount on bonds, 110,000. And the answer is C C. When you back out what you really got for the warrants in reality, your bonds sold at a discount. It's tricky. Because when warrants are detachable, you're going to treat the problem as if the issuing company went out and issued two separate securities bonds and warrants, a debt security, and an equity security.

And you have to allocate if you're the issuing company, some of the proceeds coming in to the warrant feature. So in reality, when you back out what you got for the warrants, the bonds really sold at a discount. Let's go to the investor side. As you know, in the exam. You never know what side of the transaction you would be on.

Let's say I'm on the investor side here. And I I'm, I'm the investor. I bought all these bonds. Here's my entry. If I bought all these bonds and the warrants are detachable, I'm going to debit investment in warrants, 200,000. I'm going to credit cash, 1,000,090 thousand. And I'm going to debit investment in bonds.

890,000. That's my entry from the investor. I debit investment in warrants, 200,000 credit cash, 1,000,090 thousand. I paid one Oh nine for the bonds. And I debit investment in bonds, 890,000. The same theory applies when warrants are detachable, the investor treats the problem as if they invested in two separate securities, they invested in a debt security and they invested in an equity, security.

They invested in bonds and they invested in warrants. Let's go to another question because there's another tricky point here. It says on December 30th of the current year, For it issued a thousand of its 8%, 10 year thousand dollar face value bonds with detachable. That's the word I'm looking for with detachable warrants and they sold the bonds at par each bond carried a detachable warrant for one share of Ford's common at a auction price of $25 a share immediately after issuance the market value of the bonds without any warrants.

Was 1,000,080 thousand and the market value of the warrants is 120,000. Remember, anytime warrants are detachable, the exam's going to have to tell you what the trading for. Cause that's what detachable means. The warrants will have their own market price. And there's no way you could come up with that.

So the are trading for 120,000 in the December 31 balance sheet. What would Fort report for bonds payable? Well, what's tricky in this problem is this we know because the warrants are detachable. Four, it has to allocate some of the proceeds coming in to the warranty feature for it's going to treat this problem as if they went out and issued two separate securities bonds and warrants, a debt security and an equity security.

So let's start the entry if you're for it. You know, you sold a million dollars worth of bonds at par. So you're going to debit cash, a million dollars. You're going to credit bonds payable, always for the face amount of the debt, a million. But remember four, it should allocate some of the proceeds coming in to the warrant feature because warrants are detachable, but what's tricky in this problem.

I had to show it to you is they gave us something in this problem. We didn't know before they told us what the bonds are trading for without any warrants. Here's the point. If they tell you what the market price of the bonds is without any warrants, and they tell you the market price of the warrants, you have to allocate the proceeds to both securities.

Using relative fair market values. I'll show you what I mean, we know bonds without any warrants are trading for 1,000,080 thousand. We know the warrants are trading for 120,000 added up that's 1 million, $200,000 of market value. Now you strike a ratio. You say, because warrants make up 120,000 over a million, two warrants make up 120,000 over a million to 10% of the total market value.

Then four should allocate 10% of the proceeds they collected to the Warren feature. So back to our entry, if you're for it, you're going to credit API warrants for 10% of the million, you collected a hundred thousand because warrants make up 10% of the market for it should allocate 10% of the proceeds they collected to the Warren feature.

So we're going to credit API C warrants for 10% of a million, a hundred thousand. Now you see where we are, how much cash did fourth Ford collect a million? Did all that come in for the bonds? No, we just proved that a hundred thousand came in to the warrants. So what did they really sell the bonds for 900,000?

You really sold the bonds at a discount. So we're going to debit discount on bonds a hundred thousand. So when they ask us at the bottom, at what amount would Fort report for bonds payable? How was the debt reported at the face amount, a million minus the discount, a hundred thousand. The debt is reported as a $900,000 liability.

The answer is C so w so let's be careful here. When are you going to say no, you have to solve it differently. If the CPA Exam starts telling you what bonds are trading for without any warrants, why watch out for that? Because that's something they can do. If they start telling you what the warrants are trading for and what the bonds are trading for, without any warrants, you have to allocate the proceeds to both securities.

Using relative fair market values. Again, the tip off is they start telling you what the bonds are trading for without any warrants and what the warrants are trading for. You've got to allocate the proceeds to both securities using relative fair market values. Since warrants, makeup, 10% of the market, 120,000 over a million to fortunate allocate 10% of the proceeds they collected to the Warren feature.

So in reality, they sold the bonds at a discount and the debt is reported. As a $900,000 liability, watch out for bonds with warrants, keep studying. I will look to see you in the next class. Welcome back in this FAR CPA Review course. We're going to finish our discussion on bonds because we do have one more thing we have to discuss with bonds, and that is convertible bonds.

Let me define it. Convertible bonds are bonds. That you can literally convert into stock. In other words, if I'm holding some convertible bonds and I decide, I want the stock, I turn the bonds in there illegally retired, and the company gives me stock in place of the bonds. Those are convertible bonds, the bonds that you can literally convert into shares now, convertible bonds as sort of a classic good news, bad news sort of thing.

Let me give you the good news. The good news with convertible bonds is that we convertible bonds. the CPA Exam almost always asks the same thing. When bonds are converted into stock. At what value do you record the stock? That's almost always what the CPA Exam comes after that point. If bonds are converted into stock, at what value do you record the stock?

The bad news with convertible bonds is that there are two approaches. There's the book value method of convertible bonds, and there's the fair market value method of convertible bonds. Let's do a problem. It says clay had $600,000 of convertible, 8% bonds outstanding. June 30th year one. Let's stop right there.

How many bonds are there? Well, we know that bonds are always in denominations of a thousand. So if it's $600,000 with the convertible bonds, There must be 600, $1,000 bonds. So you might wanna just scribble that in the margin. So we know that 600 bonds, each thousand dollar bond was convertible into 10 shares of Clay's $50 par value.

Common. All right. So I want you to have a little note here. We know there are 600 bonds, right? The conversion ratio was 10 to one for every bond you turn in, you get 10 shares of stock. So take 600 bonds. Times 10. I want you to pick up, take a note that the bonds are convertible into 6,000 shares of stock for every bond I turn in, I get 10 shares of stock.

So there were 600 bonds, times 10. You have a note that indicates that the bonds are convertible into 6,000 shares of stock. On July one year four, the interest was paid to the bond holders and the bonds were converted into common stock, which had a fair market value of $75 per share. The unamortized bond premium on that date was 12,000 that's on the day of conversion under the book value method.

This conversion increased the following elements of stockholders' equity, by how much? So you might want to circle book value method. the CPA Exam has got to tell you the method, and this is the book value method. Now, you know me, I like an entry. Let me show you the entry that you'd make in the book value method.

Now, one thing to keep in mind is, as we said before, when bonds are converted into stock, The bonds are turned in. They illegally retired and the company gives me stock in place of the bonds. Well, if that's true, you can really treat this almost like a retirement problem. You've got to retire the debt. So let's start our entry.

We're going to debit bonds payable, 600,000. We have to get that debt off the balance sheet. The bonds are turned in. They illegally retired. I'm going to debit the unamortized premium 12,000. Because as we learned in our other classes, if you retire bonds, you must also retire any unamortized discount premium or issue costs related to the debt.

You already know that if you retire your bonds, you must also retire any unamortized discount premium or issue costs related to that debt. All these items get retired from your balance sheet. So I'm going to debit the unamortized premium 12,000. All right now we know that 600 bonds came in. The conversion ratios tend to one.

So we take 600 bonds, times 10. We're going to give out 6,000 shares of stock times par 50. We're going to credit common stock for 6,000 shares at par 50 300,000 and just credit API C for the rest 312,000. So when they ask us at the bottom under the book value method, this conversion increased. The following elements of stockholders' equity, by how much the answer, a common stock increased by 300,000 that's 6,000 shares times part 50.

The rest is API C three 12. So we've already answered the question. Now, before we leave the book value method, notice what we've really done there. We have credited common stock, 300,000 API C3, 12 didn't. We credit capital accounts for a combined 612,000. See, that's really the book value method under the book value method.

You record the stock at the book value, the bonds that been turned in and there's never any gain or loss in conversion. I'll say that again. In the book value method of convertible bonds, you basically record the stock at the book value of the bonds that are turned in and there's never any gain or loss on conversion, never.

So the answer is a, now let's do the same problem. What if it was the fair market value method? Well, if this were the fair market value method, which the CPA Exam could ask. I want you to notice we'd start the same way we would still debit bonds payable. 600,000. We would still debit on amortized premium 12,000.

Why? Because the bonds are turned in. They legally retired. You have to retire the debt. So this is, was the fair market value method. We would start exactly the same way we would debit bonds payable, 600,000. We would debit the unamortized premium 12,000. Get the debt off my balance sheet. Wouldn't I still credit common stock for 300,000.

Why? Because 600 bonds are turned in times 10. We're giving out 6,000 shares of stock times par 50. I would still credit common stock, 300,000 for par. Notice the entry is exactly the same down to this point. So what's different. Here's, what's different in the fair market value method. We know we're giving out 6,000 shares of stock.

The stock is trading for $75. A share that was given to you again in the fair market value method. We know that we are giving out 6,000 shares of stock. The stock is trading for $75 a share. So take 6,000 shares, times 75 that's 450,000 in the fair market value method. We would credit API. But just 150,000 notice I'm crediting common stock, 300,000 API, one 50, a combined 450,000.

The fair value of the shares again in the fair market value method. I know that there's 6,000 shares going out. They're trading for $75. A share 6,000 shares, times 75. The fair value of the stock is 450,000. So if I credit common stock for par 300,000 API C would be a credit for one 50 because I have to credit common stock and API C for a combined 450,000 fair value of the shares.

Notice the entity doesn't balance. I need $162,000 credit to balance the entry out. That's a gain on conversion of bonds. Notice in the fair market value method. We record the stock at its fair value, and there's almost always a gain or loss on conversion. So these gains and losses on conversion are unique to this approach and the fair market value method of convertible bonds.

We record the stock at its fair market value, and there's almost always a gain or loss on conversion. So as I say, these gains and losses on conversion are unique to the fair market value method. The book value method is never a gain or loss on conversion. And I will say the CPA Exam usually asks for the book value method.

The book value method is theoretically preferred. And usually the CPA Exam asks for the book value method on convertible bonds. Although the fair market value method is fair game and they could ask it. But book value method is what you expect more than anything. Keep studying. I'll see you in the next class.

Welcome back in this FAR CPA Review course. We're going to continue our discussion of liabilities. And the first thing I want to get into is. When we calculate a liability for compensated absences. Now, I think, you know that when I say compensated absences, I mean, absences that an employee is compensated for holiday pay, vacation, pay, sick pay.

So here's what you have to remember. You must calculate a liability for holiday pay, vacation, pay, sick pay when you can prove it. P R O V it's gotta be four tests. P R O V. Remember, you have to prove it. Let's go over. What it stands for P it's gotta be probable are you can reasonably estimate the amount all the holiday pay the vacation, pay sick pay only relates to pass services, never future services and test for the employee's rights have vested or accumulated.

So just remember you have to prove it. P R O V has to be probable. You can reasonably estimate the amount only relates to pass services, never future services, and then test for the employee's rights have vested or accumulated. Now I'm assuming, you know what vested means. If an employee has vested rights, that means they're entitled to the money, whether they continue employment or not accumulated, I'm sure you know what it is, but you're not, you might not know the term.

Let's say I get. 15 paid vacation days a year. And this year I use three and the company lets me carry 12 over the next year. That's accumulated. So the employees rights have to be vested or accumulated. Now, assuming it meets all four tests, assuming that the holiday pay vacation, pay sick pay it's probable, you can reasonably estimate the amount.

It only relates to past services. The employees rights invested or accumulated what's the entry. You're going to debit salaries and wages expense, and you're going to credit an estimated or accrued liability. You know, wages payable. The point is we don't wait for people to take their vacations. We will on our income statement.

We want a proper matching between this year sales and this year salaries and wages. We don't wait for people to take their vacations. Now there's one little trick here. I want you to remember sick pay must be vested. It's not enough. That accompany lets you accumulate sick days. That's not enough to accrue sick time.

The employee has to have vested rights. Meaning if I quit the company, I get a check for all my unused sick time. So that's that is the distinction. You know, holiday pay the cation holiday pay vacation pay can be vested or accumulated. That's why the word is in there. But. You only accrue sick time. If the employee has vested rights, if I quit the company today, I get a check for all my unused sick time.

Now I want you to remember this to the same criteria. Yeah. P R O V also apply the post-employment benefits. Now, what do I mean by post-employment benefits? You owe former employees benefits. Now, listen, they're not retired. Don't confuse it with post retirement benefits. It's easy to do. We all. Former employees benefits health care.

It's usually healthcare, but we owe former employees benefits, but they're not retired. Just don't confuse it with post retirement benefits. So when do we accrue post-employment benefits? When it's probable, you can reasonably estimate the amount. It only relates to past services, employees, rights invested P R O V.

You gotta be able to prove it. So it applies to compensated absences and it also applies to post employment benefits. Just remember you have to be able to prove it. P R O V. You've got the criteria down and you have to remember that. Now. I also want to make sure that you know how to set up a liability for warranties.

Now, you know what a warranty is, we're guaranteeing our products against defects. How do you set up a warrant? How do you set up a liability for warranties? Let's go to question number one. It says during year one, gum introduced a new product, carrying a two-year warranty against manufacturer's defects.

The estimated warranty costs related to dollar sales are 2% within 12 months following the sale and another 4% in the second, 12 months following the sale. And then they give us sales and actual warranty expenses for years, one and two. The bottom. It says, what amount would gum report as their accrued, their estimated warranty liability December 31 year to notice now I think it'll help if we do this year by year, I want to show you what happens year by year.

Let's say I'm gum. I get the December 31 year one. What am I going to do? They told me that I expect 2% of the claims to come in within 12 months following the sale. And another 4% in the second, 12 months following the sale. So if I'm gum and I get to December 31 year one, how do I work out? My estimated liability for warranties?

The sales for year one were 150,000. Would I take the 150,000 times 2% or times 6%. That's a lot of people get hung up 2% or six it's, 6%. All of it because of it's probable and you can estimate it, you accrue all of it. So when I get to December 31 year one, I'm going to take 6% of 150,000. I'm going to debit on a crude warranty, expense 9,000.

I'm going to credit an accrued warranty liability 9,000. Then when the claims come in, when people want refunds notice the actual claims were 2250. I debit the liability 2002 50 and I credit cash 2002 50. I give the people their money back. Those two entries, that's warranty, accounting. Let's do year two.

If I'm gum, I get to December 31 year two, I'm going to take the sales 250,000 times, 6%. I'm going to accrue all of it. If it's probable and I can estimate it. I grew all of it. I don't wait for the claims to come in. It's irrelevant. When the claims come in. If it's probable and I can estimate it. I grew all of it.

So I take the 250,000 of sales per year, two times 6%. I'm going to debit an accrued warranty expense, a 15,000 credit accrued warranty liability, 15,000. And then when the claims come in, I'm going to debit the liability. 7,500 and credit cash. 7,500. Now look at the entries I just made. Didn't I, for those two years, didn't I credit liability 9,000 plus 15, 24,000.

I debited it for claims 2250 plus 7,597 50, the balance and accrued liability. At the end of year two is answer D 14,002 50. Now I showed you the long approach, cause I wanted you to understand what's happening each year. And of course, what this is all about is the matching concept. I want a proper matching on my income statement between year one, sales and year one warranty expenses.

I don't care when the claims come in, I want a proper matching on my income statement between year two sales and year two warranty expenses. I don't care when the claims come in. So I wanted you to understand that whole matching principle, what happens each year. But once you understand this, there's a shortcut.

You don't have to do entries. There's a nice shortcut. Look at the sales for both years, 400,000. Isn't the point that eventually I'm expecting 6% of that to go bad. So it takes 6% of 400,000. Eventually I'm expecting a $24,000 liability minus what I've paid out. So far, 97 50 leaves me with then accrued liability of 14,002 50.

Answer D they take two seconds. If you understand them. I'll do that again to shortcut, just look at the sales for both years, 400,000, eventually 6% is going to go bad. So it takes 6% of 400,000. Eventually I'm expecting a $24,000 liability for warranties back out what I've paid so far, 97 50 leaves me with an accrued liability of 14,200.

So use the shortcut. Definitely save you a lot of time. Now, I also want to make sure that you know how to set up a liability for coupons. They ask these a lot. Let's look at question number two in December of the current year mil began including one coupon in every package of candy that itselves offering a toy in exchange for 50 cents and five coupons.

The toys cost mill 80 cents. Each eventually 60% of the coupons will be redeemed during December mill sold 110,000 packages of candy notice. No coupons have come in. No coupons have been redeemed in the December 31 balance sheet. What would mail report as are accrued their estimated liability for coupons?

So let's work this out together. First of all, what's the total population. Well, they sold 110,000 packages of candy, right? In December, they sold 110,000 packages of candy. There's one coupon and every package they sell. So the total population is 110,000 coupons out there in the world somewhere. Right.

Are they all going to come in? No. We've had offers like this before, you know, most people throw them away, but we've had offers like this before, and we know based on past experience, 60% tend to come in. So I'm going to take 60% of 110,000. Don't expect 66,000 coupons to come in. Now here's my question.

Does mil have to go out and buy 66,000 toys? They have to go out and buy 66,000. You know, pieces of junk, whatever this is. No, why not? They have to buy 66,000 toys because it takes five coupons and 50 cents to get a toy. It's, it's incredible. They charging, you know, the poor child cash, this piece of junk, whatever it is, but it takes, it takes five coupons and 50 cents to get a toy.

So I'm going to divide. I'm going to take that 66,000 coupons divide by five. Mill company knows they have to go out and buy 13,200 toys. Now here's the question. What does each toy cost mill? Well, 80 cents, but they get 50 cents out of the, you know, the poor, helpless child. They should be ashamed of themselves piece of junk, but doesn't each toy really costs mill 30 cents.

So I'm going to take 30 cents times 13,200 toys. Here's the entry, you know, me, I like entries. They're going to debit. An accrued coupon expense, 3009 60. They're going to credit an accrued coupon liability 39 60. And the answer is a, the point is we don't wait for the coupons to come in on our income statement.

We want a proper matching between this year sales and this year's coupon expenses. Right? We don't wait for the coupons to come in. It's about the matching concept on our income statement. We want a proper matching between this year sales and this year's coupon expenses. So. If 13,000, we, if we have it, the buy 13,200 toys, times 30 cents, we set up an accrued coupon expense for 39, 60 and accrued coupon liability of 39 60.

We don't wait for the coupons to come in. All right. Now let's say that a beautiful child. Okay. An adorable child saves up five coupons. You know, tape's 52 quarters to a card. Just break your heart chocolate fingerprints on the envelope. You just. You just want to die. When you see this, they got, they actually get cash out of this child.

So a helpless child saves up five coupons tapes, two quarters to a card says, I want a toy. What's our entry. That's all we care about. Right? We're a ruthless American corporation. What's our entry. We're going to debit cash 50 cents. Right? We got cash out of that child. We're going to, we should be proud of ourselves.

We're going to debit cash 50. We're going to debit cash 50 cents. Now what do we do? Our obligation goes down 30 cents. We're going to, we're going to debit our accrued liability 30 cents, and we're going to credit toy inventory for 80 cents. We're going to have an inventory of toys. The cost is 80 cents each.

So we're going to credit toy inventory, 80 cents. And those two entries. That's how you account for coupons. So make sure you know, those two entries keep studying. Don't fall behind. I'll look to see you in the next class.

Welcome back in this FAR CPA Exam Review course. I want to talk about how you would restructure a debt. Sometimes they call this troubled debt restructuring. What happens in all these problems is that a debtor gets into financial trouble and basically goes to the bank and says to the bank, will you make concessions for me?

Will you make it easier for me to pay off this debt? Now, why would a bank ever do that? Well, of course the bank is afraid if they say, get out of my office, which they'd say to me, While all that all that's going to do is force the debtor in the bankruptcy and the bank gets nothing or pennies on the dollar.

So there really are benefits on both sides. So what we want to get into now is how to restructure a debt. Now, I will tell you that when you see troubled debt restructuring, there are two types of problems. It's either going to be a problem on. Full settlement, or it will be a problem on modification of payment terms.

Those are the two possibilities. It's either going to be a problem on full settlement, or it will be a problem on modification of payment terms. We're going to begin with full settlement. Let me explain what that means. When I say full settlement, I mean, the bank is taking assets in full settlement of the debt.

That's what I mean by full settlement where the bank takes assets. In full settlement of the debt, let's go to a problem problems. One and two, it says the following information pertains to the transfer of real estate pursuant to a troubled debt restructuring by knob to men corporation notice in full liquidation of nods liability to men.

So this is a problem on full settlement. The carrying amount of liability, that's liquidated 150,000 carrying amount of the real estate transfer to a hundred thousand. The fair value of the real estate transferred is 90,000. Let me show you the entry because once again, I think entries just about all the ways, really help you understand something.

What entry would be made here? Well, if I'm not, if I'm the debtor here, I'm going to debit notes payable 150,000 notice if I'm knob. I debit notes payable as if, what, as if it's paid off, because it is the bank took real estate in full settlement. So the debt is paid off with real estate. So that's how you handle full settlement.

If you're not, if you're the debtor, you're going to debit notes payable as if you've just paid it off. And by the way, if there was any accrued interest payable on the note, you'd also debit interest payable and wipe that out. Also, apparently there's no interest payable on the note, but as I say, if there was, if there was any accrued interest payable on the note, We'd also debit interest payable here and wipe that out as well.

But apparently there isn't, there is no interest payment. There is no interest payable here. Apparently they paid all the interest on the note to just wiping out the principal. So we're going to debit notes payable as if we paid it off 150,000, then we're going to credit the real estate for its original cost a hundred thousand.

And since the real estate has a fair value of 90 notice, I have to debit loss on real estate, 10,000. See the way they make you treat this. It's just as if knob went out and sold the land for fair value and gave the cash to the bank, but novice not going to avoid reporting. And he gained a loss on the property.

That's one little tricky thing. You have to be careful though. You do have to report and to gain a loss on the property here. It's 10,000. Now the MP doesn't balance. I need a $60,000 credit to balance the entry out. That's a gain on debt restructuring. That is a gain on debt restructuring. That game is up in continuing operations on the income statement, other gains and losses.

That's a gain on debt restructuring. Number one says what amount would not report it as gain or loss on restructuring? The payables? We have the entry, you know, what's the answer date. It's a $60,000 gain on debt restructuring. Two says what amount would not report as the ordinary gain or loss from the transfer of the real estate.

Again, you look at your entry. There was a $10,000 loss on the sale of land. Answer a, let me show you what the bank would do. Same problem. What would the bank do in this problem? Because this is another one of those cases where in the CPA exam, you never know what side you'd be on. What if you're the bank here?

Well, if you're the bank, you seize the land. So you'll debit land for its fair value. 90,000. You're going to credit note receivable for the 150,000 as if it's paid. Because the bank took real estate in full settlement. So the bank seizes the land debits the land for its fair value, 90,000 credit note receivable notice note receivable.

The bank for the 150,000 is if it's paid off because it was with land, the bank took land in full settlement and notice the bank needs a $60,000 debit to balance the entry out. That's just an ordinary loan loss for the bank happens all the time in banks. That's just an ordinary loan loss. Now, the other possibility.

With restructuring debt is modification of payment terms. Let me give you an example. Let's say that I'm a debtor and I have a $200,000 note payable to a bank. I also have 30,000 of accrued interest payable on the note. So I'm a debtor. I have a $200,000 note payable to the bank is also 30,000 of accrued interest payable on the note.

And let's say my monthly payment right now to the bank is $17,500 a month. I get into financial trouble. That's what happens in all these problems. I get into financial trouble. I go to the bank and the bank says, okay, Bob, tell you what we'll do. They're always so helpful. And they say, Bob, if you give us 10,000 every month for the next 15 months, we'll consider everything paid.

Do you see the difference? The bank's not taking assets in full settlement. The bank is modifying my payment terms. So it's a different type of problem. Notice again, the difference. Notice the difference in the fact pattern, the bank is not taking assets in full settlement. No, the bank is modifying. My monthly payment bank says, all right, Bob, you give us 10,000 every month for 15 months, we'll consider everything paid.

All right, let me show you what the bank does. You know what the bank does? It's a little tricky here. What the bank does. If you're on the bank side. Bank says, all right, 10,000 every month for 15 months, isn't that a series of equal periodic payments over a specified number of periods. It's an annuity.

What the bank would do is get the discounted, present value of that annuity at a fair rate of interest. I'm just going to give you that to save time. Let's say that's a hundred thousand, but that's what the bank does. The bank gets the discounted present value of that stream of payments at a fair rate of interest.

And let's say that's a hundred thousand and here's the analysis. When I went in the bank, I owed the bank $200,000, a principal, 30,000 of interest. I owed the bank 230,000. They're settling it in terms of today's dollars for a hundred thousand. Well, you had to notice is the loan has been impaired by 130,000.

You have to be able to get that number again. When I went in the bank, I owed the bank $200,000, a principal, 30,000 of interest. I owed the bank 230,000. They're settling it in terms of today's dollars for a hundred thousand. The loan has been impaired by 130,000. I'll show you the entry for the bank.

Although I don't think entries help that much with, with modification of terms. I think with full settlement, the best thing to do is get an entry down, but I'll just show you the entry. What the bank does is basically debit that debt expense, 130,000 and credit allowance for impaired loan allowance for bad debts, 130,000.

Again, you gotta be able to get that number. I owed the bank 200,000, the principal, 30,000 of interest to settling it in terms of present value for a hundred thousand, the loan has been impaired by 130,000. So the bank debits bad debt expense, 130,000 credit allowance from paired loans or allowance for bad debts, 130,000.

But the answer would be 130,000. Be able to get that number. Now, the debtor's a little different. If I'm the debtor in this case, the debtor does not do present value. Remember that? The debtor does not do PR when you see modification, the payment terms, the debtor does not do present value. The debtor just adds up the total cash.

That's going to be paid to the bank. If I'm the debtor here, what's the total cash that's going to be paid to the bank 10,000 every month for 15 months are going to give the bank 150,000 in total. On a $230,000 debt. So the debtor has an immediate $80,000 gain on debt restructuring. I'll do that again.

The debtor does not do present value. The debtor just adds up the total cash that will be paid to the bank. If I'm a debtor, I'm going to give the bank 10,000 every month for 15 months, the total cash I'm going to give the bank is 150,000 on a $230,000 debt. So the debtor has an immediate gain on debt restructuring of 80,000.

So the entry, again, not the Dentrix helped that much in this case. But the debtor would credit gain on debt restructuring 80,000, that game would go to the income statement for the debtor, just up, up in continuing operations, all the gains and losses, 80,000. So credit gain on debt restructuring, 80,000.

Excuse me, you would debit gain on debt restructuring 80,000. And what would you debit notes payable. You would debit notes payable, 50,000 and debit accrued interest receivable. Excuse me. Interest payable, 30,000. That's the entry they would make. They would credit gain on debt restructuring, 80,000 debit, the accrued interest payable, 30,000.

I think they'd wipe out the interest payable cause that's a current liability and then debit notes payable for 50,000. That's the entry. Again, entries don't help as much with modification of terms. You have to be able to get the number and remember that the debtor does not do present value. So the debtor's going to credit gain on debt restructuring, 80,000 debit interest payable, 30,000 wipe off that current liability and debit notes payable 50,000.

That would be the entry. Let me ask you a question. If I booked that entry, how much have I left in the note payable account? 150,000, and I'll pay that off 10,000 every month for 15 months. And there's no interest recorded after that point. So those how it works, what I've left in the note payable account after that entry is 150,000.

And if I'm the debtor, I'll pay that off 10,000 every month for 15 months. And there's no interest recorded after that point. Let's do a problem in year two Mae acquired land by paying $75,000 down and signing a note with a maturity value of a million on the notes. Due date, December 31 year seven may owed 40,000 of accrued interest.

And a million dollars a principal on the note. All right. So when may goes to the bank, may owes a million dollars principal, 40,000 of interest. So Mayo is the bank, 1,000,040 thousand magnets and the financial difficulty. Here's what the bank agrees to. The 40,000 of interest due on the note is forgiven.

So forget that principle on the note was reduced from a million to nine 50, and May's going to have to pay an interest payment in year eight of 30,000. As a result of the troubled debt restructuring may would report a gain on restructuring on the income statement of how much well am I on the bank side of the debtor side here may, as the debtor does may present value.

No, may just add up the total cash that will be paid to the bank may is going to give the bank what 950,000 principal, 30,000 of interest, the total cash may is going to give the bank is 980,000 on a million and $40,000. No. So may has an immediate $60,000 gain on debt restructuring. And the answer is C remember Meda maze.

The debtor doesn't do present value may just adds up the total cash will be paid to the bank. 950,000 to principal and a 30,000 no interest payment. May's going to give the bank in total 980,000 cash on a million and $40,000 note is an immediate $60,000 gain on debt restructuring for may. And, you know, the entry that may is going to make here, right?

What's Mae going to do here may is going to credit gain on debt restructuring for the, for the 60,000. Again, that game just goes up in continuing operations, other gains and losses. So credit gain on debt restructuring 60,000, I think they would debit interest to payable 40,000 because it's a current liability and debit.

The note payable for 20,000. And what that when you, when you book that entry, that leaves a balance notes payable of 980,000. And May's going to pay that off the nine 50 plus the 30,000, the other $30,000 payment in year eight. There's no interest recorded after that point. It's just the immediate $60,000 gain on debt debt restructuring for me, just an ordinary game on debt restructuring.

Keep studying don't fall behind and I'll look to see you in the next class. Now, you certainly know that in a formal balance sheet, a corporation reports its capital structure under the heading stockholders' equity. And we're going to begin the course by going over the different components that make up stockholders' equity.

Let's look at a stockholders' equity section and your viewers guide. And of course it starts with common stock. Notice in this example, there are 60,000 common shares issued and outstanding at $10 par per share. So the total part value for all the common shares issued and outstanding adds up to 600,000.

So notice in a formal balance sheet, corporations are supposed to report the total par or stated value in the exam. You can treat par and stated value is being exactly the same thing, but in a formal balance sheet, corporations are. Supposed to report the total par or stated value for all the shares issued and outstanding.

And that's actually where I want to begin. Since companies are required to report the total par value or stated value for all the shares issued and outstanding. What is par value since we have to report it? Well, let me just give you a quick note here. If they ask you anything in the CPA Exam about par value, just remember one key phrase, the phrase is legal capital.

That's what par value represents. It represents the legal capital of the corporation. Theoretically, it is there to provide some minimum basic protection for creditors. I'll say it again. The par value of a corporation is that corporation's legal capital, theoretically. It is there to provide some minimum basic protection for creditors.

What do I mean by protection for creditors? Well, in most States, this really does depend on. The laws of the state of incorporation, but in most States, corporations are not allowed to pay any dividends out of par value. Again, in most States, depending on the state of incorporation, but in most States, corporations are not allowed to pay a dividend out of par value.

Why? Because it is the legal capital of the corporation. It is there to provide some minimum basic protection for creditors. The next component of stockholder's equity is API C. Additional paid in capital. Now, where did that million dollars come from? I think, you know, additional paid-in capital for the most part represents what shareholders were willing to pay in excess of par or stated value to acquire shares.

That's additional paid-in capital, which shareholders were willing to pay in excess of power or state of value. What shareholders were willing to pay in excess of legal capital to acquire shares. And then we have retained earnings. You know what that is? Retained earnings is the cumulative net income of the corporation from the date of incorporation.

It is the cumulative, it's a cumulative figure. It is the cumulative net income of the corporation from the date of incorporation after you've deducted dividends, basically. And then notice there's one more component of stockholders' equity accumulated. Oh, the comprehensive income items, accumulated OCI.

Why do we have that? Well, I think, you know, there are gains and losses that are simply not on the income statement. An example, if you have an unrealized holding gain or loss from an available for sale security. No, you have an unrealized holding gain or loss from your available for sale securities, that gain or loss is not on the income statement goes directly to stockholders' equity.

As an item of OCI. If you have a gain or loss from a foreign currency, translation adjustment, for example, you translate a foreign subsidiaries financial statements to U S dollars. You have a gain of loss from a foreign currency translation adjustment that gain a loss is not on the income statement.

That goes directly to stockholders equity as an item of OCI. So we have these gains and losses. They're not on the income statement. So they flow directly to stockholders' equity as an item of other comprehensive income on item of OCI. So now in stockholders' equity, you can see, we have accumulated OCI.

Notice the word accumulated it's like having a retained earnings account. Down in stockholders' equity notes, it's accumulated OCI, it's cumulative. So it's just like having a retained earnings account down in stockholders' equity, where we accumulate all these gains and losses that are not on the income statement.

And of course, as we go through these classes, you know, we'll go over available for sale securities. We will go over foreign currency translation adjustments in more detail. Yeah. So don't worry about that. Now we're just looking at what makes up stockholders' equity. So in this example, The total value of stockholders' equity.

The total book value of the corporation is 3,000,006. Now, one of the major things that the CPA Exam likes to hit with stockholders' equity is dividends. There's a lot that I can do with dividends. Just to get us warmed up, let's start with a simple cash dividend. Let's say that this corporation that we just went through, let's say they declare a $200,000 cash dividend.

Well, if this corporation. Declares a $200,000 cash dividend. You know, the entry you're going to debit retained earnings 200,000. Remember dividends come directly out of retained earnings. They're not on the income statement. They don't affect earnings in any way. So you would just, you would simply debit retained earnings, 200,000 and credit dividends payable, 200,000.

That's a simple cash dividend. Let's try to complicate it. Let's say instead, you know, forget that $200,000 cash dividend, let's say instead the same corporation declares a dividend of 1 million, seven 50. What's going to happen here. Well, if they declare a dividend of 1 million, seven 50, you know, they're going to credit dividends payable 1 million, seven 50, but I think you see the complication they're going to debit retained earnings, just 1,000,005.

You see what's happened in this problem. The corporation has declared a dividend greater than their accumulated earnings. And here's the point if a corporation declares a dividend greater than their accumulated earnings? Well, then at that point, they are no longer distributing earnings. They're distributing capital, so that other 250,000 would be a debit to API.

See that other 250,000 is a distribution of capital. So you've got to debit the other 250,000. Two additional paid-in capital. And I want you to remember there's a name for that, that 250,000 that we debit the API. See, that's what the CPA Exam would mean by a liquidating dividend. You have now the CPA Exam talks and that is a liquidating dividend.

It is a distribution of capital. So watch out for that. If you declare a dividend greater than your accumulated earnings, then theoretically at that point, you are no longer distributing earnings. You are distributing capital. So the other 250,000 would be a debit to API C. Let's look at a question in your viewers guide question number one says a corporation declared a dividend

up portion of which was liquidating. How much would this declaration affect each of the following? Well, the portion that's liquidating with lower API C answer B and the portion that's non liquidating. With lower retain earnings. It is answer a bit decrease under bolt, right? If you declare a dividend, a portion of which is liquidated well, the portion that's liquidating lowers API, say the portion that's not liquidating comes out of retained earnings.

Answer big look at number two, by contrast two says all corporation declared and paid a liquidating dividend of a hundred thousand. The distribution resulted in a decrease in old. What. Paid-in capital you'd want. Yes. Liquidating dividends by definition are distribution of capital. They come out of API. C how about retained earnings?

No. Now liquidating dividends are a distribution of capital. And you might say, well, Bob wouldn't, they have had to go to retained earnings first. Well, how, how do you know they had earnings? You can't make assumptions. You don't know that this corporation has ever had earnings. All that you are told in this question is that there has been a liquidating dividend and liquidating dividends by definition are a distribution of capital.

So you want yes, underpaid and capital. It would decrease Hayden capital, but no under retained earnings, because again, liquidating dividends by definition are a distribution of capital. They don't touch retained earnings. Not the liquidating piece. Doesn't and as I say, if a student is thinking, yeah, but they would have gone to retain earnings first.

You don't know that they've ever had earnings. You don't know that there are any accumulated earnings. So be very careful. Now we're going to stay on dividends. And what I want to get into next is how you allocate dividends to common and preferred stockholders. They like this too. Now it's a basic type of problem.

But we have to make sure that you refresh your memory, how to do this. So if you go to viewer, your viewers guide, you'll see a stockholders' equity section. And it's basically the same stockholders' equity section that we started with. But now we've added some preferred stock. No notice there are 4,000 preferred shares, outstanding at a hundred dollars apart per share.

So the total par value for all the preferred stock issued outstanding is 400,000. And notice the preferred is 9%. It is cumulative it's fully participating and notice dividends are eight years in a rears, not including the current year. Let's assume that the board of directors have declared a $380,000 dividend.

That's what I'm going to assume that the board of directors have declared and paid a $380,000 dividend. The question they would ask you when the CPA Exam is. How much of that 380,000 dividend would go to preferred stockholders and how much would go to common. So we'll set up a column for preferred. We'll set up a column for common and let's just talk it through.

I think, you know, the minute you see that word cumulative, you know that before common stock holders can get a dime of dividends, the dividends in arrears have to be settled first. So let's work it out. You may remember this with preferred stock. The annual dividend is a fixed rate on par value. So I'm going to take the fixed dividend rate 9% times the par 400,000 let's agree that the annual per dividend is 36,000.

It's a fixed rate on par take the fixed dividend rate 9% times the par 400,000 let's agree that the annual for a dividend is $36,000. And since it's eight years in arrears, take 36,000 times eight. Let's agree. The first. 288,000 of the three 80 has to go to preferred stockholders. You have no choice.

Those are the demands of the cumulative feature. Before common stock holders can get a dime of dividends. The dividends in arrears have to be paid first. Now what comes next? That's right. Don't forget. The current year, they said that dividends were eight years in arrears, not including the current year.

So don't forget in the current year. Preferred stockholders are gonna step forward and demand to be paid first. Remember, that's the whole idea behind preferred stock? The whole idea behind preferred stock is you give up your voting rights. Remember preferred stockholders have no voice in management.

They give up their voting rights and in return they get preferential treatment. They get. Privileges that other shareholders don't receive. And their most basic privilege that they get by giving up the voting rights is that they are preferred as to dividends. So when the current year that's not going to go away before Carmen can get anything preferred stock holders are going to demand their current use, but for a dividend.

