From: Joe
(a) – I always appreciate so much all of the emails that I get from CPA Exam candidates. It is a great job when you hear from people from all around the world. It is a neat time when technology is so advanced that you can assist people living in dozens of different countries.
Here are a couple of the emails that I got this week:
"Let me start by saying your website is incredible. The questions on your website are much better then (Giant) CPA Review. The explanations of the answers are in the league of their own. . . . I hope your website puts them out of business. . . . Thank you for your website and your motivational YouTube videos."
"Thank you very much for your encouragement and the great effort behind the creation of your CPAREVIEWFORFREE website. My heartfelt appreciation goes out to the entire team behind this great work. I am a CPA student from the Middle East, planning to sit for BEC and FARE at the end of November. Although I started using (Well Known) CPA review book, I found the questions and answers on your web site quite different and more informative. Plus, they boost my confidence level. Once again, thank you very much."
And finally a request from a candidate. If you are interested in doing a study group in this area, hit "reply" and let us know and we will forward the information.
Here's the request: "I discovered your website through AccountingCoach.com and extend my gratitude for the sample questions and the guidance provided for successfully passing the CPA Exam. I live in the East Los Angeles area. I am interested in discovering other candidates in the area who might be interested in creating a study group. Your help in this matter in great appreciated."
(b) – Don't forget that you can find hundreds and hundreds of great CPA Exam review questions at www.CPAreviewforFREE.com. Study a topic intensely or take randomized exams. Read the questions and study the answers. Take notes on the ones you miss. Start adding those points to your base of knowledge. You need 75 points; we can help you get them.
(c) – If you need to unsubscribe, just scroll to the end of this email lesson and click on the appropriate link.
(1) – I am a big fan of William Shakespeare. I just think it is truly amazing that one person could write so many wonderful, beautiful, and insightful words. I even try to get my intermediate accounting students to go see Shakespeare plays because they need to know more than just accounting to be successful in life.
I was recently reading a fictional book about Shakespeare and someone in that book asked him how he could write so many magnificent works. His answer was immediate and to the point: "I worked very hard."
I think we all give way too much credence to the importance of virtually everything other than hard work. Whether you are playing football or baseball or studying for intermediate accounting or preparing for the CPA Exam, there really is absolutely nothing that takes the place of hard work. It is hard to get successful at anything without hard work.
I have taught in college now for 38 years; I have worked with tens of thousands of students and exam candidates. I have found that virtually all of my students are capable of making an A. However, I already know who WILL make an A. If you teach something for that many years, you learn such things. Almost without exception, the students who get the high grades are the ones who work the hardest. Just like Shakespeare: simple and to the point. It is not about ability; it is not about smarts; it is not about having the knack. It is much more basic than that. The students who work the hardest—put in the most hours and do so with genuine intensity—tend to earn the good grades.
Ray Kroc, the man who built McDonalds into the giant company it is today has a wonderful and famous quote: "Luck is a dividend of sweat. The more you sweat, the luckier you get."
How much are you sweating in order to pass the CPA Exam? If you are not sweating, you probably need to work a bit harder.
There is a question that is probably the most important one that you can ask yourself while you are preparing for the CPA Exam: Am I outworking the other candidates or are they outworking me? That is a question that I don't often hear people asking but I think that is the crucial question. If you can truthfully say "I know there are thousands of people who really want to become CPAs and they are studying very hard but I am still outworking them" then you are on the road to success. Your sweat is making you lucky. However, if you know, deep down in your heart, that lots and lots of people around the world are outworking you, then you know what you have to do. You have to kick it up a notch. You have to push yourself just a little bit more. You have to figure out how to work as hard as they are.
How do you start? How do you work harder? Start by working just 15 more minutes every day. If you usually work 75 minutes each day, then work 90 minutes instead. That doesn't seem like much of a change but you just increased your time BY 20 PERCENT. Everyone can find 15 free minutes per day. Don't try to double your time; that is not realistic. Make it your goal over the next week to add 15 minutes per day to your study time. Even that small of a change can add an incredible amount of points to your total.
