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April 10, 2011
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Lesson 92
From: Joe
(1) – Some great news – we just added eight brand new task-based simulations for FAR to our subscription service. Now, for just $15 per month (50 cents per day), you get hundreds of slides of content, separated out by topic for easy access. You also get a study guide. And you get task-based simulations that cover:
--Land Buildings and Equipment
--Bond Investments
--Leases
--Cash Flows
--Earnings per Share
--Current Assets
--Consolidations
--Government Accounting I
--Government Accounting II
--Not-for-Profit Accounting
More good news: we just added eight brand new task-based simulations for Regulation to our subscription service. Regulation is also just $15 per month for hundreds of content slides and you get task-based simulations that cover:
--Sales and Exchanges
--Corporate Income and Expenses
--Deductions
--Itemized Deductions
--Individual Taxes-Income
--Corporate Taxes-Other Issues
--Partnership Income Taxes
--Other Areas of Taxation
--Bankruptcy
--Sales
Our subscription service for BEC ($15 per month) currently has 29 written communication questions that cover a variety of areas such as financial management, economics, managerial accounting, and corporate governance (plus, of course, all of the hundreds of content slides).
Obviously, our 2,200 questions and answers are free and will always stay free. But if you need additional help at a reasonable price, try our subscription service for a month and see if it won’t add the points you need to pass your next part of the CPA Exam.
(2) – Several people have asked when our subscription service for Auditing and Attestation will be ready. Unfortunately, my elder daughter spent most of March in the hospital and that has thrown my work schedule behind a bit. She is out now, though, so I hope to get Auditing and Attestation up and running shortly.
(3) – We’ve received a number of nice notes recently. Can’t publish them all but here are a few. This is EXACTLY what I want from you – to hear the good news that you have passed that exam. And, also, that you have saved a ton of money.
FROM MH: “I just wanted to say thanks for the site. Using only this site I received scores of 78 - BEC, 77 - FAR, 75 - REG and 70 - AUD. I ended up retaking AUD and just received my score of 88. This site saved me a ton of money.”
FROM RR: “I'm RR from Los Angeles, CA. I cried this morning when I saw that I passed AUD with 84. This is my last part of the CPA Exams. This has been a very long journey for me. I graduated from College more than 25 years ago in a foreign country so it was really difficult for me but when a friend introduced me to your website, I found a new hope. Your inspiring words kept me going. I used your free questions to better understand what I could hardly understand from the review materials that I paid for in the big CPA review. Joe, you are my hero, you are a very nice person and I thank God for people like you.”
FROM TL: “For the last 18 months I have always read your emails, and I prayed that one day I could write to you and let you know that I passed all sections... Here is that email: It was a long journey and I almost lost my BEC credit. I took FAR twice and every time I missed it by 2-3 point. I had studied for that section probably 1,000 hours by the third and last time, but for the last time I only had a chance to study 20 hours. I knew it would be impossible to pass, but nothing is impossible with God. With being 8 months pregnant and working full time, I needed all the help and support and encouragement, and your emails and online questions were defiantly among the top resources I used. Thank you and you may know that you are making a difference in people's lives and it is very appreciated. THANK YOU, and may God bless you and your family.”
Gosh, everyone here at www.CPAreviewforFREE.com is just delighted to be able to help such wonderful folks reach their dreams. I really do appreciate all the emails.
(4) – Here is one more email that I have separated out because the writer actually includes some studying advice that I give within the subscription service. Not bad advice to think about no matter how you are going about studying.
FROM MH: “I want to thank you for your devotion to the profession and the support you provide to all future CPAs. I just retrieved my score online on Regulations which was my last section to pass and I could not believe my eye when I saw 80! I have been trying to pass since I graduated from college in ’02. I failed many times but I would always get back up and try again. I had all the excuses to fail: full time job, married with two children, and I doubted myself because English is not my first language and I was not the smartest student in my class. You got me through when you said all these excuses do not matter, but what matters the most is how hard you work. One of my favorite quotes which is put on my Outlook reminder is “You have one day and one day only when you can accomplish something”. Then I followed the study plan that you laid-out. Which is where you said that ‘I think you can boil the exam preparation down to four things at its very core:
A – Work as many problems as you possibly can. Problems are like physical exercise—the more you do the stronger you get.
B – Read the answers very carefully, especially for the problems you miss. The answers help you fill in the gaps in your knowledge. The single best way to add points is to miss a question and then figure out how to get it right the next time.
C – Take short notes. I like 3 by 5 cards with a basic question on one side and a short answer on the other. Whatever form they take, keep them to a few words and only the stuff that really makes a difference. Carry them with you everywhere.
D – Review your notes on a regular basis to keep everything as fresh in your head as you can. If you have not reviewed a topic in the last 10-14 days, the knowledge is probably beginning to fade.’”