So we add another 36,000. So if you add that up, you add up 288,000 plus 36,000. Let's agree that the first 324,000. Of the 380,000 has to go to preferred stockholders. And you have no choice. Now I have a question for you. I want you to think about this. If I told you the preferred stock was participating, I know it is we'll get there, but think of this first, if I were to tell you the preferred stock was, non-participating what I worked down to the 324,000.

Exactly the same way and just give the rest of the common. What do you think about that? If preferred was non-participating do I work down to the 324,000 just as we did and then just give the rest to common? Yes. It's a much easier problem. If preferred stock is non-participating, we're basically done. We worked down to the 324,000.

Exactly the same way. Give the rest of common and you're finished. I like you to see this the way I do when you see preferred stock is participating, what that does that puts a ceiling. It puts a limit on what you can give common stock holders at this point. What can I give common stockholders at this point?

Listen, a dividend at the same rate at the same rate as preferred. So now common can get up to 9% of their par 9% of 600,000 or the next 54,000. That's what participation does to you? It puts a ceiling, a limit on what common stockholders can get at this point. All common can be given at this point is a dividend at the same rate at the same rate as preferred.

So now common, you can get up to 9% of their par 9% of 600,000. The next 54,000. Now let's summarize, we gave the first 324,000 to preferred, right? The next 54,000 common add added up three 24 plus 54. Haven't we allocated. 378,000 of that dividend, but the dividend is 380,000. That still leaves another 2000 of dividend to be paid out this year.

That's the participation amount. Make sure you see what we get that participation amount. We've allocated three 24 plus 54, 378,000 to the shareholders. But the dividend is three 80. There's still another 2000 to distribute. That is your participation amount. And that's our final question. How do you work out participation?

In my experience with students, most students remember it pretty well down to here, but what a lot of students forget is how you work out the participation. So remember the way you work out participation is relative par values. Say it again. The way you work out participation is relative par values.

Let's do it. The total par value for common 600,000 total par value for preferred 400,000 added up what's the total par value in the corporation, a million. And now you strike a ratio. You say, since preferred makes up 400,000 over a million, 40% of the total part in the corporation preferred would get 40% of that remaining 2000 or $800 of participation.

Let's move on since common makes up 600,000 over a million, 60% of the total par value in the corporation, common would be allocated 60% of that remaining 2000 or $1,200 of participation. And you can see there is your final distribution. The final distribution of that dividend would be 324,800 to preferred 55,200 to comment.

And the problem is done. You can't go in that exam and not know how to allocate dividends to common and preferred stock holders. They could easily work that into a simulation. I mean, they certainly could have a multiple choice on that, where you allocate dividends to comment on preferred stock holders, or it's easy to imagine a simulation on stockholders' equity and they throw in a dividend and one of one or two of their questions would be how much of the dividend would go to common stockholders.

How much of the dividend would go to preferred stockholders? I want you to notice the next question. Number three, car corporation. I'd like you to do that question, have that done before you start the next class. So get that question done and I'll look to see you in the next class. Keep studying.

Welcome back at the end of our last class, I assigned a question for you to do before starting this class, and I know you've done it. Let's take a look at car corporation. The car corporation has declared a $44,000 dividend. And of course, the question is how much of that dividend would go to preferred stock holders.

How much would go to common stockholders? And you know that the minute you see that word cumulative before common stock holders can get a dime of dividends, the dividends and the rears have to be settled first. So we'll give preferred stock holders, their dividends in arrears. That's 12,000 now what's next.

The current year, don't forget that current year in the current year, preferred stockholders step forward demand to be paid first and they get it. That is their privilege to give up their voting rights. They get preferential treatment that preferred as to dividends. So they demand the current year's dividend.

So we know with preferred stock, the annual dividend is a, is a fixed rate on par value. So I'm going to take the fixed dividend rate 6% times the par a hundred. We know that the. Annual, but for a dividend is $6 per share. Times 4,000 preferred shares. Outstanding. Let's agree that the annual for a dividend is 24,000.

So we give preferred stock holders. The current year's dividend 24,000. So you add up the dividends in arrears, 12,000, the current year's dividend 24,000. That adds up to 36,000. Can I just give the rest of the common 8,000? I can. The answer is B because there's no participation to worry about. There's no participation.

It's a much easier problem. You just give the first 36,000 to preferred the rest goes to common and you're done. Now. I want to stay on dividends because there's a lot the CPA Exam can do with dividends. And what we're going to get into next is stock dividends and stock splits. Let me start with some definitions.

A stock dividend is simply a dividend that's declared in the form of shares. That's a stock dividend, a dividend that's declared in the form of shares. In other words, a corporation declares a dividend, but rather than send you cash as a dividend, they send you additional shares of stock in the corporation.

As a dividend, that's a stock dividend. Now a stock split. Is just a very large stock dividend. It's a huge stock dividend. That's what a stock split is. Now the first thing they could get into in the exam, how large is large. In other words, how large does a stock dividend have to be before you consider it a split?

I'll give you a guideline that you can always lean on. Just remember this. If a corporation increases their shares outstanding by 25% or more again, if a corporation. Increases their shares outstanding by 25% or more. You treat it as a split under 25% dividend. You're safe with that little guideline. Hey 25% or more split under 25% dividend.

Now let me say this. The secret to stock dividends and stock splits is to make sure when you get in that exam, you know how to book a stock dividend. How to record a stock dividend, how to record a stock split. So let's do a problem together. If you look in the viewer's guide, you'll see the same stockholders' equity section that we started with in our last class.

This corporation has 60,000 common shares. Outstanding at $10 apart per share. Total par for all the common shares issued outstanding 600,000 additional paid-in capital, a million retained earnings, 1,000,005 accumulated other comprehensive income items. 500,000 so that as we start the total value of stockholders' equity, the total book value of the corporation is 3 million, 600,000.

Now let's assume that this corporation declares a 10% stock dividend notice. It's below 25%. It's a small one. They declare a 10% stock dividend notice when the fair market value of the stock is $50. And I want to say worried about this, that $50. That's what the stock is trading for on the day of declaration, you be careful that $50.

That's what the stock is trading for on the day of declaration, I'm going to warn you, what the CPA Exam can do is give you, you know, several different market prices, because they know what messes people up. They'll tell you what the stock is trading for on the day of stockholders of record. They'll tell you what the stock is trading for the day.

They send out the shares. They'll tell you what the stock is trading for on the day of declaration in any dividend question. What's the only date we care about date of declaration. So that's what I look at. What is the stock trading for on the date of declaration? All right. So let's, let's do the entry to record this stock dividend.

And I want to start with basics. How many shares are going out? Well, remember if you declare a 10% stock dividend, what you are literally doing. Is increasing your shares outstanding by 10%. So I'm going to take 10% of 60,000. They're going to send out another 6,000 shares as a dividend number. That's how you read a problem like this.

If you declare a 10% stock dividend, you are literally increasing your shares outstanding. By 10%, you're sending out another 10%, another 6,000 shares. So here's our entry. I'm going to take the 6,000 shares. They're sending out as a dividend times, $50, the fair market value of the stock on the day of declaration.

And we're going to debit retained earnings 300,006,000 shares, times 50 debit retained earnings, 300,000. We're going to credit common stock for legal capital, 6,000 shares at par 10 60,000 and credit API C for the rest 240,000. That's the entry to book a stock dividend. And if you know that entry, you should be able to answer whatever they throw at you.

You have to know that entry to record a stock dividend. Now I know this next point is basic, but I have to make sure you notice it. We know that the total value of stockholder's equity, the total book value of the corporation before the stock dividend was 3,000,006, right? What's total stockholders' equity.

What's the total book value of the corporation. After the stock dividend 3,000,006. I want you to remember that stock dividends or splits will get the splits in a minute, but stock dividends were splits. Never affect total stockholders' equity. They never affect the total book value of a corporation. If you look at that entry, all we're doing is taking money out of retained earnings and putting it into other capital accounts.

You're just rearranging numbers within stockholders' equity. And there's a term you should know what you've done in that entry is you have capitalized a portion of your retained earnings. Remember that term? That's what the entry is really doing that in that entry, what we have done. Is, we have capitalized a portion of our retained earnings.

And I want you to remember that stock dividends or splits never affect total stockholders' equity. They never affect the book value of the corporation. All right. Now, listen carefully. Let's say that that 10% stock dividend never happened. All right. Wipe it from your memory banks, because I want to use the same stockholder's equity section.

So that never happened. Let's say instead, instead, this corporation declares a hundred percent stock dividend. Or what they would call a two for one split. Well, once again, let's start with basics. How many shares are going out? I remind you again, if you declare a hundred percent stock dividend, what you're doing is increasing your shares outstanding.

By a hundred percent, you're sending out another a hundred percent. You're sending out another 60,000 shares as a dividend. Now with splits, there are two ways to go. You have to know this. There are two acceptable ways of handling a split method. Number one. You just make a memorandum entry notice there's no journal entry.

You don't book anything. You just make a memorandum entry to the effect that the shares outstanding have gone from 60,000 to 120,000 shares. Outstanding have doubled and notice the par is cut in half. From 10 to five, that is a perfectly acceptable way of handling that split. You just make a memorandum entry to the effect that the shares outstanding have doubled from 60,000 to 120,000.

And the par per share has cut from 10 to five. So you still have 600,000 of legal capital. That is one way to handle a split notice. You don't book anything. There's no journal entry. Now, before I show you the second approach, notice that anytime we handle a split. With a memorandum entry Parr per share.

It goes down like in my example, shares outstanding have doubled park cut is cut from 10 to five. Anytime you handle a split with a memorandum entry, par per share has to come down well in practice that may not be possible in practice. You may be legally prohibited from doing that depending on the laws of the state of incorporation, depending on your bylaws, your articles of incorporation.

It could be that that $10 per share par value is sacred. It can't be altered. So here's the second way you can handle the split. If the corporation wants to maintain that $10 per share par value, I'll say it again. Second way of handling a split is if the corporation wants to maintain that $10 per share par value.

And as I say, it's probably a legal requirement. Then they will book an entry with a split. They will capitalize retain earnings at the par value of the shares. They're sending out, not the fair value. So we know that sending out 60,000 additional shares times par 10, you would debit retained earnings, 600,000 credit common stock, 600,000.

And that way you'd maintain the $10 per share par value. So if you, with me, those are the two ways you can handle a split. You can either make a memorandum entry. Hey shares. Outstanding of doubled power is cut from 10 to five, or if an a split you want to maintain the par per share. You duplicate entry with a split.

When you capitalize retain earnings at the par value at the par value of the shares you're sending out. Let's look at a set of questions. Look at the look at questions one and two, and your viewers guide for this class D Inc. Question number one says, how would I, how would a hundred percent stock dividend now?

You know, that's big enough to be a split. How would a a hundred percent stock dividend affect API C and retained earnings? Well, just think about what we just went through. How would a a hundred percent stock dividend, a two for one split affect API C and retained earnings. Let me ask you a question in a split.

Would it be possible to have no change under both columns? Think about that for a minute in a split. Would it be possible to have no change under both columns? Yes. If we made a memorandum entry, right? If we made a minimum write a memorandum entry, we don't book anything. There's no journal entry. So there'd be no change to API C no change to retained earnings.

I hope you see that. If in a split we do a memorandum entry. We don't book anything. There's no journal entry, so there'd be no change to API C. No change to retain earnings notice that's not an answer choice. There is no answer choice, no change under bolt. So what does that tell you? They must have done the second approach.

They must have capitalized retained earnings at par value. So they must have watched debit and retained earnings for the par value of the shares they sent out. So retained earnings would go down an API C wouldn't be touched, and the answer is D. I hope you see the way you break that down. You could have no change under both columns if they made a memorandum entry, but that's not an answer choice.

So they must have done the second approach. They must have capitalized retained earnings for the par value of the shares they set out. So they would debit retained earnings for the par value of the shares and credit common stock. So retained earnings would go down API. C's not touched now. Look at the next question.

How would a 5% stock dividend now it's a small one. How would a 5% stock dividend affect API C and retained earnings? Well, again, think of the entry. If it's a small one, if it's a 5% stock dividend below 25%, I debit retained earnings for the fair value of the shares. So retained earnings would go down. I credit common stock for par and I credit API C for the rest API C would go up.

And the answer is a, how do you know there is API? Because just above the question that said. At all times the stock was selling for more than par notice, just above the questions at all times, the stock was selling for more than par. So we know there would be some API say, but in a small dividend, you debit retained earnings for the fair value, the shares.

So retained earnings would go down. You credit common stock for par and API C would also go up. The answer is a look at the next question. Number three, saw cooperation at the bottom. They say, what was the aggregate. Amount dividend to retain earnings. Well, if you look at the schedule, we know that 25% or more split under 25% dividend.

So the 10% distribution is a dividend. So we would debit retained earnings for the fair value of the shares. So I circled the 15,000, the 28% distribution is a split. So we're going to debit retained earnings for the par value of the shares. I'd circle 30,800. So when they ask us at the bottom. What is the aggregate debit to retained earnings?

It is 15,000 plus 30,800. Answer B 45,800. Now I want to make sure you notice that I just gave you my notes on stock dividends and stock splits from the issuing side, from the declaring side, from the standpoint of the company declaring a stock dividend or split, let's go to the other side. What if I'm an investor?

What if I'm a shareholder? And I receive a stock dividend, or I receive a stock split. We might as well cover it all together. So make sure this is clear in your notes. Now we're on the investor side and it's really very simple. If you're an investor, if you are a shareholder and you receive a stock dividend, or you receive a stock split, you just make a memorandum entry.

And recalculate your per your per share cost. Again, if you're a shareholder, you're an investor and you will receive a stock dividend. You receive a stock split. Well, then you just make a memorandum entry, just a memorandum entry. Notice you don't book anything. There's no journal entry, just a memorandum entry and you recalculate your per share cost.

That's all there is to it and make sure this is clear in your notes. There's no income. There's no income. They asked that a lot, not in financial accounting. There's no income. And you may know a tax. There could be in tax law. That could be if the shareholder has a cash option, it could be some income from a tax standpoint, but not in financial accounting.

You just make a memorandum entry, recalculate, your per share costs. And there's no income. Look at number four. Stock dividends on common stock should be recorded at the fair market value. Notice by the invest door on the investor side here, when the re when the related investment is accounted for under which method, what would you have under cost method?

No equity method. No, the answer is D because it's not recorded at all. They're just trying to talk you into something they're members. It doesn't matter what method you use. It doesn't matter whether you use the cost method, equity method, make up a method. It doesn't matter what method you use to account for the investment.

If you receive a stock dividend or split, it's just not recorded. It's not booked. It's just a memorandum entry, recalculate, your per share costs. You know, if I, if before the, the stock dividend or split, I had a thousand shares of stock that costs me a hundred thousand dollars. And now there's a two for one split.

Well, now I have 2000 shares that costs me a hundred thousand. So now my basis is $50 a share rather than a hundred dollars a share. I recalculate my per share costs. There's no income, not in financial accounting. Now I'll tell you what else I worry about. I worry about this a lot. Don't be one of those students that in your mind confuses a stock dividend with a property dividend don't confuse the two.

They're very different. Let make sure you see the difference. We both know that if I'm holding a thousand shares of Microsoft stock, right. And Microsoft sends me another hundred shares of Microsoft stock as a dividend. Clearly that's a stock dividend, right? I own a thousand shares of Microsoft stock. If Microsoft sends me another a hundred shares of Microsoft stock as a dividend, that's a stock dividend.

But how about this? What if I own a thousand shares of Microsoft stock and Microsoft sends me 400 shares of AOL stock as a dividend. I know I'm dreaming, but if Microsoft sends me 400 shares of AOL stock as a dividend, that's a property dividend. They're very different. And just one quick note here, the secret to property dividends is to remember that property dividends are always recorded at their fair market value.

Use the fair value of the property. Always at fair value. The fair value of the property. Look at question five on December one. NYLO declared a property dividends. Notice the FAR CPA Exam makes it very clear. This is a property dividend of marketable securities to be distributed on December 31 to shareholders of record December 15.

Notice the CPA Exam likes to do this, give you all these dates. I ask again in a dividend question, what's the only date we care about date of declaration. So they go on to say, On December one, the date of declaration, the marketable securities had a carrying amount of 60,000, a fair value of 78,000. Let's put the entry down entries always help.

Here's the entry that you make. If you declare a property dividend, when they declared this property dividend, they're going to debit retained earnings for 78,000. The fair value of the property, as I say, the key to property dividends is to remember, to use fair value on the date of declaration. So when they declare that property dividend, they are going to debit retained earnings.

For 78,000, the fair value of that property on the date of declaration, they're going to credit investment in AOL, whatever it is for its original cost, 60,000 and notice credit gain 18,000. The point is the corporation has to report any gain or loss on the property. So in this case credit gain of 18,000, there's a gain here.

And as I say, the key is to remember that when you declare a property dividend, you record the property dividend at fair value and you have to report and he gained a loss on the property. Now we haven't answered the question yet. They go on at the bottom to say, what is the effect of this property dividend on nylons retained earnings.

After all the nominal accounts have been closed and underline that after. All the nominal accounts have been closed. Now they want you to sit in the CPA Exam and go for D right? They want you to go, Oh, it's in effect on retained earnings, 78,000. Not after the nominal accounts are closed water nominal accounts.

Well, if you haven't seen that term in a while, nominal accounts are income statement, accounts, revenues, expenses, temporary accounts. So if you look at the entry that we just booked for that property dividend, what is the nominal account? What is the income statement account in that entry? The game? Well, if that game has been closed, it's been closed to retain earnings were all gains and losses end up.

So let me summarize retained earnings went down 78,000, the fair value of the property. But if that gain has been closed, if the nominal accounts have been closed to retain earnings, retained earnings would have gone up 18,000 because of the gain on the property. So the net effect on retained earnings is 78 minus 18, 60,000 answers.

See, watch out. After the nominal accounts are closed. The net effect on retained earnings is 78 minus 18 60,000. Keep up with your work. Don't fall behind. I'll see you in the next class.

Welcome back in this FAR CPA Exam Review course. We're going to continue our discussion of stockholders' equity. And what we're going to get into next is stock options. More precisely stock options that are meant to be compensation. They are meant to be salaries and wages. Now here's the first point. If you're in the CPA Exam and you see stock options that are meant to be compensation, they're meant to be salaries and wages right away.

You know, there are two key issues. Number one, when do you measure the compensation? Again, issue number one would be, when do you measure the compensation and issue? Number two would be, how do you measure the compensation? The answer to when you measure the compensation is on the day of the grant. So that's the answer.

Wendy measured the compensation on the day of the grant. Now, how do you measure the compensation? Well, in terms of how you measure the compensation. Companies are now required to use the fair value based method. In other words, the real measure of the compensation is the fair value of those options. You know, what would somebody be willing to pay you for those options when you really get down to it?

Isn't that really how to measure the compensation, looking at what somebody would be willing to pay you for those options. Looking at the fair value of the options on the day of the grant. That is the best way to measure the compensation. And as I say, all companies are required to measure stock options as compensated as compensation, using the fair value based method.

Now, how do you estimate what options are worth? How do you estimate the fair value of options? Well, they recommended the black Shoals binomial pricing model. So what we're going to go over now is the black Shoals. Binomial pricing model. Now in the black Sholes model, we look at six factors to try to estimate what the options are worth.

And I think you should know the six factors. And if you just remember the word devils, just think of devils. If you're a hockey fan, think of the New Jersey devils, you think of devils. You've got all six factors. Let's go over the six factors the day. What are the expected dividends from the shares? You expect a large amount of dividends, small amount of dividends, no dividends.

What are the expected dividends from the stock? The E what's the exercise price. I think you'll agree if I have options. If I have options to buy Microsoft stock, there are a lot more valuable. If I can buy the stock at $1 a share, then if the option allows me to buy the stock for a thousand dollars a share, that's a very important factor.

What is the, what's the exercise price. The V is volatility. How volatile is the stock? Is this a boring old utility or is it a dynamic internet startup stock matters? Doesn't it? How, how volatile is the stock? I, as interest rates are interest rates high, low in terms of discounting L what's the life of the option.

That matters too. Doesn't it? Options are not as, not as valuable if I have to exercise them within the next seven days. But if you give me 10 years to exercise them, they're a lot more valuable. So what's the life of the option. How long do I have to exercise the option? And then S what is the underlying stock price?

Those are the six factors you look at to try to estimate what the options are worth. And when do you look at those six factors on the day of the grant? To try to estimate the fair value of the options. Because again, bottom line, that's the best way to measure the compensation. Let me give you an example.

Let's say on January 1st year 11, a company grants, an option to a, I'm assuming that a is the president of the corporation. Now the president a can use this option to buy up to 10,000 shares of stock at. $25 a share. That's the option price. That's the exercise price. So the president can use this option to buy up to 10,000 shares of stock.

The stock has a power of 10 and the exercise price is $25. So the president can buy up to 10,000 shares at that exercise price, that option price $25 a share. And one more point, these options are meant to compensate the president for four years of service. All right. So we think about our issues. First of all, when do we measure the compensation on the day of the grant?

So here's what we do on the day of the grant. On January 1st, 2011, we look at the six factors. We look at the expected dividends from the stock. We look at the exercise price, how volatile the stock is, interest rates, the life of the option, the underlying stock price. We look at the six factors and using those six factors.

We estimate the options have a fair value of $160,000. That's 160,000. Now this might make you feel better right away. I think the CPA Exam would give you that in my opinion, the CPA Exam is not going to have you evaluate the six factors and come up with a number that's beyond the scope of the exam. So don't get nervous about that.

That takes experts to come up with that. So you're not going to be asked to do that. They're not going to give you the six factors and go, okay, what are the options worth? As I say, it takes experts to come up with that. I think they'll give you the number. I think they have to. All right. So we analyze those six factors on the day of the grant and we estimate the options of worth $160,000.

So what's the entry that we make on the day of the grant. On January 1st, 2011, we're going to debit deferred compensation, 160,000 notice I debit deferred compensation, 160,000 and I credit stock options. Outstanding, 160,000. Now let's talk about this. What kind of account. Is stock options outstanding.

It's a stockholder's equity account. That's why we're covering this with stockholders' equity because that account stock options outstanding. That is a stockholder's equity account. In fact, that account is going to stay down in stockholders' equity until when, until the options are exercised, which we'll get into in a little bit.

But that account stock options outstanding. That's simply that's a stockholder's equity account. It stays down in stockholders' equity until the options come in until they're exercise. What kind of account is deferred compensation, contract equity. It's a debit and stockholders' equity. It's a reduction stockholders' equity.

So right now, down in stockholders' equity, it all washes out. Now, if you wouldn't be all that on that entry, listen very carefully. This next point is critical. Don't forget that your job in the CPA Exam now. Is that allocate that compensation over the periods of service. So many students forget that that that's your job in the exam.

You have to allocate that compensation over the periods of service. So let's go ahead a year. It's now December 31 year 11 weren't. We told that these options were meant to compensate the president for four years of service. So at December 31 year 11, what our thought process, since one of the four years have passed.

Presumably one quarter, one fourth of the services have been performed. So we're going to debit what compensation expense, 40,000 notice expense salaries and wages. It goes to my income statement and salaries and wages. These options were meant to be compensation. They were meant to be salaries and wages.

So we're going to debit compensation, expense 40,000, and we're going to credit. Deferred compensation, 40,000. Don't forget that your job in the CPA Exam is to allocate that compensation over the periods of service. And of course, I would have an identity. I'd have an identical entry to that. December 31 year 12, December 31 year 13, December 31 year 14.

We're not going to do all the entries, but you'd have four identical entries just like that. The end of year 11, 12, 13, and 14, because that's your job in the CPA Exam to allocate that compensation over the periods of service. Now, one more thing. What happens if the president exercises the options? I want to show you this because the CPA Exam can go this far.

So let's say the president now exercises all the options. If the president AE exercises, all the options, how many shares can the president by president could buy 10,000 shares? Does the president have to pay any cash? Yes. $25 a share. Remember the stock is not free. The president can buy shares at a fixed price, $25 a share the exercise, price, the option price.

So let's work it out. If all the options are exercised, the president's going to buy 10,000 shares at $25 a share. Won't the company debit cash 250,000. And now because the options have come in, we're going to debit stock options, outstanding, 160,000. Notice that account comes out of my stockholder's equity section.

I'm going to credit common stock for 10,000 shares times par 10, a hundred thousand. Now they issued, they issued the chairs. So you're going to credit common stock for 10,000 shares at par 10, a hundred thousand in credit, additional paid-in capital for 310,000. That's the entry that you make when the options are metricized.

Now listen very carefully. I hope you understand that that entry that we just made, where the options were exercised, that could be 10 years from now that has no effect at all on allocating the compensation over the periods of service. Don't mess up these time periods. In other words, they could say in the exam, The president has up to 15 years to exercise the options.

That's very generous, but it doesn't alter the fact that we have to allocate the compensation over the four years of service. Those are two very different time periods. Again, they could say the president has 150 years to excise the options. That's unbelievably generous, but it doesn't alter the fact that our job is to allocate the compensation over the periods of service.

Over those four years of service. So don't mess up the time periods. Let's look at a problem on January 2nd of the current year Kay company, granted Morgan, the president compensatory stock options to buy up to a thousand shares of $10 par stock the options call for a price of $20 a share. So there's the option price.

There's the exercise price and are exercisable. For three years following the grant date. And again, that's not the period. You really worry about how long they have to exercise the options. That's a different issue. Then they say the options are valued at 35,000 on the date of the grant. So notice they get, in other words, they look at those six factors devils, and you know why I want you to know those six factors.

You've got to know those six factors because they can ask, they can have a multiple choice on that. And of course, In a simulation, they could have a written communication, you know, write a memo to your client and explain how your client would estimate what options are worth. Dear client to estimate what options are worth.

You should look at six factors on the date of the grant. You should look at the expected dividends and so forth and so on. You know, devils, you know, that written communication really writes itself. And then they could have multiple choice on it as well. But as I said, they'll give you the number and they did here.

They said the options are valued at 35,000 on the date of the grant. Morgan exercise the options on December 30, one of the current year, the market price of the stock was $50 on January 2nd, $70 on December 31. We don't really care about that. What we cared about was the fair value of the options on the day of the grant, the 35,000, by what amount, by what net amount would stockholders' equity increase as a result of the grant and the exercise of the options?

Well, let's do a couple of entries. First of all, on January 2nd. What entry was made on the day of the grant will on January 2nd on the day of the grant, K company would have debited deferred compensation, 35,000 and credit stock options outstanding 35,000. The fair value those options on the day of the grant.

Remember that's the best way to estimate the compensation, looking at what the options are worth on the day of the grant. And they gave you that. So on January 2nd, they would have debited deferred compensation, 35,000. And credit stock options outstanding 35,000, the fair value of those options on the day of the grant.

Now on December 31, the options are exercised. So what entry is made well, if the president exercises all the options, the president Morgan can buy up to a thousand shares of stock at $20 a share that's the option price. So won't the company debit cash, 20,000 thousand shares at times 20 debit cash 20,000.

And because the options have come in. Now the company will debit stock options outstanding. 35,000. That account comes out of stockholders' equity. They're going to credit common stock for a thousand shares at par 10, 10,000. That's legal capital and credit API C for the rest 45,000. Now those are the entries that have been made here.

So when they ask us at the bottom, by what net amount would stockholders' equity increase as a result of the grant and the exercise of the options? Well, look at the exercise. If you look at that entry didn't we credit common stock, 10,000 credit API, 45,000 haven't we credited capital accounts, 55,000, but we also have deferred compensation of 35,000 that's contract equity.

So the net increase to stockholders' equity is 20,000. Let me do that again. If you look at the entries, when they exercise the options, we credited common stock, 10,000. We credit API see 45,000. We have credited. Capital accounts, 55,000, but don't forget. We have that other account deferred compensation, 35,000, that debit.

That's a debit and stockholders' equity. That's a reduction of stockholders' equity. So the net increase to stockholders' equity would be the 55,000 minus the Contra equity account, 35,020,000. Answer a keep studying and I'll look to see you in the next class. See you then.

Yeah, welcome back in this FAR CPA Exam Review course. We're going to continue our discussion of stockholders' equity. And what we're going to get into next is treasury stock. As I think, you know, when a corporation acquires shares of its own stock, that's the situation we're going to be looking at when a corporation acquires shares of its own stock.

These shares immediately go in the treasury. And it's what we mean by the phrase treasury stock now right off the bat. I think there are three big things that you want to remember about treasury stock. First of all, please remember that when shares were in the treasury, they're still considered authorized.

They're still considered issued, but they're no longer considered outstanding shares. Make sure you remember that when shares are in the treasury, they're still considered authorized. They're still considered issued, but they are no longer considered outstanding chairs. As I think, you know, what does outstanding need for shares for shares to be outstanding?

They have to be in the hands of shareholders and these shares are not in the hands of shareholders. They're in the treasury. So they're authorized, they're issued, but they're not outstanding shares. Second point. Remember that ultimately. Treasury stock gets reported in the balance sheet as a Contra equity item.

It is a debit and stockholders' equity. It is a reduction of stockholders' equity. It is in the final analysis reported as a Contra equity item. And one more point, not only is treasury stock, a Contra equity item. I want you to remember that the cost of the shares and the treasury, the cost of the chairs in the treasury.

Place a restriction upon retained earnings itself. Remember that the cost of the shares in the treasury do place a restriction upon retained earnings itself? What do I mean by retained earnings? Well, basically the company has to have a footnote that says theoretically, they could distribute all their retained earnings as a dividend, except the cost of treasury shares it, places that restriction upon retained earnings so that theoretically the company can distribute all their retained earnings as a dividend.

Except the cost of treasury stock. Now, the most important thing to know about treasury stock for the CPA Exam is how to account for treasury stock. And as you may remember, there are two methods of accounting for treasury stock. There is the cost method and there is the par value method. And I think the best way to study this is to know the entries for both approaches.

If, you know the entries for both approaches, you can answer whatever they come up with. So let's do a problem. We're going to start with the cost method. Let's say that originally, originally a company issued a thousand shares of $10. Our stock at $15 a share. That's what originally happened that the company issued a thousand shares of $10, our stock at $15 a share.

So we know the original entry, they would have debited cash for what they collected a thousand shares at 15, 15,000. They would have credited common stock for legal capital, a thousand shares of par 10, 10,000. And they would credit API for the rest 5,000. That's what originally happened. Now we're going to assume some time goes by and they've bought back 200 chairs of their own stock at $18 a share.

And they've decided to account for this treasury stock under the cost method. Let's do the entries under the cost method. We always debit the treasury stock account, but the cost of the treasury shares. That's why they call it the cost method. So we're going to start by debiting treasury stock, but 200 shares at 1830 600 and credit cash.

3,600. Because after all, under the cost method, you always debit the treasury stock account for the cost of the shares in the treasury, but the cost of the treasury share. So that's how we start debit treasury stock. The 200 shares at 1830 600. Credit cash 3,600. Now let's assume some time goes by and they sell a hundred shares out of the treasury for $20 a share.

What are we going to do? Well, if they sell a hundred shares out of the treasury for $20 a share, we know they're going to debit cash for what they collect a hundred shares at 20 or 2000. What do they credit? The treasury stock? Well, they're going to credit treasury stock for its cost. For its carrying value.

So they're going to credit treasury stock for a hundred shares at 18 1800. And I know you're with me. What we have here is a game. What happened in this situation is they sold treasury shares at a gain. Notice we need a $200 credit to balance the entry out. You know what I'm going to ask you. Should I credit gain on sale of treasury stock?

Never listen to me carefully. Here's an absolute treasury stock transactions. Never affect income statement accounts, never treasury stock transactions, the effect balance sheet accounts. And I'll give you another absolute again. Treasury stock transactions never affect income statement accounts. It's impossible.

Treasury stock transactions only affect balance sheet accounts. And that leads to this point. Here's another absolute anytime. There's a gain indicated in any type of treasury stock situation, what are you always credit API, but I'm going to be a little bit more precise here, and I'm going to credit API C from treasury stock for that 200, anytime there's a gain indicated in any type of treasury stock situation, you're always going to credit API or API C from treasury stock.

Now that account name API see from treasury stock. It's not published. Remember in a published balance sheet. A company only publishes one API C account, but in your subsidiary accounts, you keep track of API by source, but that's not why I'm covering this. You might see that account name in the CPA Exam API, see from treasury stock, but in the balance sheet, it's just all API C all right.

Now let's say some more time goes by and now they sell the other a hundred chairs out of the treasury for $12 a share, what are we going to do? Well, you know, they're going to debit cash for what they collect. A hundred shares at 12 or 1200, you know, they're going to credit treasury stock for its cost.

Its carrying value. A hundred shares at 18 or 1800. And notice now we have a loss notice. Now I need a $600 debit to bounce the entry out. Should I debit loss on sale of treasury stock? No, we covered that. Trey stock transactions never affect income statement accounts, never affect income statement accounts.

You know what I'm going to ask you. Should I debit API C for 600? Which is very tempting, but you can't the reason you can't debit API for 600 is because we have a rule, really a mind-numbing rule. And you just have to know it. Here's the rule. When you sell treasury shares at a loss, if it's a loss on treasury stock, you can only debit API C to the extent you've had gains on prior treasury stock transactions.

I'll say that again. When you sell, when you sell treasury shares out of loss, If you sell treasury shares at a loss, the rule is that you can only debit API C to the extent, to the extent there have been gains on prior treasury stock transactions. In other words, you can only debit API C from treasury stock in this case 200.

That's another good reason to separate that account, because if there are losses you're limited to that. So I'm going to debit API C from treasury stock for that 200, the rest I would debit to retain earnings 400. Only balance sheet accounts. So you see what you basically have to know about the cost method, how to buy the shares, sell them in again, sell them at a loss.

Let's look at a problem. Number one in year nine, CEDA purchased 6,000 shares of the $1 par value. Common at $36 a share. Then during year 10. Say to sells 3000 out of the shares, 3000 shares out of the treasury for $50 a share, say to users, the cost method to account for the treasury stock. What amount, what accounts and amounts would say to credit notice, say, what would, what would say to credit in your 10 to record the reissuance of the 3000 shares?

Let's do a couple of entries. We know in year nine. When CEDA bought those treasury stock, when SEDA bought those treasury shares, they would have debit of treasury stock for 6,000 shares at 36, 216,000 credit cash, 216,000, because we know under the cost method, you always debit the treasury stock account for the cost of the treasury shares.

All right. Now in year 10, when they sell 3000 shares out of the treasury fourth, $50 a share, what are they going to do? We know they're going to debit cash for what they collected 3000 shares at 50, 150,000. They're going to credit treasury stock for its cost. Its carrying value 3000 shares at 36 or 108,000 and credit.

What, anytime there's a gain indicated in any type of treasury stock situation, you're always going to credit API or API C from treasury stock, 42,000. So when they asked me at the bottom. What accounts and amounts would say to credit when they re-issue the shares, you know, what's the answer. See, we did credit treasury stock for one Oh eight.

We did credit API for 42. We didn't touch retained earnings. We didn't touch common stock. The answer is safe. Let's talk about the par value method. Let's do a problem once again, the way to study this. Is to know the entries that you make in the par value method. So once again, let's assume that originally a company issued a thousand shares of $10 par stock at $15 a share.

That's what originally happened. They issued a thousand shares of $10 bar stock at $15 a share. So we know the entry, they would have debit and cash for. A thousand shares at 15, 15,000, they would credit common stock for legal capital, a thousand shares times par 10 or 10,000 and credit AIC for the rest 5,000.

That's what originally happened. Now we're going to assume some time goes by and now they have bought back 200 shares of their own stock at $18 a share. Notice. This is exactly the same problem we did before, but now we're going to assume. They've decided to account for the treasury stock under the par value method.

Here we go. Under the par value method. We always debit the treasury stock account, but the par value of the treasury shares. That's why they call it the par value method. So we're going to debit treasury stock, but 200 shares times par 10. 2000 under the par value method, you always debit the treasury stock account for the par value of the treasury shares.

So we're going to start by debiting treasury stock for 200 chairs, times par 10 or 2000. We're going to credit cash for what we paid. 200 shares at 1830 600. Now, before we finished the entry, I want you to know that some textbooks, rather than call this the par value method, they call it the retirement method.

And I've always liked that some textbooks do call this the retirement method, by the way, the FAR CPA Exam never does the CPA exam always calls this the par value method. And that makes perfect sense. It's called the par value method because we always debit the treasury stock account for the par value of the treasury shares.

So calling it, the par value method makes perfect sense, but the reason why some textbooks call this the retirement method is because the secret to this method really is to remember. That in the opening entry, you have to constructively retire the shares in the opening entry, you have to constructively retire the shares.

And what does that mean? It means you have to debit API C as if you've retired, the shares. You've got a debit API C for the original API. See on every share. Now what's that? What's the original API. So you on every share $5. Why? Because originally they issued a thousand shares of $10 part stock at 15. So wasn't there $5 of original API.

See on every share times 200 chairs, we're going to debit that original API C for a thousand seats. The retirement method. In the opening entry, you constructively retire the shares. You've got a debit API as if you've retired the chairs. You're going to debit API for the original API on every chair. And I know that's $5 because originally they issued a thousand shares of $10 parts stock at 15.

So I know originally this $5 of API CEO and every chair. So I'm going to debit that original API, see $5 times the 200 chairs. A thousand and debit the other 600 to retain earnings notice only balance sheet accounts, never income statement accounts. Now that's really the only heart entry in this method, remembering that opening entry to constructively retire the chairs.

Then after that, it's not bad. For example, now let's say some time goes by and they sell 200 chairs out of the treasury for $14 a share. If they sell the 200 chairs out of the treasury for $14 a share, they're going to debit cash for 200 shares at 14. Or 2,800, that's the cash they collected. What do they credit?

The treasury stock be careful credit treasury stock for 200 years, times par 10, 2000. Remember what's in that treasury stock account is par not cost. So you're going to credit treasury stock, but 200 shares times part 10, 2000. And we know anytime there's a gain indicated in any sort of treasury stock situation, credit, API, or API C from treasury stock 800.

And if you look at that entry, Doesn't it look like a normal issuance of stock, you debit cash. What you collect credit treasury stock for par and the rest is API. All the other, the other entries, like a normal issuance of stock. The only little difficult entry is that first entry to remember to constructively retire the shares.

Let's do a problem on the par value method. Problem. Number two, ASP was organized January 2nd, with 30,000 authorized shares of $10 APAR common. And then during the year, The following transactions occurred on January 5th, they issued 20,000 shares at 15. So what was the Andrew let's do entries? Well, if they issue 20,000 shares of 15, they would have debited cash for 20,000 shares at 15 300,000, they would credit common stock for par 20,000 shares of par 10, 200,000 and credit API for a hundred thousand.