Okay, I know what you are going to say: "I'm working so hard now, I'm so busy now, I'm so pushed for time now, that I cannot add even 15 minutes per day."
Well, let me ask you this question. If I said that I would give you $1 million just as soon as you passed the final part of the CPA Exam, what would happen?????
The answer is simple. If the reward is big enough, YOU will make time. You would stop sleeping as much; you would take a shorter lunch break; you would stay on email less; you would cut out all unnecessary activities so you could study. If the reward is big enough, everyone will pass.
So, do not come back and tell me that you just cannot find the time. Everyone makes time for what they really want to do. I am not asking for hours. I am only asking you to add 15 minutes per day. There just has to be some way to squeeze out a few extra minutes during the day.
That is my challenge to each person on our email list for this week: I want 15 minutes more in study time each and every day. Make it happen. Don't make excuses; make it happen. You will be surprised by how much luckier you start to get when you start to work a bit harder. We can accomplish ever so much by just putting things into priority and working a bit more efficiently and adding those 15 minutes.
(2) – Here are a few quick practice questions that I want to load up on www.CPAreviewforFREE.com but I will let you have a crack at them first.
Financial Accounting and Reporting
The Impala Company has revenues of $300,000 and expenses of $200,000 for the most recent year. However, to date, no recording has been made of the company's investments in marketable securities. During the current year, the company held trading securities that went up in value by $3,000. In the same period, the company held available for sale securities that went up in value by $2,000. Assume that the fair value option has not been elected. Which of the following statements is true for the current year?
A – Net income was $100,000 and comprehensive income was $105,000.
B – Net income was $105,000 and comprehensive income was $105,000.
C – Net income was $103,000 and comprehensive income was $105,000.
D – Net income was $102,000 and comprehensive income was $105,000.
Answer is C
Changes in the value of trading securities are put directly into net income. The $3,000 appreciation of value for these securities increases reported net income immediately from $100,000 to $103,000. Changes in value of available for sale securities are put into accumulated other comprehensive income in the stockholders' equity section of the balance sheet. Hence, the $2,000 increase in value does not impact net income. However, in calculating comprehensive income, that $2,000 is included which moves net income of $103,000 up to a comprehensive income figure of $105,000.
BEC
A company produces 10 different products in 10 different plants. From the items produced in Plant 8, the company makes sales of $900,000. Variable costs are $300,000 in that plant and the fixed costs are $700,000. Because the plant is losing $100,000 per year, company officials close it at the start of the current year and lease the building to a competitor for a flat $360,000 per year ($30,000 per month). How does this decision impact the company's overall net income for this year?
A – Net income will go up by $660,000.
B – Net income will go up by $700,000.
C – Net income will go down by $40,000.
D – Net income will go down by $240,000.
Answer is D
Currently, the company is losing $100,000 from Plant 8. Unless stated otherwise, the fixed costs will not be eliminated by closing the plant. Such costs include property taxes and insurance that are often unaffected by revenues and other variables. After closing, revenues will be $360,000 from the lease but the fixed expenses of $700,000 will remain so that the company will lose $340,000. Going from a loss of $100,000 to a loss of $340,000 reduces the company's net income by $240,000.
Auditing and Attestation
Xavier, CPA is currently auditing the financial statements of the Polk Corporation. At the moment, Xavier is assessing the control risk surrounding the recognition of sales revenue. The CPA has become concerned that revenues are understated. The CPA thinks the company may be shipping merchandise to false customers with no sales invoice (or other record) being prepared. If true, company employees are using this scheme to steal goods from the company. In assessing the possibility of this problem, which of the following is the auditor most likely to do?
A – Take a sample of sales invoices and match those documents to the appropriate bill of lading or other shipping document.
B – Take a sample of receiving reports and match those documents to the appropriate sales invoice.
