FINANCIAL ACCOUNTING AND REPORTING (FAR) SAMPLE QUESTIONS

The following are actual retired questions from the Financial Accounting and Reporting (FAR) of the CPA
Exam.

The answers are provided by Kaplan Schweser. Check back each month for new questions and answers.

View questions for the other sections of the exam.

QUESTION: Which of the following is not a comprehensive basis of accounting other than generally
accepted accounting principles?

Basis of accounting used by an entity to comply with the financial reporting requirements of a
government regulatory agency.

Cash receipts and disbursements basis of accounting.

Basis of accounting used by an entity to file its income tax return.

Basis of accounting used by an entity to comply with the financial reporting requirements of a lending
institution.

ANSWER: The correct answer is D. The following accounting bases may be used to prepare financial
statements in conformity with a comprehensive basis of accounting other than GAAP:

Income tax basis of accounting.

Cash basis of accounting.

Modified cash basis of accounting.

Basis of accounting used by an entity to comply with the financial reporting requirements of a
government regulatory agency.

A definite set of criteria having substantial support that is applied to all material items in the financial
statements.
An other comprehensive basis of accounting (OCBOA) outside of the permitted bases listed above is
prohibited. A basis of accounting used by an entity to comply with the financial reporting requirements
of a lending institution is not a permitted OCBOA.

QUESTION: One criterion for a capital lease is that the term of the lease must equal a minimum
percentage of the leased property's economic life at the inception of the lease. The minimum
percentage is:

75%.

41%.

50%.

90%.

ANSWER: The correct answer is A. A lease is classified as a capital lease if one of the following criteria is
met:

The title is transferred to the lessee at the end of the lease period.

A bargain purchase option exists.

The lease period is at least 75% of the asset's life.

The present value of the minimum lease payments is at least 90% of the fair value of the asset.

QUESTION: On January 15, Year 5 Rice Co. declared its annual cash dividend on common stock for the
year ended January 31, Year 5. The dividend was paid on February 9, Year 5, to stockholders of record as
of January 28, Year 5. On what date should Rice decrease retained earnings by the amount of the
dividend?

January 15, Year 5.

January 31, Year 5.

January 28, Year 5.

February 9, Year 5.

ANSWER:The correct answer is A.Retained earnings is decreased and a current liability for the cash
dividend is recorded on the declaration date, in this case, January 15, Year 5.
QUESTION: For interim financial reporting, a company's income tax provision for the second quarter of a
given year should be determined using the:

Statutory tax rate for the year.

Effective tax rate expected to be applicable for the second quarter of the year.

Effective tax rate expected to be applicable for the full year, as estimated at the end of the first quarter of
the year.

Effective tax rate expected to be applicable for the full year, as estimated at the end of the second
quarter of the year.

ANSWER:The correct answer is D. The company should use the effective tax rate expected to be
applicable for the full year as estimated at the end of the second quarter the year because the interim
period is considered an integral part of the accounting year.

QUESTION: What type of bond matures at different points in time?

Bearer bonds.

Term bonds.

Serial bonds.

Unsecured bonds.

ANSWER: The correct answer is C. Serial bonds refer to bonds within an issue that mature at different
points in time. Generally, serial bonds are retired according to their registration number. Note that bonds
within a term bond issue all mature at the same time. Unsecured bonds are backed only by the general
credit of the borrower and are not backed by any specific property. In the case of a bearer bond, there is
no record of ownership – interest is paid to the holder of the bond.

QUESTION: Which of the following statements comparing straight-line depreciation methods to

alternative depreciation methods is least accurate? Companies that use:

accelerated depreciation methods will increase the total amount of depreciation expense in the latter
years of the asset's life.
accelerated depreciation methods will decrease the amount of taxes in early years.

straight-line depreciation methods will have higher book values for the assets on the balance sheet than
companies that use accelerated depreciation in the early years.

units-of-production methods to depreciate assets will overstate income during periods of low
production.

ANSWER: The correct answer is A. Accelerated depreciation methods will increase the amount of
depreciation expense in the early years of the asset’s life, but the depreciation expense will be less in the
latter years of the asset’s life. All other answer options are true.

QUESTION: Gar Co. factored its receivables without recourse with Ross Bank. Gar received cash as a
result of this transaction, which is best described as a:

Sale of Gar's accounts receivable to Ross, with the risk of uncollectible accounts retained by Gar.

Sale of Gar's accounts receivable to Ross, with the risk of uncollectible accounts transferred to Ross.

Loan from Ross collateralized by Gar's accounts receivable.

Loan from Ross to be repaid by the proceeds from Gar's accounts receivables.