That's what originally happened. Now it does say that ASP does use the par value method. To record the purchase and the reassurance of the treasury shares. So let's apply the par value method. On July 14th, they purchased 5,000 shares of their own stock at $17 a share let's apply the par value method. We know on July 14th, they would have debit of treasury stock for the par value of the treasury shares.

So they would have debit of treasury stock for 5,000 shares at par 10 or 50,000. They'd credit cash. Four or 5,000 shares at sit at $17 a share 85,000. But remember, that's why they call it the par value method, because you're always debiting the treasury stock account for the par value of the treasury shares.

So debit treasury stock for 5,000 shares at par 10 50,000 credit cash for what you paid 5,000 shares at 1780 5,000. Now we're back to the point. Yes, you can think of this as the par value method. That's what the CPA exam always calls this, but they also refer to this. In some textbooks as the retirement method, because the key to the method is to remember in the opening entry, you have to constructively retire the shares, which means you have to debit API for the original API on every share.

And isn't that again? $5, because originally back on January 5th, they issue 20,000 shares of $10 part stock at 15. So I know there's $5 of original API CC on every share times 5,000 shares. I'm going to debit that original API C for 25,000, and I'm going to debit retained earnings for the other 10,000 notice only balance sheet accounts, never income statement accounts, but that's the entry that we'd make on July 14th to record the purchase of the shares.

All right, now some time goes by and on December 27th, they reissue the 5,000 shares at 20. So what MTD make while you're going to debit cash for what you collect? 5,000 shares at 20 a hundred thousand. You're going to credit treasury stock for par 5,000 shares of par 10 50,000. Remember what's in that treasury stock account is par value, not cost.

So you're going to credit treasury stock for 5,000 shares of par 10 50,000. And what have we said all through this? Anytime there's a gain indicated in any type of treasury stock situation, what do you always credit API or API seek from treasury stock in this case 50,000, those are the entries that would have been made here.

So when they ask at the bottom. In the December 31 balance sheet, what amount would a report as additional paid-in capital what's API? See, at the end of the year, we'll look at your entries. API see started at a hundred thousand, it went down 25,000 on July 14th. Right? It went down 25,000 on July 14th.

Cause we had to take out the original API so on every share, but then it went up 50,000. On December 31. So it's a hundred minus 25 plus 50. The answer is B API C is now 125,000. Make sure you study both methods, but I will say that the CPA Exam usually hits the cost method. You can't ignore the par value method, but usually the CPA Exam is going to hit the cost method, but make sure you review both that finishes our discussion on stockholders' equity.

I'll look to see you in the next class. Keep studying.

Welcome back in this FAR CPA Exam Review course. I want to begin our discussion of partnership accounting. And I think, you know, that the problem with partnership accounting is that there are a lot of issues that the CPA Exam can get into.  First of all,the CPA Exam  could ask you questions about how you allocate profits and losses to individual partners.

Now in practice, it's fairly simple. Because in practice, the way we allocate profits and losses to individual partners is based on the partnership agreement. However, they agree in the partnership agreement to allocate profits and losses. That's what we adhere to. What if the CPA Exam is silent? Well, I think, you know, if the CPA Exam is silent, you'd have no choice, but to assume that profits and losses are allocated equally.

So I want you to think the way I do. Do you think they're likely to be silent? No, it's too easy. If they're silent profits and losses would be allocated equally that just lets everybody off the hook. No, you trust me on this. If they have a problem in the CPA Exam on how you allocate profits and losses to individual partners, the method of allocation will be laid out in detail.

In that problem, you just have to read it carefully because again, if they're silent, it's just equal. That's too easy. The method of allocation will be in the problem. Some of the ones they like, they could give you some sort of profit loss sharing ratio, 60% for you, 40% for me, another one, they like you could allocate profits and losses based on their average capital balances and their favorite example.

The individual partners might take some sort of salary or bonus, and then any remaining profits and losses would be allocated in some profit loss sharing ratio. That's their favorite example. But as I say, if they're going to test you on this, the method of allocation has to be really laid out in the problem.

It's just a matter of reading it carefully and following it through. Let me show you what I mean multiple choice question. Number one, it says red and white. Formed a partnership at the beginning of the year, the partnership agreement provides for an annual salary allowance of 55,000 for red 45,000 for white, the partnership profits equally, but losses on a 60 40 ratio.

The partnership had earnings of 80,000 for the current year. Before any allowance to partners, what amount of these earnings would be credited to each partner's capital account? All right, so let's solve it together. We'll set up a column for red and a column for white. We'll work it through, we'll start with their salary allowances.

You know, they're taking a salary. Red takes a $55,000 salary. White takes a $45,000 salary, you know, to live, you know, they, they take this monthly, weekly, whatever, just so they can live. And it turns out that the partnership profit for the year. Was 80,000. When I back out the salary allowances that they've taken a hundred thousand, that throws the partnership into a $20,000 loss.

And remember they allocate losses 60, 40. So red would get 60% of that loss or 12,000 white would get 40% of that loss or 8,000. So there's your final distribution? 43,000 to read 37,000 to white. And the answer is B and that's pretty much what they're like. The method of allocation really has to be laid out in the problem.

So as I say, you have to read it carefully. Now the problem with partnership accounting, as you know, is that there are other things they could get into. For example, they could ask you about the formation of a partnership. They might ask you questions about the admission of a new partner to a partnership.

They might ask you questions about. The retirement or the withdrawal of an old partner from a partnership. And of course everybody's favorite. They may ask you how to liquidate a partnership. There's so many things they can get into. Let's get into formation. Let's go to question number two. It says able and car formed.

Notice that word forum. This is a question on formation, Abel, and car Ford, the partnership. And agreed to divide initial capital equally. That's important. So when they formed the partnership, Abel and Carr agreed to divide initial capital equally, even though a contributes a hundred thousand and C only contributes 84,000 in assets under the bonus approach to adjust the capital accounts.

What is cars? Unidentifiable asset. Now, I don't know if you've seen this term before or not, but when you see unidentifiable asset that's Goodwill, remember technically Goodwill is an unidentifiable intangible. Why is it unidentifiable? Because I can't sell you Goodwill. I paid for you. Can't sell me.

Goodwill. You paid for Goodwill is not an identifiable asset that we can buy and sell back and forth. You know, a patent. I could sell you my patent. That's an identifiable intangible. I could sell you my copyright. That's an identifiable intangible. These are identifiable assets that can be bought and sold, but Goodwill is an unidentifiable intangible.

So when you see they have an unidentifiable asset, that's Goodwill. Now I think the best way to study formation is to look at the possible entries here. Entries really help a lot. Now they said they're under the bonus approach. Let me show you the bonus approach. Under the bonus approach, they said a contributes a hundred thousand in assets, C contributes, 84,000 in assets.

So you have the partnership we'll debit assets, bring the assets on the books, 184,000. So the partnership debits assets, 184,000. And because they said that they agreed to divide initial capital equally. I'll credit a capital 92,000 and I'll credit C capital 92,000. See, the way you could look at this in a sense is an a really giving see an $8,000 bonus C only contributed 84,000 and assets, but ends up with a capital account of 92,000 equal to eight.

So you could argue that a is giving see a $8,000 bonus. That's the bonus approach. So what's the answer. What is the unidentifiable asset? It's zero. The answer is D there is no Goodwill in the bonus approach. There's only Goodwill in the Goodwill approach. So hope you see that the answer here is D there's no unidentifiable asset here.

There's no Goodwill in the bonus approach. There's only Goodwill in the Goodwill approach. Let me show you the Goodwill approach. Same problem. If this were the Goodwill approach and you got to know it because they could ask either in the Goodwill approach. The partnership would bring the assets on the books.

So you're going to debit the asset. That's 184,000. And not only will you credit a capital a hundred thousand, you'll also credit C capital a hundred thousand. They said they were going to divide initial capital equally. So in this case, not only will I credit a capital, a hundred thousand, I'll also credit C capital a hundred thousand.

And I'm recognizing that C. Must be bringing in 16,000 of Goodwill. So I'll debit Goodwill, 16,000, and now the answer would be B. I think if I were you, if you're studying, I would write next to answer, be their Goodwill method. If this were the Goodwill method, the answer would be B, but because it is the bonus method, it is D there is no Goodwill in the bonus method.

There's only Goodwill in the Goodwill myth, and that's really pretty much all they can test on the admission. Excuse me on the formation of a partnership. That's pretty much it. So if you know those two entries, what's the entry information under the bonus approach. What's the entry information under the Goodwill approach.

I think you're all set. Now let's go to maybe their favorite thing to test. And that is how do you handle the admission of a new partner to a partnership? Let's go to question number three. It says Blau and Ruby. Our partners who share profits and losses in the ratio of 60, 40, equally 60, 40 respectively on may.

One of the current year, their respective capital accounts were as follows. So notice they share profits and losses 60, 40, and on may. One of the current year here are their capital accounts. Blau has a $60,000 capital account. Ruby has a $50,000 capital account. I want you to maybe bracket those just for your own information.

Notice as of may, one total capital in the partnership adds up to 110,000. Just make a note of that. 60 plus 50, as of may, one total capital invested is 60 plus 50, 110,000. Then it says on that day, lend was admitted as a new partner. With a one-third interest in capital and profits for an investment of 40,000, like you to circle that word investment, I'll say more about it later, but for an investment of 40,000, now this is very subtle.

Then they say the new partnership began with total capital of 150,000. Notice that line. It is very subtle. They said the new partnership began with total capital of 150,000. Let me ask you what was total capital before Lynn came in? 60 plus 51 10. How much is Lynn bringing in 40? That adds up to one 50.

Doesn't it? And because they said the new partnership began with total capital of one 50, they're telling you they are not going to record any Goodwill. This is the bonus approach. So you might want to jot that down. It's very Sabal again, total capital invested before lend one, 10 Lynn brings in 40 and because they said that's all they're going to start with total capital of one 50.

They're not going to record any Goodwill. This. Is the bonus approach immediately after Lynn's admission. What is blouse capital? Well, let me show you the valance approach. It's not bad. Here's the bonus approach under the bonus approach, Linden vests 40,000 in the partnership. So the partnership is going to debit cash 40,000 and didn't they say they're going to give Linda a one-third interest in capital and profits.

So I'm going to take one third of one 50. Number total capital now is one 50. Lynn gets a one third interest in capital and profits. So I'm going to credit Lynn capital for one third of one 50 or 50,000. See the way you look at this, the old partners are giving lend a $10,000 bonus. That's really the perspective in the bonus approach that the old partners, Blau and Ruby are giving lend a $10,000 bonus.

And what we do is take that $10,000 bonus out of the original partners accounts in their profit loss sharing ratios. So I'm going to debit Blau capital for 60% of the bonus or 6,000. I'm going to debit Ruby capital for 40% of the bonus or 4,000. So when they asked me at the bottom, I immediately after Linda admission, what is blouse capital?

Well, blouse capital used to be 60,000 blouse capital has gone down six because of the bonus. So what's the balance and blog capital. Now answer B 54,000. That is the bonus approach. Now, you know, I can't leave it there. How about the Goodwill approach? That's the bonus approach? Let me do the same problem.

All right. So same problem. But now it's the Goodwill approach. I'm just gonna change it a little bit. Let's say that Linde invests $40,000. Same problem for a 20% interest. I'm going to change it a little bit. What if land invests? $40,000 for a 20% interest in capital and profits. But now we're running the Goodwill approach.

Now listen carefully. Anytime you see Goodwill approach, you got to think formula you'll get used to it. Oh, it's Goodwill approach formula got to set up a formula. Here's the formula. And I know you've seen it before. We have to set this up. 20% of X X is what the implied value of the whole business. 20% of X X stands for the implied value of the whole partnership.

Is equal to 40,000 now, as, you know, whatever we do to one side of an equation we have to do to the other. So we're going to divide both sides by 20%. And what we end up with is this X, the implied value of the whole business, the implied value, the whole partnership is equal to what 40,000 divided by 20%.

Or 200,000. I hope you see how we got the implied value of the whole business 200,000. So let's carry it through if the implied value of the whole partnership, the whole business is 200,000. What's been invested. What was invested before Linda came in 60 plus 50, 110,000. What did Len bring in 40 total?

Capital invested is one 50. So take 200,000 minus one 50. The implied Goodwill here is 50,000. I hope you see where I got that. If the implied value of the whole business is 200,000, what's been invested is just one 50, 60 plus 50 plus 40. So that gives us the implied Goodwill of 50,000. So in the Goodwill method, we record that Goodwill.

So we're going to debit Goodwill 50,000. We credit Blau capital for 60% or 30,000 credit Ruby capital for 40% or 20,000. Remember the old partners built up the Goodwill. Lin has nothing to do with that Goodwill. The Goodwill was built up by the old partners. So I'm going to record that Goodwill. I'm going to debit the Goodwill 50,000.

I'm going to credit Blau capital for 60% or 30,000. I'm going to credit Ruby capital for 40% or 20,000. And then you just bring in debit cash, 40,000 credit lend capital 40,000. That is how you handle the admission of a new partner under the Goodwill method. And of course you have to know both. No the bonus method.

No, the Goodwill method. Now I have to ask you something now don't hate me for this, but I've got to ask in this problem, is Linde putting the $40,000 into the partnership or is lender giving the $40,000 to the individual partners outside the partnership? Bob? I don't want to think about it. No, you have to think about it in this problem is lend.

Giving the $40,000 to the individual partners outside the partnership or putting the 40,000 into the partnership. That's right. Linda's putting the 40,000 in the partnership. How do I know that? Because of the word invested, that's why that's important. They said Lynn invested money in the partnership. So I've got to ask, I'm going to change the problem again.

Say prob let me change it. What if lend pays $40,000 to the individual partners outside the partnership? For a 20% interest in capital and profits. I'll say it again. Now I'm going to assume that Lynn pays the individual partners 40,000 outside the partnership for a 20% interest in capital and profits.

Well, let me show you the bonus approach because that's not bad in the bonus approach. Here's all you have to do. You would debit Blau capital for 20% of their capital 20% of 60,000 or 12,000? I would debit Ruby capital for 20% of their capital, 20% of 50,000 or 10,000 and credit Lin capital 22,000 because the money went to the individual partners outside the partnership.

You see the difference? So the bonus methods really pretty easy. You see, Blough sells 20% of their capital interest. Ruby sells 20% of their capital interest. So you would debit Blau capital for 20% of 60,000 or 12,000 debit Ruby capital for 20% of 50,000 or 10,000 and bring Linde in credit Lin capital 22,000.

That's the bonus approach. If the money goes to the individual partners outside the partnership, Not yet. No, I can't leave it there. What if land pays the individual partners outside the partnership, $40,000 for 20% interest in capital and profits, but now it's the Goodwill approach. When you see Goodwill approach, what do you think right away formula you'll get there.

Trust me many, all Goodwill formula. Let's set it up. Let's cut right to the chase. Don't we know that X. The implied value of the whole business equals what 40,000 divided by 20%. Isn't that true? Don't we know that X, the implied value of the entire partnership is equal to what 40,000 divided by 20% X, the implied value, the whole partnership must be worth 200,000.

So help me do this. If the implied value of the whole partnership is worth 200,000, what's been invested, what's been invested. Tell me that what's been invested one 10 or one 50, one, 10 or one 51 10 number the 40,000 went to the individual partners outside the partnership. All that's been invested is the original one 10.

So now the implied Goodwill is 90,000. You see the difference. All of it's been invested as the original 60 plus 51 10, because the 40,000 went to the individual partners outside the partnership. So let's record that Goodwill. I'm going to debit Goodwill 90,000. I'm going to credit Blau capital for 60% or 54,000.

I'm going to credit Ruby Capitol, the 40% or 36,000,

the old partners built up the Goodwill land has nothing to do with that. Goodwill was built up by the old partners. All right. Now the question for you now, follow me through this. Now, after that entry. What's the balance in Blau capital? Well, Blau capital. When we started with 60,000, it just went up 54,000 to 114,000.

I hope you see that plow capital. When we started with 60,000, just went up 54,000 because of the Goodwill. So isn't the balance and cloud capital. Now 114,000. I'm going to take 20% of one 14. I'm going to debit Blau capital 22820% of one 14. What's the bounce and Ruby capital. Well, it was. 50,000, it just went up 36 to 86,000 times, 20%.

I'm going to have it. Ruby capital, 17,200. And I'm going to credit Lynn capital 40,000. I'd bring Linda in again. Lao capital went from 60,000 up 54 to one 14 debit Blau capital for 20% of one 14, 22,800 Ruby capital went from. 50,000 up 36 to 86,000 times 20%. I'm going to have it Ruby capital for 17,200.

I'm going to credit Lynn capital 40,000. That's. If the money goes to the individual partners outside the partnership, and it's the Goodwill approach I'm telling you, you will get used to this now, the way you sort of think in the exam, kind of in the CPA Exam questions on that, you go, wait a minute. Is the money going in?

Inside the partnership or outside the partnership. Oh, okay. It's inside. Is it bonus method or Goodwill method? Goodwill method, formula. That's kind of where you end up sitting the CPA Exam and go in it. Is the money going into the partnership or outside the partnership? Oh, it's in the partnership is opponent's method of Goodwill method, Goodwill method formula.

You do a couple of these and you just get used to the basic process. Now we're not done with partnership accounting. We're going to finish partnership accounting. In our next class. Now, when you go to the next class, you're going to see that there is a set of questions at the beginning of that at the beginning of that module on Eddie Fox and grim.

Now it's a set of two. I just want you to do the first question. So I want you to, before you do that class, now promise me now, before you do that class, do the first question of Eddie Fox and grim because that's admission of a new partner. You solved that question, just come up with a solution admission mission of a new partner.

Now, number two, the withdrawal or the retirement of a partner. And we'll, we'll do the withdrawal or the retirement of a partner together. But the first question on that set, Eddie fought Fox and grim. And then we'll do the second question together. And I looked to see you then see you next class. Welcome back in this FAR CPA Exam Review course, we're going to finish our discussion on partnership accounting.

And you remember at the end of our last class, I assigned the first of the two questions that we have in this FAR CPA Exam Review course on Eddie Fox and grim. And I hope you tried that before coming to this class, let's take a look at Eddie Fox and grim. They give us the condensed balance sheet. For the partnership of Eddie Fox and Graham.

And then they say ham is admitted as a new partner with a 25% interest in the capital of a new partnership for a cash payment of 140,000. So obviously the first of the two questions in this set are about. The admission of a new partner to a partnership. Now, you know, any time you see a question in the CPA Exam on the admission of a new partner to a partnership, your first thought is what is the money coming into the partnership, or is the money going to the individual partners outside the partnership?

What's the case here? Notice the money's coming in. As capital to a new partnership, the money's not going to the individual partners outside the partnership. No, the cash payment from ham, the investment is going to be capital in the creation of a new partnership. So the money is coming in to the new partnership.

Notice they say total Goodwill implicit in the transaction is to be recorded. So it's not the bonus method. It is the Goodwill method immediately after admission of ham. What is Eddie's capital account? Well, you know, the minute you see Goodwill method, what do you think formula? Right. The first thing you think in any Goodwill problem on partnerships is formula.

So let's set up the formula. We'll cut right to the chase. We know that X the implied value of the whole business, the whole partnership would be hams, 140,000 divided by 25%. You'd take 140,000 divided by 25% X. The implied value of the whole business. The whole partnership must be worth 560,560,000 is the implied value of the entire business.

The whole partnership. Now what's been invested well, Eddie Fox and grim have invested a total of 320,000. That's right on the balance sheet beforehand came in, ham brings in one 40. So the total amount invested is 460,000. If the implied value of the whole business is 560,000, but what's been invested is 460,003, 20 plus one 40.

The implied Goodwill in this transaction is a hundred thousand. So what do we do? We record that Goodwill. We're going to debit Goodwill a hundred thousand. We're going to credit Eddie capital for 50%, 50,000. We're going to credit Fox capital to 30% or 30,000. We're going to credit grim capital for 20% or 20,000.

Because that's their profit loss sharing ratios. And remember ham had nothing to do with that Goodwill. The original partners built up that Goodwill. So we record that Goodwill, give it to the old partners, the original partners in their profit and loss sharing ratios. And now what do you do? You just bring Hammond?

So the partnership will now debit cash 140,000 and credit ham capital 140,000. Those are the entries that are made now, when they ask us at the bottom. Immediately after admission of ham Hetty's capital account would be what well before admission of ham, Eddy capital was 160,000 Eddy capital just went up 50,000 because of Eddie, sheriff Goodwill.

So now Eddie capital is 210,000. Yeah, that's her B I think you'll find that if you study these entries, you know what to do in all these different situations, you really do get used to it. I dunno if you believe me on that or not, but you do, you get used to it. As I said, in our previous class where you sort of get down to is you're in the exam.

You see a problem. You go, wait a minute. Is the money coming into the, into the partnership or is it going to the individual partners outside the partnership? Nailed that down. And then his a bonus method of Goodwill. Oh, it's Goodwill method formula. And you'll you'll by studying those entries, I think you'll get very comfortable with this.

Now there's also a second question in this set, they say in the second question, assume instead, that ham is not admitted as a new partner and that Eddie decides to retire from the partnership. So now we'll get to get into another situation exam likes, and that is the withdrawal or the retirement of a partner from a partnership.

And by mutual agreement is to be paid 180,000 out of partnership funds. For his interest total. Good. Well, it's the Goodwill method here. So he, once again, it could be the bonus approach. It could be the Goodwill approach. This is the Goodwill approach. Total Goodwill implicit in the agreement is to be recorded after Eddie's retirement.

What are the capital balances for the other partners? While even though they asked for the Goodwill method here, let me show you the bonus method in the bonus method. Here's the way you look at it. Eddie is retiring, right? So, you know, you're going to debit Eddie capital for the balance in Eddie capital's account.

And that is 160,000 Eddie's gone. So you're going to start by debiting Eddie capital for 160,000. Bring it to zero. What should I credit to cash? That's right. 180,000 because they said buy mutual funds. The other partners agreed to pay Eddie 180,000 out of partnership funds for his capital account. So we're going to credit cash 180,000.

Seeing the bonus approach. The way you're looking at this is that the surviving partners, Fox and grim are giving Eddy a $20,000 bonus notice. I debit Eddie capital 160,000. Bring it to zero. I credit cash for 180,000. Really the old partners are giving Eddy a $20,000 bonus. Now this is the tricky part.

You're going to take that $20,000 bonus. Out of the surviving partners' accounts in their surviving ratios. Let me say that again. You're going to take that $20,000 bonus out of the surviving partners accounts in their surviving ratios. Now, what do I mean by their surviving ratios? We'll notice that Fox gets 30% of profits and losses.

Grim gets 20% 30 plus 20 is 50. So Fox, if I'm going to use the surviving ratios, Fox is going to get 30, over 53 fifths of the bonus out of Fox's account. Graham will get 20 or 52 fifths of the bonus out of Grimm's account. So I'm going to now finish the entry. I'm going to debit Fox capital for 20, over 52 fifths of that.

20,000, excuse me, 30 over 53 fifths of that $20,000 bonus or 12,000. I'm going to debit grim capital for 20, over 52 fifths of that $20,000 bonus or 8,000. You take the bonus out of the surviving partner's capital accounts in their surviving ratios. Fox gets 30% of profits and losses. Grim gets 20% 30 plus 20 is 50.

So Fox will get 30 over 50. Three-fifths of that bonus or 12,000 out of Fox's capital account Graham will get 20 or 52 fifths of that bonus out of Grimm's capital account. And that's 8,000 and that's the entry. Now notice what the answer would be here. If this were the bonus approach. Now I know it's not, they want the Goodwill approach, but they said after Eddie's retirement, what would be the balances and the other capital accounts, the other partner's accounts?

Well, if it were the bonus method, look at answer a. Hasn't Fox gone from 96,000 down 12 to 84,000. Hasn't grim gone from 64,000 minus eight down to 56,000. So just for your own studying, remember if this has been the bonus approach, the answer would be a, because Fox just went from 96,000 minus 12 to 84,000.

Graham just went from 64,000 down eight to 56,000. The answer would have been a, if it were the bonus approach now, obviously they don't want the bonus approach. They want the Goodwill approach. When you see Goodwill approach, what do you think of right away formula? You're going to have to set up a formula.

This might be a little tricky at first. What's the balance in foxes. Excuse me. What's the balance in Eddie's capital account before the retirement. 160,000, right? Boulton Eddie's capital account before the retirement is 160,000. How much did they agreed to give Eddie out of partnership funds? 180,000, an extra 20,000 in the Goodwill approach to retirement.

The way we look at this is that that extra 20,000 the partners are going to give Eddie. That must be Eddie share of Goodwill. That's how you look at it. And the Goodwill approach that, that extra 20,000 cash. That the partners are giving Eddie must be Eddie share of Goodwill. So now we set up our formula since Eddie gets 50% of profits and losses, that's the profit loss sharing ratio for Eddie, 50% of X, the total Goodwill in the partnership must be worth 20,000.

So that's how you set it up. 50% of X X being the total Goodwill in the partnership equals 20,000. And what you come down to is that X, the total Goodwill and the partnership. Is equal to what the 20,000 divided by 50% or 40,000, the implied Goodwill for the whole partnership must be 40,000. So we record that Goodwill.

I'm going to debit Goodwill 40,000. I'm going to credit Eddy capital for 50% or 20,000. I'm going to credit Fox capital for 30% or 12,000. I'm going to credit grim capital for 20% or 8,000. I have to record that Goodwill in the Goodwill approach. Now, after that entry, what's the balance in Eddie capital.

Hasn't gone from one 60 up 20 up to one 80. Now we just let Eddy retire. I'll debit Eddie capital, 180,000 credit cash. 180,000. Now we just let Eddie withdraw now after Eddie's retirement. What are the capital balances for the other partners? Well, notice what's happened to Fox Fox in the Goodwill approach just went from 96,000 up 12 to one Oh eight.

Look at answer. See didn't Fox. Just go from 96,000 up 12 to one Oh eight didn't Graham go from 64,000 up eight to 72,000. The answer is C in the Goodwill method. It would have been a in the bonus method. Make sure. You know, both approaches. Now, there is one more thing that we have to hit in partnership accounting before we leave partnership accounting.

And I know you're going to like it, and that is how do we liquidate a partnership? You've got to be ready for this. Let's look at question three. They say on January one of the current year, the partners of cob Davis and Eddie. Who share, who share profits and losses in the ratio of 50, 30, 20 respectively, decide to liquidate the partnership.

Now they give us the condensed balance sheet before the liquidation notice they're showing on the asset side cash, a 50,000 other assets with a book value of 250,000. So total assets come out to 300,000 liabilities or 60,000. And the balance in Cobb capital is 80,000. Davis capital 90,000 Eddy capital, 70,000.

That's our starting point. Then they say on January 15th of the current year, the first cash sale of other assets with a carrying amount of 150,000 realized just 120,000 safe installment payments to the partners were made in the same year. How much cash? Would be distributed to each partner. All right now, to really, to really understand this, you really have to lay out a schedule.

So we're going to lay out a schedule. We're just going to pull the information right out of the balance sheet. As we begin, we have what cash of 50,000 other assets with a book value of 250,000. That's when the asset side liabilities are 60,000 C capitalist, 80,000 D capital is 90,000. eCapital is 70,000.

And keep in mind that they share profits and losses in the ratio of 50, 30, 20 respectively. All right. So we get that set up a schedule. It's really the way to do this. Now what's the first thing we have to deal with while they said that the first cash sale of other assets with a carrying amount of 150,000 realized only 120,000.

So let's put that in our schedule. So what would happen? Cash would go up. By 120,000. So Cassius went from 50,000 up to 170,000 other assets would drop by carrying value of 150,000. And notice there's a $30,000 loss in that sale. So of course, C would get 50% of that loss or 15,000 D would get 30% of that loss or 9,000.

He would get 20% of that loss or 6,000. So. Now we have what, 170,000 cash. It was, it was 50, it went up 120,000 because of the cash sale of other assets. We have 170,000 cash now. And I know, you know, this, what is the first thing we have to do with that cash? That's right. Pay off any liabilities. You can't give any cash to partners until all liabilities are paid.

So let's pay off our liabilities. The liabilities on the balance sheet are 60,000. So they'll go down to zero and our cash will drop to 110,000. So now we have $110,000 cash. That's what we have to distribute 110,000 cash. After we pay off all of our liabilities. Now listen carefully. You know what a lot of people do in the exam, they get down to this point and they go, I see it.

Now. I see it. There's 110,000 of cash to distribute. Wouldn't see, get 50% of that or 55,000. Do you get 30% or 33,000? If you get 20%, 22,000, I'm looking at, I'm looking at answers, say, hell lo say, and that's not. See, I'll tell you a lot of people do that. Hey, there's 110,000 cash to distribute this isn't I see.

It's not bad. C would get 50% of 55,000. You would get 30% or 33,000 Dean would get 20% or 22,000. I like saying, and it's wrong. Why doesn't that work? Why isn't it safe? Don't you think it ought to be? See, in fact, we disagree with, with the board of examiners. It is C isn't it? No, but why not? Why isn't it C.

Listen carefully because we're not allocating profits and losses. We're allocating capital. You don't allocate capital in profit loss, sharing ratios. No, you allocate capital based on what's left in the capital accounts, OPC that these are not profits and losses. You can't use the profit and loss sharing ratio.

We're not allocating profits and losses. We're allocating capital and you allocate capital based on what's left in the capital accounts. So remember that difference now, do we know what's left in the capital accounts yet? No. Cause there's another adjustment. Didn't we, when we began. Have other assets with a book value of 250,000.

We sold other assets with a book value of one 50 don't we still have other assets with a book value of a hundred thousand. What's the worst thing that could happen. The worst thing that can happen is that all the rest of the assets are sold for zero. What if they're a total loss it's really conservative.

It's really conservatism. Isn't it? You know, what's the worst that could happen. We get nothing for the rest of the ass. They're a total loss. This is called maximum possible loss. M P L. The worst thing that could happen is we get nothing for the rest of the ass. They were total loss of a hundred thousand.

They call that MPL maximum possible loss. So we allocate that loss. See what get 50% or 50,000 D you would get 30% or 30,000. He would get 20% or 20,000. And when you back out the maximum possible loss, here's, what's left in the capital accounts. There's a balance still left in Cobb capital, a 15,000 Davis capital 51,000 Eddy capital 44,000.

And the answer is a you allocate capital based on what's left in the capital accounts. After maximum possible loss. Don't forget at that. So the answer is a not say, and I know you with me on that, but I'm not done yet. There are a couple of things that they could put into a problem like this that are not here, and you've got to be ready for them because if this were a simulation and that's always a possibility that this would make a nice little simulation, wouldn't it liquidating a partnership.

And if there's a simulation I'm afraid they might throw in a couple of wrinkles. For example, what if you're going to liquidate a partnership? And when you look on the partnership balance sheet, there are loans receivable from partners or loans, payable to partners. What if I look on this balance sheet and I see there are loans receivable from partners or loans, payable to partners.

Listen very carefully. If you see on the balance sheet, there are loans receivable from partners, loans, payable to partners. Combine those loans with the partner's capital accounts before you begin, and then you can do it as a normal liquidation. Just give me a quick example. Let's say I look on this balance sheet and there was a loan payable to Davis of 5,000.

You with me, I look on the balance sheet. They're liquidated. And I see on the balance sheet loan payable to Davis 5,000, what you basically do before you start is debit that payable 5,000, wipe it out credit David's capital 5,000 before you begin. In other words, you'd make David's capital 95,000. Before you started another example.

Let's say I look on the balance sheet and I see they have a $3,000 loan receivable from Eddie. I looked at, I see it on the balance sheet, a $3,000 loan receivable from, from Eddie. Well, before I start, I would credit loan receivable from Eddie, wipe it out, and I would debit Eddie capital 3000. In other words, I'd make Eddie capital 67,000 before I start.

So if there's any loans, payable to partners, loans receivable from partners, combine those loans with the partner's capital accounts. Before you begin wiped them out, combined with the partner's capital accounts before you begin. And then you can just proceed as you normally would. One more point. What if one of the partner's capital accounts went into deficit?

You know, for example, let's say I was doing this liquidation and Cobb capital went into deficit. Listen very carefully. If a partner's capital account goes into deficit before you allocate any cash to partners. You have to allocate that deficit to the surviving partners in their surviving ratios. Now, you know what I mean?

By the surviving ratios, let's say Cobb capital went into deficit. Well, David's his profit loss sharing ratio is 30%. Eddy's is 20% 30 plus 20 is 50. So Davis would get 30 over 50. Three fifths of Cobb's deficit. Eddie would get 20 or 52 fifths of Cobb's deficit allocates their capital account, and then you could be, then you just couldn't do it as you normally would.

So watch out for that. If any partner's capital account goes into deficit before you allocate any cash, you have to allocate the deficit to the surviving partners in their surviving ratios. Watch out for partnership accounting study these entries. That we went over and make sure you know how to do a liquidation.

Now see you in the next class.

Welcome back in this FAR CPA Exam class. I want to talk about cash to a cruel. We know that in the cash basis of accounting, life is easy because in the cash basis, we only recognize the revenue. That we've actually collected. It's nice and clean, only recognize the revenue you've actually collected. And we only recognize the expenses that we've actually paid very clean, very simple, but we know that under generally accepted accounting principles, financial reporting should be on the accrual basis.

And it's not that the accrual basis is that bad. It's not that complicated. But it is more challenging because under the accrual basis, we recognize revenue as it's earned, doesn't matter what we collect. It's what we earned and we recognize the expenses. We've incurred. Doesn't matter what we've paid. And I know you know that, but I bring this up because in the CPA Exam they have questions on cash to a cruel, and you've got to be ready for these.

And naturally cash to a cruel makes a good multiple choice question. No doubt about that, but also cash to a cruel makes a pretty good simulation. So we're going to do one. If you look in your viewers guide, you'll see barren flowers. You can see that in this simulation, we're given a trial balance and we're told that barren flowers.

Uses the cash basis of accounting. And if you go to the requirement, it says, prepare the adjusting entries. So we need journal entries here, prepare the adjusting entries necessary to convert the trial balance of barren flowers to the accrual basis for the year ended December 31 year four. So we actually have to do adjusting entries.

And if you read the information that says the following information pertains to Baron flowers, a calendar year sold prior to ship, which maintains their books on the cash basis. Baron plans to expand into the wholesale flower market and is in the process of negotiating a bank loan. The bank is requesting year four financial statements prepared on the accrual basis during the course of a review engagement.

Muir Barron's accountant obtain the following additional information. So we have to go through this additional information and decide on the adjusting entries. We'd have to make, to convert this trial balance from cash to a cruel at the end of year four. Now, besides the trial balance accounts, we also have amount choices.

To choose from and the choice of additional accounts that we might need. So let's look at the first one. Number one says accounts due from customers total $32,000, December 31 year four. Well, if you look on the trial balance accounts, we'll see on the trial balance. And of course that would be December 31 year three, totaled 16,200.

Well, that account should now be 32,000, the correct balance at the end of year four. So we adjust for the difference. The difference between what's on the trial balance 16,200, and what the balance should be 32,000 is 15,800. So we're going to debit accounts receivable 15 eight, and that account is on the trial balance.

That's not an additional account that we need. We're going to debit accounts receivable, 15, eight. What are we credit sales? Another account that's on the trial balance 15 eight. So we didn't need any additional accounts there. We could judge that. We could just adjust the accounts on the trial balance, not too bad.

Number two, on analysis of the above receivables revealed that an allowance for uncollectable accounts of 3,800 should be provided for well, if you look on the trial balance, there is no allowance for bad debts. So we're going to have to record it. We're going to debit bad debt expense, 3,800. That's one of our additional accounts that we needed to choose from and credit allowance for bad debts.

Another additional account that we had to choose from 3,800, not too bad. Number three, unpaid invoices. So now we're talking about accounts payable, unpaid invoices for flowers purchased. Told total 30,517,000 at 1231 year four and 1231 year three respectively. So at the end of year three accounts payable was 17,000.

Now your later it should be 30,500. So we're going to credit accounts payable for the difference 13 five, that brings accounts payable from 17,000. The, the bounds of the end of year three, up to what's correct balance now 30,500. Credit accounts payable, 13 five. And that's an account that's on the trial balance.

We don't need an additional account there. What do we debit purchases, debit purchases, the account we usually debit when we credit accounts payable, debit purchases, another account that's on the trial balance, not an additional account for 13 five, number four, they do a physical count of inventory. The inventory.

Total 72,800 based on a physical count, December 31 year for the inventory was priced at cost, which approximates market. All right, so we take a physical count. We find our inventory balance. At the end of year four is 72,800. If you look on the trial balance, the inventory December 31 year three, total 62,000.

So our job here is to adjust. That inventory from 62,000 up to the physical account, 72 eight, we're going to debit inventory 10,800. That account is on the trial balance. So debit inventory, 10,800, that brings inventory from 62,000. The amount on the trial balance up to the correct balance based on the physical count, 72 eight.

So debit inventory, 10,800. What do we credit? Well, Couple of choices here. You could credit cost of goods sold, but you may notice that's not an additional choice, but that would be okay. You could credit cost of goods sold. The argument would be that if there's more on hand, you sold less basically cost of goods.

Sold is overstated is more on hand, but the account we're going to use here is the one that's in the addition, in the additional accounts and that's income summary inventory, income summary for inventory. 10,800 number five looks innocent enough. Revive says on may, first year for Baron paid $8,700 to review its comprehensive insurance coverage for one year.

The premium on the previous policy, which expires April 30th, year four was 7,800. Looks innocent enough. Might've been the hardest adjustment in this entire simulation. We have some work to do here. Let's think about this. If on may one year four, we pay $8,700 for a policy that's meant to cover a full year.

Well, if it's a full year that goes from May 1st year four to April 30th, year five. So why aren't we repaying? Aren't we. Excuse me prepaying for insurance for January, February, March, April of year five. Cause this, this coverage is going to go from May 1st year four to April 30th, year five. It's a one year policy.

So my point is we are pre-paying for insurance for January, February, March, and April of year five. So let's work that out. I'm going to take January, February, March, April four, twelfths. Four twelfths times 8,700 comes out to 2,900. They should have a prepaid insurance for 2,900. Now let's let's think about something else before we do our adjusting entry.