C – Take a sample of cash receipts and match those payments to the appropriate sales invoice.
D – Take a sample of bills of lading (or other shipping document) and match those documents to the appropriate sales invoice.
Answer is D
The company is shipping merchandise but may not be preparing a sales invoice. The auditor should look for shipping documents (usually a bill of lading) and then make sure that a sales invoice was subsequently prepared for each. The auditor typically goes from the event that is known to happen to the event that might not have happened. Here, the shipment was made but the auditor is afraid that the sales invoice was never produced.
Regulation
In Year One, Nancy Dru's husband died. They had three children, two of which were still dependents. Nancy does not remarry and the two children remain as her dependents living with her until Year Five. What is her filing status for federal income tax purposes?
A – She is head of houseful for Years One through Four.
B – She is a qualifying widow (surviving spouse) for Years One through Four.
C – She is a qualifying widow (surviving spouse) for Years Two and Three and head of household for Year Four.
D – She is a qualifying widow (surviving spouse) for Year One and head of household for Years Two through Four.
Answer is C
In the year of death, the couple files a joint return as long as they would have been able to file a joint return at the time of death. Because of the dependent children, she can then file as a qualifying widow for the next two years. After that time, she can file as head of household as long as the children are dependents or unmarried and continue to live with her.
Okay, start finding those extra 15 minutes each day to study for the CPA Exam. That is your assignment for this week.
Joe Hoyle
Co-Founder
CPAreviewforFREE
www.CPAreviewforFREE.com
PASS THAT EXAM -- YOU CAN DO IT!!!!
Monday, October 20, 2008
Sunday, October 19, 2008
Study Group
If you are interested in a study group, here's where you join. We've had interest from comments back to us. Sound off! Come together here.
Monday, October 6, 2008
Success on the CPA Exam - You CAN Do It
Lesson 11
Giving Thanks for Missed Questions
From: Joe
(a) - As always, I want to thank everyone who passes our emails along to their friends, relatives, enemies, strangers, and random tourists. Last week alone, our traffic at www.CPAreviewforFREE.com grew by a wonderful 21 percent, including visitors from 69 countries. We owe that growth to you.
(b) - And, now for the legal requirements: if you need to unsubscribe, scroll down to the end of this email and click on the Unsubscribe button. However, DON'T GO!!! We like having you with us for these email lessons. We are a small community of people who believe that having the chance to pass the CPA Exam should be a opportunity that is available to everyone, even the people without big bank accounts. We like having you as part of this community. Stay as long as you can.
(1)-In my 28 years in CPA Review, the comment that I probably hear more than any other is the very troubling "I keep missing questions." The candidate is upset; the candidate wants to get the question right. The candidate misses a question and gets scared.
Not surprisingly, the candidate is often not too thrilled when I am less troubled by missed questions. But I always think about what a candidate once told me "a missed question is like fertilizer, it is the one thing in this whole process that really helps your knowledge to grow." That is absolutely true. The key, though, is not missing the question but what you do after you miss the question.
Many candidates make a mistake and say "I missed a question." I honestly do not believe that is exactly true. The solution to virtually any question on the CPA Exam is a series of sequential steps: you do A and then you do B and then you do C and eventually you get to the right answer. Some of these steps are computational (multiply X times Y) and some of these steps are more verbal (which types of interest expense are deductible on an individual tax return). Some answers have one or two steps; some answers have 4-8 steps.
When you get a question correct, it shows that you have mastered this series of steps. When you miss a question, you really don't miss the entire question. Instead, you got to a particular step in the process and you missed that step. Once you get past that particular step, you may well be able to answer the question just perfectly. That one step in the process is your stumbling block.