ANSWER: The correct answer is B. Factoring of receivables is a sale of the receivables to another party.
"Without recourse" means that Gar Co. has transferred the risk for the uncollectible accounts to Ross
Bank and Ross does not have any recourse against Gar Co. if the accounts are not collected. Thus, Gar
has sold the accounts receivable to Ross Bank along with the risk associated with the uncollectible
accounts.

QUESTION: Reportable segments are not required to disclose which of the following:

Intersegment sales.

Capital expenditures.

Amortization expense.

Long-term debt.

ANSWER: D) Long-term debt and all liabilities are not required disclosures on segment data. All the other
choices are required disclosures.
QUESTION: During 2009, Tedd Co. became involved in a tax dispute with the IRS. At December 31, 2009,
Tedd's tax advisor believed that an unfavorable outcome was probable. A reasonable estimate of
additional taxes was $400,000, but could be as much as $600,000. After the 2009 financial statements
were issued, Tedd received and accepted an IRS settlement offer of $450,000. What amount of accrued
liability should Tedd have reported in its December 31, 2009, balance sheet?

$400,000.

$450,000.

$500,000.

$600,000.

ANSWER: A) The minimum amount within the range must be accrued since an unfavorable outcome is
probable.

QUESTION: Extraordinary items are:

reported above the line.

unusual and infrequent.

unusual or infrequent.

reported on the balance sheet.

ANSWER: B) Extraordinary items are unusual and infrequent, reported below the line separate from
income from continuing operations on the income statement, and would include such items as: foreign
government confiscation, earthquake damages, losses from volcanic eruptions, etc.

QUESTION: Presenting consolidated financial statements this year when statements of individual
companies were presented last year is

A correction of an error.

An accounting change that should be reported prospectively.

An accounting change that should be reported by restating the financial statements of all prior periods
presented.
Not an accounting change.

ANSWER: C) This is a change in accounting entity which requires restatement of prior periods being
presented.

QUESTION: The following computations were made from Clay Co.'s 2009 books: What was the number
of days in Clay's 2009 operating cycle?

Number of days’ sales in Inventory: 61

Number of days’ sales in trade accounts receivable: 33

33.

47.

61.

94.

ANSWER: D) 94 days. The operating cycle is the average time for a company to expend cash for inventory,
process and sell the inventory, and collect the resulting receivables, converting them back into cash. The
number of days in the operating cycle (94) is equal to the number of days' sales in inventory (61), plus
the number of days' sales in accounts receivable (33).

QUESTION: Which of the following is NOT a criteria for a lease to be classified as a capital lease?

The lease term is equal to 90% or more of the estimated economic life of the asset.

Ownership in the asset is transferred at the end of the lease term.

The lease contains a bargain purchase option.

The present value of the minimum lease payments is 90% or more of the fair value of the asset at the
inception of the lease.

ANSWER: A) To be considered a capital lease, the lease term should be equal to 75 percent or more of
the estimated economic life of the asset, not 90 percent.
QUESTION: An entity purchased shares of its $100 par stock for retirement that was originally issued at
$200 per share. The entity repurchased the stock for $250 per share. Upon retirement, which of the
following accounts would NOT be affected?

Paid-in capital.

Common stock.

Treasury stock.

Retained earnings.

ANSWER: C) When the stock of an entity is purchased specifically for retirement, it is no longer able to
be reissued and therefore would NOT affect treasury stock. The entity would record the transaction by
removing the common stock at its par value, with any additional paid-in capital that was originally
recorded being removed as well.

The difference between the original issue price and the reacquisition price requires a reduction in
retained earnings because the entity repurchased the stock for an amount greater than the original
issuance price.

A reduction in the cash paid for the stock is recorded as well. The journal entry for the repurchase and
retirement of one share of its outstanding stock would appear as follows:

Debit: Common stock $100

Debit: Paid-in capital $100

Debit: Retained earnings $50

Credit: Cash $250

QUESTION: Conceptually, interim financial statements can be described as emphasizing

Timeliness over reliability.

Reliability over relevance.

Relevance over comparability.

Comparability over neutrality.

ANSWER: A) Interim statements are affected by estimates, cost allocations, seasonality and other factors
which may affect the usefulness of the information. Therefore, the emphasis on timeliness over
reliability.

QUESTION: St.Petersburg Glass Company plans to issue the following 10-year bond:

PV: $25,325

FV: $20,000

Annual payments: $2,000

Using straight-line amortization calculate the bond interest expense for year 1 for St. Petersburg Glass
Company?

$532.50.

$1,467.50.