We know they need a prepaid insurance of 2,900 that's four twelfths of 8,700 represents prepaid insurance for year five. So they should have prepaid insurance of 2,900. Now another question, is this, what is the insurance expense for the year? Well, if you look on the trial balance, doesn't it make perfect sense because they use the cash basis.

They have insurance expense on the trial balance at 8,700. In other words, all Baron flowers did was just debit. When they paid the policy debit, the expense 8,700 credit cash, 8,700 cash basis is easy. So it should make perfect sense to you that when you look on the trial balance, They're showing it insurance expense at 8,700, but here's the question.

What should the insurance expense be for year four? Well, don't we know that January, February, March, April, may, June, July, August, September. Pardon me? January, January. I want to get the months right. Don't we know that we paid this policy May 1st. So don't we know that may June, July, August, September, October, November, December, those eight months, eight twelfths of that 8,700 applies to this year, year four.

Again, that we paid it on May 1st. So that's may, June, July, August, September, October, November, December eight. Twelfths of that $8,700 policy applies to this year. So if you take a 12th of 8,700. That comes out to 5,800. Is that all, is the insurance expense for this year? 5,800? No, because they said the policy for last year was 7,800.

That expired April 30th of year four. So hadn't, they prepaid back in year three for January, February, March, and April of year four. In other words, Four twelves of the old policy applies to this year. If you take four twelfths again, that January, February, March of ape, January, February, March, and April of this year, your four, four twelves of the old policy, 7,800, that adds up to 2,604 12.

So the old policy applies to this year. So let's add it up. What's the true insurance expense for year four, eight, 12 of the new policy. Eight twelfths of 8,700 comes out to 5,804 twelfths of the old policy that goes up to 2,600 added up the true insurance expense for year four is 8,400 5,800 plus 2,600 8,400.

Now, if you look on the trial balance, what are the, what are they showing for insurance expense? Again, all they did was they have a simple life cash basis, debit insurance expense, 8,700 credit. Cash 8,700. So now we can do our adjusting entry. We know they should debit prepaid insurance for 2,900. We know that, right?

Because four twelfths of the current policy, 8,700 applies to year five. So we know that she debit prepaid insurance, 2,900, that account's not on the trial balance, not a trial balance account. That's one of the additional accounts that we can choose now on the trial balance, they're showing insurance expense, 8,700.

That should be 8,400. So credit insurance expense, 300 credit insurance expense, 300. I'm going to lower that insurance expense from the 8,700. They have on the trial balance down to 8,400 5,800 plus 2,608 12 to the new policy for 12 to the old policy. So we're going to credit insurance expense 300. Now the entry doesn't balance.

I need a credit of 2,600 to bounce the entry out. What do I credit for 2,600 Baron capital credit Baron capital 2,600 wide Baron capital because last year's policy, 7,800 back in year three, they just would have Devede onto the cash basis. Debit expense, 7,800 and credit cash. But. Back in year three, they had prepaid for January, February, March, and April of year four.

So back in year three, they overstate their expense by four twelves of 7,800 2,600. And if you overstate your expense in year three, you understate your income and you understate Baron capital. So now I'm co I'm correcting Baron capital by 2,600. So that's my adjusting entry debit, prepaid insurance for 2,900.

That's one of our additional accounts. That was not on the trial balance. I'm going to credit insurance expense 300, that's a trial balance account, and I'm going to credit Baron capital 2,600. That is a trial balance account. That's a tough adjustment, a lot going on there. Number six on January 2nd year for Barron entered into a 25 year operating lease for a vacant lot.

Just adjacent to. Baron store. The gunny uses a parking lot as agreed in the lease barren, paved and fence the law at a cost of 45,000. So what we have here is a leasehold improvement. You remember what to do with leasehold improvements, you capitalize them and depreciate them over the useful life to the lessee.

That's how you handle a capital on a cap. That's how you handle a leasehold improvement. It gets capitalized and amortized over the useful life. In this case to Barron, which is 15 years, the improvements were completed on April one, a year four, have an estimated useful life of 15 years. That's useful life, the Baron 15 years because the lease is 25 years.

So you wouldn't amortize this over the life, life of the lease. It's the useful life to barren. Which in this case would just be 15 years. That's the life of the, that happens to be the life of the part of the parking lot. Let me ask you this. What if the useful life of the parking lot was 15 years and the lease is going to run out Nate you'd amortize over how many years, eight, the useful life to the lessee.

But in this case, the useful life to the lessee Barron also happens to be the useful life of the parking lot. 15 years, no provision for depreciation or amortization has been recorded depreciation on the furniture and fixtures 12,000 for year four. So now we can work it out. What Baron should do is take that leasehold improvement 45,000 divide by 15 straight line years, the useful life in this case of the parking lot and the useful life to barren.

So that's $3,000 of amortization. On that leasehold improvement for an entire year. We don't want an entire year because notice it was completed on April one. So all we want is April through December nine, twelfths, three quarters of a full year, three quarters of 3000 or 2002 50 Barron should take 2002 50 of amortization on that lease hold improvement and also 12,000 of depreciation on the furniture and fixtures.

So what Baron should debit here is depreciation and amortization expense, 14,000 to 50, 2250 amortization, 12,000 of depreciation. So debit depreciation, amortization expense. That's one of our additional accounts, 14,002 50 and credit accumulated depreciation and amortization 14,000 to 50. Another additional account.

That we have to choose from now, item seven gets us into accrued expenses. And I know from experience that accrued expenses bother a lot of students. So before we dive into this one, you know, we just think of a classic example of an accrued expense, like interest don't. We normally have to accrue interest up to December 31.

Cause the next interest payment date might not be Phil. February 11th of the following year. No, we accrue payroll taxes up to December 31 because the next pay day might not be till Friday, January 3rd, we accrue utilities up to December 31, cause we're not going to get our electricity bill till January 20th of the next year.

These are classic accrued expenses. So item seven says accrued expenses at December 31 year three and four were as follows notice at the end of year three. They had accrued utilities of 900 accrued payroll taxes of 1100 a year later, which the year weekend we care about your, for. They had accrued utilities of 1500 and accrued payroll taxes of 1600.

Now remember Baron hasn't made up rules, barren uses the cash basis. We're trying to convert to a cruel. So let's go back before we do this, I can look at the trial balance. First, if you look at the trial balance, Find the payroll taxes on the trial balance. They're showing payroll taxes of 12,400. You look on the trial balance, it's there.

They have payroll taxes of 12,400. I want to ask you a question that 12,400 a payroll tax that you see on that trial balance, does that include the 1100. That they should have accrued at the end of year three. Yes. Because remember they don't, they don't make accruals. Barron has always used the cash basis.

They're only getting into the accrual basis because they want a bank loan. So back in year three, Baron didn't make any rules. Barron made no cruise at the end of year three. So when the, when the payroll came up in year four, they just debit expense and credited cash. So when you look at that trial balance and you see payroll taxes of 12,400, that includes.

The 1100, they should accrued at the end of year three on the trial balance. I want you to find the utilities expense on the trial balance utilities expense is 12,600. Does that 12,600 include the 900? They should've accrued at the end of year three. Yes, because they didn't make a rules. When the electricity bill came in in January, they just debit it expensive credited cash.

They never made a rules. Parents only thinking about a cruel accounting now because they want a bank loan. So, I just want you to recognize that the payroll tax expense on the trial balance 12 four includes the 1100. They should have accrued at the end of year three, but did not. The 12,600 of utility expense on the trial balance includes the 900.

They should have accrued at the end of year three, but they didn't bother. Now. We also know what they should accrue for year four. So what do we do with this? Well, let me just emphasize there's more than one way. You can do an adjustment like this. I'll show you what I think works best, but you can do this other ways, but you know what I like to do, I just think it simplifies it first reverse.

What's wrong. Let's reverse. What's wrong on the trial balance that payroll tax of 12,400 includes the 1100 of payroll tax. They should have been accrued at the end of year three. That was really a year three expense. So that expense on the trial balance is overstated by 1100. So I'm going to credit.

Payroll taxes, 1100, the utilities expense on the trial balance. 12,600 includes the 900. They should have accrued at the end of year three. So it's overstated. So I'm going to credit utilities, expense 900 notice I'm going to reverse what's wrong. So I credit payroll taxes, 1100 credit utilities, 900. What do I debit for 2000 Baron capital.

I'm going to debit barren capital. Why am I going to debit Baron capital. Because if back in year three, they didn't make a cruelty. If back in year three, they didn't accrue 900 of utilities. They did not accrue 1100 and payroll taxes. Then back in year three, they understated their expenses by 2000. So they overstated their income and overstated Baron capital by 2000.

I go over that again, you're back into year three. They didn't make any accruals. Then they understated their expenses by 2000. So they. Overstated income and overstate of Baron capital by 2000. Now I'm going to correct that debit Baron capital to thousands of I debit Baron capital 2000. That's an account that's on the trial balance.

I credit payroll taxes for 1100. That's an account that's on the trial balance and I credit utilities 900. That's an account that's on the trial balance. I just reversed. What's wrong now once you reverse what's wrong now just make the current user cruel. Now you can just make a current use of cruel. I'm going to debit utilities for 1500, excuse me, 1600.

I'm going to debit utilities. Now it is for 1500. I've got a debit payroll tax for 1600 and I'm going to credit accrued expenses for 3,100. Now I just make this as a cruel. They told me what the cool should be for your fork. So I'll make it debit utilities, 1500 debit payroll taxes. 1600 and credit accrued expenses, 3,100.

And that accrued expenses. That's one of the additional accounts that we have to choose from just reverse. What's wrong. Then you can just make this use accrual. I think that's the easiest way to do it. Although there are other ways. Number eight, Barron is being sued for 400,000. The coverage under their comprehensive insurance policy is limited to 250,000.

The attorney believes that an unfavorable outcome is probable. So this is a probable contingency and that a reasonable estimate of the settlement is 300,000. Well remember, probable contingencies have to be accrued. So if the lawyers right, and we lose this case, what are we going to have to pay? What's their estimate of the settlement?

300,000. Our policy is limited to two 50. So presumably Barron would have to make up the $50,000 difference. So we're going to debit lawsuit loss 50,000, that loss would have to be accrued it's probable, and we can estimate it. So we accrue it. We're going to debit lawsuit loss 50,000. That's one of the additional accounts that we choose from, and I'm going to credit provision philosophy, 50,000, another additional account that we had to choose from.

This is part of a crew. This is part of a cruel accounting with contingencies. If they're probable, if that loss is probable and you can estimate it, you must accrue it. Didn't have to worry about that on the cash basis, but on the accrual basis, it's required. Number nine, the salaries account that's on the trial balance includes 4,000 every month paid to the proprietor.

And then Barron also received $250 a week for living expenses. That's nice if you take 250 times 52 weeks, that's why on the trial balance, you see living expenses $13,250 a week for 52 weeks. So on the trial balance, living expenses, 13,000, well, you know that those living expenses, that's not unexpensive the business.

So we're going to credit living expenses, 13,000. You count this on the trial balance. Okay. Amount that Baron has been taken as a salary. That's not an expense of the business in a sole proprietorship. Any money that the proprietor takes out is drawing. The proprietor is going to get simply taxed on any profit from the business.

Yeah. A sole proprietor is not allowed to deduct a salary expense to themselves. That's not an expense of the business. No, whatever profit the business makes that's going to be the profit for the proprietor. So that salary should have been, should have been drawing. So we're going to credit the living expenses, 13,000, that's the trial balance account.

We're going to credit salaries for 48,000. 1000 a month times, 12 months, that's trial balance account, and we've got a debit Baron capital $61,000. Those drawings should have come out of Baron capital. It's always good to review cash to a cruel because as I say, it makes a, a good simulation and certainly it makes a good multiple choice as well.

Keep studying. I'll look to see you in the next class.

Welcome back in this FAR CPA Exam class, we're going to begin our discussion of different problems that can come up in the CPA Exam on recognizing revenues and expenses. And we're going to start that topic in this FAR CPA Exam class by talking about long-term contracts. Basically long-term construction contracts, as you probably know.

There are two acceptable methods. There are two acceptable methods of accounting for long-term contracts. There is the percentage of completion method, and there is the completed contract method. Now, even before we begin, let me establish something. The percentage of completion method is theoretically prefer because, because it's more consistent with a cruel accounting recognizing profit from a longterm project each year of the project.

As theoretically you earn some of the profit each year. Whereas in completed God track, we recognize no profit from a project, no profit until the project is completed until it's finished. That's the basic difference. In percentage of completion, we recognize profit from a longterm project each year of the project, because theoretically we earn some of the profit each year.

It's more consistent with a cruel accounting recognizing profit as it's earned, whereas in completed contract. We recognize no profit from a project until it's completed until it's finished. Now, I think the best way to cover this, we're going to start with percentage of completion and we're going to do a problem together.

And I want to show you the entries for both approaches. Now, I want to clarify something by doing these entries. I'm not suggesting in any way that if you get a multiple choice on this. In the exam, you've got to lay out all these entries. You don't have time. Why do I do the entries? A couple of reasons.

First, if you see the entries, you'll understand this a million times better. Really? You understand it much better. Not only that, but you'll see in multiple choice, they start throwing around account names, construction, and progress, progress. Billings. If you don't know how these accounts are used, you can't break down a multiple choice.

Anyway. So to me, there's no way around this. You've got to go through the journal entries. So if you'll go on your viewers guide, you'll see a problem and illustrate a problem on long-term contracts. What we have here is a three-year construction project. The company has signed a three-year construction project for 1,800,000.

So that is the. The price of that. If you're this construction con, if you're this construction company you're going to be paid 1,000,008 for this project, it's what they call a fixed price contract. It's a fixed price contract. If you're this construction company you're going to be paid that fixed price for this project.

1,000,008, it's a three-year project in year one. The construction costs were 203, 3000 at year end, the still a million, two 50 of estimated remaining costs to, to finish the project. And during year one, they build their client 220,000 and they collected 180,000. So together let's go through the entries that we would make for year one under the percentage of completion method.

Well, first of all, when we're told that the construction cost for your one, which is 150,000, they're going to debit an account called construction in progress 250,000 notice construction costs always end up as a debit to an account called construction in progress. There's all kinds of credits, credit cash payables, other credits for 250,000.

But the main point is construction costs always end up as a debit. Always end up as a debit to an account called construction in progress. All right, now they said they build their client 220,000. Now, you know, when they build their client 220,000, they're going to debit accounts receivable 220,000, but I want you to notice what they credit.

They credit an account called progress billing 220,000. That's a balance sheet account progress billings 220,000. I want to talk about this for a minute. Normally in accounting, I think you'd agree with this normally in accounting when you bill it's because you weren't. In other words, normally in accounting, when you debit accounts receivable, you credit sales you bill, because you've earned listen carefully, not in long-term contracts.

In longterm contracts, the act of billing does not give rise to the recognition of revenue or profit. I'll say it again. In longterm contracts, the act of billing does not give rise to the recognition of revenue or profit in long-term contracts. When you debit accounts receivable, you credit a balance sheet account called progress billing.

We'll say more about that later, but that's unique to long-term contracts. Now. They said they collected 180,000 cash from the client. Well, that's just the normal entry. We're going to debit cash 180,000 and credit accounts receivable, 180,000. Those are the entries that would be made now because this is percentage of completion.

We're now going to have to make a fourth entry where we estimate how much profit we earned in year one. All right. Now let's do the calculations together, but just notice it's better to do it in steps. That's what I always tell my students do on this. Do it in steps. The first step. Is to work out the total estimated profit.

You think you're going to make from this project at the end of year one, let's work that out. What's the total estimated profit from this project. We think we're going to make it the end of year one. Well, the contract price is a million, eight so far. We've spent 250,000 on construction costs and isn't there another 1 million, two 50 of estimated remaining costs to finish the project.

So when we're all done, we expect the profit on the project to be 300,000. We need that number. So that's always your first step. What's the total estimated profit. We think we're going to make on this project at the end of year, one, 300,000. Now you'll go to your formula and you're going to have to memorize this formula.

You've got to memorize this formula. It's not too bad in the numerator. You want cumulative cost to date in the numerator. You want cumulative cost to date in the divisor. You want the total estimated costs at completion again in the numerator. Cumulative cost to date in the divisor total estimated cost when you're finished at completion.

And you're going to multiply that ratio times the total estimated profit. You think you're going to make on this project at the end of year one. And we just worked that out to be 300,000. So let's fill it in what's cumulative cost to date 250,000. Right? So far we've spent 250,000 on construction costs.

What's total estimated cost and completion. Well, so far we spend 250,000 on costs. Isn't there another 1 million, two 50 of remaining costs. Added up total costs when we're finished 1,000,005, if you take the ratio of 250,000, over 1,000,005, that's one sixth, we're using that ratio to estimate the project is one six complete.

So theoretically we've earned one sixth of the total profit we're going to make on this project, which we just worked out to be 300,000. Multiply that ratio one sixth. Times the total profit. We think we're going to make on this project 300,000, we've earned 50,000, our fourth entry, our fourth, Andrew, we're going to debit construction in progress.

50,000 notice notice, not only do construction costs, go to CIP, construction and progress. So to profits, you have to know how these accounts are used. So you want to notice, not only do construction costs go to CIP, so to profits, and we're going to credit income 50,000. Those are the four entries that we've made.

Under percentage of completion accounting for your one, let's do some financial statements. That's always a good idea. Let's let's say we had to do some financial statements at the end of year one. You know, you know, if I have to do an income statement at the end of year one, I'm going to show 50,000 of estimated profit from this project on their income statement.

At the end of year one, if I have to do a balance sheet at year one, What do I have for balance sheet accounts? I've got cash. That's a balance sheet account. I've got accounts receivable. That's a balance sheet account, but I want you to focus on two other accounts. I want you to focus on progress billings.

That's a balance sheet, account and construction in progress. That's a balance sheet account. Now, here is what we do. Here's the balance sheet rule at year end, construction and progress is netted against the billings account. I'll say it again at year end. What happens for the balance sheet? Is that the construction in progress account is netted against the progress billings account.

And here's how it works out. If construction and progress is greater than progress billings. In other words, that's out to a debit. If construction in progress is greater than progress billings, if it nets out to a debit, goes on the balance sheet as a current asset position. Now I want that to make sense to you.

Why is that? Why is it caught that way? What does it really mean? Logically if construction's ahead of billing. If construction and the billing, doesn't it mean I've accomplished more as a construction company, I've accomplished more than the contracts letting me bill for you all meet you all me. That's a receivable called construction in progress in excess of progress billings.

So remember that if construction and progress is greater than progress billings at year end, and that's out to a debit, goes on the balance sheet as a current asset position, it's going to go on the balance sheet as a current asset position. All right. Let's move on. If progress billings are greater than construction progress, that's out to a credit.

It goes on the balance sheet as a current liability position. And doesn't that make sense? Because what does it mean? Anytime? Billings, right of construction. If billings are at a construction, doesn't that mean you've let me bill for more than I've accomplished. So I owe you, I owe you some constructions, a liability it's like unearned revenue.

I've built more than I've earned. So that's the balance sheet rule. If constructions had a billing, current asset position, billing, Zeta construction, current liability position can remember that if constructions had a billing current asset position, billings had a construction current liability position.

How about in this case year at the end of year one, what's the balance in CIP. What's the balance in construction in progress while didn't we put the 250,000 of construction costs in that account and the 50,000 of profit. So right now at year end, The balance in CIP is 300,000. What's the balance in progress billings 220,000 notice construction and progress is greater than progress.

Billings. By 80,000, we have an $80,000 current asset position. Let's go to year two. And I have to tell you that. It's no accident that I'm making this do with three, a project, a lot of students have trouble with the middle year. I wanted to make sure we did at least a three-year project. Cause I want to have a middle year.

In other words, we could have done a five-year project and the trouble spot for a lot of students would be it's two, three, four, middle years seem to bother people. They're not that bad, but you gotta pay attention. You gotta be careful. So I want to have at least a middle year. So let's. Go to the second year.

It says in year two, the company has construction costs of 990,000 and there's still 310,000 of remaining costs to finish the project during the year to build their client 1 million, one 30 and collected 1,000,040 thousand. Let's do some entries. Well, first of all, we know the construction costs always end up as a debit to CIP.

So we're going to debit construction in progress or CIP. 990,000 all kinds of credits, cash payables, other credits 990,000. But the main point is construction costs always end up as a debit to an account called construction in progress. They said they build their client 1 million, one 30. So, you know, they're going to debit accounts receivable, 1 million, one 30, and they're going to credit progress billings 1 million, one 30, because anytime you debit accounts receivable in long-term contracts, you credit progress billings.

The act of billing does not give rise to the recognition of revenue or profit. Anytime we debit accounts receivable, we credit that progress billings account. They collected 1,000,040 thousand cash from the client. That's the normal entry, debit cash, 1,000,040 thousand credit accounts receivable, 1,000,040 thousand.

The entry any company would make. Alright. Now, where are we? Because this is percentage of completion. We now have to make a fourth entry, right? We have to make a fourth entry. Where we estimate how much profit we earned in year two. All right. So let me ask your opinion on this. How do I start? If I'm going to work out the profit for year two?

How do I start formula  formula? No, not the formula. Maybe you do this in steps. The first step is to do a quick calculation on the total estimated profit. You think you're going to make on this project at the end of year two, don't go too fast. You can do this in steps. That's the first step always work out the total estimated profit.

You think you're going to make on this project at the end of year two, let's work it out. We know the contract price is 1,000,008. What are our construction costs? Will the year one construction costs 250,000 a year to construction costs 990,000. And at the end of year two, we're still estimating there's another 310,000 of remaining costs.

To finish the project, the added all up the total estimated profit. We think we're going to make on this project. The end of year two is 250,000. You need that number 250,000. I'm confused on something. Maybe you can help me. I thought we were going to make 300,000 on this project. Why has it changed? You understand my question?

I thought we were going to make 300,000 on this project. Why is it two 50? You know what I'm getting at? What kind of changes this to change an estimate, right? Which that's, that's why I have to do it every year. These are estimates. They keep changing. It turns out you worked more overtime than you thought.

You're, you're paying labor more money and materials. Price of materials went up. These are all estimates. They change. That's why you have to do it. Year after year, when you change an estimate like this, do you go back and redo statements? No. Prospective only prospective only, right? Just go forward with it.

That's how we handle a change in estimate we don't touch prior periods. We just go forward with the new estimates. All right. So we know the total profit we're going to now make on this project. 250,000. Now we go to our formula. Now you want to go to your formula in the numerator cumulative cost to date in the divisor.

Total estimated costs at completion when we're finished, you're gonna multiply that times, the total estimated profit. We think we're gonna make on this project at the end of year two. And we now know that's 250,000. Let's fill it in what's cumulative cost to date. Well, I've got to take the 250,000 of construction costs from year one.

Plus the 990,000 construction costs from year two, cumulative cost to date 1 million, two 40. Notice it's cumulative cumulative cost. It's the 250,000 of construction costs from your one plus the 990,000 of construction costs from you to 1 million to 40. Or how about the divisor what's total estimated cost at completion?

Well, so far we spent 1 million to 40 on costs. Isn't there another 310,000 invested made the remaining costs. To finish the project. Total cost of completion, 1 million, five 50. If you take the ratio of 1 million to 40, over 1 million, five 50, it's 80%. We'll using that ratio to estimate the project is 80% complete.

So theoretically we've earned 80% of the profit, 80% of 250,000 or 200,000. That's how much we've earned. The project is 80% complete. So theoretically we've earned 80% of that. 250,000, the estimated profit on the project or 200,000. Careful. Now you back out the profit from your one 50,000. So yeah, so far we've earned 200,000 profit on this project, but we already recognized 50,000 of estimated profit in year one.

So the profit for year two, which you back into is 150,000 watch out for that middle year. All right. What's my fourth entry debit construction in progress, 150,000. Don't forget, not only do construction costs go to CIP, so to profits. So we're going to debit construction in progress, 150,000 and credit income, 150,000.

Those are the four entries I would make under construction under percentage of completion for year two. Let's do some financial statements. I always liked that. You know, you know, if I were to do an income statement at the end of year two, I'm not going to show 150,000 of estimated profit from this project on my income statement.

The end of year two, if I do a balance sheet at the end of year two, what's the balance in CIP right now. It's the balance in construction and progress. While I've got to add it up, I've got to take the 250,000 of construction costs from year one. Plus the 50,000 of profit. From year one, plus the 990,000 of construction costs year two, plus the 150,000 of profit from year two right now, right now, the bounce and CIP is 1 million.

hope you see where I got that it's the 250,000 of construction costs from your one plus 50,000 of profit from year one, plus the 990,000 of construction costs from year two, plus the 150,000, the profit from year two right now, the balancing construction in progress. Is 1 million, four 40. What's the balance in progress billings?

Well, 220,000 from year one, 1 million, one 30 from year two. Right now, the balance and progress billings, 1 million, three 50, the net it out since construction and progress is greater than progress. Billings. It's a $90,000 current asset position because that's the balance sheet rule. Construction's had a billing current asset position, billings out of construction, current liability position.

We know that. Let me ask you this. Let's say that a construction company is working on five projects, five projects, three of the projects construction's ahead of billing, current asset position, right? Two of the projects, billings ETA construction, current liability position. Right? So that's the situation they're working on five projects, three of the projects, constructors had a billing current asset position, two of the projects.

Billings out of construction, current liability position. So they have a current asset position for the three projects where construct instead a billing, they have a current liability position for the two projects where billings were head of construction. My question is, can they do a final netting? Can they offset the asset positions with the liability positions?

No, no, no. There's no right of offset. You can't offset asset positions with liability positions. No. What that company is going to have to do is show an asset position on the balance sheet for the three projects we're construct instead of billing. And they'll have to show a liability position on the balance sheet for the two projects where billings are are ahead of construction, but there's no final netting.

There is no right of offset. You cannot offset asset positions with liability positions. Let's go to. Year three,

we're going to go to year three and notice in year three, the company encouraged the final construction costs of 290,000. They build their client 450,000 and they collect 530,000. Let's do the entries for year three. Well, first of all, We know the construction costs always end up as a debit to CIP. So they're going to debit construction in progress or CIP 290,000 credit cash payables are the credits 290,000.

They billed the client for four 50. So we know what to do. They're going to debit accounts receivable 450,000 credit. The progress billings account four 50 billing has nothing to do with revenue or profit. That's unique to long-term contracts. Billing has nothing to do with revenue or profits. When they debit accounts receivable, they credit the progress.

Billings account 450,000. They collected 530,000 cash in the client. So they're going to debit cash, 530,000 and credit accounts receivable 530,000. The entry any company would make. And now you know where we are because this is percentage of completion. We now have to make a fourth then. Well, we estimate the profit we've earned for year three.

Now let's work out year three. We know the contract price is 1,000,008. We're going to be paid 1,000,008 for this project. What are the construction costs from year one, 250,000 construction costs per year to 990,000 construction costs for year three, 290,000. If you added up the total actual construction costs on the project, 1,000,530, the actual profit we made on the project.

It's 270,000. I'm sure you noticed we don't need estimates. Now we don't need estimates. We have actual information. Turns out the actual construction costs on the project. 1,530,000, the actual profit we made on the project. It's an actual figure, 270,000. Now what do we do back out the profit we've already recognized.

We recognized 50,000 of estimated profit in year one, 150,000 of estimated profit near to. We've already recognized in prior years, 200,000 of estimated profits back those out the profit for year three, which you back into is 70,000. My fourth entry. You know what to do. I'm going to debit construction in progress 70,000, because not only do construction costs go to CIP.

So to profits and I'll credit income, 70,000 now because the project is finished well, now I'm going to make a fifth entry. See if it makes sense. Now there's a fifth entry. If you add up all the credits to progress, billings added up, they showed up to add up to 1,000,008 because by the end of the project, you'd build your client for the full amount.

So I'm going to debit progress, billings 1,000,008, close it out again. If you would add up all the credits we put into progress billings, they should add up to 1,000,008 because by the end of the project, we would have billed our client for the full amount. Now we debit progress, billings, 1,000,008, close it out.

If you add up all the debits to CIP, If you did it properly, they should have added up to 1,000,008. I'm going to credit construction and progress 1,000,008. And that entry closes out the project that is percentage of completion accounting. Now what we're going to do in the next class is take the same problem.

Now that we kind of know the numbers we'll take the same problem, but we'll change the method to complete a contract. I'll see you in the next class. Welcome back in this FAR CPA Exam class. We're going to finish our discussion on. Long-term contracts. And you know that in our last class we spent the whole class on percentage of completion, accounting, and now we're going to take the same problem we did in our last class on a percentage of completion accounting, we're going to switch the method to complete a contract.

And as a teacher, I like to do that. I really think a lot of times it helps to see the same problem solved under two methods, because that way you get used to the numbers and what you focus on is what you should focus on. And that's. The difference in the methods. So let's do the journal entries under completed contract notice once again, company signs, a three-year construction project.

It's a fixed price contract for 1,000,008 in year one. The construction cost, which 150,000 end of the year. There's 1 million, two 50 of remaining cost to finish the project. During year one, they build their client 220,000 and they collected 180,000. So what would be the entries? Under completed contract.

Well, you know, the construction costs always end up as a debit to CIP. So we know they would have debited CIP 250,000 credit cash payables, other credits 250,000 when they build their client 220,000, we know they would debit accounts receivable 220,000. And yes, they'd credit progress billings 220,000 because in long-term contracts, whatever method you use, percentage of completion or completed contract, when you bill.

You set up the progress. Billings account billing has nothing to do with revenue or profit under either approach. So we still credit the progress billings account that collected 180,000 cash from the client. That's the normal entry, debit cash, 180,000 credit accounts receivable, 180,000, the entry any company would make.

But do you see my point? That's it. You just have to do those three entries. If this were percentage of completion, we now have to make a fourth entry. Wouldn't we will. We estimate how much profit we earned at the end of year one, but in the completed contract, we recognize no profit from the project. No profit until the project is completed.

So it's just the first three entries you got to love completed contract. Maybe love is too strong, a word, but you have to really, you have to really like it because it's just the first three entries let's go to the second year. In the second year company has construction cost of 990,000. At the end of year two, this 310,000 of remaining cost to finish, build a client 1 million, one 30 and collected 1,000,040 thousand cash.

Let's do the three entries I hope you can do in your sleep. Now, construction costs would be a debit to CIP, always 990,000 credit cash payables. Other credits. 990,000 when they build their client 1 million, one 30 debit accounts receivable, 1 million, one 30 credit to progress, billings account, a balance sheet account 1 million, one 30, by the way, you know, the balance sheet rule is still the same, not going to go through it in the same detail, but at year end, you're going to look at the balance and construction and progress and progress billings, and those accounts get netted.

And you have the same balance sheet rule in completed contract. If. Construction's at a billing current asset position, billings, Loretta construction, current liability position, same rule applies in year two. They collected 1,000,040 thousand cash in their client. Well, that's the normal entry. They would debit cash, 1,000,040 thousand credit accounts receivable, 1,000,040 thousand.

And that's it. And that's it. Just the first three entries again, if this were, if this were percentage of completion, we now have to make a fourth entry where we estimate how much profit we earned in year two and back out the profit from year one and do the calculation and the formula. You see how much easier completed contract is.

Let's go to year three and year three company and curves the final construction cost of 290,000 bills. Their client, the final 450,000 and collect 530,000. Let's do the entry. Construction costs would be a debit to CIP 290,000 credit cash payables, other credits 290,000 when they build their client they'll debit accounts receivable 450,000 credit progress.

Billings 450,000. When they collect the cash of five 30, they would debit cash 530,000 and credit accounts receivable 530,000. I know you can do those first three entries in your sleep. Now we now are going to recognize profit right? In completed contract. We recognize no profit until the project is completed.

Well, the project is completed now. So what's our profit. Well, we worked this out before, but let's just look at it again. How would work out the profit while the contract price is 1,000,008, we got paid that fixed price for the project construction costs for year one, 250,000 construction costs a year to 990,000 construction costs for year three.

300 and 290,000, the added all up the actual construction cost on the project. 1,530,000 notice. We don't need estimates in completed contract. You don't need any estimates ever in completed contract. You always have actual information. That's why it's a more conservative approach. Complete a contract is more conservative than percentage of completion because with completed contract, you always have actual information.

You'd never need estimates of any kind. All right. So if you added up total actual construction costs on the project, 1 million, five 30, the actual profits you made on the project 270,000, and it's all gonna be recognized in year three. So we're going to debit construction in progress 270,000, because we know not only do construction costs go to CIP.

So it profits. So we're going to debit construction in progress, 270,000 credit income, 270,000. All the profit is recognized when the project is completed now, because the project is completed, we're going to make a fifth entry. You know what it is. If you add up the credits to progress billings, they do add up to 1,000,008, because by the end of the project, you to build your client for the full amount.

Now I debit progress, billings, 1,000,008, close it out. If you add up all the debits to construction and progress, if you do it right, they should add up to 1,000,008. I'm going to credit construction in progress, 1,000,008, that entry closes out the project. So remember the basic difference percentage of completion is theoretically preferred.

It's more consistent with a cruel accounting cause you recognize profit from a longterm project each year of the project, because theoretically you were in some of the profit each year, completed contract is more conservative. You don't recognize any prof until the project is completed. And I want you to think about this.

Let's say we're a construction company. We sign a ten-year construction contract. Listen carefully. Now we're construction company. We sign a ten-year construction contract. It's a 10 year project contract price is $3 million, 3 million. We get to the end of year, one end of year one it's 10 year project.

End of year one, we estimate the total cost on the project are going to be 3 million for what's the problem. Well, if the contract price is a fixed price contract of 3 million and at the end of year one, First of 10 years, we now realize our total costs are gonna be 3 million for aren't. We projecting a $400,000 loss on this project.

Here's my question. Could I do this? Could I make this argument? Could I, could I make the argument look, I have consistently used percentage of completion accounting. So at the end of year one, the product is 11% complete. I'll recognize 11% of that loss. No, that argument will not stand. I understand the argument.

Hey, I consistently use percentage of completion accounting. So at the end of year one, the product is 12% complete. I'll pick up 12% of the loss. Nope. That argument will not stand. Could I make this argument? Hey, I consistently use completed contract. So I'll recognize that entire loss in year 10 when I complete the project.

No, that argument will not stand. No. What the entry I'm going to make here at the end of year one, I'll accrue a loss I'll debit loss for all 400,000 debit loss. 400,000 credit, a provision for a loss or an estimated liability of 400,000 under either method. It doesn't matter what method you use. Why?

Because when a loss is probable, when a loss is probable and you can reasonably estimate the amount, you must accrue the loss. So be careful of losses. That's one of their favorite tricks in the exam. If you're expecting a loss on a project, it doesn't matter what method you use. You book the entire loss because when a loss is probable and this certainly is, and you can reasonably estimate the amount and we can, we book it, we book it.

So we're going to debit loss for the entire 400,000 and credit, an estimated liability for 400,000. So watch out for losses. Let's do a couple of problems. First problem. The viewers guide says bark corporation started a long-term construction project in the current year. Here's the following information.

We know the contract price. We know the costs incurred in the current year, estimated cost to complete progress billings and collections. The product is accounted for under the percentage of completion method, embars, current year income statement. What amount of gross profit would they report? So how do I start formula formula?

No, no, do it in steps, always work out. First of all, the total estimated profit. You think you're gonna make on this project? So let's work that out. What's the profit we think we're gonna make on this project. Contract price is 4 million, two so far we spent 1 million, seven 50 on costs. There's another 1,000,007 50 of remaining costs.

So aren't we expecting the total cost of the project to be 3,000,005. If you take 4 million to minus 3 million, five, we're expecting to make a $700,000 profit on this project. Now you go to your formula. Now you want your formula in the numerator. Cumulative cost to date that's 1,000,007 50. So, so far we've spent 1 million, seven 50 on costs.

How about the divisor total estimated cost when we're finished? Well, so far he spent 1 million, seven 50 and there's another 1,000,007 50 remaining costs. So we expect the total cost of the project to be 3,000,005. If you take the ratio of 1,000,007 50, over 3,000,005, we using that formula to estimate the project is 50% complete.

And if the project is 50% complete, theoretically we've earned. 50% of that profit 50% of 700,000 answer a 350,000 step by step, by the way, notice how we didn't care about progress, billings collections. You know, if you've studied this, you know, billings collections have nothing to do with revenue or profit in long-term contracts, they've separated billing from revenue and profits.

Billings collections have nothing to do with revenue or profit. And of course, a lot of students get hung up right there. You know, what do I do with billings? What do I do with collections? If you've studied it, you know, they're irrelevant. Number two, half corporation, a half construction company has consistently used the percentage of completion method.

January 10th year one half began work on a $3 million project. All right. So it's a fixed price contract, 3 million. At the inception date, the estimated cost of construction, 2 million, two 50, and we have the following data. We know the income recognized back in year one. We know the cost incurred from January 10th, year one to December 31 year two, and the estimated cost to complete the remaining costs in the income statement for the owner, December 31 year two, what would be the gross profit they report?

Well. First of all you do this in steps. What's the total profit you think you're going to make on this project? Well, I want you to notice when you sign the contract, when you sign the contract, because a lot of students get hung up here. Contract price was 3 million and they thought the total cost of the project will be 2 million, two 50.

The day they signed the contract, they thought they'd make a $750,000 profit on this project. What do we do with that? Nothing. That's irrelevant number. These are estimates. They keep changing. Here's what's important. The contract price is 3 million so far. They spent 1,000,008 on costs and there's another 600,000 of remaining costs.

So don't, we now expect the total cost of the project to be 2,000,004. If you take the contract price 3 million minus 2,000,004 in costs, we're expecting to make a $600,000 profit. On this project. That's what's important. Remember, these are estimates. They're always changing. Now. Let's go to our formula in the numerator.

We want cumulative cost to date, the cost incurred from January 10th, year one to December of year two, 1 million nights. When the numerator we put cumulative cost to date in divisor, we want the total cost when we're finished. Well, so far we spent 1,000,008 on costs and there's another 600,000 of remaining costs.

So don't we expect the total cost of the project to be 2,000,004. If you take the ratio of 1,000,008, over 2 million, four, it's 75%, it's three quarters we're using that ratio to estimate the project is three quarters complete. So theoretically we've earned three quarters of that $600,000 profit or 450,000 and a is so tempting.

Answer a is so tempting. A lot of students go for a, you know, there's just something exciting about your work three or four minutes on a problem, come up with a number and it's there. That's just exciting. You know, you're in the exam, you've got to take the exam. You know what I'm talking about, but you work on a problem, but two or three minutes finally come up with a number and you look and go, Oh my God, it's there.