It is that stumbling block that you want to identify and resolve. I hear students all the time who will tell me "I cannot do present value" or "I cannot do deferred taxes" or "I cannot do pensions." (I am convinced that saying "I cannot do" is one of the biggest crutches that humans cling to because it provides them with an automatic excuse.) But they are wrong. In doing those topics, they just get to some step along the way that they do not understand and it becomes their stumbling block. They need to pinpoint that one step and work to learn how to do it. Once they understand that one step, often the rest of the answer falls perfectly into place. Their knowledge has a hole in it.
So, when you are practicing the questions at www.CPAreviewforFREE.com, whenever you miss a question, always say to yourself "Great, now I can learn something. At which step did I miss this question and how do I go about getting past this stumbling block so I will get it right the next time."
(2) - I know this might be hard to believe (as an accounting professor) but I was reading a book this morning about Zen meditations (I like to read lots of different stuff). Just a few minutes ago, I read the following lines (which actually inspired me to write this email):
"There are three qualities for training: Great Faith, Great Doubt, Great Effort." Simple stuff but very true.
Great Faith: As I have said before in these email lessons, you have to believe in yourself if you want to succeed. Okay, none of us are Albert Einstein but we are capable of learning enough accounting, auditing, tax, law, and the like to pass the CPA Exam. It is easy to fall back on "I'm the dumbest person on the planet" but that is simply not true. You are a college graduate with an Accounting major; everyone knows you are quite smart. You can read questions, you can work problems, you can analyze answers, you can take notes. You have the ability to learn enough material to pass the CPA Exam. It does take time but you can get there.
You also need to have great faith in the preparation program you are using. One of the problems with many of the CPA Review programs is that candidates realize that they are not very well made. But once you have paid your money, what do you do? The questions are old and stale and the explanations tend to be confusing. It is very helpful if you have great faith in the program that you use in preparing for the CPA Exam. It is ever so much easier to do the work if you have faith that the program is well constructed.
Great Doubt: One of the problems with Great Faith is that it can lead to arrogance and over-confidence. I have known many extremely smart people who failed the CPA Exam because they assumed they did not need to do the work. Wrong!!! You must understand from Day One that if you do not put in your best effort on a consistent basis you are going to fail. It is not that you cannot pass. It is that you cannot pass without doing your very best.
That understanding that failure is very possible is a wonderfully motivating force. Often candidates will write to me and moan that they are having trouble getting motivated to do the work. My response is always the same: "If you do not do the work absolutely to the best of your ability, YOU ARE GOING TO FAIL." There needs to be doubt in your heart because that will push you to do your best. And, if you do your best, you will pass.
Great Effort: If it were not difficult, everyone would do it. If you really want to do something special (such as pass the CPA Exam), you must understand that a great effort will be required. And, it is that great effort that actually makes it all so special.
Everyone will tell you that they would like to pass the CPA Exam but a whole lot of people simply do not have what it takes to put out that great effort. They have good intentions but not good follow-through.
If you come to the CPA Exam with Great Faith and with Great Doubt and with Great Effort, you will pass. Okay, maybe not the first time, nothing in life is ever guaranteed, but you will eventually conquer the CPA Exam. The race does not necessarily go to the swift but rather to the persistent.
(3) - My Intermediate Accounting II students are currently beginning to learn about lease accounting, a favorite topic in accounting education. In (1) above, I talked about looking at answers as a series of sequential steps. I thought I would use a lease question to demonstrate that idea.
Acme Company needs a truck on January 1, Year One, and leases one from a local dealership for 8 years with annual payments of $10,000 each with the payments beginning immediately. The truck is expected to have a life of 10 years. At the end of the lease Acme will give the truck back to the dealership. The contract does not specify any required value at the time of the return. Acme has an incremental borrowing rate of 10 percent per year. Acme does not know the implicit interest rate factored into the contract by the dealership. The present value of an ordinary annuity for 8 years at a 10 percent annual rate is 5.335. The present value of an annuity due for 8 years at a 10 percent annual rate is 5.868.
Question One: At the end of Year Two, what net liability balance (if any) should Acme report on its balance sheet?