$4,792.50.

Bond interest expense cannot be amortized.

ANSWER: B) The bond interest expense for St. Petersburg Glass Company would be $1,467.50. The
amortized amount of the bond premium is subtracted from the annual payments. $5,325/10 = 532.50,
$2,000 - 532.50 = $1,467.50.

QUESTION: Calculate depreciation for year 2 based on the following information:

Historical cost $40,000

Useful life 5 years

Salvage value $3,000

Year 1 depreciation $7,400

$7,400.
$8,000.

$8,600.

$13,040.

ANSWER: A) The depreciation method used must be straight line because year 1 depreciation is $7,400
(($40,000 - $3,000) / 5 = $7,400).

Year 2 depreciation would also be $7,400.

QUESTION: A company recently took out a $25,000 loan with interest payable at the rate of 9 percent,
compounded annually. The loan is to be paid off in one lump sum, at the end of 3 years. Given it is to
include both principal and interest, the amount of the loan

payment will be closest to:

FV of $1@ 9% for 3 years = 1.295

PV of $1@9% for 3 years = 0.7722

$27,250.

$31,750.

$32,375.

$34,000.

ANSWER: C. This can be solved with either the PV or FV of $1 equation; using the correct factor:

PV = FV x PVfactor or FV = PV x FVfactor. So: $25,000 = FV x 0.7722 = %32,375. Or, FV = $25,000 x 1.295 =

$32,375.

QUESTION: At January 1, 2009, Simpson Co. had a credit balance of $260,000 in its allowance for
uncollectible accounts. Based on past experience, 2 percent of Simpson’s credit sales have been
uncollectible. During 2009, Simpson wrote off $325,000 of uncollectible accounts. Credit sales for 2009
were $9,000,000. In its December 31, 2009, balance sheet, what amount should Simpson report as
allowance for uncollectible accounts?

$115,000.

$180,000.
$245,000.

$440,000.

ANSWER: A. The beginning balance is added to the new provision of $180,000 (2% × $9,000,000) and is
reduced for the write off of $325,000 (260,000 + 180,000) – 325,000 = 115,000.

QUESTION: The Welsh Corporation has maintained a defined benefit pension plan for a number of years.
At the end of the current year, the company has a net pension cost of $177,000, a projected benefit
obligation of $829,000, and plan assets of $580,000. What is the total amount of liability this company
should recognize on its balance sheet, in connection with this pension plan?

$116,000.

$122,000.

$117,000.

$249,000.

ANSWER: D. $249,000.

According to FASB 158, an employer is required to recognize the overfunded or underfunded status of
the pension plan. This amount is the difference between the Projected Benefit Obligation and the Plan
Assets, or $249,000 ($829,000 – $580,000) in this case. It will be reported as a liability since the PBO
exceeds the plan assets.

QUESTION: What is the difference between the direct and indirect method of calculating cash flow from
operations?

The indirect method starts with gross income and adjusts to cash flow from operations, while the direct
method starts with gross profit and flows through the income statement to calculate cash flows from
operations.

The direct method starts with sales and follows cash as it flows through the income statement, while the
indirect method starts with net income and adjusts for non-cash charges and other items.

Balance sheet items are not included in the cash flow from operations for the direct method, while they
are included for the indirect method.

The direct method will result in a lower or higher cash flow figure for operating activities as it details all
of the income statement items, while the indirect method only uses net income.

ANSWER: B. The direct method starts with sales and follows cash as it flows through the income
statement, while the indirect method starts with net income and adjusts for non-cash charges and other
items.

The main difference between the direct and indirect methods of calculating cash flows is the way that
cash flow from operations is calculated. The direct method starts with sales and follows cash as it flows
through the income statement, while the indirect method starts with income after taxes and adjusts
backwards for noncash and other items. Both methods will have the same result for operating cash
flows. The direct and indirect method calculates the financing and investing cash flows the same way,
and both methods will result in the same cash flow figure.

QUESTION: On January 1, Year 1, Giant Company (Giant) pays $900,000 for all of the outstanding shares
of Small Corporation (Small). On that date, Small has a net book value (assets – liabilities) of $700,000. In
analyzing the company prior to the acquisition, Giant discovers that Small is working on several in-
process research and development projects that are worth a total of $170,000 although none of the
projects has yet reached the point of technological feasibility. Which of the following statements is true?

Goodwill of $30,000 should be recorded as a result of this acquisition.

An expense of $170,000 should be recognized immediately at the date of acquisition.

Any goodwill allocation will be amortized at the end of Year 1.

The life attributed to any goodwill allocation will be 40 years or less.