God does love me. Look at it. It's there. Why isn't the day? What that student forget. That's right. We're in the middle year here. You've got to back out the profit. You've already recognized back in year one, 300,000. So the profit for year two, which you back into is 150,000 answer D I hope you did well on that problem.

Keep studying and I'll see you in the next class.

Welcome back in this FAR CPA Exam Review, we're going to begin our discussion of nonprofit accounting or fund accounting, and the way fund accounting breaks down, there are two main areas. First we have state and local governmental accounting. Remember, it's all nonprofit. And the first big area is state and local governmental accounting.

And you can expect state local, governmental accounting to make up somewhere between eight and 12% of your grade. And then the other large area in this topic is O N P O's, other nonprofit organizations. In other words, other than state and local governmental units. Other nonprofit organizations would include private, not for profit hospitals or healthcare entities, private, not for profit colleges or universities, voluntary health and welfare organizations.

And you can expect other nonprofit organizations to make up another eight to 12% of your grade in the financial exam. So as you can see. This is huge. And we're going to spend the majority of our class time on state and local governmental accounting, because you'll see, as we get into this, that governmental accounting is just a lot more complicated.

This is, there's just a lot more to it. Other nonprofit organizations basically use normal accrual accounting, generally accepted accounting principles. They really aren't that involved? I'm not saying there aren't some tricky, tricky things they can ask. There are, but other nonprofit organizations, I don't think you'll find are that bad, but governmental accounting, there's quite a bit to it.

So we are going to spend most of our class time on governmental accounting. And as we start governmental accounting, I want to remind you that when you're talking about governmental accounting, you're no longer talking about the FASBI. Now you're talking about the Gasby, the governmental accounting standards board, the governmental accounting standards board establishes generally accepted accounting principles for state and local governmental units.

So just keep in mind through this discussion. We're talking about the Gasby. Now the first thing I want to say about governmental accounting is this. That governments, I don't care whether you're talking state government, city, government township, government borrow government governments, no matter how big, how small governments exist to perform different services.

For the community. Let's just start with that thought governments, whether it's state, government, city, government township, government, however big, however, small, the reason governments exist is to perform different services for the community. And what a government will do is set up a different fund for all the different services that they provide for the community.

So that's all that's going on here. They set up a different fund for all the different services that they do provide for the community. So with that said, let's get right down to it. What is a fund? A fund is an accounting and fiscal entity. That's all it is. It's an accounting and fiscal entity. It has accounting responsibilities.

It has fiscal responsibilities. And what it does is keep track of the money coming in and the money going out as the government performs. Different services for the community. That's what a fund is. It's an accounting and fiscal entity that simply keeps track of the money coming in and the money going out as the government performs different services for the community.

I don't know if you've studied this area before, but if you want to picture what a fund is, this might help you as we go through this in these classes, just picture each fund as a separate checking account. I think that works pretty well. It's as if the government has all these separate checking accounts, we call them funds where they keep track of the money coming in and the money going out as the government performs different services for the community.

Now let's get some language down here. Let's be careful with some terminology, a governmental unit. What's a governmental unit, like a city, a governmental unit, like a town uses three different types of funds. The first type. They use governmental funds. So a governmental unit, like a city, a governmental unit, like a town does use three different types of funds.

The first type is governmental funds. The second type, they also use proprietary funds and the third type, they also use fiduciary funds. Those are the three types of funds they use. Now we're going to begin. With the governmental funds. And you'll see, when you do your homework, that a lot of the grading points in the CPA Exam really come down to you.

Knowing the names of all the funds used by a governmental unit and what each one does. And that's why we're going to start this way. Let's go through the governmental funds because you have to know the names of the funds and what each one does. The first governmental fund is called the general fund.

I'll give you a note on it. The general fund. Accounts for the general day to day operations of a municipality. Again, the general fund accounts for the general day-to-day operations of a municipality. And before I go any further, I want to give you a little tip. Also when you're studying these funds, as much as you possibly can, let the name of the fund help you remember its purpose.

In other words in my mind, you have to let the name of the fund be more than just the name. Let the name prompt you to remember what it does. In other words, what I have in mind is that this is the general fund. Why? Because of the counts for general operations, I think you really have to do that. Lift the name of the fund, prompt you to remember what it does.

So that's the general fund it accounts for the general day to day operations of the municipal of the municipality. Second governmental fund. It's called a special revenue fund. The government sets up a special revenue fund when the government collects revenue that is earmarked, it is restricted for some special public purpose.

The government has collected revenue. That's re restricted it's earmarked for some special public purpose, classic example. And I think examples always help, always have examples in your notes because it helps let's say a town, for example, gets a state grant. That's dedicated for highway maintenance. That is a classic special revenue fund because of a town gets a state grant that is restricted.

It's dedicated to be spent for highway maintenance that money's restricted. It can only be spent on that special public purpose. And that's why you need a special revenue fund. So notice when you need a special revenue fund when the revenue is special, but the name help the revenue is special. It can only be spent on some special public purpose.

Now there's another point. Always remember. That the special revenue fund is an expendable fund. What do I mean by expendable? It means you can spend the interest. You can spend the dividends, you can spend every dime of the principal in this fund for that special public purpose, whatever it is, it is an expendable fund.

Third governmental fund is called a capital projects fund. The government sets up a capital projects fund. To account for the construction of major capital assets. So the government's going to set up a capital projects fund to account for the construction of major capital assets. So if they're going to build a new high school, if they're going to build a library, if they're going to build a museum, if they gonna build a civic center, you account for projects like this through capital projects fund, because it accounts for the construction of major capital assets.

Fourth, governmental fund is called the permanent fund. Now the government sets up a permanent fund when the government collects revenue that is earmarked, it's restricted for some special public purpose, but this fund is non expendable. What does that mean? Non expendable means you can never spend the original principle.

That's why it's permanent. You can never touch it. Let the name help. It's permanent. You can never touch it. You can never spend the original principle. You can only spend the interest and the dividends on some special public purpose. For example, let's say bill Gates donates a billion dollars to the city of Seattle for scholarships, for needy, for needy students and bill Gates specifies.

Cause it's up to the donor bill Gates specifies. You can never spend the original billion dollars. All you can give out as scholarships are the interest and the dividends on the billion, that is a permanent fund because the billion is permanent. You can never spend the original principle. You can only spend the interest and the dividends on some special public purpose.

Let me ask you this. What if bill Gates said that you can spend the interest, the dividends and you can even spend. The original billion dollars on scholarships. Now what fund that's right. Special revenue now would be a special revenue fund because remember the only difference really between the special revenue fund and the permanent fund is that the special revenue fund is an expendable fund, but the permanent fund is non expendable.

It's permanent. Now what we're going to get into are some things that. All four of these funds have in common. Cause there are some things that all four of these funds, general fund, special revenue fund capital projects, fund permanent fund. There are some things they have in common. For example, none of these four funds are allowed to carry their own long-term debt.

You have to remember that these four funds are forbidden to carry their own longterm debt. Let me be more specific. You would never see the account bonds payable in any one of these four funds. And let's be honest, what the CPA Exam is likely to throw at you as bonds. But I want you to know that you would never see the account bonds payable in any one of these four funds.

You would never see the account long-term notes payable in any one of these four funds because these four funds are not allowed. They are forbidden to carry their own long-term debt. So let's think about this for a minute. Let's say one of these funds goes out and issues some long-term debt. Cause it does happen.

You know, for example, let's say the capital projects fund goes out and issues, some bonds to pay for the construction. Cause that that might happen. So the capital projects fund goes out issues, some bonds to pay for the construction, whatever it is. Well, if they go out and they issue. So bonds to pay for the construction.

Think about the entry that's made here, you know, in the capital projects fund, when they issue the bonds, they're going to debit cash for whatever they collect, but you see my point, they can't credit bonds payable. They're not allowed to, in that entry, you would not be allowed to credit bonds payable because the capital projects is forbidden to carry its own long-term debt.

So what do they credit? They credit an account that we're going to be seeing a lot in these classes, other financing sources. What they credit is other financing sources control. So notice bond proceeds end up as a credit to other financing sources. And we'll talk about that account in more detail later on.

Now, what do you think, do you think the government reports the debt somewhere? Well, of course they do. The government reports, the debt. In what they call the government wide statement of net assets. We're going to look at that later, but the government would actually report the debt. Of course they have to, and they would report the debt in what they call the government wide statement of net assets.

We'll look at that later, but let's get back to these four funds. These four funds are not allowed. They're forbidden to carry their own long-term debt also. These four funds are not allowed. They're forbidden to service their own long-term debt. These four funds are not allowed to carry their own long-term debt.

These four funds are not allowed to service their own long-term debt. In other words, you're never going to see the account interest expense in any one of these four funds they're forbidden to serve as their own long-term debt. So we need another fund, the fifth and final governmental fund. Is called the debt service fund.

Let's get into it. All the debt service fund does is accumulate money to make interest payments and principle payments on long-term debt of the first four funds. That's all it does. I'll say it again. All the debt service bond does is accumulate money to make interest payments and principle payments on long-term debt of the first four funds.

In other words, all the debt service bond does is service debt. That's why you have to let the name of the fund help you get through that. As I've said before, what the name of the fund prompt you to remember what it does? They call it the debt service bond, because all it does is service debt. Now, when we come back in our next class, we'll talk about some things that all five governmental funds have in common because now we know.

The five governmental funds. Those are the five generals general fund special revenue fund capital projects fund permanent fund debt service fund. Those are the five governmental funds and in the next class, we'll talk about some things that the five governmental funds have in common. I'll look to see you then

welcome back. In our last class, we talked about the five governmental funds. We know there's the general fund, the special revenue fund, the capital projects bond, the permanent fund. And of course the debt service fund. And now what we're going to get into in this FAR CPA class are some things that all five of these governmental funds have in common.

First of all, all five of the governmental funds have what they call the same measurement focus. Kind of thing the FAR CPA Exam likes to ask you. So let's be clear on this. The measurement focus in all five governmental funds, all of them is the flow of current financial resources. That is the measurement focus in all five governmental funds, the flow of current financial resources.

Remember we said in our last class, that one way to think of these funds, you can think of each fund as a separate checking account. And if I were to ask you, and I'm sure you've never thought about this in your life, but if I were to ask you, what is the measurement focus in your personal checking account?

I'm sure you've never thought about that, but let's think about it for a second. What is the measurement focus in your personal checking account? I think it is the flow of current financial resources, keeping track of the money coming in and the money going out as you live. Well, same thing here. That is the measurement focus.

The flow of current financial resources. Now these five governmental funds also have something else in common and it's huge. All five governmental funds, all of them use what they call modified accrual accounting. Now, I want you to know before we get into this, that modified accrual, accounting is not something you can cover in.

A couple of minutes, there's a lot to it. And in fact, we're going to be spending a huge proportion of our remaining class time on this, on modified a cruel there's a lot to it. And because we have to start somewhere, here's where I want to begin. Just to get us started into this. When you boil it down.

What is the major difference in modified a cruel on the revenue side? And what is the major difference? Not the only one, but what is the major difference in modified a cruel on the expenditure side? Let's start that way. Let's start with revenue. Now, you know that if we were talking about a profit making company, you know, that a profit making company under normal accrual accounting, Recognizes revenue as it's earned.

And I just mentioned that because that's what we're all used to. Right? That's normal, cruel accounting, profit making companies recognize revenue as it's earned. It doesn't matter when they collect it. It's as it's, as it's earned. We know that now I want you to see the basic problem here. When you get into these five governmental funds, what kind of revenue are you dealing with for the most part tax revenue?

And I think you see the basic problem. You can't say that a government should accrue tax revenue as they earn it. Why not? Because they don't earn it. We know that they just tax right. Governments don't earn it. They just tax. So here's the point under a modified accrual governments, accrue tax revenue, not what it's earned when it's available and measurable.

Make sure you remember that phrase in modified accrual. Governments accrue tax revenue, not when it's earned, they don't earn it. They accrue tax revenue when it's available and measurable. Now we're not done with this yet by a long shot. What does available and measurable mean? For example, let's say that a government levies taxes, if a government levies taxes, does that make that tax money available and measurable?

No notice. I don't look at the tax levy. Now what you have to do in modified a cruel. Is estimate what they expect to collect from that tax levy within the current fiscal year. And even up to 60 days into the next fiscal year, what you estimate that they expect to collect from a tax levy within the current fiscal year, and even up to 60 days into the next fiscal year, all of that money.

Is considered available to pay off current expenditures. That's what they mean by available and measurable. It's a technical definition. So you have to estimate what you expect to collect from a tax levy within the current fiscal year. And even up to 60 days into the next fiscal year, all of that money is considered available to pay off current expenditures.

That's what they mean by available and measurable. Now, furthermore, there's another little complication. In modified a cruel, there are only five types of tax revenue that you would ever accrue. There's only five types of tax revenue that are subject to a cruel. Let's go over them. Number one, property taxes.

Number two real estate taxes. Number three, income taxes again in modified a cruel, there are only five types of tax revenue that you would ever recruit. Number one, property taxes. Number two real estate taxes. Number three, income taxes, number four, sales taxes and number five tax payments due from other governmental bodies.

Get number five would be tax payments due from other governmental bodies. Let me say worried about that last one, cause that might not be clear. What do I mean by tax payments due from other governmental bodies will be something like this. Let's say a town. Was anticipating collecting some sort of state matching funds.

The town could accrue that if a town is anticipating collecting some sort of state matching funds, the town could accrue that because it would fall in that fifth category tax payments due from other governmental bodies. All right. So if you, you, with me on the list, those are the five types of tax revenue that are subject to a cruel and modified accrual.

When you accrue those five. When you think about that, when do you accrue those five? That's right. When available and measurable, those are the five that you accrue when they're available and measurable. Now, listen carefully, all other tax revenue, all the tax revenue, parking meter, money, hunting, license fees, fishing, license fees.

Anything else you can think of? But the first five. Is recorded on a cash basis and you know exactly what that means. Nothing is recorded until collected. So again, all other tax revenue, other than the five, all of the tax revenue, parking meter, money, hunting, license fees, fishing, license fees, anything else you can dream up except the first five is recorded on a cash basis, which of course simply means nothing is recorded until it's actually collected.

That's a big part of modified a cruel art. And if you, with me on that, that's the major difference in modified a cruel on the revenue side. What is the major difference in modified a cruel on the expenditure side? Listen very carefully. Here's the major difference? Not the only one, but the major one, none of the five governmental funds, general fund special revenue fund capital projects fund permanent fund debt service fund.

None. Of the five governmental funds are allowed to carry their own fixed assets. Remember that it's a rule. These five governmental funds under modified a cruel are forbidden to carry their own fixed assets. So here's what happens if one of these funds goes out and buys a fixed asset because it does happen.

If one of these five funds goes out and purchases a fixed asset. Think about the entry, they can't debit machinery. They can't debit equipment. They can't debit building. They're not allowed to. So what are they? Debit expenditures control and credit vouchers payable. In other words, these five funds treat the purchase of a fixed asset, like an expense.

And when you really boil it down, that's the major difference in modified accrual on the expenditure side, the idea that if any, one of these five governmental funds goes out and purchases a fixed asset. They treat it like an expense that is the major difference in modified accrual on the expenditure side.

What do you think? Does the government report the fixed asset somewhere? Of course, the government reports the fixed assets in the government wide statement of net assets. And again, we're going to look at that later on, but yeah, the government would actually have to report the fixed assets in the government wide statement of net assets.

As you'll see later in these classes, the government wide statements. Are all done under normal accrual accounting. So you see why this gets complicated because the five governmental funds use modified a cruel, but the government wide statements, which we'll look at later, use normal cruel accounting. So it is a bit of a mess.

And it's a little bit complicated. Let's look at a question. And your viewers guide question number one, the following information pertains to property taxes levied by Oak city. For calendar year. Number one, notice the total levity is 700,000. We know what they collected in year one. We know what they expect to collect during the first 60 days of year two, what they expect to collect the balance of year two, what they expect to collect January of year three what's uncollectable and they say, what amount would Oak report in year one for property tax revenue?

Well, of course the first thing that they're testing is. Our property taxes handled on the cash basis or cruel. We know it's a cruel cause in modified a cruel, there are five types of tax revenue that are subject to a cruel property taxes, real estate taxes, income taxes, sales taxes, and tax payments due from other governmental bodies.

So my point is that property taxes is one of the five. It is subject to a cruel and modified a cruel when you accrue it, when it's available and measurable. And my point is you don't look at the levy. I know, you know that the answer is not a, you don't go by the levy. What you have to do is estimate what you're going to collect from that levy within the current fiscal year notice I've actually collected 500,000.

And even what you estimate, you're going to collect from that levee within the first 60 days of year two, that's all accrued as year one revenue, all that money. Is considered available to pay off current expenditures. So we pick up the a hundred thousand also, and the answer is C, as I said before, it's a big part of modified or cruel.

It's not all there is to it by a long shot, but it is a big part of it. We will continue talking about modified a cruel in our next class. And I look to see you then

welcome back in this FAR CPA class. We're going to continue our discussion of governmental accounting or fund accounting. And we know that there are five governmental funds, the general fund, the special revenue fund, the capital projects fund the permanent fund, the debt service fund. There are five governmental funds and we know that all five governmental funds use modified accrual accounting, and the best way to understand modified a cruel.

Is to go through all the journal entries that you make with modified a cruel. Now you're going to find that the actual accounting with modified accrual is very basic. It's not going to bother you at all, but what's a little bit of a challenge is that you're going to have to learn a whole new set of account names.

And there's really no way around this because as you'll see, when you're doing your homework, you'll get into multiple choice. And in the multiple choice, they start talking about these account names and you have to know how they're used. So there's really no way around this. You have to know how all these accounts are used, and you're going to have to get used to these account names.

Now, right now, to go through modified accrual, we could do a problem on the general fund. We could do a problem on the special revenue fund or the capital projects fund or the permanent fund or the debt service fund, because they all use modified a cruel, but to get us started right now, we're going to do a problem.

On the general fund. And if you look on the viewer's guide, you'll see the problem on pine city and also in the viewer's guide, you'll see that there's a whole set of T accounts as well. And what I'd like you to do is we go through this problem. As we get the entries down, I'd like you to take the time to post the entries to the T accounts, because I think it's really the best way to learn this.

I'm only going to make you do this once, but I think it's critical to keep track of T accounts. At least one time. I think it will help you understand the flow a lot better, but you can see from that list of T accounts, there's a lot of account names you're going to have to be comfortable with. And as I say, there's really no way around this.

the CPA Exam expect you to know how these account names are used. So let's take a look at the problem. It says pine city just came into existence. Well, that helps. Doesn't it. Because it means that there's a zero in all these accounts. And on the first day of the fiscal year, pine city adopted the following budget.

So now we have all the information about pine city and we have two requirements. It says, prepare the appropriate journal entries for pine city's general fund and prepare the closing entries for the general fund. We have to do both. But we're going to do all the entries under modified accrual for the general fund.

Now they start by giving us the information about the budget on the first day of the fiscal year pine city adopted the budget and here's the budget. During the fiscal year, they're estimating that they're going to collect a hundred thousand in tax revenue and notice they have legislative authority to spend up to 97,000 of that.

Also during the year, the general fund is estimating. That they're going to receive a permanent transfer from notice that word from they're gonna receive a permanent transfer from the capital projects fund, but they're also estimating they're going to make a permanent transfer. Notice to the general fund is going to make a permanent transfer to the debt service fund.

So they, as your budget information, and now we're ready to do our first entry because you have to know this one of the major differences in modified accrual. Is the idea that under modified a cruel, not only does the government have a budget, but they actually make a journal entry to record the budget.

So that's what we're going to start. We're going to start with the entry to book the budget. When they say that during the fiscal year pine city is estimating that they're going to collect a hundred thousand in tax revenue. We're going to start our budget entry. We're going to debit notice debit estimated revenues control a hundred thousand.

Because they're estimating, they're going to collect a hundred thousand in tax revenue during the year. That's how we start our budget. We're going to debit estimated revenues control a hundred thousand. Now they also say that they have legislative authority to spend up to 97,000 of that. Well, you have to know that legislative authority to spend money.

That's the definition of an appropriation. So in our budget entry, we're going to credit credit, appropriations control. 97,000. So remember that legislative authority to make contracts in Corolla allegations, basically legislative authority to spend money. That's the definition of an appropriation. So we're going to credit appropriations control 97,000.

Now we have to get into this idea of permanent transfers. And I can tell you right now, the CPA Exam loves transfers of money from one fund to another. So reading again, what they have here. They're estimating that during the fiscal year, the general fund is going to receive a $7,000 permanent transfer from the capital projects fund.

And the general fund is going to make us a $2,000 permanent transfer to the debt service fund. And what this gets us into is a rule. And it's a rule that we're going to work with many times. The rule is a permanent, not a temporary now a permanent transfer of money. From one fund to another for operating purposes is always called other financing sources or other financing uses.

Let me say it again. A permanent transfer, not a temporary transfer. We'll talk about that later, but a permanent transfer of money from one fund to another for operating purposes is always called other financing sources or other financing uses. And always remember the fund that receives the money. It's a source, the fund that sends the money.

It's a use. Now I bring this up because if you're setting up your budget and you're estimating that during the fiscal year, there's going to be permanent transfers, permanent transfers are part of your budget. Permanent transfers have to be budgeted for not temporary transfers, which we'll talk about later, but if you're setting up your budget and you're estimating it during the fiscal year, there's going to be permanent transfers.

Permanent transfers have to be budgeted for. So let's continue our budget. Let's start with the, transfer it to the debt service fund they're estimating. During the fiscal year, the general fund is going to make a $2,000 permanent transfer to the debt service fund. So in our budget entry, we're going to credit appropriations dash estimated other financing uses 2000 and you see why it's uses because the general fund is going to send the money.

To the debt service fund. So to the general fund, that's going to be a use. So in our budget, we're going to credit appropriations dash estimated other financing uses 2000. Now they're also estimating during the fiscal year that the general fund is going to receive a $7,000 permanent transfer from the capital projects fund.

Well, of course now the general fund is going to be receiving the money. So it's going to be a source. So in our budget entry, we're going to debit. Debit estimated other financing sources 7,000. Now that's all the budget information and you'll notice the entry doesn't balance. If you do out the math, I simply need an $8,000 credit to balance the entry out.

We're going to credit budgetary fund balance, budgetary fund balance 8,000. That's the entry to record the budget in the general fund. And I can tell you that the CPA Exam loves the entry to book the budget. Don't minimize how important this entry is. When you do your homework, you're going to see a lot of multiple choice questions about the entry to record the budget.

And I think the reason why the CPA Exam has always tested this pretty hard is because there's nothing like this in profit making accounting. In other words, if you had to generalize what the CPA Exam loves to hit hard is what's different. Between what a profit making company does and what a government does.

And the fact is profit making companies have a budget, but they don't make an entry to record the budget. They don't book the budget, but in modified accrual, cruel, we do. And that's why the CPA Exam loves to hit it as they do. So make sure you're comfortable. I mean, could do it in your sleep, comfortable with the entry to book the budget.

And as I say, you'll certainly see a lot of questions on that entry. And aspects of that entry and your multiple choice questions and your homework. All right, now let's move on to the actual activity. We booked the budget and now they also give us the actual activity that occurs during the year. Item.

Number two says, now levy starts levying. Now they start levying real estate taxes and pine city levies real estate taxes of $108,000. And notice 8,000 is estimated to be uncollectable. All right. Now let's back up here. What do we know? We know that in modified a cruel, there are only five types of tax revenue that you'd ever accrue.

Property taxes, real estate taxes, income taxes, sales taxes, and tax payments due from other governmental bodies. So obviously real estate tax is one of the five. We are going to accrue it. When do we accrue it? That's right when it's available and measurable. Now, how do we know what's available and measurable?

We look at what we estimate we're going to collect from this tax levy within the current fiscal year, up to 60 days into the next fiscal year, all of that money is considered available to pay off current expenditures. Well, they didn't give us all that detail, but because they told us what was uncollectable notice, 8,000 is estimated to be uncollectable.

We have to assume that the other a hundred thousand. They're going to collect within the current fiscal year up to 60 days. If for the next fiscal year, the is not always going to give you that precise detail, but we know what's uncollectable here. So let's book our entry. We're going to debit estimated, excuse me.

We're going to debit taxes receivable current. We're going to, we're going to accrue this tax levy. We're going to debit taxes, receivable, current 108,000. We're going to credit estimated uncollectable taxes. 8,000. That's like your allowance for bad debts in a profit making company. And we're going to credit revenues control a hundred thousand notice.

Actual revenue ends up as a credit to revenues control. You've got to know that actual revenue always ends up as a credit to revenues control. Now, if you look at that entry, you can see from that entry, we just did. It's very basic accounting. It's not going to bother you. But as I said before, What is a bit of a challenge is getting comfortable with all these new, new account names.

That's just, it's just a big part of it. And you have to get more and more comfortable with the account names themselves. All right. Now, item three. Now people start to pay their real estate taxes and the city collects 106,000 and real estate taxes. Well, if the city collects 106,000 in real estate taxes.

In the general fund, we're going to make the basic entry. They're going to debit cash 106,000 and credit. The receivable credit taxes receivable, current 106,000. Just make a very basic entry, but you'll notice there's a little bit of a problem here. Doesn't it turn out that we collected more in real estate taxes than we estimated.

We were going to look at the little problem we have here. Turns out, we collected more in real estate taxes than we estimated we were going to collect. So my point is we're going to have to make an adjustment. We're going to have to make an adjusting entry. So let's think about it originally. How much did we estimate would be uncollectable 8,000 now, apparently how much is uncollectable?

Just 2000. So isn't that account overstated. So we're going to debit estimated uncollectable taxes. 6,000 because that account is overstated. So we're going to debit estimated uncollectable tax is 6,000. What would you credit? Very good revenues control because we didn't record enough actual revenue either.

Did we? So credit revenues control 6,000. We had to make that adjustment item for now. They collect 11,000 in parking meter money. Well here again, we know in modified a cruel there's just five types of tax revenue that would ever be accrued. Property taxes, real estate taxes, income taxes, sales taxes, and tax payments due from other governmental bodies, all other tax revenue like parking meter money is recorded on a cash basis, which simply means nothing is recorded until it's actually collected.

So here they collected the money. So we're going to debit cash in the general fund, 11,000 and you know what to credit. Revenues control 11,000 because actual revenue always ends up as a credit to revenues control item five. Now pine city starts to order goods and services and supplies. They start sending out purchase orders and it says pine city approves purchase orders for goods services, supplies, estimated to cost 82,000.

But notice. Included in that order is an order included in that 82,000 is an order for a Xerox machine estimated to cost 6,000. All right. Now, before we get into the entry that's made here, I want you to think for a minute, if a profit making company sends out a purchase order, does a profit making company make an entry at this point?

No. If a profit-making company sends out a purchase order, there's no journal entry. You know, this very well profit making companies would make no entry until the goods and services are delivered until we're extended credit until we're billed. And I bring this up because that's what we're all used to.

Right? Profit making company sends out a purchase order. There's no entry, not at that point. Profit-making companies would make no entry. Until the goods and services are delivered until they're bailed until they're extended credit. But I bring this up because we've hit another major difference in modified a cruel in modified a cruel, just the act of sending out a purchase order requires a journal entry.

Why? Because governments use an incumbent system. So what we're about to get into now is the incumbent system. And do I even need to say it? the CPA Exam loves. The incumbent system you knew they would, and you already know why they love it because there's nothing like this in profit making accounting, they love the differences.

So let's go through the entry. When the government sends out those purchase orders in the general fund, we're going to debit encumbrances control. We're going to debit and conferences control for that 82,000. And we're going to credit budgetary fund balance reserve for encumbrances. 82,000, just the act of sending out a purchase order requires an entry because governments use an incumbent system.

So those purchase orders go out in the general fund. We will book an entry we'll debit and conferences control 82,000. And we're going to credit budgetary fund balance reserved for encumbrances 82,000. Now a couple of points since governments do use an encumbered system. What isn't encumbered. Well an encumbrance.

If you think about it is a potential obligation. We know it's not an actual obligation. It's not an actual obligation until the goods and services get delivered until we're built to our extent till we're extended credit, it's not an actual obligation, but what you're running into here is another major difference in modified a cruel and modified a cruel.

We don't just keep track of actual obligations. We keep track of. Potential obligations. That's what an encumbrance represents. It's not an actual legal liability. It's not an actual obligation, but as the government sees it, it's a commitment. It is a commitment. It is a potential obligation. It's not an actual obligation yet, but the government sees itself as already committed to this.

It's a commitment. So just remember and modified a cruel, we don't just keep track of actual obligations. We keep track of potential obligations, commitments, and that's what the incumbents represents. And another point always remember that an encumbrance is only an estimate of what we think goods and services are going to cost.

It's only an estimate of what we think goods and services are going to cost. We won't know the actual amount until we're built. So keep that in mind as well. Now, item six. Now the goods and services start to come in and the city is billed $75,000 for goods and services and supplies that they estimated would cost 71,000.

And notice that didn't include the Xerox machine Xerox hasn't come in yet that doesn't come in until item eight. But the point is that the city is being built. $75,000 for goods and services and supplies that they estimated would cost 71,000. So what do we do? Listen carefully the way the incumbent system works when you're built, you always start off by reversing, gotta think reverse.

You always start by reversing the original encumbrance for the original estimated amount. That's how you always start by reversing. The original encumbrance for the original estimated amount. So when those bills come in, we're going to debit budgetary fund balance, reserved for and conferences. And we're going to credit and conferences control not 75,000, not 75,071,000.

What we estimated those goods and services were going to cost. We always reverse the original encumbrance for the original estimated amount. Now, once we've done that, now we booked the expenditure and the liability. Vouchers payable for what we're actually built either more or less here. It's more. So now we're going to debit expenditures control 75,000 and credit vouchers payable.

75,000 always reverse the original encumbrance for the original estimated amount. And then you book the expenditure and the liability vouchers payable for whatever you're built, either more or less. Now item seven says the invoices. For 75,000 we're approved for payment. So we'll make the normal entry.

We're going to debit vouchers payable, 75,000 and credit cash. 75,000 notice. There's no problem with recording of vouchers payable, a short-term liability. We know that the five governmental funds, right? We know, we know general fund, special revenue fund capital projects on a permanent fund are not allowed to carry any long-term debt.

Right. We know that about just payable is a short term debt and that's okay. A short-term debt can be recorded, but when they pay it, item seven, we, they tell us they were all approved for payment. We'll debit vouchers payable, 75,000 and credit cash, 75,000. Make sure you're comfortable with the encumbrance system.

It's not that it's difficult, but it's different. And the CPA Exam loves it. They always have we'll continue this problem in our next class. I look to see you that

welcome back in this FAR CPA class. We're going to continue the problem on pine city. We're going to continue the journal entries under modified accrual accounting. Let's go to item eight in this problem. Item eight says, well, now the Xerox machine comes in with a bill for 6,000, with a bill for $6,500. Well, we know when that bill comes in, because we use the encumbrance system.

We're going to start by reversing the original encumbrance for the original estimated amounts. We're going to start off here by debiting budgetary fund balance, reserved for encumbrances. We're going to credit and conferences control not 6,500, 6,000. What we estimated that Xerox machine would cost.

Always reverse the original incumbrance for the original estimated amount. Now, once you've done that, we can record the Xerox machine at its actual amount, but you know, we're not going to debit equipment because the general fund, the special revenue fund, the capital projects fund the permanent fund, the debt service fund, all five governmental funds offer bidden to carry fixed assets.

They're forbidden. They're not allowed to carry their own fixed assets. So, what do we debit here for fixed asset expenditures control 6,500. We're going to book the expenditure for what we're actually built even more or less than the incumbents. We're going to debit expenditures control 6,500, and we're going to credit vouchers payable, 6,500.

That's the way the encumbrance system works. We always reverse the original encumbrance for the original estimated amount and then book. The expenditure and the liability vouchers payable at whatever were built either more or less here. It's more now notice we haven't paid for this invoice. Maybe the invoice is in dispute.

We don't really know, but for some reason, at this point we haven't paid for the invoice. Where will the government actually report the Xerox machine in the government wide statement of net assets, which we'll talk about later in these classes, but. The government wide statement, the net assets is done under normal accrual accounting.

So the government's going to report its fixed assets. All its fixed assets in the government wide statement of net assets. And we will get to that later item number nine at year end, they do a physical count and they find based on a physical count that they have a thousand dollars of supplies on hand and notice they use the purchase method.

For supplies and the purchase method is really very compatible with modified cruel. Not that you don't have to use the purchase method, but I think a lot of governmental units would use the purchase method for something like supplies. Because as I say, it's very compatible with modified accrual and it's actually very simple.

Here's how the purchase method works. When you see the purchase method for supplies, it means that as the city goes through the fiscal year, every time they purchase supplies, They just debit expenditures, control credit vouchers payable. Every time they purchase supplies, debit expenditures, control, credit vouchers, payable, debit expenditures, control, credit vouchers payable.

In other words, every time they purchase supplies, they just expense it. Then at year end, they take a physical count. If they now have a thousand dollars of supplies on hand they'll debit inventory of supplies, a thousand and credit, what is called the non spendable fund balance. A thousand. And now what you're starting to see is how there are different designations for our fund balance.

Ultimately, we're going to distinguish different parts of our fund balance, and we're going to credit here. What is called the non spendable fund balance. And of course it's non spendable because it's part of the fund balance that represents money. That's already been spent. It can't be spent again, it's already been spent on supplies.

So the correct credit would be to the non spendable fund balance. And we'll say more about the different fund balance designations later on. Now I don't want to dwell on this, but you know, what you normally see in a profit making company for supplies would be the consumption method. That's what really used to remember how the consumption method works and the consumption method.

Every time you purchase supplies, you debit inventory of supplies, credit accounts, payable, debit, inventory supplies, credit accounts, payable, debit, inventory supplies, credit accounts payable. Then at year end, you take a physical count and expense what you consumed. That's what you see most often in a profit making company, the consumption method, but don't be surprised if it's modified accrual that you would see the purchase method.

Item 10. Now the general fund makes a temporary that's an important word. A temporary transfer of $3,000 to the special revenue fund. Well, what does temporary mean here? Well, it means that eventually the special revenue fund has to pay it back. It's temporary. So here we go, because this is a temporary transfer of money from one fund to another.

In the general fund, they're going to debit a receivable called do from. Special revenue fund 3000 and credit cash 3000 again, because this is a temporary transfer of money from one fund to another. Eventually the special revenue fund has to pay it back to the general fund. So in the general fund, we're going to debit a receivable debit due from special revenue fund, 3000 credit cash, 3000.

And just to show you the other side, over in the special revenue fund, they're going to get the money debit cash 3000 and credit, a payable called do too. General fund 3000. So let me just summarize, this is how you handle a temporary transfer of money from one fund to another. The fund that sends the money debit to receivable called do from the fund that receives the money credits, a payable called do too.

And they're really very easy. And as we said earlier, temporary transfers don't have to be budgeted for, they do not have to be permanent transfers as you know, Have to be budgeted for. And now in 11 and 12, we get back to permanent transfers. We, we included them in our budget and now they've actually taken place.

11 says now the general fund makes a permanent transfer. Excuse me. They receive a permanent transfer from the capital projects fund of $7,000. So now the general fund has received a $7,000 permanent transfer. From the capital projects fund. So what do you do in the general fund? You've got to debit cash 7,000, and now you back to the rule because it's a permanent transfer money from one fund to another for operating purposes that the general fund is going to credit other financing sources, 7,000.

And on the other side, what would you say? In the capital projects fund you because they're sending the money, you would debit. Other financing uses 7,000 and credit cash, 7,000. That's what looks like on both sides. Remember the fund that receives the money. It's a source, the fund that sends the money it's a use.

So because in this case, the general fund received the 7,000 general fund will debit cash, 7,000 and credit other financing sources, 7,000. And as I say, over in the capital projects fund, because they sent the money they'll debit, other financing uses. 7,000 credit cash, 7,000. Now you see why permanent transfers have to be budgeted for because they're permanent.

They have the same effect of spending the money. Never the money is permanently transferred. Money is never going to be given back. So it really has the same effect in the capital projects fund. It has the same effect of spending in this case. Money's never going to go, never kind of come back. So permanent transfers as, you know, have to be part of your budget.

Item 12. Now the general fund makes a permanent transfer of $2,000 to the debt service fund. Well, we're back to the rule again, because the general fund is making a permanent transfer. They're sending the money in the general fund to use. So the general fund is going to debit. Other financing uses 2000 and credit cash.

2000 now be careful. Once in a while on the exam, rather than debit other financing uses they'll debit, operating transfers out. That's an account name you should know. Also once in a while in the exam, rather than debit other financing uses they'll debit, operating transfers out. And I want you to know that operating transfers out.

It's the same thing as other financing uses it eventually would be closed in to other financing uses it'll show up in the financial statements as other financing uses, but you might see that accountant. What's it look like on the other side? Well, of course the special revenue fund is, excuse me. The debt service fund is receiving the money.

So the debt service fund is going to debit cash 2000 and credit other financing sources, 2000 or what operating transfers in. You might see that account operating transfers in is the same thing. As other financing sources, it eventually gets closed into other financing sources. It'll show up in the financial statements as other financing sources, but.

It gets back though, to the basic rule, a permanent transfer of money, a permanent transfer of money from one fund to another for operating purposes is always other financing sources or other financing uses. Just be careful. The fund that received the money. It's a source, the fund that sends the money.

It's a use. Now, what we've answered to this point is requirement a, but there's also requirement B. We have to do the closing entries for the general fund as well. And don't think that we do closing entries, you know, just as busy work you're going to see when you do your homework, a lot of the multiple choice or about the closing entries.

This is why I make you do a problem with me, right. To the bitter end, right through closing entries. Now here's what I want you to do. We're going to do these closing entries in our next class. So between the time that I see you in the next class, and now make sure you have. All the journal entries, you've got all the entries that we've done together.

All the entries have been posted to your T accounts and you've taken a balance in all 80 accounts. That's where I want you to be before you open up the, the next class, will we go through the closing entries? Make sure you've got all the entries because that's what you want to study the entries, but also want to make sure that you've posted all the entries to the T accounts and you've got a balance and all the T accounts.

And then I'll see you in the next class. We'll go through the closing entries. See you then.

Welcome back in this FAR CPA course, we're going to finish the problem on pine city because we have one more thing that we have to do for pine city. And that's the closing entries. And as I mentioned in our last class, don't think closing entries are just busy work. They're not a lot of the multiple choice in your homework.