I realize that I wrote that myself so I am biased but that does seem like excellent advice in preparing for the CPA Exam. Work those questions, read those answers, keep note cards with only a few essential words, carry those cards with you everywhere, and review those cards whenever you have ten free seconds.
(5) – We have a gazillion or maybe two gazillion good folks who get these email lessons every week or two (more often when my daughter is out of the hospital). We love having you; we love working with you; we love hearing from you; and—most of all—we love celebrating your success with you. It doesn’t always happen on the first time but if you keep adding points, you are going to make it.
However, if you are ready to stop getting these email lessons, always know that you can scroll to the bottom of any lesson and there will be a link that will allow you to unsubscribe and have your name removed. Stay as long as you want but when you are ready to leave, don’t hesitate to unsubscribe.
(6) – I was lying in bed this morning wondering what I could write that would help you add points and the words conveyed by MH (above) ran through my head “The single best way to add points is to miss a question and then figure out how to get it right the next time.”
I have long believed that the answer to virtually all questions is developed in a sequential pattern. You figure out A, then you figure out B, then you figure out C, and eventually you arrive at the answer. Some questions only have 2-3 steps whereas others might have a dozen. The answer is really a puzzle where you put the pieces together in the proper order.
Therefore, if you miss a question, it doesn’t mean that you missed the entire question. Rather, it means that at some point in this series you made a misstep. I believe it is locating that misstep that is essential to your adding points and passing the CPA Exam. It just seems to me that missing a question does not do you any good unless you can isolate the step that tripped you up. Saying you missed a lease question is not helpful. Saying you missed a particular step (such as determining the life of the asset) is quite helpful especially if you follow up with “and now I know how to get that step correct myself.”
Let’s do a question together so I can show you what I mean by working the question as a series of steps.
Assume you go to take the FAR part of the CPA Exam and you get 74 points and you have one more question left. If you get it right, you’ll probably pass but if you miss it you’ll get the dreaded grade of 74. Here is the question. (And before someone asks – no, you do not actually know your score while you are taking the exam. This is just hypothetical.)
On January 1, Year One, Company A leases equipment for eight years for $10,000 per year with the first payment to be made immediately and every January 1 thereafter. The equipment has a ten-year life. At the end of eight years, Company A can buy the equipment for $9,000. That $9,000 is not viewed as a bargain because the asset is only expected to be worth $7,000 at that time. Company A has an incremental borrowing rate of 10 percent but does not know the implicit interest rate that the lessor built into the contract. The present value of $1 in eight years at a 10 percent annual rate is .424. The present value of an annuity due of $1 for eight years at a 10 percent annual rate is 5.868. The present value of an ordinary annuity of $1 for eight years at a 10 percent annual rate is 5.335. Company A uses the straight-line method of depreciation. What is the total expense that Company A should recognize for Year Two?
GETTING TO THE ANSWER: Here is the sequence of steps that I would follow to get this question answered correctly. Could you make it through each of these steps? If not, where would you falter? It is THAT step that you want to focus your attention on.
--ONE – What is the question asking? It is amazing to me how often students/candidates try to answer a question without getting a handle on what the question is. They are nervous and want to get started. Thus, that start trying to solve a question and they don’t even know what the question is. Take a deep breath and make sure you are comfortable that you know what is being asked. Here, Company A has leased an asset and you are asked for the total expense in the SECOND YEAR. If it is an operating lease, that will be rent expense based on the amount paid. If it is a capital lease, there will be depreciation expense for the cost of the asset and interest expense on the liability.
--TWO – Is it a capital lease or an operating lease? The lease is for 8 years out of 10. That is 75 percent or more of the life of the asset. That meets one of the four criteria so it must be reported as a capital lease.
--THREE – As a capital lease, you must start off by determining the cash flows. Here that is $10,000 per year at the start of each of the next eight years. The $9,000 is not included because it is not viewed as a bargain. The lessee does not expect to make that payment.
--FOUR – You find the present value of the future cash flows (which basically removes all future interest from those cash flows). Since the first payment is made immediately, it is an annuity due and the present value is $10,000 times 5.868 or $58,680.
--FIVE – The asset is only to be used for the eight-year life of the lease. Straight-line depreciation is used to allocate the cost of the asset to expense so depreciation each year will be $58,680 divided by 8 years is $7,335. At the end of those eight years, Company A will give the equipment back to the owner/lessor so the $7,000 residual value has nothing to do with Company A.
