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.