You'll see are about the closing entries. So this is something you have to be comfortable with. And I think there's something that might help you try to remember that under modified cruel, you're always looking to close out three things. Number one, you've got to close the budget. Number two, you have to close out the actual activity.

And number three, you have to close out the encumbrances. I'm hoping that gets your organized, Hey, it's modified a rule. I've got to close the budget. I've got to close the actual activity and I've got to close the encumbrances, as I say, hopefully just get your organized. All right. That's what I have to do.

Let's close the budget. Now, when you close the budget, all you have to do is reverse the entry that you made when you set it up in the first place. So now we debit the budgetary fund balance 8,000. That should zero that out. Now we debit appropriations dash estimated other financing uses 2000 should close that out.

We debit appropriations control, 97,000. We credit other estimated other financing sources, 7,000 and we credit estimated revenues control a hundred thousand. I promise you that's all that entry is ever going to amount to. It's just a matter of reversing the entry that you made when you set it up in the first place.

Now it seems like a big waste of time because all you do with the budget is you open it up at the beginning of the fiscal year, and then you close it basically just reverse everything. It might seem like a big waste of time, but theoretically in modified a cruel, the reason we record the budget. Is it is theoretically there as a control.

See if he can fill in this blank. I record the budget right at the beginning of the fiscal year. And then I know as I go through, I go through the fiscal year that my expenditures, plus my encumbrances should never exceed my, what can you fill in that blank? Mostly the budget is recorded as a control. So I was like, Oh, the fiscal year, I know that my expenditures.

And my encumbrances should never exceed my appropriation, my legislative authority to spend that's theoretically, why it's there, but I promise you that's all that entry's ever going to amount to just a matter of reversing the entry that you made to set it up in the first place. All right. So we, we have to close the budget.

Now, the second thing you close out is the actual activity. Now, what do I mean by close out actual, we have to close out actual revenues, actual expenditures, actual sources, actual uses. That's what I mean when I say we have to close out actual, we have to close out actual revenues, actual expenditures, actual sources, actual uses.

So let's do it. We're going to debit revenues control 117,000. That should close that out. We're going to credit. Expenditures control 81,500. Notice I close out the actual revenues, the actual expenditures. Now I also have to close out the actual sources. I'm going to debit other financing sources control 7,000 close up.

The actual uses credit of the financing uses control 2000. That's what I mean when I say we close out actual, we close out actual revenues, actual expenditures. Actual sources, actual uses. In other words, all the actual activity. Now you'll notice the entry doesn't balance. This next number is a plug.

There's really no other way to get it. If you do out the math, I simply need a credit of 40,500 to balance the entry out. What is that? That is my on assigned fund balance. So when you close out the actual activity, that's going to give you the balance in the unassigned. Fund balance for the general fund.

Now the unassigned fund balance, what that represents is a fund balance that is spendable it's spendable, it's uncommitted, it's unreserved. If you will, that's called the unassigned fund balance. Again, it's the fund balance that is spendable. It represents the fund balance. That's spendable uncommitted unreserved.

Now you've got, gotta be careful in. It's only called the unassigned fund balance in the general fund. Now, if we were talking about any of the other four governmental funds, the special revenue fund, the capital projects fund, the permanent fund, the debt service fund, you were talking about the other four governmental funds.

The fund balance would be called the assigned fund balance because that fund balance is assigned. To the purpose of the special revenue fund, the fund balance is assigned to the purpose of the capital projects fund. The fund balance is assigned to the purpose of the permanent fund. The fund balance is assigned to the purpose of the debt service fund and the other for governmental funds, the fund balance would be called the assigned fund balance unless it's in deficit.

If it is in deficit for the other four governmental funds, then it's on a side. I know it's tricky, but you gotta be careful. So one more time. The fund Bab this fund balance in the other four, governmental funds would be called the assigned fund balance because that fund balance would be assigned to the purpose of those four governmental funds.

Unless it's in deficit, anytime it's in deficit, then it's called on assigned. But back to the general fund, whether it's in deficit or not, it's called the unassigned fund balance deficit or not on assigned fund balance simply means it's. On a sign it's uncommitted. It is spendable. It's unreserved. That's what it means.

And when you close out the actual activity, that'll give you the balance in the unassigned fund balance. Now the third thing we have to close out are the encumbrances. Now, if you've done this problem, the way I asked you've been good about posting all the entries to the T accounts you got to balance and all the T accounts.

Look at the balance and encumbrances control, they should be a $5,000 debit balance in encumbrances control. Look at budgetary fund balance reserve for in conferences. They should be a $5,000 credit in budgetary fund balance reserving conferences. Now, before we get into how we close this out, why is there a balance in those accounts?

What I'm asking is what does it tell you? Doesn't it tell you? That there must be $5,000 of purchase orders out in the world somewhere, but the goods and services haven't come in yet. Doesn't it tell you that the fact that there's a balance in those accounts tells you they must be $5,000 of purchase orders somewhere in the world, but the goods and services haven't been delivered yet.

In other words, we still have. Some potential obligations here. In other words, not all our fund balances on a signed. Some of it is committed to these purchase orders, but you see that's the problem. Not all our fund balance is really unassigned because I've got these purchase orders out there in the world.

Somewhere 5,000 of my fund balance is committed. So here's how you close out the encumbrances. It takes two entries. We're going to start by debiting. Budgetary fund balanced reserve for encumbrance is 5,000 and credit and conferences control 5,000. So those accounts are closed out debit, budgetary fund balance, reserved for encumbrance conferences, 5,000 credit and coverages control 5,000.

All right, those accounts are gone, but as I say, we're not done yet because these purchase orders are out there in the world somewhere. Not all my fund balance is on a sign. So I'm going to debit the unassigned fund balance. I'm going to lower it. I'm going to debit the unassigned fund balance 5,000 and I'm going to credit committed fund balance 5,000.

I'm going to draw a distinction. I'm going to tell the world, I'm going to tell the reader of my balance sheet. Look, not all my fund balance is on the side. I have some potential obligations here. I have some commitments, you know, we've got purchased sorted out in the world. We're committed this, these commitments haven't matured yet into actual obligations.

These commitments are commitments, but they haven't matured yet into actual obligations, but I'm going to have to draw this distinction because not all my fund balances on a side. So I'm going to debit on is I'm going to debit my unassigned fund balance 5,000 and credit the committed fund balance 5,000.

Now, if you look at your T accounts at this point, you see where we are. Once you close out the budget. And once you close out the actual activity, and once you close out the encumbrance is all that's left our balance sheet accounts. And here's my point. If we do a balance sheet for the general fund, it's in your viewers guide, and I want you to look at it.

It's an example of the balance sheet in the viewers guide. Notice under assets, we've got cash 44,000. We've got an inventory of supplies of a thousand. We have tax receivable current of 2000, but we also have estimated uncollectable taxes of 2000. So the net receivables is zero. Notice that due from special revenue fund, remember that was a temporary transfer to the special revenue fund.

Eventually that money is going to come back. And that shows up in the general fund balance sheet as a receivable due from special revenue fund 3000. So total assets add up to 48,000. Now there's only one liability, the vouchers payable. For some reason, we haven't paid for that Xerox machine yet. We don't know the invoice is in dispute.

Something's wrong, but I want you to pay particular attention to how we present the fund balance. Notice there are different designations. Yes. We have an unassigned fund balance. In other words, a fund balance that is spendable it's on committed on, on reserved. If you will, we have an unassigned fund balance.

Of 35 five, but we also have a committed fund balance of 5,000 that's because of the purchase orders. And we have a non spendable fund balance of 1000 it's non spendable because it was already that money was already spent on supplies. That money, that fund that part of fund balance is just non spendable.

So you see the different designations of fund downs. Now there's only one other. Possible designation of fund balance. And that would be called the restricted fund balance. The restricted fund balance would be the fund balance. That's restricted by legislative action by legislative requirements, maybe to meet, you know, debt, covenants, something like that.

So that's the one, that's the one other fund balance designation you could see restricted fund balance fund balance. That's restricted by legislative action by legislative Fiat. Legislative requirements. As I say, maybe to meet debt covenants, a certain part of your fund balance can't be spent that would be called restricted fund balance.

The one other that could be there, but these fund balance designations are very important. Now, also in your guide, you'll see the statement of revenues, expenditures and changes in fund balance for the general fund notice under revenues, we have the. Real estate tax revenue of 106, the miscellaneous parking meter money revenue of 11,000 total revenues, 117,000 total expenditures, 81,500.

So there was an excess of revenues over expenditures of 35 five. Then we had other financing sources of seven other financing uses of two that gave us an excess of revenues and sources over expenditures and uses of. 40,500, but we're going to have to back out the committed fund balance. Right? We've got commitments.

They haven't matured yet into actual obligations, but in modified a cruel, we also keep track of potential obligations commitments. So we have that committed fund balance of 5,000 back that out. And that gives us. The increase in unassigned fund balance 35 five, and then all you have to do to finish the statement is show the unassigned fund balance back on January one.

That was zero because the city just come into existence. And then you show the unassigned fund balance at year end 35 five. All right, now we do these financial statements for funds. We do these fund financial statements, and they're supposed to help us with three things. These fund financial statements are supposed to help us with.

Political decisions, these statements supposed to help us make political decisions. These statements are supposed to help us establish social policy and number three, which is what I really want to talk about. These statements, these funds statements are supposed to help us evaluate what is called generational equity.

You might see this mentioned in the exam. What do we mean by generational equity? Well, in this context, equity means equitable. Fairness think of it as generational fairness. And what it essentially means is that we're not supposed to charge future generations for the, for the cost of services we're getting today.

That would be generational inequity, generational unfairness. If we're charging future generations for the cost of services we're getting today, that would be generational inequity, generational unfairness. Now, if you look at that balance sheet, there is generational. Equity. Why? Because notice there's an unassigned fund balance 35, five, you know, positive balance, not in deficit.

What you're really looking for here is deficits. That's really how you evaluate generational equity. You may never have heard that before, but that's what a deficit really represents. A deficit represents charging future generations. For the cost of services you're receiving today, it's what a deficit really represents, but there is generational equity in this particular case pine city, because the unassigned fund balance has a positive as a PA has a positive balance.

Now you'll see that there are eight multiple choice that have to be done. And I want you to try to have these eight multiple choice done before you do the next class. Please get these done. Get your answers to all eight questions. And then we'll do them together in the next class. I'll see you then

welcome back in our last class. I assigned eight questions to you, and I'm hoping that you've done these eight questions. You've come up with your answers. And now we have a chance to go through them together. Now I mentioned in our last class that. When you do all your homework, you'll see that the CPA Exam really loves two things.

They love the entry to book the budget because as you know, there is no entry like that in profit making accounting. So they tend to emphasize it a lot. Also. They love closing entries. And question number one is about both question. Number one is asking you how booking the budget and closing entries affect one account name.

The budgetary fund balance, but you had to read it carefully because the opening sentence says the budget of a governmental unit for which appropriations exceeded estimated revenues. Well, think about it. If you record a budget where appropriations exceed estimated revenues, it would look something like this.

We'll just make up some numbers. This is a governmental unit. This is a town say that Devin had estimated revenues control. For say 7,000, but credit credited appropriations control 9,000. Oh, that's great. They have legislative authority to spend more than they're going to collect. This is how we get into so much trouble.

Oh, that's just a great idea. We have legislative authority to spend more than we're going to collect, but the point is we're going to debit budgetary fund balance. 2000 budgetary fund balance would start off in deficit. As a debit. And then at year end, when you close out the budget, you just reverse everything you would credit by jury fund balance, 2000 debit appropriations, 9,000 credit estimated revenue, 7,000.

Remember when you closed the budget, you just reverse the entry that you made when you set it up in the first place. So that's why the answer is C what is the effect on budgetary fund balance? Well, we debit it at the beginning of the year because it was in deficit and we credited it at the end of the year.

When we closed it out, you had to read it carefully. Number two, they say the following information pertains notice to pine city's general fund. They give us the list of information and they say at the bottom after Pine's general fund accounts were closed at the end of the year. What is the unassigned fund balance?

So this is a little multiple choice about closing entries. Let's go back to our last class. Remember I said in our last class, that it always helps when you're in modified your cruel to just stop and think. No, wait a minute. Anytime I'm in modified a cruel, I'm always looking to close out three things.

I've got to close the budget. I've got to close the actual activity and I have to close the encumbrances. Try to remember that because it will get you organized. Hey, it's modified a cruel, I'm looking to close out three things. The budget. Actual activity in conferences. So let me ask you in this multiple choice, are they asking us to close out the budget?

No. The only budget account we have is appropriations. We don't know estimated revenues. We don't know about Sherry fund balance. There's no way we can close the budget. We don't have enough information. Are they asking us to close out in conferences? No, we don't know the encumbrances. No. What they're asking us to do is close out the actual activity.

And I know you remember what that means. We close out actual revenues, actual expenditures, actual sources, actual uses. That's what it means to close out the actual activity. So let's do it. Let's put an entry down. We're going to debit revenues, control 8 million. We're going to credit expenditures control 5 million.

Notice I close out the actual revenues, the actual expenditures. Now they say that they have an other financing source. Of 1,000,005, if it's a source, did the general fund send it or receive it? Well, it's a source. They received it. Right? So that means during the year they debit and cash credited sources.

So to close it out, I debit other financing sources, 1,000,005. How about the other financing use? Well, they must have sent the money right during the year. If it's a use, they must have debit it. Other financing uses 2 million credit cash, 2 million. So to close it out, we credit. Oh, the financing uses 2 million.

That's what it means to close out actual close out actual revenues, actual expenditures, actual sources, actual uses. And when you close out all that actual activity, the entry doesn't balance, we need a credit of 2 million, 500,000 to balance the entry out. You know what that is? That's the unassigned fund balance.

That's what they wanted. And the answer is B and notice, this is the general fund. In the general fund, it's called the unassigned fund balance. It's spendable, it's unreserved, it's uncommitted. It's the unassigned fund balance. Remember if we were talking about any other governmental fund, it would be called the assigned fund balance because the balance and that the balance in say the capital projects bond is assigned to the purpose of that fund.

So it's only in the general fund where we would call this the unassigned fund balance. And this is. The general fund number three, Elm city issued a purchase order for supplies that they estimated would cost 5 million. Well, when they send out the purchase order, they debit it in conferences control 5,000.

They credited budgetary fund balance reserve ring conferences, 5,000. Then it says when the supplies were received, there was a, an invoice that was an act with an actual price of 49 50 that they received. You know what an encumbrance is, just an estimate of what you think goods and services will cost.

You don't know the actual amount until they're built. And here when they, when the bill came in, it was 49 50. So you know what to do when the bill comes in, you reverse the original encumbrance for the original estimated amount. When that bill came in for 49 50 you debit advisory fund balance reserved for in conferences, 5,000, you credited in conferences control 5,000.

You always have to reverse the original encumbrance for the original estimated amount. Then book the expenditure. And the liability vouchers payable at whatever you're billed more or less here, it's 49, 50 a little less. But when they ask at the bottom, what amount would Elm and it would be debit or would they debit to the reserve for in conferences?

When that bill came in 5,000 and the answer is D cause you always reverse the original encumbrance for the original estimated amount. Number four, they say which of the following amounts. Are included in the general funds in comments count. Aren't they really asking us what's an encumbrance. I mean, they didn't put it that way, but there you are in the CPA Exam and not, they sort of looking you in the eyes saying, okay, what's an encumbrance.

How about number one is an encumbrance and outstanding vouchers payable amount. No, that's an actual obligation of vouchers payable. Remember an encumbrance is a potential obligation. It's a potential obligation. It's a commitment. It's a commitment, but it hasn't matured yet into, into an actual obligation.

It's not going to be an actual obligation until the goods and services are delivered until we're billed until we're extended credit. Has it matured yet? This is a potential obligation to commitment. Yes, but in modified accrual, we keep track of potential obligations commitments. We do. So, no, I wouldn't find vouchers payable in the encumbrance account.

That's an actual liability, the outstanding purchase orders I would and outstanding purchase order. That is a potential obligations, a potential commitment hasn't matured yet into an obligation. Yes. I'd find that any encumbrance account. How about number three? How about the excess of the amount of a purchase order over the actual expenditure for that order?

We'll know if the actual expenditure has come in, I've reversed the original encumbrance for the original estimated amount. That's no longer in the encumbrance account it's been reversed out. So all I'm going to find in the incumbent's account is number two and outstanding purchase order, because that is a potential obligation.

It hasn't matured yet into an actual obligation. But it is a commitment and that's what in conferences are all about. Number five and the current year new city issued purchase orders and contracts of 850,000. You know, the entry, debit and commerce is control 850,000 credit budgetary. Very fine balance reserve fund conferences, 850,000.

When those purchase orders and contracts go out, they were chargeable against. Budgeted appropriations of a million. So they haven't, they have not exceeded their legislative authority, Ben, which they should not. The journalists entry to record the issuance of the purchase orders and contracts would include what answer B R credit to buy.

Sure. Refund boundaries are for in conferences. You got to know that in conference system, the CPA Exam loves it for the reason we said, there's nothing like the encumbrance system in profit making accounting. And you know, when those purchase orders and contracts went out, It was a debit to in conferences control and answer be a credit 200 bursary fund balanced reserve for in conferences, eight 50, number six, which of the following journal entries, what a city used to record 250,000 in fire department salaries.

Could it possibly be a, are we ever going to debit salaries, expense and credit appropriations? I just hope that bothered you. Do we ever combine an actual account with a budget account? Never, never. It modified a cruel, there are actual accounts and there are a budget accounts and they don't co-mingle in the same entry ever.

You never got a co-mingle in an entry, right? An actual account with a budget account. No, there are actual accounts and their budget accounts and they never meet. So a is nonsense and I hope it seemed like nonsense to you. Same thing with B. Are we ever going to debit salaries, expense and credit and conferences?

No. That's mixing actual activity with a budget account. No. Would I ever, for example, answer, say debit expenditures. Would I ever debit encumbrances and credit a payable? No, again, that's mixing a budget account with an actual account and that's just not done, but answer D makes sense. Would I ever debit an expenditure and credit a liability?

Of course I would. Because we know that modified accrual is just basic accounting with a lot of different account names, which you have to get used to, but hopefully answer D was the only answer that made any sense to you whatsoever. Number seven, the measurement focus of governmental type funds. You know, this five governmental type funds, general fund special revenue fund capital projects fund permanent fund debt service fund.

Those are the five governmental type funds. So they say, what, what is the measurement focus of governmental type funds? Is it the first column flow of financial resources? You bet it is. Yes. Cause they're like checking accounts. They keep track of the money coming in and the money going out as the government performs different services for the community.

What the CPA Exam calls that is the flow of financial resources. That is the focus. In all five, the metal funds. How about financial position? You have to say yes, there too. It is answer D because of generational equity. We do care about financial position. We want to know, are we trying to charge future generations for the cost of services that we're receiving today?

That is part of the focus of the governmental funds. Are we running deficits? Is that generational equity or is there generational? Inequity? Yeah, financial position is a focus of all the governmental funds as well. Number eight on December 31 he'll city paid a contractor 5 million for the total cost of a new of a brand new municipal annex built on city owned land.

You know, what kind of fund this would be? Capital projects. It accounts for the construction of major capital assets, like an annex. Financing was provided by a $3 million general obligation bond issue at face sole that face December 31 and the remaining 2 million was transferred from the general fund.

They say, what account and amount would be reported in the general fund in the general fund? Well, wouldn't this be a permanent transfer from the general fund to the capital projects fund. Money's never coming back. The money's going to be used for construction. So in the general fund, it's a permanent transfer.

The general fund is sending the money. So the general fund would debit, answer a other financing uses and credit cash. Now I would like to talk a minute about how we handle restricted money under modified accrual. If let's say a town got a state grant, and this usually comes up in the CPA Exam with a grant, but let's say a town gets a state grant and the grant restricts the money to the purchase of some assets, but the money is restricted.

Well, I bring this up because in modified a cruel there's a rule, the restricted money. And it's simply this, that if a governmental unit re receives any kind of restricted money, like a grant in modified a cruel that governmental unit is not allowed to recognize that grant money is revenue until they spend the money for the intended purpose.

Let's say for example, that a town gets $105,000 state grant, and the money can only be used to purchase equipment. So the money's restricted and the town can only use the money to purchase equipment. Here's what the town would do when the town gets that grant, you know, the town is going to debit cash 105,000, but you see my point, they can't credit revenue in modified a cruel.

A governmental unit cannot recognize restricted money as revenue until they spend the money for the intended purpose until they meet the terms of the grant. So what they would credit here. Would be deferred revenue, 105,000. The credit would be to deferred revenue. If you do a balance sheet balance sheet right now, what kind of account is deferred revenue, it's a liability and you know why it's a liability because theoretically, if they never use the money for the intended purpose and that's never happened once in the history of the world, believe me, they'll use it.

But theoretically, if they never used the money for the intended purpose, they have to give it back. So, if you do a balance sheet right now, deferred revenue would be on the balance sheet as a liability. Now let's say they go out and they purchase $65,000 worth of equipment. Well, if they go out and purchase $65,000 worth of equipment, we know they can't debit equipment because in modified a cruel.

These governmental funds are not allowed to carry fixed assets. So they would debit expenditures control 65,000 credit vouchers payable 65,000. And now that they've spent 65,000 of that grant money meeting the terms of the grant they'll debit, deferred revenue, 65,000 and credit revenues control 65,000.

That's how the rule works with journal entries. But the simple point is in modified a cruel, a governmental unit cannot recognize restricted money as revenue until they spend the money for the intended purpose until they meet the terms of the grant. And I like to emphasize this because you're going to see later in these classes that not for profit hospitals, universities, other nonprofit organizations, don't have this rule.

This rule is unique to modify to cruel. This rule applies to governmental units. But as I say, not to other nonprofit organizations, let's look at number nine. Nine says financing for the renovation of a municipal park was begun and completed was completed during the year. And it came from the following sources.

They got a grant from the state government. They got proceeds from. A general obligation bond issue, and they got a transfer from the general fund in the capital projects fund operating statement. These amounts will be reported as what revenues, other financing sources. We'll start at the bottom. How about the transfer from the general fund?

How it capital projects can handle that as a debit to cash and credit other financing sources. Presumably it's a permanent transfer from the general fund that money's never going to be sent back. It's going to be used for this renovation. So yes, capital projects would debit cash, the a hundred thousand and credit other financing sources that would be other financing sources.

How about the proceeds from the bond issue? We'll remember, we have already talked about at once. If one of these five governmental funds issues, bonds, they're going to debit cash. So they would debit cash for the 500,000, but they can't credit bonds payable, the general fund, the special revenue fund, the capital projects fund the permanent fund.

These funds are forbidden to carry their own long-term debt. So when they issue long-term debt, they're going to debit cash and credit. Yes. Other financing sources, that would be another financing source. But the grant from the state government that's recorded as grant revenue. If they've spent the money for the intended purpose and they must have, because this renovation is complete.

So the answer is C they're going to have 400,000 of grant revenue, 600,000 of other financing sources. I look to see you in the next class, keep studying.

Welcome back in this FAR CPA course. We're going to continue our discussion on governmental accounting. And we already know that a governmental unit like a town, a governmental unit, like a city does use three types of funds. We know they use governmental funds. And we know there are five of those general fund, special revenue fund capital projects fund, permanent fund debt service fund.

They also use proprietary funds. There are two of those and they also use fiduciary funds. There are four of those. So a governmental unit, like a town uses 11 different types of funds, five governmental funds, two proprietary funds for fiduciary funds. Now we've talked about governmental funds, let's get into the proprietary and the fiduciary fund.

Now the proprietary and the fiduciary funds carry their own fixed assets and they depreciate their own fixed assets. So you would see depreciation expense in the proprietary funds and the fiduciary funds, also the proprietary and the fiduciary funds. Carry their own longterm debt. So you'd see an account like bonds payable, long-term notes payable in the proprietary and the fiduciary funds.

Also the proprietary and the fiduciary funds service their own longterm debt. So you would see an account like interest expense in the proprietary and the fiduciary funds. The bottom line is the proprietary and the fiduciary funds use normal accrual accounting, not modified accrual. We're not talking modified accrual now.

No, the proprietary and the fiduciary funds use normal accrual accounting. Also the proprietary and the fiduciary funds have the same measurement focus. The measurement focus in the proprietary and the fiduciary funds is total economic resources. That's why they carry their own fixed assets. That's why they carry their own longterm debt because their focus is total economic resources and income measurement.

These funds want to know if they're making a profit or not? That's their focus, total economic resources and income measurement. Let's talk about the proprietary funds. There are two proprietary funds. The first proprietary fund is called an enterprise fund. Now, remember the government sets up an enterprise fund.

Anytime the government is going to act just like a private enterprise. Let the name help. Oh, it's an enterprise fund. So the government is acting just like a private enterprise. What's an enterprise fund. I mean, missable gas, municipal electric, municipal water department, any kind of public utility will be an enterprise fund.

And that's usually what you see in the exam, a public utility. So remember municipal gas, municipal electric, municipal water department, and the kind of public utility is going to be an enterprise fund. Let me just stop and think for a minute. How would you finance the day-to-day activity? I mean, it's the water department.

You would charge consumers, you charge the public for the service, just like a private enterprise. This could be a municipal parking garage. You know, how are you going to finance the day-to-day activities of a municipal parking garage? You charge the public, you charge the people who park there. You charge consumers, just like a private enterprise.

Now the second proprietary fund is called an internal service fund. The government sets up an internal service fund. When one agency, the government is servicing other agencies of the government. So this would be something like a central motor pool for all governmental vehicles, a central printing office for all governmental agencies, a central data processing department for all governmental agencies.

You've got one agency, the government servicing other agencies of the government. So you just stop and think for a minute. How would you finance the day-to-day operations of a central printing office? You charge whom. Oh, the governmental agencies for services, and that's really why you need to proprietary funds.

Enterprise funds charge the public charge, consumers just like a private enterprise, but internal service funds charge other governmental agencies for services. And that's why there's two of them. Now. Finally, there are the fiduciary funds and in the fiduciary funds, we have the trust funds. Now why does the government need a trust fund?

A government sets up a trust fund anytime. The government is holding assets in trust. That's why they need trust bonds, because there are times when the government holds assets in trust. So the first trust, the first fiduciary fund is called the pension trust. The pension trust is for the retirement system, the pension system for city employees.

That's that has to be a trust fund because the government is technically holding that money in trust. The government does not own that money. The employees do. So the pension trust, the re the pension trust is for the retirement system for city employees, because the governmental unit is holding that money in trust for the employees.

The second fiduciary fund is called a private purpose. Trust the government sets up a private purpose trust when the government's holding money in trust, that'll benefit, a private individual or private organization note it's called notice. It's called a private purpose trust. Because the government's holding money in trust, that'll benefit a private individual or an organization.

Let's say somebody dies, leaves the city a million dollars and wants all the interest in dividends to go to a nursing home. But if the nursing home ever goes out of business, the city keeps the million. That would be a private purpose trust because the government would hold that money in trust. And it benefits a private organization.

Somebody dies, leaves $10 million to the city, and once all the interest and the dividends. To go to a chess club and it's kind of things happen. But if the chess club ever disbands, the city keeps the 10 million, well, that would have to be a private purpose trust because the city would hold that money in trust and the benefits that private organization.

So that's a private purpose trust. The third fiduciary fund is called the investment trust. Let's say the government runs a very temporary surplus. Doesn't last very long, but let's say the government runs a temporary surplus. Well, if they run a surplus. They don't own that money. The taxpayers do. So the government really has to, has to keep that money in trust and they normally invest it in government backed bonds.

That's what the investment trust is for government runs a temporary surplus. They set up the investment trust. They invest that surplus in government backed bonds, and it has to be a trust bond because the government does not own that money. The taxpayers do so the government technically is holding that money in trust in what they call.

The investment trust. Now there is one more fiduciary fund and the CPA Exam mentions it. It's not a trust fund. It's called the agency fund. Now the government sets up an agency fund. Anytime the government is going to act as an agent for somebody else, let the name help. That's why you need an agency fund when the government's acting as an agent for somebody else.

And here's the example they love. Let's say a municipality agrees to collect school taxes for a hundred different school districts. Well, if a municipality agrees to collect school taxes for a hundred different school districts, that's going to have to be an agency fund because that municipality is acting as an agent for all of those school districts.

I just want to show you one entry. Let's stay with that example. We have a municipality, they have agreed to collect school taxes from a hundred different school districts. So they set up an agency fund and they go out and they collect all the school taxes. They're acting as an agent for all those school districts, but when they collect those school taxes, Notice the entry in the agency fund.

When they collect the school taxes, they're going to debit cash and they credit due to district one due to district two, due to district three, there'll be a hundred credits and I'm making a point. All you ever see in an agency fund is cash and due to somebody else, you're acting as an agent for somebody.

So all you've ever seen an agency fund is cash. And due to somebody in other words, listen carefully. It is literally impossible for an agency fund to have revenues. Or expenditures or a fund balance or a net asset position of any kind. I'll say it again. It is, you know, the example of his exceptions and it's literally impossible for an agency fond to have revenues or expenditures or a fund balance or any kind of net asset position or have fixed assets or anything else you can think of.

Why, because all an agency fund ever is, is cash. And due to somebody they're acting as an agent for somebody. It's a, just a, it's just a temporary holding account for money. Another example, you could use an agency fund for federal withholding, the city employees, debit cash credit due to federal government, life insurance deductions, you know, health insurance deduction, the city employees, debit cash credit due to insurance company.

All an agency fund is, is a temporary holding account for money. So if you see it, that's all it is. It's not a trust bond, just a temporary holding account for money. Let's do some questions. Number one sets. The town of Hill operates municipal electric and water utilities. And what kind of fund is this going to be?

Any kind of public utility? It's going to be an enterprise fund to answer a cause the government's acting just like a private enterprise. Number two, an enterprise fund would be used when the governing body requires, what would you use an enterprise fund for number one, accounting for the financing of an agency services.

To other government departments. Now that's an internal service fund, right? Don't ball. That is a proprietary fund, but that's an internal service fund because one agency of the government is servicing other agencies of the government. How about number two? Would you use an enterprise fund for user charges to re to cover the costs of general public services?

Yes. If you're charging the general public, you're acting just like a private enterprise, that's an enterprise fund. How about number three, net income information. Yeah. And then an enterprise bond is just like a private enterprise. They want to know if the making a profit or not. So net income information would be needed.

So the answer is D statements two and three are all about an enterprise fund, but not number one. That's internal service. Number three, Cedar city issues, a million dollars of 6% bonds at par April one to build a waterline for its notice enterprise fund. Interest is paid every six months. What would be the interest expense for the year ended December 31?

Well, let's get away from fund accounting for a minute. What would a profit making company do here? Just forget for a minute. We're even talking about governments. If this were a profit making company, wouldn't a profit making company, take 6% of a million, which would be $60,000 of interest for a full year, right.

60,000. Divided by 12 months, basically these bonds accrue 5,000 interest every month. That's 6% of a million of $60,000 of interest for a full year divided by 12 months. These bonds accrue 5,000 of interest every month. All right, now they were issued on April one. Now they pay interest every six months.

So let's count six months off, April, may, June, July, August, September. So at the end of September or say October 1st, When they have to debit interest expense for six months, times 5,000 or $30,000 and credit cash 30,000. Cause it's actually paid every six months. So on October 1st, they're gonna have to pay the interest for April, may, June, July, August, September six months, times 5,000 every month.

So debit interest expense, 30,000 credit cash, 30,000. And then if it's a profit making company, wouldn't they accrue interest for October, November, December. They don't make a payment until six months go by, but they would accrue interest. For October, November, December three months, times 5,000 a month, 15,000, when they debit at year end interest expense, 15,000 and credit interest payable, 15,000.

So if this were profit making company and they say what's the interest expense at December 31? Well, it would be the 30,000 that was booked on October one and the 15,000. It was accrued at December 31. Answer's C 45,000. Now that would be the answer for profit making company. And that's the answer for an enterprise fund to cause an enterprise fund is just like a private enterprise.

It's normal, cruel accounting. So answer C would be the answer for any profit making company. And answer C is the answer for an enterprise fund because an enterprise fund is just like a private enterprise. I have to ask you something. What would be the answer if it was a governmental fund? What if it was not a proprietary fund?

What if it was general fund special revenue fund capital projects on permanent fund? Well, be careful if it were a governmental fund, the interest expense for the year would be answered B just the 30,000 that was paid October one because the debt service fund records interest only when it's mature doing payable on a payment date, the debt service fund would not accrue interest for October, November, December, right.

They don't make a cruel. In modified a cruel debt service bond uses modified accrual. So all you'd see in a governmental fund for interest is the 30,000. They paid after six months on October 1st answer bait. They wouldn't make the accrual for October, November, December, but as I say, an enterprise fund it's answer C because just like a profit making company, they would have to record nine months of interest expense, six months, they paid three months.

They accrued. Number four seaside County collects property taxes, levied within their boundaries and relates a 1% fee for administering these collections on behalf of municipalities located in the County classic agency fund because new County, excuse me, seaside County is acting as an agent for all those municipalities.

That's when you need an agency fund, any time you're acting as an agent for somebody else. Seaside County go out, goes out and collect a million dollars from all the municipalities, but they only remit 990,000 because they keep the 1% fee of 10,000 in the initial recording of the 1% fee that 10,000 the agency fund would credit.

What? Well, if we're together, you know, it can't be a, because an agency fund can't have a fun balance. Or any kind of net asset position, it can't be B and it can't be D because an agency fund never has revenues or expenditures or any kind of net asset position. Remember all you ever seen an agency fund is cash and do to somebody.

So what you're looking for here for an answer, what do they credit? Some kind of due to somebody. And of course the answer is C due to seaside County, the general fund 10,000. An agency fund never keeps the money in the agency fund. Never notice even the 1% fee they keep, they wouldn't give him the agency fund.

They're going to send that to the general fund it's gonna be due to somebody's agency fund never keeps anything. It's just a temporary holding account for money. Number five, James city issued a million dollars of general obligation bonds at one Oh one to build a new city hall. Well, this would be a capital projects fund.

Wouldn't it. Because the capital projects fund accounts for the construction of major capital assets, as part of the bond issue, the city also paid 500 and underwriters fees in 2000 and other debt issue costs. So the bond issue costs add up to 2,500 here. What about with James city report? His other financing sources?

Well, you know that when the capital projects fund issues, bonds like this, if they go out and issue a million dollars with the bonds at one Oh one. They're going to debit cash, 1,000,010 thousand. They can't credit bonds payable because the capital projects fund is forbidden to carry long-term debt. So the capital projects fund does credit other financing sources for the million and 10,000.

And the answer is a, by the way, the bond issue costs would be a debit to expenditures, controlling credit cash wouldn't affect other financing sources. Now the bond issue costs would simply be a debit to expenditures control and a credit to cash in the debt service fund, where they service the debt.

Wouldn't affect other financing sources. Other financing sources would be answer a number six says through an internal service fund, new County operates a centralized data processing center to provide services to other governmental units. This is a classic internal service fund. One agency of the government is servicing other agencies.

The government it's a central printing off a central data processing department. They say. This internal service bond build. That's an important word. The internal service bond build the parks and recreation fund 150,000, but data processing services. Here's what I want you to recognize here. The important thing to notice in this question is that this is not a transfer between funds.

This is a transaction between funds. We have one fund billing, another fund for services. You see the difference. That's what you have to pick up on right away. Hey, this is not a transfer between funds. Which a lot of students get caught up in. No, this is a transaction between funds. These are called  external transactions.

I, we spent want to right next to the question QET, just for your own study. That's what this is. This is a QET, it's a  external transaction. And as long as you pick up that, it's not a transfer between funds. It's a transaction between funds. There are actually very simple. Here's how you handle all quasar external transactions.

Just remember. The fund that sells the goods or services credits, revenues control the fund that buys the goods or services, debits expenditures control. It's that simple. That's how you handle all cuase I external transactions. The fund that sells the goods and services credits, revenues control the fund that buys the goods and services, debit expenditures controls.

So when they ask at the bottom, what account would the internal service fund credit to record? The $150,000 billing? Well, they sold the internal service bond, sold the service. So they would credit answer D operating revenues control. Look at number seven, a city's electric utility, which has operated as an enterprise fund.

That makes sense, rendered billings for electricity supply to the general fund. So we have the enterprise fund billing, the general fund, but services again, it's not a transfer between funds. It's a transaction between funds. This is another QET. It's a quasar external transaction, which of the following accounts would be debited by the general fund.

Well, the general fund bought the service. So the general fund would debit expenditures control answer be now, as I say, the important thing to pick up in those questions is that it was a transaction between funds, a quasar external transaction, but let's go back for a minute to transfers of money. Not transactions, but transfers of money from one governmental fund to another governmental fund.

Now in these classes so far, we've talked about two types of transfers. We said, well, that could be a temporary transfer of money from one governmental fund to another governmental fund. How do you handle that? You know, if you see a temporary transfer of money from one governmental fund to another governmental fund, the fund that sends the money, debits are receivable called due from the fund that receives the money credits a payable called do too.

Really very simple. Now the other type of transfer we looked out in these classes is that there could be a permanent transfer of money, a permanent transfer of money from one governmental fund to another governmental fund operating purposes. How do you handle that? You know, if there's a permanent transfer of money from one governmental fund to another governmental fund operating purposes, the fund that sends the money, debits, other financing uses the fund that receives the money, credits other financing sources.

Well, I bring this up because. There is a third type of transfer that could be mentioned. It's called a residual equity transfer. Let me give you a definition because the CPA Exam could mention it. Our residual equity transfer is a permanent. It is permanent, a permanent transfer of money from a governmental fund to say a proprietary fund, but not for operating purposes.

So that's a residual equity transfer, a permanent transfer of money from one fund to another, but not for operating purposes. Let me give you an example. Let's say that the general fund makes a $100,000 residual equity transfer to the enterprise fund, or it's a very simple problem. We have the general fund sending a residual equity transfer and the CPA Exam will be very specific.

They'll call it a residual equity transfer of a hundred thousand dollars. To the enterprise fund. How do you handle it? Well, it is permanent. So in the general fund, it's, we're going to follow the rules. It's permanent. So we're going to debit in the general fund. Other financing uses dash residual equity transfer, a hundred thousand credit cash, a hundred thousand.

So the general fungus ball's the rule it's permanent. So debit other financing uses dash RET residual equity transfer and credit cash. What's the enterprise fund. Do the enterprise fund. Debit cash a hundred thousand and credit and account you should know of transfers in that they don't use other financing sources out of financing uses.

