Batch6 CPA REVIEW QUESTIONS

CPA QUESTIONS BATCH 6
When a principal debtor defaults and a surety pays the creditor the entire obligation,
which of the following remedies gives the surety the best method of collecting from the
debtor?

A) Exoneration
B) Contribution
C) Subrogation
D) Attachment
Correct Answer: C
Explanation: The right of subrogation allows the surety to gain the creditor's rights, once the
creditor has been paid in full. Subrogation would give a surety not only their own right to collect
from the debtor (reimbursement), but also additional rights that the creditor might have had.
The remaining answer choices are incorrect for the following reasons:
• Exoneration would simply give a surety a court order demanding that the debtor pay.
Exoneration does not confer additional collection rights against the debtor.
• Contribution is only available to one cosuretor against other cosuretors. It is not available
against the debtor.
• Attachment is the right of all creditors to place a lien on a debtor's property so it will be
available to satisfy a judgment. Subrogation is the better answer because it is specific to surety's
collection rights against a debtor and gives the surety additional rights.
A CPA should not submit unaudited financial statements of a nonpublic company to a

client or others unless, as a minimum, the CPA complies with the provisions applicable to:

A) Compilation engagements
B) Review engagements
C) Statements on auditing standards
D) Attestation standards
Correct Answer: A
Explanation: Since the CPA is associated with the financial statements (he is submitting them),
he must indicate the degree of responsibility he is taking with respect to the statements. Since the
statements are unaudited and the company is nonpublic, the appropriate standards are
compilation standards.
The functional currency of Nash, Inc.'s subsidiary is the French franc. Nash borrowed
French francs as a partial hedge of its investment in the subsidiary. In preparing
consolidated financial statements, Nash's translation loss on its investment in the
subsidiary exceeded its exchange gain on the borrowing. How should the effects of the loss
and gain be reported in Nash's consolidated financial statements?

The translation loss less the exchange gain is reported separately as other comprehensive
A)
income.
B) The translation loss less the exchange gain is reported in the income statement.
The translation loss is reported separately in the stockholders' equity section of the balance
C)
sheet and the exchange gain is reported in the income statement.
The translation loss is reported in the income statement and the exchange gain is reported
D)
separately in the stockholders' equity section of the balance sheet.
Correct Answer: A
Explanation: Gains and losses on foreign currency transactions that are designated as economic
hedges of a net investment in a foreign entity should be reported in the same manner as a
translation adjustment. Current changes in translation adjustments are reported as other
comprehensive income.
In an income statement prepared using the variable costing method, fixed factory
overhead would

A) Not be used.
B) Be used in the computation of the contribution margin.
Be used in the computation of operating income but not in the computation of the
C)
contribution margin.
D) Be treated the same as variable factory overhead.
Correct Answer: C
Explanation: Under the direct or variable costing method, variable costs are deducted from sales
revenue to determine contribution margin and all fixed costs (overhead, selling, general and
administrative) are then deducted to obtain net income or income from operations. The
contribution margin is calculated in two steps:
1. Sales revenue less (variable) cost of goods sold = Contribution margin: manufacturing
2. Contribution margin: manufacturing less other variable costs (S, G & A) = Contribution
margin: final

Under the Commercial Paper Article of the UCC, for an instrument to be negotiable it
must _________________

A) be payable to order or bearer.
B) be signed by the payee.
C) contain references to all agreements between the parties.
D) contain necessary conditions of payment.
Correct Answer: A
Explanation: To be negotiable an instrument must be signed by maker or drawer, be

unconditional, be payable in a certain sum of money, be payable to bearer or order and be
payable on demand or at a definite time. Thus, for an instrument to be negotiable it must be
payable to order or to bearer. (Note: checks may omit the word "order" and still be negotiable.)
• It is the maker or drawer that must sign, not the payee.

• There is no requirement that the instrument contain any reference to agreements between the
parties to be negotiable.
• An instrument must be unconditional to be negotiable and may not contain necessary
conditions of payment.
The most likely strategy to reduce the breakeven point would be to

A) Increase both the fixed costs and the contribution margin.
B) Decrease both the fixed costs and the contribution margin.
C) Decrease the fixed costs and increase the contribution margin.
D) Increase the fixed costs and decrease the contribution margin.
Correct Answer: C
Explanation: Breakeven point represents your fixed costs divided by your contribution margin.
Mathematically, by decreasing your numerator (fixed costs) or increasing your denominator
(contribution margin), your breakeven point must decrease.
Baker, CPA, was engaged to review the financial statements of Hall Company, a nonpublic
entity. Evidence came to Baker's attention that indicated substantial doubt as to Hall's
ability to continue as a going concern. The principal conditions and events that caused the
substantial doubt have been fully disclosed in the notes to Hall's financial statements.
Which of the following statements best describes Baker's reporting responsibility
concerning this matter?