Question Two: At the end of Year Two, what net asset balance (if any) should Acme report on its balance sheet?
Answer
Step One. Leases can be operating leases or capital (nonoperating) leases). There are four criteria. If any one of the four criteria is met, the lease is a capital lease. In this problem, title does not transfer and there is no bargain purchase option. There is not enough information to determine if the present value of the minimum lease payments is 90 percent or more of the value of the asset. However, the life of the lease (8 years) is 75 percent or more of the life of the asset (10 years). That alone makes it a capital lease.
Step Two. The lessee (Acme as the user of the asset) accounts for a capital lease at the present value of the payments. The payments are $10,000 each year over 8 years. The interest rate to use is the lower of the incremental borrowing rate or the lessor's implicit rate. Since the lessor's implicit rate is not given, the 10 percent incremental borrowing rate must be applied.
Step Three. To get the present value, a conversion rate must be used. Because the first payment is made immediately, the annuity due factor of 5.868 is appropriate. The present value of these cash flows is $10,000 times 5.868 or $58,680. Both the liability and the truck should be recorded at $58,680 to begin.
Step Four. After the present value has been established, the liability and the asset will be accounted in totally separate ways. They are no longer really connected. The liability is reported based on recognizing interest at the end of each year as well as payments at the beginning of each year.
Step Five. The liability begins at $58,680 but there is an immediate first payment of $10,000 to reduce the balance to $48,680. That is the balance throughout the first year. At the end of the first year (interest is ALWAYS computed and recorded at the end of the period), the interest expense to be recognized is $48,680 times 10 percent or $4,868. Since that interest is not paid, it is compounded (added to the principal). Compounding on December 31, Year One, increases the liability balance from $48,680 to $53,548.
Step Six. Another payment of $10,000 is made on the lease on the first day of the second year. That reduces the liability from $53,548 to $43,548. This balance is retained throughout Year Two. At the end of Year Two, interest expense is computed again and it is $43,548 times 10 percent or $4,355. Once again, no interest is actually paid directly on a lease so that entire balance is compounded. The $43,548 principal for the period plus this $4,355 interest for Year Two brings the reported liability up to $47,903.
Step Seven. Now, let's go back to the truck. It was originally capitalized at the present value of the cash flows or $58,680. Acme will make use of it for 8 years and then give it back with no guarantee as to its residual value. Annual depreciation of this asset should be $7,335 ($58,680 divided by 8 years).
Step Eight. After two years, the asset will be reported at $58,680 minus $7,335 and $7,335 for a net value of $44,010.
Your two answers are: the net liability is $53,548 and the net asset is $44,010.
If you got it right, great! Move on and do something else. You have the basic capital lease steps down for the lessee. If you did not get these answers, you did NOT miss the question. You missed one of these 8 steps. Go back now and focus on that one step where you stumbled and make sure you understand it completely and then try again.
You can add points and you can pass the CPA Exam. Give it a great effort.
Giving Thanks for Missed Questions
From: Joe
(a) - As always, I want to thank everyone who passes our emails along to their friends, relatives, enemies, strangers, and random tourists. Last week alone, our traffic at www.CPAreviewforFREE.com grew by a wonderful 21 percent, including visitors from 69 countries. We owe that growth to you.
(b) - And, now for the legal requirements: if you need to unsubscribe, scroll down to the end of this email and click on the Unsubscribe button. However, DON'T GO!!! We like having you with us for these email lessons. We are a small community of people who believe that having the chance to pass the CPA Exam should be a opportunity that is available to everyone, even the people without big bank accounts. We like having you as part of this community. Stay as long as you can.
(1)-In my 28 years in CPA Review, the comment that I probably hear more than any other is the very troubling "I keep missing questions." The candidate is upset; the candidate wants to get the question right. The candidate misses a question and gets scared.
Not surprisingly, the candidate is often not too thrilled when I am less troubled by missed questions. But I always think about what a candidate once told me "a missed question is like fertilizer, it is the one thing in this whole process that really helps your knowledge to grow." That is absolutely true. The key, though, is not missing the question but what you do after you miss the question.