ANSWER: A. Goodwill of $30,000 should be recorded as a result of this purchase.

In creating a business combination, any amount attributed to the value of in-process research and
development must be recognized. Any portion of the acquisition price in excess of the subsidiary’s
underlying book value that cannot be assigned to an identifiable asset or liability is reported as the
intangible asset, Goodwill. Here, the purchase price was $900,000 and the book value was $700,000 so
the excess was $200,000. Of that amount, $170,000 is assigned to in-process research and development.
The remaining $30,000 is reported by the consolidated companies as goodwill. Goodwill is no longer
amortized over a period of time but is rather checked periodically for impairment.

QUESTION: Orleans Co. (Orleans), a cash-basis taxpayer, prepares accrual basis financial statements. In
its Year 6 balance sheet, Orleans’ deferred tax liabilities increased when compared to Year 5. Which of
the following changes would cause this increase in deferred tax liabilities?

I. An increase in prepaid insurance.

II. An increase in rent receivable.

III. An increase in warranty obligations.

I only.

I and II.

II and III.

III only.

ANSWER: B. I and II.

The increase in prepaid insurance in Year 6 creates a deductible amount for income tax reporting
purposes for the insurance paid; however, for financial reporting purposes the expense is not recognized
until years subsequent to Year 6. As a result, net taxable income for future years is increased; thus, the
deferred tax liability increases.

The increase in rent receivable in Year 6 also increases the deferred tax liability. For income tax purposes,
rents are not included in income until received (i.e., years subsequent to Year 6). However, the amount
of the receivable is earned and recognized in the income statement in Year 6.

The increase in warranty obligations results in warranty expense for Year 6 and will provide future
deductible amounts because tax rules do not allow a deduction for warranty cost until such a cost is
incurred. Future deductible amounts lead to deferred tax assets.

QUESTION: During Year 1, Smith Corporation filed suit against West Company because of damages that
were allegedly inflicted on Smith. At the end of Year 1, officials of Smith believe it is reasonably possible
that between $300,000 and $400,000 will be won but probable that the amount will actually be
between $160,000 and $300,000. No number in either range stands out as more likely than any other
number. Officials working for West have exactly the same opinion of what is going to happen. In the later
part of Year 2, the case is settled when West pays Smith $280,000 in cash. What is the impact on income
reported by these companies in Year 2?

Smith West
A. $120,000 gain $20,000 gain

B. $280,000 gain $120,000 gain

C. $280,000 gain $120,000 loss

D. $120,000 gain $50,000 loss

ANSWER: C. $280,000 gain; $120,000 loss

As the potential winner, Smith will not recognize a gain until the process is substantially completed. That
happens in Year 2. Therefore, the entire profit is recognized when the case is settled in Year 2.

As the potential loser, West will recognize a loss as soon as the amount becomes probable. Here, that is
in Year 1. When the amount can only be estimated to within a range, the most likely number in the range
is used. If no number is most likely, the lowest number in the range is recognized. For that reason, West
recognized a $160,000 loss in Year 1 which then had to be increased in Year 2 by $120,000 to arrive at
the actual figure of $280,000.

QUESTION: Norina Co. (Norina) has a portfolio of marketable equity securities that it does not intend to
sell in the near term. How should Norina classify these securities and how should it report unrealized
gains and losses from these securities?

Classification Reporting of unrealized gains and losses

A. Trading securities Component of income from continuing operations

B. Available-for-sale Separate component of other comprehensive income securities

C. Trading securities Separate component of other comprehensive income

D. Available-for-sale Component of income from continuing operations securities

ANSWER: B. Available-for-sale; Separate component of other comprehensive income securities

In accordance with SFAS 115, marketable equity securities (MES) are classified as either trading (held for
current resale) or available-for-sale (if not categorized as trading). Because Norina does not intend to sell
these securities in the near term, they should be classified as available-for-sale.

SFAS 115 requires MES to be carried at market value. The unrealized gains or losses of available-for-sale
MES are reported as a separate component of other comprehensive income. It is important to note that
unrealized gains or losses on trading securities would be reported as a component of continuing
operations on the income statement.

Thus, Answer B is correct because the securities would be classified as available-for-sale and unrealized
gains or losses from these securities would be reported as other comprehensive income.

QUESTION: Marcel, Inc. (Marcel) has a gross profit margin of $45,000 on sales of $150,000. The balance
sheet shows average total assets of $75,000 with an average inventory balance of $15,000. What is
Marcel’s total asset turnover and inventory turnover amounts, respectively?