A) Baker is not required to modify the accountant's review report.
B) Baker is not permitted to modify the accountant's review report.
C) Baker should issue an accountant's compilation report instead of a review report.
D) Baker should express a qualified opinion in the accountant's review report.
Correct Answer: A
Explanation: An accountant's review report must be modified for departures from GAAP and/or
inadequate disclosure only. The going concern problem is adequately disclosed in the financial
statements; therefore no modification of the accountant's review report is necessary. The
accountant may modify his review report but again it is not necessary to do so.

A subsidiary's functional currency is the local currency which has not experienced
significant inflation. The appropriate exchange rate for translating the depreciation on
plant assets in the income statement of the foreign subsidiary is the:

A) Exit exchange rate
B) Historical exchange rate
C) Weighted average exchange rate over the economic life of each plant asset
D) Weighted average exchange rate for the current year
Correct Answer: D
Explanation: Income and expense items are generally translated using the weighted average
exchange rate for the year when the functional currency is the foreign currency.
In an income statement prepared as an internal report using the direct (variable) costing
method, fixed selling and administrative expenses would

A) Be used in the computation of the contribution margin.
Be used in the computation of operating income but not in the computation of the
B)
contribution margin.
C) Be treated the same as variable selling and administrative expenses.
D) Not be used.
Correct Answer: B
Explanation: Under the direct or variable costing method, variable costs are deducted from
revenue to determine contribution margin, and all fixed costs (manufacturing, selling, general
and administrative) are then deducted to obtain net income or income from operations. The
contribution margin is calculated in two steps:
1. Revenue less variable cost of goods sold = Contribution margin: manufacturing

2. Contribution margin: manufacturing less other variable costs (S, G & A) = Contribution
margin: final

On October 1, 2009, Mild Co., a U.S. company, purchased machinery from Grund, a
German company, with payment due on April 1, 2010. If Mild's 2009 operating income
included no foreign exchange transaction gain or loss, then the transaction could have:

A) Resulted in an extraordinary gain
B) Been denominated in U.S. dollars
C) Caused a foreign currency gain to be reported as a contra account against machinery
Caused a foreign currency translation gain to be reported as a separate component of
D)
stockholders' equity
Correct Answer: B
Explanation: Denominated means that the liability is fixed in terms of the amount of currency in
which it will be paid. If the liability is fixed in the amount of U.S. dollars to be paid, fluctuations
in the German currency would not affect the amount to be paid and a foreign currency
transaction gain or loss would not occur.
Transaction gains or losses are not extraordinary.
Transaction gains or losses are a part of income from continuing operations.
Burn Manufacturing borrowed $500,000 from Howard Finance Co., secured by Burn's
present and future inventory, accounts receivable, and the proceeds thereof. The parties
signed a financing statement that described the collateral and it was filed in the
appropriate state office. Burn subsequently defaulted in the repayment of the loan and
Howard attempted to enforce its security interest. Burn contended that Howard's security
interest was unenforceable. In addition, Green, who subsequently gave credit to Burn
without knowledge of Howard's security interest, is also attempting to defeat Howard's
alleged security interest. The security interest in question is valid with respect to
_________________

A) both Burn and Green.
B) neither Burn nor Green.
C) burn but not Green.
D) green but not Burn.
Correct Answer: A
Explanation: A creditor with a security interest will have rights against a debtor when
attachment has occurred. Three elements are required for attachment: an agreement between the
debtor and the creditor, value must be given by the creditor and the debtor must have rights in
the collateral. Howard will have rights against Burn (debtor), because there was a written
security agreement, value was given by Howard ($500,000) and the debtor had rights in the
collateral (inventory and accounts receivable). When two creditors are fighting over the same
collateral, usually the first creditor to perfect wins. Since Howard perfected by filing before
Green gave credit, Howard's security interest has priority over Green.
An auditor who was engaged to perform an examination of the financial statements of a

nonpublic entity has been asked by the client to refrain from performing various audit
procedures and change the nature of the engagement to a review of the financial
statements in accordance with standards established by the AICPA. The client's request
was made because the cost to complete the examination was significant. Under the
circumstances the auditor would most likely:

A) Qualify the auditor's report and refer to the scope limitation.
B) View the request as an indication of a possible irregularity.
C) Complete the examination which was in progress.
D) Honor the client's request.
Correct Answer: D
Explanation: The client has changed the type of service that it wishes the CPA to perform.
Before honoring the request, the CPA should determine whether the client has a sound business
reason for the change. In this case, the cost of the audit was excessive and could be honored by
the CPA.
Attachment and perfection will occur simultaneously when _________________

A) the security agreement so provides.
B) there is a purchase money security interest taken in inventory.
C) attachment is by possession.
D) the goods are sold on consignment.
Correct Answer: C
Explanation: There are only three different ways to perfect: by possession, by filing and
perfection by attachment. Possession will not only create the security agreement required for
attachment, but will also result in perfection. Thus when attachment is by possession, attachment
and possession occur simultaneously. Note that they would also occur simultaneously when
perfection by attachment occurs.
• Perfection will not occur merely because the security agreement so provides. You must perfect
by one of the three methods.
• No possession or filing occurred and perfection by attachment requires a PMSI creditor in
consumer goods, not a PMSI creditor in inventory. Thus, no perfection occurred.
• No possession, filing or perfection by attachment occurred and therefore there is no perfection.
Manhof Co. prepares supplementary reports on income from continuing operations on a

current cost basis in accordance with FASB Statement No. 89, Financial Reporting and
Changing Prices. How should Manhof compute cost of goods sold on a current cost basis?

A) Number of units sold times average current cost of units during the year
B) Number of units sold times current cost of units at year end
C) Number of units sold times current cost of units at the beginning of the year
Beginning inventory at current cost plus cost of goods purchased less ending inventory at
D)
current cost
Correct Answer: A
Explanation: According to FASB #89, cost of goods sold should be measured by using the
current cost at the date of sale. Since Manhof incurs sales throughout the year, cost of goods sold
should be calculated by using the number of units sold multiplied by the average current cost per
unit during the year.
Jago Co. has 2 products that use the same manufacturing facilities and cannot be
subcontracted. Each product has sufficient orders to utilize the entire manufacturing
capacity. For short-run profit maximization, Jago should manufacture the product with
the

A) Lower total manufacturing costs for the manufacturing capacity.
B) Lower total variable manufacturing costs for the manufacturing capacity.
C) Greater gross profit per hour of manufacturing capacity.
D) Greater contribution margin per hour of manufacturing capacity.
Correct Answer: D
Explanation: As both products can utilize full capacity, the greatest profit will result from the
greatest contribution margin (selling price - variable costs) for capacity. Fixed costs are
irrelevant as they are not affected by the decision.
One example of a "special report," as defined by Statements on Auditing Standards, is a

report issued in connection with:

A) A feasibility study
B) A limited review of interim financial information
C) Price-level basis financial statements
D) Compliance with a contractual agreement not related to the financial statements
Correct Answer: C
Explanation: There are four types of special reports, one of which in a definite set of criteria
having substantial support that is applied to all material items appearing in financial statements.
Price-level financial statements qualify as a basis of accounting having substantial authoritative
support.
Winslow Co., which is in the business of selling furniture, borrowed $60,000 from Pine
Bank. Winslow executed a promissory note for that amount and used all of its accounts
receivable as collateral for the loan. Winslow executed a security agreement that described
the collateral. Winslow did not file a financing statement. Which of the following
statements best describes this transaction?

Perfection of the security interest occurred even though Winslow did not file a financing
A)
statement.
Perfection of the security interest occurred by Pine having an interest in accounts
B)
receivable.
Attachment of the security interest did not occur because Winslow failed to file a financing
C)
statement.
Attachment of the security interest occurred when the loan was made and Winslow
D)
executed the security agreement.
Correct Answer: D
Explanation: Three elements are required for attachment: an agreement between the debtor and
the creditor, value must be given by the creditor and the debtor must have rights in the collateral.
Attachment occurred when the loan was made because an executed agreement was present, Pine
gave value by making the loan and the debtor certainly had rights in the collateral since the
collateral was all of the debtor's receivables. Filing is the only way to perfect with accounts
receivable and no filing occurred.
How should a usage variance that is significant in amount be treated at the end of an
accounting period?