So the enterprise fund, the proprietary fund would credit transfers in transfers in that's the account you want to be aware of. Now, you know, I say that this is a permanent transfer, not operating purposes. Well, if it's not operating purposes, what's it for? It's usually capital. To get an enterprise fund started or to acquire an enterprise fund, to acquire an internal service fund, you know, to get it started it's seed money because it's a permanent transfer, not for operating purposes.

If it's not for operating purposes, almost always. It's seed money capital to get an enterprise fund started or an internal separate turtles. Internal service fund started look at number eight, gem city's internal service fund. Received a residual equity transfer. the CPA Exam specified this was a residual equity transfer of 50,000 from the general fund.

This $50,000 transfer will be reported in the internal service bond as what, a debit to cash and a credit to answer B transfers in. So just be aware of that account name, keep studying and I'll look to see you in the next class.

welcome back in this FAR CPA study course. We're going to continue our discussion on modified a cruel. And as I've said in previous classes, I think the best way to understand, modify to cruel and to study modified a cruel is to make sure that, you know, the journal entries, the account names that you will use and modified a cruel.

And in a previous class, I made us do. A problem where we went through the journal entries, the account names for the general fund. Well, now what I want to do next is a problem on the capital projects fund. And that's going to force us to get into the debt service fund. Now we're not going to keep track of T accounts here.

I think really you only have to do that one time to get more comfortable with it. All we're going to do in this problem are journal entries. But as I say, by doing capital projects fund. That's going to force us to deal with the debt service fund. Also. Now I remind you, we're going to set up a capital projects fund to account for the construction of major capital assets.

So if you're going to build a new civic center, if you're going to build a library, you're going to build a new police station. You're counting for projects like this through a capital projects fund, because after all it accounts for the construction of major capital assets, let's look at the problem. In your viewers guide, you'll see the problem on mill city.

It says mill city wants to build a new city hall. This is the type of project we account for through a capital projects. Fund mill city has legislative authority to spend up to 675,000 on the construction financing for the construction will be provided by issuing $600,000 worth of bonds. 10 year bonds.

And also getting a hundred thousand dollars state grant. We have two requirements prepare the appropriate journal entries for the capital projects fund prepare the closing entries for the capital project fund. Well, we know from our previous class that in modified accrual, not only does the government have a budget, but they actually make a journal entry to record the budget.

They actually booked the budget. So that's what we're going to start. They say an item. Number one, the budget of 675,000 was approved. So how would we record the budget? Well, there's a little wrinkle here we haven't seen yet. So let's talk about this. They said that financing for this project is going to be partly provided by issuing $600,000 worth of 10 year bonds.

Now, later in the problem, when we actually issue the bonds. We know they're going to debit cash, but you remember they can't credit bonds payable because they're not allowed to carry term debt in the capital projects bond. So what they're going to credit when they issue the bonds will be other financing sources.

We'll do that later, but here's my point. If you're setting up your budget and you're estimating that during the fiscal year, you're going to collect bond proceeds. You have to budget for that as a debit to estimate it. Other financing sources in this case, 600,000. That's how we're going to start our budget as a debit to estimated other financing sources 600,000.

Now they're also estimating they're going to get a hundred thousand dollars state grant. So we're going to debit estimated revenues control a hundred thousand. Now they have legislative authority to spend up to 675,000 on the construction. You know what that is? There's your appropriation. Legislative authority to spend.

So we're going to credit appropriations control 675,000. All right. Now it's time for a little pop quiz. The entry doesn't balance. I need a $25,000 credit to balance the entry out. What do I credit for 25,000 very good budgetary fund balance 25,000. So that would be the entry to record the budget in the capital projects fund.

Now let's get into the actual activity. Item number two says now they actually receive the a hundred thousand dollars state grant. Well, when they receive the state grant, you know, when the capital projects fund, they've got to debit cash, a hundred thousand, what would you credit? Not revenue, not revenue.

Why? Because this is restricted money. This is modified rule. And in modified a cruel, a governmental unit can not recognize restricted money, grant money as revenue until they spend the money for the intended purpose until they meet the terms of the grant. So we're going to credit deferred revenue here.

Be careful credit, deferred revenue, a hundred thousand item number three. Now they actually go out and they issue the $600,000 with the 10 year bonds. But notice they sold the bonds at a premium. They sold the bonds for 635,000. And I'll be honest. This is one of the main reasons that I wanted us to do this problem together, because what we haven't talked about yet is how we handle selling bonds at a discount, selling bonds at a premium.

Let me start with a discount. So I'm going to change the problem. This is a premium, but I wanted to show you a discount because a discount is not bad. Let's say instead. They went out and they sold $600,000 worth of bonds for 580,000. I'm just going to change the problem for a second. If instead they sold $600,000 worth of bonds for 580,000 a discount.

What you'd see in the capital projects fund would be a debit to cash 580,000. That's what they collected. We know they can't credit bonds payable. The capital projects fund is forbidden to carry any longterm debt. So they would credit other financing sources. For the 580,000. And I want you to know with a discount, that's really, it that's really all you have to do because the real issue with a discount is did they get enough money to do what they want to do?

That's really the issue with the discount. Did you collect enough money to do what you want to accomplish? If you did not, there's going to have to be another source of financing in the problem. So as you can see discounts. Really very easy. Cause that's really the real issue with the discount. Did you get enough money from the bond issue to accomplish what you want to accomplish?

If you did not, there's going to have to be some other source of financing in the problem. I guess what I'm trying to say in so many words is don't worry too much about discounts. A premium is a little bit more complicated, so let's get back to this problem. They went out, they sold $600,000 worth of bonds for 635,000.

So in the capital projects fund, we'd start the same way. We would debit cash for the 635,000. We can't credit bonds payable. So we would credit other financing sources, 635,000. You would start the same way. Now, let me ask you a question. If this were a profit making company, what would a profit making company do with that premium?

That amortize it? And I want you to know this is another difference in modified a cruel in modified a cruel there's no amortization taken. On bond discount or bond premium, make sure that's in your notes. That's an important point. That's another difference in modified a cruel in modified a cruel there's no amortization taken on bond discount or bond premium.

So we're not worried about amortization, but I want to ask you another question, maybe more basic question. What would a profit making company do with that extra $35,000 cash? What would they do with that little windfall? Well, my point is who are we kidding? A profit-making company would use that extra $35,000 cash to service the debt.

This is why when you buy bonds at a premium you're effective yield is a little lower because they're going to pay you back with some of your own money. That's what a profit making company would do. They would use that extra $35,000 cash to service the debt. Well, in this regard, governments are no different.

A government is going to use that extra $35,000 cash. To service the debt. So now we're going to make another entry in the capital projects fund, where we literally transfer this $35,000 premium over to the debt service fund with a debt is service because they're going to use that extra $35,000 cash to service the debt.

All right. So let's make another entry in the capital projects fund, where we literally transfer there's $35,000 premium over the debt service fund. Wouldn't this be a permanent trance. It's never coming back. Wouldn't this be a permanent transfer of money from one fund to another for operating purposes.

So in the capital projects fund, we're going to debit other financing uses 35,000 credit cash, 35,000. I hope you see why that entry is being made to transfer that premium over to the debt service fund. Let's go to the debt service fund. Let's take a look in there. What would the debt service fund do that service would debit cash.

35,000 and credit other financing sources, 35,000 let's stay on the debt service fund for a little bit. Remember we said at the beginning of our discussion on governmental accounting, that all the debt service fund does is accumulate money and service debt accumulate, money, service, debt. It's all it does.

It pay. It makes interest payments, principal payments on long-term debt of the other four. Governmental funds. All it does is serve as debt. Maybe the first thing we should think about where does the debt service fund get the money to service the debt? Well, there's pre there's three primary sources.

First of all, there could be transfers from other funds like this one, like this 35,000, there could be special tax levies. And then don't forget number three, the debt service bond has all this cash laying around. So they make investments. They generate a lot of, a lot of investment income. That's where the debt service fund gets the cash to service the debt transfers from other funds that could be special tax levies.

They generate a lot of investment income. Now let me show you the kind of entries that are made as they service the debt. Let's say six months go by. All right. Six months go by it's time for the first semi-annual interest payment. Here's what you'd see in the, in the debt service fund there'll would be a debit to expenditures control.

Say 18,000. I'm just making up a number. They would debit expenditures control 18,000 and credit matured, interest payable, 18,000. That word matured is important. I'll say more about it in a minute, and then they get approval to send out the checks. So they'll debit, matured, interest payable, 18,000 credit cash, 18,000.

Just want to give you some idea of what entries are made as they service the debt. Now, these are 10 year bonds. What happens 10 years from now? When the bonds mature? Well, 10 years from now, when the bonds mature. Wouldn't the debt service fund have to make the last interest payment and pay back the principal.

So you'd see entries like this 10 years from now. When the bonds mature, you'd see in the debt service fund, a debit to expenditures control 618,000 credit matured interest payable, 18,000 credit matured bonds payable, 600,000. Then as I say, they get approval to send out the checks. So you would debit matured, interest payable, 18,000.

Debit matured, bonds payable, 600,000 and credit cash. 618,000. This is all the debt service fund does it makes interest, payments and principle payments on long-term debt for the other four governmental funds. All it does is service debt. That's why they call it the debt service fund. Now I say worried about this word, matured exam likes this too.

Another major difference in modified accrual is this. In modified accrual in that debt service fund, they never accrue interest like a profit making company. They don't make a cruelty again in modified a cruel, they would never accrue interest in the debt service fund. They don't make a cruelty, no, in the debt service fund, they don't record interest or principal interest or principle until it's mature, due and payable until it's a payment date.

Remember that? They don't make a cruelty. No, they're not going to record interest or principle until it's matured due and payable until it's a payment date. That's an important point to remember. Let's go to item number four. Now let's go back to the capital projects fund. We took that little detour into the debt service fund.

Now we'll go back to the capital projects fund number four says now they signed a contract with the construction company to build a city hall. For 600,000 and notice mill city agrees to furnish some labor on the project and some raw materials on the project. Well, let's go back to our previous class.

We know when the city signs a contract like this, it creates a potential obligation. Doesn't it? It's not an actual obligation, not yet, but it's a potential obligation. It is a commitment. It hasn't matured yet into an actual liability, but it is a commitment. It is a potential obligation. And we know in modified accrual, we don't just keep track of actual obligations.

We keep track of potential obligations. So when they sign that contract, they're going to debit and conferences control 600,000, and they're going to credit budgetary fund balance reserved for encumbrances 600,000. Don't forget the incumbent system. I know you won't item number five. And, and just to remind you that encumbrance is just an estimate.

Of what we think something's going to cost. And encumbrance is always just an estimate of what we think goods and services will cost. We never know the actual amount until we're built as, you know, item five. Well, they said back and forth that mill city agreed to furnish some labor on the project. And item five says, now they're paying 15,000 of wages to people who work on the project.

Probably planning. We don't have a lot of detail here, but they're paying 15,000. You know, to city employees who worked on the project, because I say probably planning. So in the capital projects fund, we're going to debit expenditures control 15,000 credit cash, 15,000. Now they also said back in item four, that they agreed to furnish some raw material on the project.

And item six says they approve now purchase orders for raw materials, estimated to cost 30,000 will, as you certainly know, You send out those purchase orders that creates a potential obligation. It is a commitment. It hasn't matured yet into an actual liability. Not until it's delivered, not until we're built, not until we're extended credit, but we have the in system to worry about.

So when they send out those purchase orders, we're going to debit in conferences, control 30,000 and credit budgetary fund balance reserved for in conferences, 30,000. I want you to get to the point we could do that in conferences and in your sleep. And I know you're getting there. You're not there yet.

That's good. That's a good thing. Now. Here's what I want you to do before we come to the next class, try to finish the problem, do the rest of the entries and the closing entries. And in the next class, we'll do them together. I'll see you in the next class.

Welcome back in our last class. As you know, we started mill city. And we took it through item six and then I wanted you to finish the problem from seven from item seven on and do all the entries from item seven on do the closing entries. And now we'll have a chance to do them together. Let's get into item seven.

Item seven says the raw materials were actually delivered with an invoice for 36,000. Well, you know, The way the encumbrance system works when we're billed, we always start by reversing. You think reverse, you got to reverse the original encumbrance for the original estimated amount. So when the bill comes in, we're going to debit budgetary fund balance reserve for in conferences.

We're going to credit and conferences control not 36,000, 30,000. What we estimated the raw material would cost. Now, once we've done that, We're going to record the expenditure and the liability vouchers payable at whatever we build more or less here, it's more, it's 36,000. So we're going to debit expenditures control 36,000 credit vouchers payable, 36,000.

Now they said the invoice was approved for payment. So of course we'll debit, Boucher's payable, 36,000 credit cash, 36,000. I'm hoping that you're starting to feel Bob. I could do the incumbent system in my sleep. That's what I want. Item eight. The construction is finished and we get a bill from the construction company for 609,000.

Well, here again, when that bill comes in, we've got to reverse the original encumbrance for the original contract amount in this case. So I'm going to start here by debiting budgetary fund balance, reserved for in conferences. I'm going to credit and conferences control, but not for 609,600,000. The original contract amount.

Now I record the city hall at its actual amount, but you know, the capital projects fund is forbidden to carry fixed assets. All five governmental funds are forbidden to carry fixed assets. So capital projects is going to treat this like an expenditure. They're going to debit expenditures control for what they were actually billed 609,000.

Credit vouchers payable, 609,000. Remember the city hall is actually carried in the government wide statement of net assets, which again, we'll talk about later. Now they said the invoice was approved for payment. So we're going to debit vouchers payable, 609,000. We're going to credit cash 609,000, but there's something else we have to do.

They said that the S the state grant has been dispersed. During the completion of the project. Well, now that we've used that state grant to meet the terms of the grant, we're going to debit deferred revenue, a hundred thousand and credit revenues control a hundred thousand when you've used the restricted money for its intended purpose.

When you meet the terms of the grant, now you can recognize that revenue that's how modified accrual work. So, as I say, we can now debit deferred revenue, the a hundred thousand and credit revenues control a hundred thousand. So those were all the entries in the capital projects, bond that's requirement a, but there's also requirement B.

They also want the closing entries for the capital projects fund. So how do we get organized? You know how to get organized? You go wait a minute. It's modified a cruel, I've got to close out three things. I've got to close the budget. I've got to close the actual activity and I've got to close the encumbrances.

That's modified rule. I've got to close the budget. I've got to close the actual activity. I've got to close the encumbrances. Let's close the budget. As you know, when you close the budget, it's just a matter of reversing the entry that you made when you set it up. So now I debit that budgetary fund balance for 25,000.

Now I debit appropriations control for the 675,000, and I'm going to credit estimated other financing sources. For 600,000, I'm going to credit estimated revenues control a hundred thousand. All I do is reverse the entry that I made when I set it up in the first place. And as I said, in a previous class, that's really all that entry is ever going to be.

It's not a hard entry. As long as you remember, it's got to be done. You have to close the budget. So debit, budgetary fund balance 25,000. Debit appropriations control 675,000 credit. The estimated other financing sources for 600,000 and credit estimated revenues control a hundred thousand. That takes care of that.

Now we have to close out the actual activity and you know what that means. We close out actual revenues, actual expenditures, actual sources, actual uses. That's always what we mean when we say close out, actual close out all the actual activity. So let's do it. I'm going to debit other financing sources for the 635,000.

You might remember that account was created. When we issued the bonds, I'm going to debit revenues control a hundred thousand. That was the state grant I'm going to credit. Other financing uses control 35,000. Now that account was created when we sent the premium to the debt service fund and I'm going to credit expenditures control 660,000.

Now, if you had a T account, this might be obvious, but I want to make sure you see it. Where did that? 660,000 come from. That's the total expenditures on the project. You know what makes that up? What makes up that 660,000 would be the 609,000. We paid to the construction company, the 36,000 of raw material that we paid on.

The project that we provided on the project and the 15,000 of wages we paid on the project. Just it's all the expenditures on the project. That's what that 660,000 comes from. As I say, if you had a T account, it would be obvious. The 609,000, we paid to the construction company, the 15,000 of wages we paid on the project and the 36,000 of raw material that we provided on the project.

It's all of the expenditures on the project. And here's my point. If you were to look on the government wide statement of net assets, This is where the government reports it's fixed assets. And if you were to look on the government wide statement of net assets, you'd find this city hall at 660,000. In other words, we capitalize all the expenditures on the project, not just what we paid to the construction company.

It's important that you know, that, that we must capitalize all the expenditures on the project. Not only what we paid to the construction company. All right, now the entry doesn't balance. This next number is a plug. I need a $40,000 credit to balance the entry out. Just plug it in. I need a $40,000 credit to balance the Andrea out.

And I'd like you to tell me what it is. I'll give you a choice. Should I credit on assigned fund balance or assigned fund balance? Very good. Signed fund balance because this fund balance is assigned to the purpose of this fund. Remember the only time this fund balance would be called on a sign is if it were in deficit.

Remember if you're talking about special revenue fund capital projects, fund permanent fund debt service fund, the only time the fund balance is called unassigned in those four funds is when it's in deficit, but here it's not in deficit. So it's called the assigned fund balance. Now in the general fund, it's always called the unassigned fund balance.

Always. But because it's not in deficit here, it would just be called the assigned fund balance of 40,000. We plug it in. It's assigned to the purpose of this fund. And when you close out actual revenues, actual expenditures, actual sources, actual uses, that'll give you the assigned fund balance. Now the third thing you close out are the encumbrances, but if you had T accounts, this would be obvious.

There are no outstanding in conferences. There are no outstanding conferences. We don't have to worry about that. Now, even though there are no outstanding and conferences we're not done yet, there's something else we have to do. Now, just trust me on this. If we had kept track of T accounts in this problem, once you close the budget and once you close the actual activity, and again, there were no encumbrances.

Here's all this left. All that's left. If he had T accounts. Would be a debit to cash or 40,000 via debit balance and cash 40,000 and a credit in assigned fund balance of 40,000. That's all that's left. And here's the point in a capital projects fund. If the project is finished, it's gotta be finished and there's an assigned fund balance.

They would want you to assume that you would use that remaining 40,000 to service the debt. That would be the assumption. In a capital project fund. If the project is finished, it's gotta be finished and there's an assigned fund balance. They would want you to assume they would use that remaining money to service the debt.

So now we're going to make another entry in the capital project fund, where we literally transfer this remaining 40,000 to the debt service fund. So we're going to debit all the financing uses 40,000 and credit cash, 40,000. Isn't this a permanent transfer of money from one fund to another operating purposes.

So in the capital projects fund, they're going to debit other financing uses 40,000 credit cash, 40,000. And now we make one final entry in capital projects where we debit the assigned fund balance 40,000 and credit other financing uses 40,000 and that entry actually closes out the capital projects fund.

And obviously over in the debt service fund, it'd be a debit to cash 40,000 and a credit to other financing sources, 40,000. So you can see there's a couple little wrinkles and a capital projects fund that we hadn't seen up until this problem. But the most important thing was knowing how that, how a governmental fund interrelates with the debt service fund and how to handle bonds sold at a premium.

Now, what I'd like you to do is try a simulation on governmental accounting. If. You look in your viewers guide, you'll see, you do have a simulation it's called bell city. And what I'd like you to do before you come to the next class, you know, give yourself 30 minutes and come up with your answers. It's the best way to learn to get them right.

You'll feel great. And if you don't get them right, it's frustrating, but it's how you learn. You've got to see the kind of mistakes you might make. So after that simulation, Then come to class and we'll go through it together. I'll see you then

welcome back in this FAR CPA study course. We're going to try this simulation on bell city and the thing about governmental and nonprofit accounting. It makes a great simulation. It just does. And the thing about a simulation is that with a simulation, they can give you a lot more information. Than they would in a multiple choice.

And that's the thing about bell city. There's a lot of information. It says bell city whose first fiscal year ends December 31 has only the long-term debt specified in the information and only the funds necessitated by the information. And they give you a lot of information. We've got information on the general fund.

We have information on the capital projects fund. We have information on an enterprise fund. A lot more information than you get in a multiple choice. Now there are six computational questions here, the first two questions, one and two relate to the general fund just to the general fund. And the first question says, what was the amount recorded in the opening entry for appropriations?

So over in the general fund, what was the amount recorded in the opening entry for appropriations? So let's do this together. Let's record the entry, the book, the budget. In the general fund, because that's what they're asking about. So if you go back to the general fund section, notice they gave, it, gave us a budget column.

And we know from that budget column that their total budgeted revenues are 6 million. So we're going to debit estimated revenues control 6 million. We've got that. Now their total budgeted expenditures are 5,000,006, but you got to notice a couple of things. If you look down. At the capital projects fund, it says financing for Bell's new civic center was provided by a combination of general fund transfers, a state grant and an issue of bonds.

So they're telling us that during the fiscal year, they had to be a transfer from the general fund. Now they gave us the closing entry at the end of the first year of construction. Where they closed out the actual activity. They closed out the actual revenues, the expenditures, the sources, the uses.

Here's my question from that closing entry for the capital projects fund. Can we tell what the transfer from the general fund must have been with the transfer from the general fund to the capital products fund had been 800,000? No, because capital project wouldn't treat a transfer as revenue. It's not 1 million, two 30, because that came from bonds.

It must've been the 500,000. It must've been the 500,000 because capital project would have treated a transfer from the general fund as other financing sources operating transfers in. So you might just want one to right next to that general fund that must've come from the general fund. During the fiscal year, there must've been a $500,000 transfer from the general fund looked down on the enterprise fund.

It says bell issued $4 million of revenue bonds at par. These bonds together with a $700,000 transfer from the general fund. We're used to acquire a water utility. Well, this would be a residual equity transfer from the general fund that must've been a $700,000 residual equity transfer from the general fund to the enterprise fund.

Remember what a residual equity transfer is? It's a transfer, a permanent transfer of money from one fund to another, but not for operating purposes. Again, a residual equity transfer. Is a permanent transfer of money from one fund to another, but not for operating purposes. And notice this was not property purposes.

This transfer from the general fund was used to acquire a water utility to start a water utility, to create a water utility was not for operating purposes. It's a residual equity transfer. Now here's the point when you're setting up your budget as we are here for the general fund, you're estimating that during the fiscal year.

There are going to be permanent transfers. Permanent transfers must be budgeted for because they have the same effect to spending the permanent. The money's never coming back. It has the same effect to spending. So let's go back to our, our budget entry. We know we debited estimated revenues control 6 million.

Now let's, let's figure out our appropriation because we're estimating that we're going to make a $500,000 permanent transfer during the fiscal year to the capital projects fund. And a $700,000 residual equity transfer to the enterprise fund. We're going to credit appropriations dash estimated other financing uses 1 million, 200,000.

Again, when we set up our budget, we're estimating, we're going to make a $500,000 permanent transfer to the capital projects fund a $700,000 residual equity transfer to the enterprise funds. So in our budget entry, we're going to credit appropriations dash estimated other financing uses 1 million, 200,000 permanent transfers.

Have to be budgeted for not temporary transfers. As you know now, did you notice from the budget column for the general fund, the total budgeted expenditures are 5,000,006. Well, this is 1 million to have it. So we're going to credit appropriations control for the other 4 million for now. Don't get me wrong.

You could have just credited appropriations control 5 million, six. That's fine. That's not wrong. This is part, the permanent transfers are part of your appropriation. Why? Because you have to have legislative authority to make a permanent transfer. As I keep saying, it has the same effect to spending it's permanent.

The money's never going to come back. So you have to have legislative authority to make a permanent transfer. Permanent transfers are part of your appropriation. So like I say, if you had just credited appropriations control, 5 million, six, that's not wrong. But a lot of times in the exam, they'll split it up like this.

So I've credited appropriations dash estimated uses 1 million, two, and credit appropriations control 4 million for now the entry doesn't balance. We need a $400,000 credit to balance the entry out. You know what that is? Budgetary fund balance 400,000. So now we can answer the question. First question says, what was the total amount recorded in the opening entry for appropriations?

We know it was 5 million, 600,000. 5,600,000. Number two. What was the total amount debited to property tax receivable? Well, if you go back to the general fund section, look at the actual column, their actual property tax revenue for the year 4,000,007. So we know they credited revenues control 4,000,007.

We know they did. Now, if you look a little, a little bit below there at year end, they had property tax receivable, delinquent 420,000 less. An estimated uncollectable taxes, allowance of 50,000. So they are net receivables in Iran, ERN 370,000. Now notice they set a couple of things here. They said second bullet below there.

No property taxes have been written off during the year. And the allowance for uncollectable taxes balance is unchanged from the initial entry at the time of the original tax levy three, that again, they say no property taxes receive a woman written off. And the allowance for uncollectable taxes balance is unchanged from the initial entry at the time of the original tax levy.

So in other words, when they made the original tax levy, let's go back to our entry. They credited estimated uncollectable taxes, 50,000. It's been unchanged. Nothing's been written off. It's been unchanged from the original levy. So in this entry, they would have credited it estimated uncollectable taxes, 50,000, and now we can plug the debit.

They must've debited taxes, receivable, current. 4,000,007 50. So the answer to number two, what was the total amount debit at the property tax receivable? 4,750,000. As you know, that's a very basic entry, but don't be surprised if in a simulation like this, they kind of make it. They make you piece it together.

You have to look at several things to try to, well, if I know the credit to revenues control and I know the credit estimated uncollectable taxes, then I can figure out the debit to the receivable. No, you sort of had to do the entry backwards. It's kind of thing they can do in a simulation. That's much harder to do in a multiple choice.

Now, in questions, three to six, these relate to Bell's funds other than the general fund, number three, they say, okay, when you boil it down, what was the completed cost of the civic center? When you really boil it down? What it really costs you to make that civic center. Now, I hope you tried this and let me say that a couple of ways you can get this answer, but I'll show you what I think is the easiest way to do this.

If you go to the capital project fund section, if you read it carefully, you notice that the civic center was a two year project. And what they gave us in the simulation was the closing entry at the end of the first year of construction, where they closed out the actual activity. The actual revenues, the actual expenditures, the actual sources, the actual uses look at that closing entry from that closing entry, what resources did they have?

Let's let's list, the resources that we knew they had in the capital projects plan. They had 800,000 of revenue. They had, they had 1 million, 230,000 from the bond proceeds and they got 500,000 from the general fund. Those are all the resources they had in the capital projects fund in the first year of construction, 800,000 of revenue, 1 million, two 30 from bond proceeds and 500,000 from the general fund.

Now this was a two year project. Did they get anything the second year? You gotta be careful. Well, if you look at the last bullet in that section, it says you got to read everything. That's the thing about a simulation. There's a lot more information. And the last bullet in that section says during the following year, Capital projects received no other revenues, no other sources.

So this is it. This is all they had. These are the total resources they had in the capital projects fund. Just add it up. If you add up 800,000 plus 1 million to 30 plus 500,000, it adds up to 2,530,000. Those are the total resources they had in the capital projects fund 2 million, 530,000. Now that they keep all that money in the capital projects fund.

No. Didn't they send the $30,000 bond premium to the debt service fund. We know that right. They would have sent the $30,000 bond premium to the debt service fund. You can see that in the closing entry, that's why they had the other financing use of 30,000, because they would have sent that $30,000 bond premium to where they service the debt in the debt service fund.

So back out that 30,000, they didn't keep that in the capital products fund. Did they. Send any other money out of the capital projects fund? Yes. The last bullet in that section says the civic center building was completed early the following year and the capital project fund was closed by a transfer of 27,000 to the general fund.

So when they were all done, they sent 27,000 to the general fund. So back out 27,000, if you take that 2 million, five 30 back out to 30,000 premium that went to the debt service fund back out the 27,000, that went to the general fund when the project was finished. The balance 2 million, 473,000. I have to assume everything else in that capital projects fund must have been the total expenditures on the project.

All, everything that's left in the capital projects fund must have been the total expenditures on the project. And remember that's what you capitalize. You capitalize all the expenditures on the project. So what did it cost you to make that civic center? All those expenditures, 2 million. 473,000. I'll hope you tried to work that out and I hope it makes sense to you now that makes sense.

Do you, I think the next one, will they say a number four? What was the amount of the state capital grant for the civic center? What was the state grant? We'll look at the resources in the capital project fund was the state grant 500,000? No, that came from the general fund. Was the state grant 1 million, two 30?

No, that came from bonds. The state grant must've been 800,000. So all the only thing that was there. Must've been 800,000 of grant revenue. So the answer to number four, 800,000 number five says in the capital projects fund, what was the amount of total encumbrances recorded during the year? And of course they mean the first year of construction.

What was the total in conferences in that first year of construction? So it's a little test on the incumbent system. Now, as I've said all through these classes, The encumbrance system is not difficult, but you gotta get used to it. So how do we work out the total encumbrances for the capital projects fund in the first year of construction?

Well, let's go back to that closing entry, go back to the capital project fund section. Look at the closing entry, where they closed out the actual activity. Notice the total expenditures were 1,000,080 thousand. So let's piece together. What must've happened in the first year of construction. If the total expenditures were 1,000,080 thousand.

They must've debit it. Expenditures control 1,000,080 thousand credit vouchers payable, 1,000,080 thousand. What would they have done before they recorded those expenditures? Wouldn't they have reversed the original encumbrance for the original estimated amount. I think you can agree with me on that before they would have booked those expenditures, they would have reversed the original encumbrance for the original estimated amount.

Look at the second bullet below that entry. Gotta read everything. That's the thing about a simulation, so much more information. It says during the year total capital projects, bond encumbrances exceeded the corresponding expenditures by 42,000. All right. So before they debit an expense before they debit it, expenditures control 1,000,080 thousand credit vouchers payable, 1,000,080 thousand.

They must've debit it. Budgetary fund balance reserved for in conferences, credit and conferences control. For a million, one 22, in other words, 42,000 more than the million 80, because they said total capital projects, funding conferences exceeded those corresponding expenditures by 42,000. So before they recorded those expenditures, they would have debited budgetary fund balance reserved from conferences, 1 million, one 22, and credit and conferences control 1 million, one 22, because you always reverse the original encumbrance for the original estimated amount before you book the expenditure.

So my point is. There's 1 million, $122,000 of encumbrances. Anything else? Yes. The first bullet below that entry says at year end, December 31 capital projects reflected Bell's intention to honor the 1,300,000 of outstanding purchase orders and commitments that are outstanding at year end. So at year end they still had 1 million, 300,000 of outstanding purchase orders.

Other commitments. So it, so at year end, it was still 1 million, 300,000 of outstanding in conferences. So we're going to take that 1,000,001 22. Add the 1,300,000 of outstanding in conferences at year end added up total and conferences for the year. Must've been 2 million, 422,000. Just to add it up the 1 million, one 22 and the 1,000,003 have outstanding encumbrances at year end 2,422,000.

As I've said, make sure you know that encumbered system finally, last question. Number six in the capital projects fund, what was the assigned fund balance at December 31? And they mean year one, December 31, you know, first year of construction. What was the assigned fund balance? Well, if you go back to that closing entry, go back to the capital projects.

One section, look at that closing entry in that closing entry didn't they give us the assigned fund balance. 1 million for 20. Isn't the answer? 1 million for 20. No. Why not? Why isn't it just the one, the, why isn't it just the 1 million for 20. They gave us in the entry. Well, what I'm hoping we'll get you out of this problem.

If you, if you would, if you might've tripped on it, I'm hoping what would get you out of this is that you always stop and think, wait a minute. This is modified accrual. In modified a cruel, I'm always looking to close out three things. What's number one, the budget. They didn't give us the budget in the capital projects fund.

Number two, I have to close out the actual activity. They did that for you. We have the entry where they closed out the actual activity. What's number three. Oh, that's right. I got to close out the encumbrances and at year end, wasn't there 1 million, 300,000 of outstanding and conferences. You got to remember how to close out the incumbent is.

In other words, if at year end there was 1 million, 300,000 of outstanding encumbrances. Doesn't that mean there was a debit balance and encumbrances control 1 million, 300,000, and isn't there a credit in budget rate fund balance reserved for in conferences, 1,000,003. So the first thing you would have done is debit budgetary fund balance reserved for in conferences, 1 million, three, and credit and conferences control.

1,000,003, you'd close those accounts out, but you're not done. You still have 1 million, 300,000 purchase orders out in the world. Somewhere. Eventually those goods and services are going to come in. You still have some potential obligations. And in modified a cruel, we don't just keep track of actual obligations.

We keep track of potential obligations, commitments. So we make another entry in the entry they gave us. Well, they closed out the actual activity. Didn't we establish, we had an assigned fund balance of 1 million, four 20. Now I'm going to debit that assigned fund balance 1 million, 300,000. And I'm going to credit committed fund balance 1 million, 300,000.

You see what I'm doing? Because I still have 1 million, 300,000 of purchase orders. They haven't, they haven't matured yet into an actual obligation, but they are commitments. So I'm going to debit that assigned fund balance 1,300,000, and I'm going to credit the committed fund balance. And that's a balance sheet account.

When you look at the balance sheet for the capital projects fund, you're going to see that committed fund balance. You know, that that's a part of your fund balance that represents commitments. It hasn't matured yet into an actual liability, but they're considered commitments of the government. The are commitments.

So when you book that entry, when I debit the assigned fund balance 1 million, 300,000, that lowers the, assigned the assigned fund balance down to 120,000, he signed fund balance, just went from 1 million, four 20 down, 1 million, three to 120,000. I hope you did well on that. Simulation, keep studying and I'll see you in the next class.

Welcome back. As you may remember. Earlier in these classes, we talked about a rule that is unique to modify, to cruel where we said under modified a cruel, if a governmental unit receives restricted money, like a grant that governmental unit is not allowed to recognize that grant money as revenue until they spend the money for the intended purpose until they meet the terms of the grant.

And in the example we discussed. We had a governmental unit get a state grant and they debited cash credited deferred revenue. But I want to emphasize that in that example, the money was available immediately. In other words, that grant was not received in advance of any timing requirements. The money could be spent immediately.

And in that case, if the money's not in advance of timing requirements, It's as we said, the governmental unit would debit cash and credit deferred revenue. And then when they spend the money for the intended purpose, they debit deferred revenue and credit revenue. They recognize the revenue as they spend it.

But now I want to talk about a governmental unit receiving a grant in advance of timing requirements. That's a little bit different. If a governmental unit receives a grant. In advance of timing requirements. Of course they would debit cash, but they're going to credit an account called deferred inflow of resources.

I want you to be aware of these account names. So if a governmental unit gets a grant in advance of timing requirements, in other words, that they aren't allowed to spend it yet, they're going to debit cash and credit on account called deferred inflow. Of resources. Now that account for an inflow of resources always has a credit balance.

And in the governmental fund balance sheet, it would be, it would be shown below liabilities below liabilities on the governmental fund balance sheet. It'll also the same account would be shown below liabilities in the government wide statement of net position. Which we'll be getting to it in a little bit, but you may, I just want to go over this cause you might see it.

So if so, just to illustrate, if a governmental unit did receive a grant in advance of timing requirements, they're going to debit cash, credit, deferred inflow of resources that would now be shown below liabilities on the governmental fund balance sheet will be, it'll be shown below liabilities and the government wide statement of net position.

And then when they can. Now, when they now have met the timing requirements, they will debit that account debit, deferred inflow of resources and credit revenue when they have met the timing requirements. And this is used in a couple of situations, you would also use this account deferred inflow of resources.

When there's a deferred gain from refunding debt, you would use that account always has a credit balance. So you would use that for deferred gain. On refunding debt, a deferred gain on a sale leaseback transaction. If the governmental unit receives proceeds from the sale of future revenue. And then one more, if there was an increase in the fair value of a hedge of a future transaction, if there's an increase in the fair value of a hedge of future transactions, what the.

Governmental unit would do is debit the investment, debit, the hedged security, write it up to fair value and credit deferred inflow of resources. So you may see that accountant on the other hand, you might see an account called deferred outflow of resources. Let's say that grant expenditures. Are paid in advance of timing requirements.

If grant expenditures were paid in advance of timing requirements, the governmental units going to debit deferred outflow of resources and credit cash. Again, debit deferred outflow of resources and credit cash. That's the grant expenses are paid in advance of timing requirements. Now you're debiting deferred outflow of resources and credit and cash.

And that account deferred outflow of resources will be on the governmental fund balance sheet. Below assets, it would be in the government wide statement of net position below assets always has a debit balance. And then when timing requirements are met, then the government unit can debit the expenses and credit deferred outflow.

So that account look, look for it in the governmental fund balance sheet again, below assets or in the government wide statement of net position below assets. This can also be this account also has to be used if there's a deferred loss form from refunding debt. If there's a deferred loss on a sale leaseback transaction, that's what this account is used.

Deferred outflow of resources will be used if there's a deferred loss from refunding debt, a deferred loss on a sale leaseback transaction. If there's a cost to acquire future revenues. Defer it outflow of resources. And if there's a decrease in the fair value of head securities, when they're hedging future transactions, again, if there's a decrease in fair value of hedged securities, when they're hedging in future transactions, you would debit deferred outflow and credit the investment.

So I want you to be aware that those accounts show up in these financial statements in both the. Governmental fund statements and the government wide statement of net position as well. So with that mentioned, and that in our mind, let's talk about the comprehensive annual financial report. The comprehensive annual financial report is the reporting model for state and local governmental units.

It was established by Gasby 34. And it's very heavily tested. This comes up a lot in the exam. And as I say, the comprehensive annual financial report, the CAFR is the reporting model for state local governmental units. And there are six parts to CAFR. Let's talk about each six. Let's talk about each of the six parts part.

One of CAFR is the management discussion and analysis, the MD and a, the management discussion and analysis always precedes the financial statement. That's where it belongs. It always precedes the financial statements and it compares the current year to the prior year. Explains any major changes and one little fine point.

The MDA, the management discussion and analysis is part of your RSI. It's part of your required supplementary information, even though the management discussion and analysis is always presented where it precedes the financial statements, always. It's considered part of the required supplementary information.

It's part of the RSI. If they ask part two of CAFR is the heart and soul of the whole thing. Part two is the basic financial statements. Now listen carefully. The basic financial statements are made up of first, the government wide statements. There are two government wide statements. There's a government wide statement of net position.

Basically a balance sheet, but it's called a government wide statement of net position and the government wide statement of activities, basically an income statement. So those are the two government wide statements. There's a government wide statement of net position and there's a government wide statement of activities.