Many candidates make a mistake and say "I missed a question." I honestly do not believe that is exactly true. The solution to virtually any question on the CPA Exam is a series of sequential steps: you do A and then you do B and then you do C and eventually you get to the right answer. Some of these steps are computational (multiply X times Y) and some of these steps are more verbal (which types of interest expense are deductible on an individual tax return). Some answers have one or two steps; some answers have 4-8 steps.
When you get a question correct, it shows that you have mastered this series of steps. When you miss a question, you really don't miss the entire question. Instead, you got to a particular step in the process and you missed that step. Once you get past that particular step, you may well be able to answer the question just perfectly. That one step in the process is your stumbling block.
It is that stumbling block that you want to identify and resolve. I hear students all the time who will tell me "I cannot do present value" or "I cannot do deferred taxes" or "I cannot do pensions." (I am convinced that saying "I cannot do" is one of the biggest crutches that humans cling to because it provides them with an automatic excuse.) But they are wrong. In doing those topics, they just get to some step along the way that they do not understand and it becomes their stumbling block. They need to pinpoint that one step and work to learn how to do it. Once they understand that one step, often the rest of the answer falls perfectly into place. Their knowledge has a hole in it.
So, when you are practicing the questions at www.CPAreviewforFREE.com, whenever you miss a question, always say to yourself "Great, now I can learn something. At which step did I miss this question and how do I go about getting past this stumbling block so I will get it right the next time."
(2) - I know this might be hard to believe (as an accounting professor) but I was reading a book this morning about Zen meditations (I like to read lots of different stuff). Just a few minutes ago, I read the following lines (which actually inspired me to write this email):
"There are three qualities for training: Great Faith, Great Doubt, Great Effort." Simple stuff but very true.
Great Faith: As I have said before in these email lessons, you have to believe in yourself if you want to succeed. Okay, none of us are Albert Einstein but we are capable of learning enough accounting, auditing, tax, law, and the like to pass the CPA Exam. It is easy to fall back on "I'm the dumbest person on the planet" but that is simply not true. You are a college graduate with an Accounting major; everyone knows you are quite smart. You can read questions, you can work problems, you can analyze answers, you can take notes. You have the ability to learn enough material to pass the CPA Exam. It does take time but you can get there.
You also need to have great faith in the preparation program you are using. One of the problems with many of the CPA Review programs is that candidates realize that they are not very well made. But once you have paid your money, what do you do? The questions are old and stale and the explanations tend to be confusing. It is very helpful if you have great faith in the program that you use in preparing for the CPA Exam. It is ever so much easier to do the work if you have faith that the program is well constructed.
Great Doubt: One of the problems with Great Faith is that it can lead to arrogance and over-confidence. I have known many extremely smart people who failed the CPA Exam because they assumed they did not need to do the work. Wrong!!! You must understand from Day One that if you do not put in your best effort on a consistent basis you are going to fail. It is not that you cannot pass. It is that you cannot pass without doing your very best.
That understanding that failure is very possible is a wonderfully motivating force. Often candidates will write to me and moan that they are having trouble getting motivated to do the work. My response is always the same: "If you do not do the work absolutely to the best of your ability, YOU ARE GOING TO FAIL." There needs to be doubt in your heart because that will push you to do your best. And, if you do your best, you will pass.
Great Effort: If it were not difficult, everyone would do it. If you really want to do something special (such as pass the CPA Exam), you must understand that a great effort will be required. And, it is that great effort that actually makes it all so special.
Everyone will tell you that they would like to pass the CPA Exam but a whole lot of people simply do not have what it takes to put out that great effort. They have good intentions but not good follow-through.
If you come to the CPA Exam with Great Faith and with Great Doubt and with Great Effort, you will pass. Okay, maybe not the first time, nothing in life is ever guaranteed, but you will eventually conquer the CPA Exam. The race does not necessarily go to the swift but rather to the persistent.