Total asset turnover Inventory turnover

A. 7.00 times 2.00 times

B. 2.00 times 7.00 times

C. 0.50 times 0.33 times

D. 10.00 times 0.60 times

ANSWER: B. 2.00 times; 7.00 times

Total asset turnover = sales/total assets = 150/75 = 2 times

Inventory turnover = COGS/average inventory = (150 – 45)/15 = 7 times

QUESTION: According to the FASB Conceptual Framework, which of the following relates to both
relevance and reliability?

Consistency Verifiability

A. Yes Yes

B. No No

C. Yes No

D. No Yes

ANSWER: C. Yes; No
Consistency in financial presentation means the use of the same accounting procedures for presenting
information in different periods. Because trend analysis is a strong element in projecting the future,
investors and creditors find consistency important in making data useful, or relevant in formulating
decisions. Consistent presentation also removes potential bias from presentation that might be caused
by selecting the procedure each year that makes the company look best. A consistent presentation
enhances the neutrality of the information, which is an element of reliability. Thus, consistency relates to
both relevance and reliability.

Verifiability means the development of information by an approach that would cause different people to
arrive at the same figures. Verifiability makes information more reliable but does not tell us whether the
information being developed happens to be relevant to the user.

QUESTION: A company (the lessor) buys a car and then leases it to one of its customers (lessee). Which
of the following is correct?

Unless the title eventually transfers to the lessee, the lease should be reported as an operating lease.

If the car has a life of ten years and the lease is for eight years, the lease must be reported as a capital
lease.

If the lease is a capital lease, then the lessee must account for the contract as either a direct financing
lease or a sales type lease.

If the lessee is given the option to purchase the car at the end of the lease, both parties will account for
the contract as a capital lease.

ANSWER: B. If the car has a life of ten years and the lease is for eight years, the lease must be reported
as a capital lease.

The FASB has established four criteria for a capital lease. If any one of these is met, then the lease has to
be recorded as a capital lease:

The title transfers to the lessee

There is a bargain purchase option (a bargain is viewed as an option price that is significantly below
expected fair value so that it is reasonable to expect the lessee to acquire the asset).

The life of the lease is 75% or more of the life of the asset.

The present value of the minimum lease payments is 90% or more of the fair value of the asset.
For a capital lease, the lessee only has one method of reporting (basically, the asset is being recorded as
an acquisition using long-term financing). However, the lessor must classify the lease as a sales type
lease or an operating lease based on certain factors.

QUESTION: Assuming that a company’s stock has a fair value in excess of its par value, how would the
declaration of a 15% stock dividend by a corporation affect each of the following?

Additional

paid-in capital Total stockholders’

equity

A. Increase No effect

B. No effect No effect

C. No effect Decrease

D. Decrease Decrease

ANSWER: A. Increase; No effect

Issuing a 15% stock dividend increases the number of shares outstanding but it does not impact
stockholders’ equity because there is neither an increase nor a decrease in the net assets of the
company. Because the dividend was less than 20% to 25%, it is viewed as small stock dividend, and,
hence, it is recorded at fair value. Because the fair value is greater than the par value, the amount in
excess of par will be recorded as an increase to the additional paid-in capital account.

QUESTION: On November 1, Year 1, a company purchased a new machine. The machine does not have
to be paid for until November 1, Year 3. The total payment on November 1, Year 3, will include both
principal and interest. Assuming interest at a 10% rate, the cost of the machine would be the total
payment multiplied by what time value of money concept?

Present value of $1.

Present value of annuity of $1.

Future value of $1.

Future value of annuity of $.

ANSWER: A. Present value of $1.

The requirement is to determine what time value of money concept would be used to determine the
cost of a machine when a payment (principal plus interest) is to be made in two years.

Answer A is correct because the cost of the machine is to be recorded immediately; therefore, the cost
of the present value of a lump-sum payment would be used.

Answer B is incorrect because a lump-sum payment is involved, not an annuity. Answer C is incorrect
because a future amount would be used in computing the payment and not the cost of the machine.

Answer D is incorrect because a future amount would be used in computing the payment and not the
cost. Also, a lump-sum payment is involved and not an annuity.

QUESTION: Harbor City’s appropriations control account at December 31, 2008, had a balance of
$7,000,000. When the budgetary accounts were closed at year-end, this $7,000,000 appropriations
control balance should have:

appeared as a contra account.

been credited.

remained open.

been debited.

ANSWER: D. been debited.

When the budget is initially recorded for governmental accounting systems, the appropriations control
account is credited for authorized expenditures. At year-end, the budget entry is reversed; thus the
appropriations control account would be debited to close it out.