And then there are the fund financial statements. You've got your five governmental funds, general fund, special revenue fund capital projects, bond, permanent fund debt, service bond. And the fund financial statements for the five governmental funds are all done under modified accrual. And then there are the two proprietary funds enterprise internal service, and they have financial statements are done under normal accrual accounting.

And finally, there are the fourth fiduciary funds, the pension trust, the private purpose trust, the investment trust, the agency fund, and those financial statements are done under normal accrual accounting. Now, let's start with the government wide statements. If you look in the viewers guide, we're going to start with the government wide statement of net position.

And there's an example of the government wide statement of net position and your viewers guide. And if you look at it again, it's a balance sheet, but I want to point out some important things that you should notice. What I'm trying to point out are where I think the grading points are here. If you look at that government wide statement of net position, a couple of things you want to notice right away.

Notice the whole thrust of the government wide statements is to separate governmental activities from business type activities. First thing you should notice. That's the thrust of the government wide statements to separate governmental activities. What would be an example of a fund that's clearly governmental activities, general fund special revenue fund capital projects fund.

So there are. Governmental activities. What's an example of a fund that would be clearly business type activities, enterprise fund. So the government wide statements are going to separate governmental activities from business type. Now, if you look at the government wide statement of net position, you'll see that there's fixed assets with accumulated depreciation.

This is where the government. It has gone up. This is where the state of local government is going to report their fixed assets. So notice on the government wide statement of net position, there's fixed assets with accumulated depreciation, and I want to make a point in those fixed assets, you would find infrastructure.

You've got to be aware of this what's infrastructure infrastructure would be roads and bridges and sewer systems. And what the CPA Exam might ask you is this would the governmental unit depreciate infrastructure. The answer is no, no, you are not required. A governmental unit is not required to depreciate infrastructure.

If they do three things, number one, they have to keep an up-to-date inventory of their infrastructure. Again, number one, they have to keep an update inventory of their infrastructure. Number two, they have to assess its condition at least every three years. And number three, they have to estimate. And disclose the expenditures that will be required to maintain it.

Those are the three requirements. As long as they keep an up-to-date inventory of their infrastructure, they assess the condition at least every three years and disclose the expenditures that will be required to maintain it. They do those three, do those three things. They do not have to depreciate infrastructure.

And that is called the modified approach of depreciating infrastructure. You have to be aware of that. That's called the modified approach of depreciation for infrastructure, which means it's not taken now, as I've said, the whole point of the government wide statements and the thrust of the government wide statements is to separate governmental activities from business type activities.

So, and I find the fiduciary funds, Sherry funds be governmental activity or business type listen carefully. The fiduciary funds. Are excluded from the government wide state. And you've got to know that see the fiduciary funds are really trust funds. The government's really holding money that belongs to somebody else in trust.

So when you look at the fiduciary funds, they're not really governmental activity, they're not business type activity, then it really neither, it's just the government holding money in trust that belongs to somebody else for the most part. So just remember fiduciary funds are excluded. From the government wide statements.

If you look to over to the right on the statement, you see the column component units, what is that? A component unit would be something like a school district, a school board, a board, a school district, a board of education, maybe a, a rescue squad. Now here's the issue with component units. Listen carefully.

If the component unit is organized as a separate legal entity, if it's organized as a separate legal entity and the governing body of the component unit is not substantially the same as the governing body of the primary government. Again, if the component unit is organized as a separate legal entity and the PR and the governing body of the component unit is not substantially the same, not substantially the same as the governing body, the primary government.

Then it would be shown as we have it shown here as what they call a discreet presentation in a separate column. On the other hand, if it's not organized as a separate legal entity and the governing body of the component unit is substantially the same as the primary government. And it really exists to serve as the primary government.

Well, in that case, it would not be a separate column. You would just blend it. That's the word you would blend the component unit within. Just blended into governmental activities. So that's the issue. Notice here. It must be a separate legal entity. The governing body is not substantially the same as the governing body, the primary government.

So it's a discreet presentation it's reported in a separate column. Another point, where would I find the internal service fund? Well, this bothers a lot of people you might think. Well, Bob, the internal service bond is a proprietary fund. It must be in business type activities. It's a mistake. A lot of people make no.

When the government wide statements, the internal service bond is always included within governmental activities, always because what is the internal service bond? It's one agency, the government servicing other agencies of the government. So who are we kidding? It's governmental activities. So always in the government wide statements, internal service bond.

It's governmental activities. Try to remember that. And if you look at the statement, you see the internal balances, you know what that represents, that would be like a do from on the general fund balance sheet and a corresponding do to in the enterprise fund balance sheet. That's what the, that's what the internal balance represents.

It would be a, say a do from. On the general fund balance sheet and a do to in the enterprise fund balance sheet. Now here's the point if there's a do to do from within governmental activities within governmental activities, that would be eliminated from the government wide statements because they don't want you to gross up your assets.

If there's a do to do from within business type activities, that would be eliminated from the government wide statements. But if there's a due to due from the Twain. Governmental and business type activities. We leave it in the statement. What I want you to remember is that in the government wide statements, there's a partial elimination of interfund transactions, not a total elimination of interval fund transaction.

Let me go over that again. If there's a due to do from within governmental activities would be eliminated from the government wide statements. If there's a due to do from within business type activities would be eliminated from the government wide statements. They don't want you to just gross up your assets.

But if there's a due to do from between governmental and business type activities, we leave it in the statement. So the bottom line is there's a partial elimination in of interferon transactions in the government wide statements, not a total elimination of interfund transactions. Also, I want you to notice in the government wide statement and that position notice below assets, you see that deferred outflow.

Of resources notice there it is. As I said, that can show up in the government wide statement of net position. It would also could also show up in a fund financial statement, notice below liabilities, you see deferred inflow of resources. So you know what that's all about. And then finally, I want you to notice the way that the net position, this is a.

Government wide statement of net position. And please notice how the net position is reported. It's three categories, three categories of net position. First there's the net investment in capital assets. That the way you derive with the way you arrive at that number is you take the capital assets, less accumulated depreciation, less, any mortgages, any debt related to the, to the fixed asset.

It's the net investment. In capital assets and then there's restricted and unrestricted. So there are three categories of net position. Also in your viewers guide, you'll see the government wide statement of activities, basically it income state, but it's called a government wide statement of activities.

And you already know a lot about this. You already know a lot. Notice the whole thrust of the statement is to separate governmental activities from business type activities. Once again, where would I find the fiduciary funds? You know, they're not there. The fiduciary funds are trust funds, the government's holding money and trust that belongs to somebody else.

So the fiduciary funds are not really governmental activity. They're not really business type activity. The fiduciary funds, as you know, are always excluded from the government wide statements. Where would I find the internal service fund, you know, in governmental activities, even though it's a proprietary fund.

It's one agency, the government servicing other agencies of the government. It always belongs in governmental activities and the government wide statements. Notice again, the component units and you know what that is. The fact, this is a discreet presentation, isn't it? This is a separate column. So that tells you that it's organized as a separate legal entity.

The governing body is not substantially the same as the governing body, the primary government, you know, it doesn't exist just to serve the primary government. So the component unit is a discrete presentation to separate column as it's illustrated here. But as I say, if it's not a separate legal entity, if the governing body is substantially the same as the governing body, the primary government then would just be blended into governmental activity.

So, as I say, you already know a lot about this. Now, if you look at the statement. You can see once again, that in the government wide statement of activities, they're going to separate governmental activities from business type, and the statement starts off showing net revenues and net expenses by program.

That's the thrust of this statement. Yes. It's going to separate governmental activities from business type, and then it starts off by reporting net revenues or net expenses by program. And once it's done that, once it's reported net revenues or net expenses by program notice, then the general revenues come in.

They're separated now, but we don't want you to have net revenues, net expenses by each program. Then below now separated come in the general revenues and then extraordinary items. Extraordinary items are. You know what they are gains or losses that are both unusual and infrequent, there are special items.

What are special items, gains or losses that are unusual, but not infrequent in frequent, but not unusual. Those are special items, but notice the general revenues are separated. The extraordinary items, the special items are separated.

Now we're still talking about. Part two of CAFR. So we've gone over the government wide statements. Remember there's only two government wide statements, government wide statement of net position. Government-wide statement of activities. Now we're going to talk about the fund financial statements and we'll get into the fund financial statements in our next class.

See you then.

Welcome back in this FAR CPA study course, we're going to continue our discussion of the comprehensive annual financial report. The C a F R. When we left off in our last class, we were in part to the basic financial statements. And in our last class, we covered the government wide statements. Now we're going to continue and talk about the fund financial statement.

As you know, there are five governmental funds, the general fund, the special revenue fund, the capital projects fund, the permanent fund and the debt service fund. And the five governmental funds have to do a balance sheet and a statement of revenues, expenditures and changes in fund balance. Those are the statements that are required for the five governmental funds, a balance sheet, and a statement of revenues, expenditures and changes in fund balance.

And of course these statements are done under modified a cruel. And if you remember earlier in these classes, when we went through the journal entries and the account names for a general fund, we looked at the balance sheet for the general fund under modified accrual and the statement of revenues expenditures and changes in fund balance under modified rule.

These are the statements that are required for the five governmental funds. Now the proprietary funds. Enterprise internal service. The proprietary funds have to do a statement of net position, basically a balance sheet, but it's called a statement of net position. And the basic formula is that your assets, plus your deferred outflows minus your liabilities and deferred inflows.

Give you your net position. That's the basic formula. Isn't it. If you take your assets, plus your deferred outflows. Minus your liabilities and your deferred inflows, you have your net position. So the proprietary funds have to do a statement of net position and a statement of revenues, expenses, and changes in fund net position.

They also have to do a statement of revenues, expenses and changes in fund net position, you know, basically an income statement and. The proprietary funds are the only funds in governmental that have to do a statement of cash flows. Again, the proprietary funds are the only funds in governmental that have to do a statement of cash flows.

And if you look in your viewers guide, you'll see the format for statement of cash flows for a profit making company, which we know so well, if you just, just to refresh your memory, we know how a profit making company does. A statement of cash flows. In other words, under the FASBI format, there's cash flows from operating activities.

This cash flows from investing activities, cash flows from financing activities. And I know you remember it very well, but if you look in your viewers guide, you'll also see the format for statement of cash flows under the Gasby format. And when the proprietary funds do a statement of cash flows, and I know this can be, be confusing even though.

Their statements are done under normal cruel accounting number, the proprietary funds do their statements under normal accrual accounting. They're part of a governmental unit. So when they do the statement of cash flows, they don't follow the FASBI format. They do follow the Gasby format. And in your viewers guide, you'll see the format for a statement of cash flows onto the Gasby.

Notice this cash flows from operating activities. That's not bad. That's cash revenues, less cash expenses. What you'd expect it to be cash flows from operating activities. Then this cash flows from investing activities. No, if you buy or notice, if you buy or sell investments, that's cash flows from investing activities.

If there's cash received the interest cash received for dividends, that's cash flows from investing activity. Let me, let me ask you something. Where would I find cash receipt for interest in cash? Receive the dividends. Where would I find it in the FASBI format? That's on the income statement. It's operating here.

It's investing be careful. So cash receipt, the interest cash receipt for dividends. If this were profit making company, that would be on the income statement, it would be operating activity, but here it's investing. And then what the Gasby format does is divide financing activity into two first there's cash flows from non-capital financing activity.

What's cash flows from non-capital financing. Well, if they borrow or repay principle for purposes, other than to acquire construct or improve capital assets, that's cash flows from non-capital financing. And did you notice cash interest paid? You might want to focus in on that? Where would I find cash paid for interest in the FASBI format for profit making company?

It's on the income statement. It's operating here. It's financing. And then finally there's cash flows from capital and related financing activity. What would it be? Cash flows from capital and related financing activity. While again, if, if I borrow a repay principle to acquire construct or improve capital assets, that's cash flows from capital and related financing activity.

But did you notice if I buy or sell PP and E if I buy or sell property plant equipment, if I buy or sell property plant equipment, that's cash flows from. Capital and related financing activities. Where would it be in the statement of cash flows for profit making company, you know, investing, buy or sell PPD that's investing activity in the FASBI format, but in the Gasby format, it's financing, be careful and notice again, cash paid for interest for a profit-making company.

That's on the income statement it's operating. That would be. In the FASBI format for cash flows, operating activity, but here notice it's financing, you know, keep in mind that you could get a simulation where they want you to do a statement of cash flows for a proprietary fund. You'd have to know these distinctions.

That's why I'm trying to point them out. No, what's different because that's a real possibility, a simulation where they ask you to do a statement of cash flows for a proprietary fund. It's a little different, isn't it? And I should mention, it's always the direct method under the Gasby format. Only the direct method is used.

Let's talk about the fiduciary funds. You know what the fiduciary funds are, the pension trust, the private purpose, trust the investment, trust the agency fund. Now the fiduciary funds have to do two statements. A statement of fiduciary net position, basically a balance sheet, but it's called a statement of fiduciary net position and a statement of changes in fiduciary net position.

Again, it's a statement of fiduciary net position, basically a balance sheet and a statement of changes in fiduciary net position. And of course, fees statements are done under normal accrual accounting. And that is part two that's part, two of CAFR, the basic financial statements, as I said, that's the heart and soul of the whole, the whole thing.

Part three of CAFR would be notes to the financial statements. This is where perhaps you would disclose how many employees have vested rights in the pension plan. Something like that. Part four of CAFR would be the RSI. The required supplementary information, other than MTNA other than management discussion and analysis, which always precedes the financial statements.

So part four is the RSI, the required supplementary information. What is your required supplementary information? Well, here's what they compare the original to the final budget. This is where they disclose fixed asset accounting methods. This is where they would disclose, for example, that they using the modified approach of depreciation for infrastructure.

This is where they would disclose a ten-year schedule for pension trust funds, things like that. That's required. Supplementary information. Part five of CAFR would be combining statements for non-major funds and non-major components. Again, part five would be combining statements for non-major funds.

Non-major components. What we're saying is if a governmental unit has non-major funds and non-major components, they can be aggregated and reported in a separate column, not only in the government wide statements, but also in the fund financial statements as well. Now we're drawing a distinction now between major funds and non-major funds, major components and non-major components.

So how do we decide what is what? Well, first of all, you have to be aware that internal service funds. And fiduciary funds are exempt from this analysis. Listen carefully, no such thing as a major and a non-major internal service fund. No such thing as a major and a non-major fiduciary fund, those funds are exempt from this analysis.

No such thing as a major and a non-major internal service bond. That distinction is not made no such thing as a major and a non-major fiduciary fund. That distinction is not made just exempt from this analysis, but let's get to it. What's a major fund. Well, the general fund is always made. The general fund is always major.

Also any fund is major whose assets liabilities, revenues, expenses are equal to or greater than 10% of the funds in the same category. Again, what's a major fund general fund is always major. Also any fund major whose assets, liabilities, revenues, expenses are equal to, or greater than 10% of the total funds in the same category.

You know, either governmental. Or enterprise and, and equal to, or greater than 5% of the total for all funds. That's what I'm major fund is general funds always major. Also any fund has major whose assets liabilities, revenues, expenses are equal to or greater than equal to, or greater than 10% of the total for funds in the same category, governmental or enterprise and equal to, or greater than 5% of all funds the total for all funds.

And then one more point, the governmental unit. Can deem any fun. They want to be major. In other words, regardless of the criteria, the governmental unit can say, we consider the capital project fund to be major. They can deem regardless of the criteria, they can deem any fund. They want to be major. But the point is that if the primary government has non-major funds non-major components, if they have them, if, if the primary government has non-major funds and non-major components, They can be aggregated and reported in a separate column in the government wide statements and also in the fund financial statements as well, the sixth and final part of CAFR would be all the individual fund statements and schedules for all the primary government's funds.

Again, part six would be all the individual fund statements and schedules for all the primary government's funds. And you know, there's a lot of detail here. They could have, you know, 47 capital projects funds going. This is where you'd find all the detail they could have, you know, 75 special revenue funds going.

Here's what you'd find all the fund statements and schedules for all the primary government's bonds. So this is where all the detail is also the primary government has the option to have a statistical section as well. So those are the six parts of. C a F R. And before you come to the next class, there were some questions I want you to get answered.

Please get those questions answered, and then I'll look to see you in the next class. See you then

welcome back to our discussion on governmental accounting. As you know, I assigned 11 questions that I wanted you to answer before coming to this class. So let's start the class by going through those questions together. And number one, they say Marta cities, school district. So right away, you know what we're talking about a component unit.

It is a legally separate entity. That's significant, isn't it? Two of its seven board members are also city council members. Well, if it's two of seven, you can't say that the governing body of this component unit is substantially the same as the governing body of the primary government. This school district would be reported.

How. As a discrete presentation, wouldn't it, it's a separate legal entity. The governing body of this component unit is not substantially the same as the governing body of the primary government. This would be answer, be a discrete presentation in a separate column in the government wide statements.

Number two, Shay city uses an internal service fund for a central motor pool, and they want to know how this would be reported. In the government wide statement of net position. Well, it's this odd point again, isn't it that even though the internal service fund is a proprietary fund and you would think logically it's business type activities.

Nope. In the government wide statements, government wide statements, internal service bond is always governmental activities. Don't miss that answer a number three. Dale town's public school system. We're back to a component. Unit is administered by a separately elected board of education. That's not the governing body.

The board of education decides things like curriculum. That's different. That's not the governing body. Notice the board of education is not organized as a separate legal entity. That's very significant. It says they don't have the power to levy taxes. They never would. The town council approves the school's budget.

That's pretty standard. The main point is it's not organized as set as a separate legal entity. This is answer B. You would just blend it. It would not be a discreet presentation. Just blended into governmental activities. Number four, Barry townships eligible infrastructure assets, roads, bridges, source systems are exempt from depreciation.

If the modified approaches used. This is the modified approach of depreciation we're talking about, which of the following required, which of the following are requirements of the modified approach? Number one, the end of the performs condition assessments. Yes. They have to do that at least every three years to the entity annually estimates the amount of reserve.

Yes. They have to disclose the amount of preserve three, the entity assesses asset condition in comparison to condition levels established by the national association of public work engineer. Or a comparable organization that sounds like it ought to be true, but it's not. Nope. You know, the three requirements keep an up-to-date inventory of your infrastructure.

You assess its condition at least every three years and disclose the expenditures that will be needed to maintain it. That last one, it's not a bad idea, but it's not a requirement of the modified approach. Just the first two aunts or B

number five Dogwood city's water enterprise fund. Received interest. We're talking about cash receipt, the interest cash received for interest of 10,000 from long-term investments. How would this amount be reported on the statement of cash flows? Well, of course the enterprise fund is a proprietary fund and as you know, the proprietary funds are the only funds in governmental, then have to do a statement of cash flows.

So where would I find cash receipt for interest? In a statement of cash flows for proprietary fund. We remember this odd point, even though the PR, even though the proprietary funds use normal cruel accounting, they are connected to a governmental unit. They don't follow the FASBI. So when they do this statement of cash flows, they follow the Gasby format and then the Gasby format cash received.

The interest is investing activities. Answer D if it were the FASBI format, if we're a profit making company cash receipt, the interest it's on the income statement, it's operating. But no in the Gatsby format, it's investing activity number six, which of the following is a required financial statement for an investment trust bond.

While an investment trust bond is a fiduciary fund. The answer's D they have to do a statement of changes in fiduciary net position. They have to, those are the, the two statements. That are required for the fiduciary funds are a statement of fiduciary net position and a statement of changes in fiduciary net position, not a, not a statement of revenues, expenditures and changes.

No, not say not a statement of revenues, expenses and changes. Now just a statement of fiduciary net position and a statement of changes in fiduciary net position, answer date number seven. It is inappropriate, inappropriate. To record depreciation expense and the government wide financial statements related to the asset, the asset of which type of fund, well, B, C and D enterprise fund general fund, special revenue fund.

All of these funds can have fixed assets. All of them can, the enterprise fund fixed assets would be in business type activities in the government wide statement of net position. And it would be appropriate to take depreciation for the general fund special revenue fund. If there are fixed assets related to those bonds, they can't carry the fixed assets and modified a rule.

But if there are fixed assets related to those funds, they'd be carrying they'd report it in the government wide statement in that position in governmental activities with accumulated depreciation, but an agency fond answer, a agency fund does not have revenues does not have. Expenditures does not have assets does not have liabilities and agency fund can never have any kind of net position, any kind of net asset position.

It's it's impossible. An agency fund could never have fixed assets or liabilities or revenues or expenses. So depreciation would be inappropriate for an agency fund. Answer a number eight during the current year Knox County levied property taxes. Of 2 million, they expect 1% to be uncollectable. And at the bottom it says, what amount of property tax revenue would they report?

I think this is a very important question and I hope you listening very carefully. I think this is an important point now for the exam. Listen carefully when you are in that exam and they start talking about financial statements, always take a breath, skip a beat, take a breath and go wait a minute. Are we talking about the government wide statements?

Which a normal accrual accounting or the fund financial statements, which are modified accrual. That's a very big difference. So anytime they start multiple choice or simulation, start asking about financial statements for a primary government in governmental, you have to stop and take a breath. Wait a minute.

Are we talking about the government wide statements, which are normal cruel accounting or the fund financial statements, which are modified accrual? Notice they said, what amount of property tax revenue would Knox County report in their entity wide statement of activities? It's a gov, it's a government wide statement.

It's normal accrual accounting. So let me show you the entry here. Here's the entry that Knox County would make when they levy those property taxes, they would debit taxes, receivable current for the 2 million, the whole levee. They think 1% is uncollectable. So they would credit estimated uncollectable taxes for 1%, 20,000 and credit revenue.

For 1,000,980, the answer is C and all that information about 60 days means nothing because it's normal, cruel accounting, not modified rule that whole 60 day rule. That's modified accrual. So I hope you really, really pick up on that distinction. Hey, wait a minute. Are we talking about. A fun financial statement, which is modified a rule or government wide statement, which is a cruel accounting.

Hey, this is, this is entity wide statement of activities. It's a cruel accounting. So they'll just debit taxes, receivable current for the levy to a million credit estimated uncollectable taxes like allowance for bad debts for 1%, 20,000 and credit revenues control 1,000,009 80 and all of that 60 day stuff.

That's for modified rule. This is entity wide statement, normal cruel accounts. Be very careful. Number nine. On March 1st, wag city issued a million dollars of 10 year, 6% general obligation bonds at par with no bond issue costs. The bonds pay interest September one and March one. What amount of interest expense and interest payable would wag report and the government wide financial statements, government wide it's normal cruel accounting at the close of the fiscal year on December 31.

We've got to figure out the interest expense. That would be on the government wide statement of activities and the interest payable that would be in the government wide statement of net position. Well, this is government wide statements to normal cruel accounting. So just do this like a profit making company.

I'm going to take 6% of a million. Don't the bonds pay 60,000 of interest annually. That's 6% of 1,000,060 thousand of interest annually or 5,000 a month. All right. So if it's 5,000 a month, We know that in terms of the interest expense, the interest expense would be March 8th. The bonds were issued on March one.

So the interest expense for the year would be March, April, may, June, July, August, September, October, November, December 10 months, times 5,000 or 50,000. What's the interest payable while it was paid on September one. So it would be a crude. What would be a crude would be September, October, November, December.

Four months, times 5,000 and 20,000. The answer is a again, the interest expense, just like a profit making company interest expense for the year would be March, April, may, June, July, August, September, October, November, December 10 months, times 5,000 a month, 50,000. But what's payable cause it was paid on September one.

It's what you would have accrued for September, October, November, December four months, times 5,000 or 20,000. But the answer is a number 10. On January 2nd, the city of Walton issued 500,000 of 10 year 7% general obligation. Bonds interest is paid annually beginning, January 2nd of the following year. What amount of.

Interest is Walton required to report in the statement of revenue expenditures and changes in fund balance for its governmental funds. If the close of the fiscal year is September 30th, so you're in the exam. You go, wait a minute. Now it's a fun financial statement. Wait a minute. A statement of revenue expenditures and changes in fund balance.

That's a fund financial statement and the fund financial statements are done under modified accrual and under modified a cruel G. The bonds were issued on January 2nd. Interest isn't payable to the following January 2nd. So how much interest expense would be in the financial statements? September 30th, zero answer Ray, because under modified accrual in that debt service fund, they don't record interest until it's matured due and payable until it's a payment date, they don't make a cruel.

So make sure you're clear on that because this is a fun financial statement. It's modified a cruel and in modified a cruel. We don't record principle or interest until it's mature, due and payable until it's a payment date, there'd be no accruals. The answer is zero.

Number 11. The following are boa city's long-term assets. They have fixed assets use in an enterprise fund infrastructure assets, and all of the general fixed assets. What aggregate amount would bowl report in? Governmental activities in the government wide financial statements, what's going to be under what's in the government wide statement in position.

What will be under governmental activities will not the million, not a million, that's an enterprise fund that's business type activities, but the infrastructure assets 9 million and all the other general fixed assets, 1,000,008 answers C 10,000,008 would be fixed assets. Okay. In the government wide statement in that position under governmental activities, which is what they wanted.

Oh, he did well on that set. Now you can see that what we end up with in the comprehensive annual financial report are the government wide statements under normal accrual accounting and the fund financial statements under modified accrual. And there has to be a reconciliation. There are in the CAFR, there are two required reconciliations where they make you reconcile.

From modified accrual to accrual accounting. If you look in your viewers guide, let's look at the illustrator problem we have on this in the first one, notice all the governmental fund balances under modified accrual are showing total fund balance of 24 million. We're given three reconciling items and we have to decide, would you add, or you would you subtract to reconcile two?

The net position in governmental activities in the government wide statement of net position. So that's, that's the first re required reconciliation where you reconcile from all of the fund balances for your governmental funds under modified a rule to the net position in governmental activities in the government wide statement of net position.

All right. So if you look at it, all the governmental fund balance sheets are showing total fund balances of 24 million. That 24 million was calculated under modified Nichols. So all they did was look at their five governmental funds, general fund, special revenue fund capital projects, fund debt service fund, permanent fund.

Right. They looked at the five grade metal funds, general funds, special revenue fund capital projects, fund permanent fund, that sort of funding just added up their fund balances under modified accrual added up to 24. There were three reconciling items. Let's see if we can reconcile to the net position.

In governmental activities in the government wide statement of net position under normal cruel accounting. All right. The first one long-term debt issued for the capital projects fund. Now, you know, this, if a capital projects bond issued 13 million, if the capital projects fund issue 13 million in long-term debt.

What did the capital projects fund do under modified a rule? Didn't they debit cash 13 million. They can't credit bonds payable. They're not allowed to carry longterm debt. So they credited other financing sources. Remember now what happens at year end at year end? When you close out your actual revenues, your actual expenditures, your actual sources, your actual uses.

When you close out those actual sources at year end, that would have increase that would have increased the fund balance. But in the government wide statement of net position that should not increase the net position in government, like governmental activities, it should increase the debt. We're going to report the debt.

So back it out. Hope you see the thinking there one more time. When the capital project fund issue that longterm debt, they debit cash. They can't credit bonds payable. They credit all the financing sources. So ERN, when they close out their actual revenues, their actual expenditures, their actual sources, their actual usage.

They closed out those actual sources that would have caused an increase to the fund balance, but in the government wide statement of net position that should not increase the net position in governmental activities, it should increase the debt. So back it out, it's a different way of thinking. Isn't it.

Next one, fixed assets acquired by the general fund. Now, you know, this, when the general fund bought fixed assets, they can't debit machinery. They can't debit equipment. They're not allowed to carry fixed assets. So they debit it, expenditures control and credit vouchers payable. Then what happens at year end when you close out your ax revenues and your actual expenditures, when you close out the actual expenditures that would have caused a decrease to the fund balance, but in the government wide statement of net position that should not decrease the net position in governmental activities, it should increase fixed assets because now they're going to report the fixed assets.

So add it back. I'll go through that again. General fund bought fixed assets. They can't debit machinery. They can't debit equipment. They just have it expenditures control for the 9 million and they credit vouchers payable year end, close out those actual expenditures that would have caused a decrease to the fund balance.

But in the government wide statement of net position that should not decrease the net position, governmental activities, it should increase fixed assets. They can report the fixed assets. Add it back. Now, let me just say if this, if this is driving you crazy, if you go Bob, I see your lips moving. I just not sure I really follow this.

We're going from modified a cruel to a cruel the way I look at it. We're going from insanity to sanity. That's all I look at modified rule makes no sense. So we're trying to go from insanity to sanity is what we're trying to do. And if it's driving you crazy, you could memorize those two are very common.

Just remember that debt is always subtracted. Fixed assets are always added G Bobby can't be that simple. It is. So if it drives you crazy, just remember debt is subtracted. Fixed assets are added. The last one. Internal service fund balance of 2 million. Let me ask you a question. Is that 2 million already in the 24 million is the 2 million already there?

No, it's not a governmental fund. All that's in the 24 million at the top or the fund balances for the general fund special revenue fund capital projects fund permanent fund debt service pond. The five gold medal funds. The internal service fund wouldn't be there, but in the government wide statements, remember internal service fund is always governmental activities.

So add it in. So that's how you get to the 22 million. The 22 million would be the net position in governmental activities in the government wide statement of net position. Now, you know, the net position in governmental activities on the government wide statement of net position.

welcome back. We're working on the reconciliations that are required in Gatsby 34, where you reconcile from modified or cruel to accrual accounting and the second real reconciliation that's required. You have to reconcile the net change. In all the governmental fund balance is during the year under modified rule to the net change in the net position from gov for governmental activities under normal cruel accounting in the government wide statement of net position.

So if you look at the example in your viewers guide notice during the year there was a net increase in all the fund balances of 12 million, 500,000. That's modified accrual. In other words, all we did. Was looking at the fund balances for our five governmental funds, general fund, special revenue fund capital products fund permanent fund debt service bond.

We look at the fund balances for those five governmental funds last year, compared them to the fund balances for those five governmental funds this year. And there's been a net increase of 12 million, 500,000 under modified rule. Let's reconcile to the net increase or decrease in the net position for governmental activities in the government wide statement of net position.

Under normal, cruel accounting. We're going to go from modified rule to a cruel. We have six reconciling items. First, the current bond proceeds. I know you get used to this. If a governmental, if one of the governmental funds had bond proceeds for 3 million, they would have debit cash, 3 million. They can't credit bonds payable.

They're not allowed to carry debt. So they credit other financing sources, right? That's what they do and modified a rule. And then at year end, when they close out. The actual revenues, the actual expenditures, the actual sources and the actual uses when they closed out those actual sources that would have caused an increase to the fund balance, but in the government wide statement of net position that should not increase the net position in governmental activities.

It should increase the debt. So back it out, but you could subtract it as I say, you see debt, subtract it. Next one. Current repayment of bond principle. Now think what happens when the debt service fund makes a principal payment of a hundred of 150,000, the debt service fund, just debits expenditures control.

Remember debt service fund uses modified a rule. So the debt service one would debit expenditures control 150,000 and credit matured bonds payable. Now at year end, when they close out their actual revenues in their actual expenditures, when they closed out those actual expenditures that would've caused a decrease.

To the fund balance in modified or cruel, but in the government wide statement of net position that should not decrease the net position in governmental activities, it should decrease the debt cause the carrying the debt, reporting the debt. So add it back. Let me just do that one again. If the debt service fund makes it a principal payment.

They would just debit expenditures control 150,000 credit matured bonds payable one 50 at year end when they closed out. The actual expenditures would cause the decrease in fund balance, but in the government wide statement of net position that should not decrease the net position and government activities should not, should decrease the debt.

So add it back. Number three, the excess of revenue earned over, available and measurable. Now what's at the top. What's in the 12,000,005 or under available and measurable, you know, available and measurable. At the top and the 12,000,005 it's modified a rule. So it would be available and measurable, but in the government wide statements, it's normal, cruel accounting.

So if they've earned more than what was available and measurable added in, hopefully that makes a lot of sense. Number four, another one, they ask a lot current fixed asset acquisitions. Let's do it again. If the, if one of the governmental funds buys a fixed asset, they can't debit machinery. They can't debit equipment.

Just debit expenditures, control credit vouchers payable at year end when they close out their actual revenues, close out their actual expenditures, right? When they close out those actual expenditures, that would cause a decrease to the fund balance. But in the government wide statements that should not decrease the net position and governmental activities.

It should increase the fixed assets. They're going to report the fixed assets. So add it back. As I said before, If you just want to memorize, Hey, that is always subtracted. Fixed assets are always at it. Fine. It's never going to be any different. Number five depreciation expense of 200,000 was depreciation expense taken at the top and the 12,000,005, no, in modified a rule they're not allowed to carry fixed assets or depreciate fixed assets, but in the government wide statements, it's normal cruel accounting.

Take the depreciation back out the 200,000. And then finally, the last one, I know you can do it in your sleep. The internal service fund net revenues. That is that 800,000 already in the 12,000,005? No, Bob, no, it can't be, it's not a governmental fund. It's a proprietary fund, but in the government wide statements, it's always governmental activity.

So add it in. And that's how you get to the 12 million. Excuse me, to the 11,000,008 50. We've gone from modified rule to a cruel S we've gone from insanity to sanity. I want you to good at it. Now for the next class. I want you, there's a reconciliation. I want you to do and a couple of multiple choice as well.

Please get those done. And then I'll look to see you in that class.

Welcome back to our discussion on governmental accounting. You know, for this class, I have assigned a couple of multiple choice and also another reconciliation. Let's start with the multiple choice. First knock city, it says, knock city reported a $25,000 net increase in their fund balances for all the governmental funds.

Now, you know, that 25,000 was calculated under modified accrual, and they also reported an increase in net position for the following. We've got three reconciling items. It says, what amount would NOx report as. The change in the net position from, for governmental activities in the government wide statement of net position, we've got to decide, add or subtract.

Well, of course the first one, the motor pool, internal service fund. One more time, even though it's a proprietary fund, that 9,000 is not already in the 25. That's not already there because it's not a governmental fund. Remember all that's in the 25,000 or the five governmental funds, the 9,000. Wouldn't be there already.

But in the government wide statement of net position, the internal service fund is always governmental activities, even though it's a proprietary fund. So you would add that in that's going to be added the government wide statement of net position. Internal service fund is always governmental activities.

So we're going to add that in. How about the enterprise fund of 12 million 12,000. No, ignore it. Why? Because that's business type activities don't fall for that. Remember, we're trying to work out the change in the net position for governmental activities. Enterprise fund is business type activities.

It's irrelevant. How about the pension fund? No, don't worry about it because that's a fiduciary fund. And remember the fiduciary funds are excluded from all the government wide statements. So the answer is B it's just 25,000 plus the nine. 34,000 in the second question, tree city tree city reported a $1,500, $1,500 net increase in all the fund balances.

And you know, that's modified accrual during the year they purchased general capital assets of 9,000 recorded depreciation expense of three. What would tree report as the net change in the net position from gov for government governmental activities in the government wide statement of net position?

Well, We know that there was an increase in all the fund balances of 1500, but that's modified rule. Let's reconcile the fixed assets of 9,000. Always added you've memorized it anyway. Right? Fixed assets are always added. Add the nine. And now the depreciation of three that wouldn't be reflected in the 1500 at the top because in modified or cruel, you're not allowed to carry fixed assets or depreciate fixed assets, but in the government wide statements, It's normal.

Cruel accounting. You take the depreciation back out three. So the answer is C 1500 plus 9,000 minus 3000. Now also we have a reconciliation to do that's a little bit more extensive. We're going to also reckon we're going to reconcile the net change in all the governmental fund balances under modified or cruel to the net change.

In the net position for governmental activities in the government wide statement of net position. So if you look at your viewers guide at the top of this problem during the year, there was a net increase in all the fund balances of 2,000,006, and you know, that's modified approval all week. All we did was look at our five governmental funds, general fund, special revenue fund capital projects fund permanent fund debt service fund.

We look at the fund balances for those five governmental funds last year. Look at the look at the comparison with this year, and there's been a net increase in all those fund balances on a modified accrual of 2,000,006. We have nine reconciling items got to decide. Do we add a subtract? Here we go. The depreciation expense for governmental fixed assets of 200,000, is that reflected in the top?

It's not reflected in the 2,000,006 because in modified or cruel, they're forbidden to carry fixed assets, to depreciate fixed assets, but to the government wide statements. It's normal, cruel accounting. You got to take the depreciation. So back it up, take out that 200,000 same thing with the second item amortization on the discount of bonds payable.

Is that reflected in the top? No, because in modified accrual, there's never any amortization taken on bond discount or a bond premium, but in the government wide statements, it's normal cruel accounting. Take the amortization back out the 50,000 number three, fixed assets, always added. You've memorized it anyway.

I don't even have to think it through anymore. Next one is you can do in your sleep internal service fund net revenues of a million. Is that already in the 2,000,006? You go, no, Bobby, can't be, it's not a governmental fund. It's a proprietary fund. But in the government wide statement in that position, it's always governmental activities added in.

How about number five enterprise fund net revenues. Oh no. That's business activities. That's business type activities. We're trying to work out the net change. In the net position for governmental activities. Hey, enterprise fund is business type activities. Ignore it. Number six, current on proceeds for the capital projects fund and you know, debt is always subtracted.

You memorized it anyway, back it out. How about number seven? The current debt service ratio payment of bond principle, a hundred thousand. Let's go over that again. When the debt service fund makes a principal payment, remember it's modified accrual and they just debit. Expenditures control a hundred thousand.

That's what the debt service bond does when they make a principal payment, debit expenditures, control, credit, matured, bonds payable. Then at year end, when they close out their actual revenues and their actual expenditures, when they close out those actual expenditures, that would cause a decrease in the fund balance.

But in the government wide statement, it's normal, cruel accounting that should not decrease the net position in governmental activities. It should decrease the debt. So add it back. I hope you got that one. Add that one back number eight, excess of revenue earned or available and measurable. You know, this what's reflected in the top number what's reflected in the 2,000,006, the top earned or available and measurable, you know, available and measurable.

That's modified a rule, but in the government wide statement, that's normal cruel accounting. So if you earn more than what was available and measurable, add it in. And then finally, number nine, the fiduciary fund net revenues. Add or subtract neither, neither ignore it because the fiduciary funds are always excluded from the government wide statements, as you know, and the answer is 3,825,000.

We have reconciled from modified or cruel to a cruel we've reconciled from. The net change in all the fund balances on the modified rule to the net change in the net position for governmental activities in the government. Why statement of net position normal cruel accounting. As I say, we've gone from insanity to sanity and that's what we should be doing.

Don't fall behind. Keep studying. I'll see you in the next class.