--SIX – The first $10,000 payment is made immediately so the liability for this capital lease falls from $58,680 to $48,680 and remains at that figure for all of Year One. Interest is determined at 10 percent so interest expense for the first year is $4,868. Interest is not explicitly paid in a lease so the amount is computed and recognized by compounding—it is added to the liability. That increases the liability from $48,680 to $53,548. The next $10,000 payment reduces that liability to $43,548 at the beginning of the second year. That is the balance for the second year so interest is 10 percent of $43,548 or $4,355 rounded.
--SEVEN – Question asks for total expense for Year Two. Depreciation expense is $7,335. Interest expense is $4,355. Total expense is $11,690
The problem seemed terribly difficult but in seven, fairly easy steps, you walked right through it to the correct answer to get that point you needed to get from 74 to 75. YOU CAN DO THIS!!!
The key, though, is that if you missed any one of these seven steps did you stop right then and read the answer very carefully to figure out what you missed and how to get it right the next time. That is the key to getting better. That is the key to adding points. To me, that is the key to passing the CPA Exam.
(7) – Okay time for you to practice.
FAR
Company A leases a car on January 1, Year One for $20,000 per year for five years—the entire life of the vehicle. The first payment is made immediately with additional payments every January 1 in the future. Company A has an incremental borrowing rate of 10 percent per year but knows that the lessor built in an implicit interest rate (in setting the annual payments) of 12 percent per year. The present value of an annuity due for 5 years at 10 percent annual interest is 4.170. The present value of an annuity due for 5 years at 12 percent annual interest is 4.037. What does Company A report as its net liability for this lease on the December 31, Year Two balance sheet?
A. $54,714
B. $56,724
C. $57,832
D. $58,152
Answer is A
The lessee (Company A) uses its own incremental borrowing rate unless the lessor’s implicit rate is known and it is less. Here, the implicit rate is known but it is more so the lessee uses its own 10 percent rate. The cash flows are $20,000 per year and the present value factor for 10 percent and five years is 4.170. Present value of these cash flows is $20,000 times 4.170 or $83,400. Here, you are not worried with the asset but just with the liability. It is $83,400 at first but an immediate payment reduces it by $20,000 to $63,400. Interest for the first year is 10 percent or $6,340. In a lease, that is not paid but, rather, compounded bringing the total up to $69,740 ($63,400 + $6,340). The second payment (made on January 1, Year Two) reduces the liability by $20,000 to $49,740. Based on that balance, interest for the second year is $4,974. Compounding that expense at the end of the second year brings the balance up to $54,714 ($49,740 + $4,974).
BEC
A company makes widgets using 3 pounds of product X with a standard cost of $4.00 per pound. The company bought 11,000 pounds of product X for $45,700 and then used 9,100 pounds to produce 3,000 widgets. What was the unfavorable material price variance?
A. $1,391
B. $1,406
C. $1,635
D. $1,700
Answer is D
The 11,000 pounds that were acquired should have cost $4.00 per pound or $44,000. Those pounds actually cost $45,700 which was an extra (unfavorable) amount of $1,700.
Regulation
On January 1, Year One, the Jones family refinanced the mortgage loan on their home in order to reduce the previous 9 percent interest rate to a 5 percent rate. The old loan had a remaining life of 15 years while the new loan is for 20 years. The Jones family was required to pay $3,000 in points at that time as one of the costs of the refinanced loan. What amount of this $3,000 can the Jones family deduct in Year One?
A. Zero
B. $150
C. $200
D. $3,000
Answer is B
According to the instructions for the form 1040, “generally, you must deduct points you paid to refinance a mortgage over the life of the loan.” Here, the loan was for 20 years, so $150 of these points can be deducted each year ($3,000/20 years).
Auditing and Attestation
The independent audit firm of Zeller and Henson has been engaged to audit the Williams Corporation. In performing an audit, an assessment must be made of inherent risk. Which of the following situations would indicate that the level of inherent risk here should be assessed at a particularly high level?
A. The CPA assigned by Zeller and Henson to manage this audit has never worked on an engagement of this type before.
B. A particularly important control procedure is performed by a relatively new company employee.
C. The CPA firm has decided to perform negative confirmations of accounts receivable rather than positive confirmations.
D. The company employee who codes checks for recording purposes is relatively inexperienced.
Answer is D
The chance that a material misstatement will occur within the reporting company’s accounting system is known as inherent risk. If coding (assigning accounts for journal entry purposes) is done by an inexperienced person, the chances of errors occurring will go up. That increases the level of inherent risk. The chance that company control procedures will not discover or prevent a material misstatement is referred to as control risk (answer B). The chance that the independent auditor will fail to detect a material misstatement is known as detection risk (answer A). Positive and negative confirmations are used to gather evidence in hopes of reducing the overall audit risk to an acceptably low level.
Have a great week – add lots of points.
Let’s get this exam finished off sooner rather than later.
Joe Hoyle
Co-Founder
CPA Review for FREE
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