(3) - My Intermediate Accounting II students are currently beginning to learn about lease accounting, a favorite topic in accounting education. In (1) above, I talked about looking at answers as a series of sequential steps. I thought I would use a lease question to demonstrate that idea.
Acme Company needs a truck on January 1, Year One, and leases one from a local dealership for 8 years with annual payments of $10,000 each with the payments beginning immediately. The truck is expected to have a life of 10 years. At the end of the lease Acme will give the truck back to the dealership. The contract does not specify any required value at the time of the return. Acme has an incremental borrowing rate of 10 percent per year. Acme does not know the implicit interest rate factored into the contract by the dealership. The present value of an ordinary annuity for 8 years at a 10 percent annual rate is 5.335. The present value of an annuity due for 8 years at a 10 percent annual rate is 5.868.
Question One: At the end of Year Two, what net liability balance (if any) should Acme report on its balance sheet?
Question Two: At the end of Year Two, what net asset balance (if any) should Acme report on its balance sheet?
Answer
Step One. Leases can be operating leases or capital (nonoperating) leases). There are four criteria. If any one of the four criteria is met, the lease is a capital lease. In this problem, title does not transfer and there is no bargain purchase option. There is not enough information to determine if the present value of the minimum lease payments is 90 percent or more of the value of the asset. However, the life of the lease (8 years) is 75 percent or more of the life of the asset (10 years). That alone makes it a capital lease.
Step Two. The lessee (Acme as the user of the asset) accounts for a capital lease at the present value of the payments. The payments are $10,000 each year over 8 years. The interest rate to use is the lower of the incremental borrowing rate or the lessor's implicit rate. Since the lessor's implicit rate is not given, the 10 percent incremental borrowing rate must be applied.
Step Three. To get the present value, a conversion rate must be used. Because the first payment is made immediately, the annuity due factor of 5.868 is appropriate. The present value of these cash flows is $10,000 times 5.868 or $58,680. Both the liability and the truck should be recorded at $58,680 to begin.
Step Four. After the present value has been established, the liability and the asset will be accounted in totally separate ways. They are no longer really connected. The liability is reported based on recognizing interest at the end of each year as well as payments at the beginning of each year.
Step Five. The liability begins at $58,680 but there is an immediate first payment of $10,000 to reduce the balance to $48,680. That is the balance throughout the first year. At the end of the first year (interest is ALWAYS computed and recorded at the end of the period), the interest expense to be recognized is $48,680 times 10 percent or $4,868. Since that interest is not paid, it is compounded (added to the principal). Compounding on December 31, Year One, increases the liability balance from $48,680 to $53,548.
Step Six. Another payment of $10,000 is made on the lease on the first day of the second year. That reduces the liability from $53,548 to $43,548. This balance is retained throughout Year Two. At the end of Year Two, interest expense is computed again and it is $43,548 times 10 percent or $4,355. Once again, no interest is actually paid directly on a lease so that entire balance is compounded. The $43,548 principal for the period plus this $4,355 interest for Year Two brings the reported liability up to $47,903.
Step Seven. Now, let's go back to the truck. It was originally capitalized at the present value of the cash flows or $58,680. Acme will make use of it for 8 years and then give it back with no guarantee as to its residual value. Annual depreciation of this asset should be $7,335 ($58,680 divided by 8 years).
Step Eight. After two years, the asset will be reported at $58,680 minus $7,335 and $7,335 for a net value of $44,010.
Your two answers are: the net liability is $53,548 and the net asset is $44,010.
If you got it right, great! Move on and do something else. You have the basic capital lease steps down for the lessee. If you did not get these answers, you did NOT miss the question. You missed one of these 8 steps. Go back now and focus on that one step where you stumbled and make sure you understand it completely and then try again.
You can add points and you can pass the CPA Exam. Give it a great effort.
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