A) Reported as a deferred charge or credit.
Allocated among work-in-process inventory, finished goods inventory, and cost of goods
B)
sold.
C) Charged or credited to cost of goods manufactured.
Allocated among cost of goods manufactured, finished goods inventory, and cost of goods
D)
sold.
Correct Answer: B
Explanation: This method provides for allocation among all units that were handled during the
period.
Which of the following conditions is necessary for a practitioner to accept an attest

engagement to examine and report on an entity's internal control structure over financial
reporting?

The practitioner anticipates relying on the entity's internal control structure in a financial
A) statement
audit.
Management presents its written assertion about the effectiveness of the internal control
B)
structure.
The practitioner is a continuing auditor who previously has audited the entity's financial
C)
statements.
Management agrees not to present the practitioner's report in a general-use document to
D)
stockholders.
Correct Answer: B
Explanation: AT 400 states that a practitioner may examine and report on management's
assertion about the effectiveness of an entity's internal control structure if the following
conditions are met:
• Management accepts responsibility for the effectiveness of the entity's internal control
structure.
• Management evaluates the effectiveness of the entity's internal control structure using
reasonable "control criteria" for effective internal control structures established by a recognized
body.
• Sufficient evidential matter exists or could be developed to support management's evaluation.
• Management presents its written assertion about the effectiveness of the entity's internal control
structure based upon the control criteria referred to in its report.
• The examination may be separate or in conjunction with an audit.

• No requirement for previous engagement exists in order to issue a report on the client's internal
control.
• If management's assertion is presented in a report that accompanies the practitioner's report,
then it is considered appropriate for general distribution.
Kerr Company purchased a machine for $115,000 on January 1, 1992, the company's first
day of operations. At the end of the year, the current cost of the machine was $125,000.
The machine has no salvage value, a five-year life, and is depreciated by the straight line
method. For the year ended December 31, 1992, the amount of the current cost
depreciation expense which would appear in supplementary current cost financial
statements is:

A) $14,000
B) $23,000
C) $24,000
D) $25,000
Correct Answer: C
Explanation: Assuming that average current cost was used, the average current cost of the
machine is $120,000 for 1992, which would generate depreciation expense of $24,000 (5 year
life).
During a period of inflation, the specific price of a parcel of land increased at a lower rate
than the consumer price index. The accounting method that would measure the land at the
highest amount is:

A) Historical cost/nominal dollar
B) Current cost/nominal dollar
C) Current cost/constant dollar
D) Historical cost/constant dollar
Correct Answer: D
Explanation: Since the inflation rate was higher than the rate of increase in the specific value of
the land, current cost should not be used, only constant dollar (at historical cost) which would
generate the highest amount.
If a company follows a practice of isolating variances at the earliest point in time, what
would be the appropriate time to isolate and recognize a direct material price variance?

A) When material is issued.
B) When material is purchased.
C) When material is used in production.
D) When purchase order is originated.
Correct Answer: B
Explanation: Since the material price variance relates to the difference between standard price
and actual price and might be viewed as measuring the performance of the company's purchasing
department, the variance should be determined on the basis of the units purchased and should
therefore be computed when the purchase occurs.
Accepting an engagement to examine an entity's financial projection most likely would be

appropriate if the projection were to be distributed to:

A) All employees who work for the entity
B) Potential stockholders who request a prospectus or a registration statement
C) A bank with which the entity is negotiating for a loan
D) All stockholders of record as of the report date
Correct Answer: C
Explanation: A financial projection is a prospective financial statement that presents, to the best
of the knowledge of the party responsible for its preparation, given one or more hypothetical
assumptions, an entity's financial position, results of operations, and changes in cash flows. As
compared to a financial forecast, which is available for general use, a financial projection is a
limited use report that is not appropriate for general distribution. Limited use refers to the use of
prospective financial statements by the responsible party and third parties with whom the
responsible party is dealing directly, such as a bank, that is able to question the responsible party
directly about the information.
The incorrect answer choices refer to general users of financial information who are typically not
dealing directly with those responsible for preparing the prospective information.
Under the UCC Sales Article, an action for breach of the implied warranty of
merchantability by a party who sustains personal injuries may be successful against the
seller of the product only when _________________

A) the seller is a merchant of the product involved.
B) an action based on negligence can also be successfully maintained.
C) the injured party is in privity of contract with the seller.
D) an action based on strict liability in tort can also be successfully maintained.
Correct Answer: A
Explanation: The implied warranty of merchantability arises if the seller is a merchant.

Merchantability does not require a showing of negligence, privity or strict liability.
Webstar Corp. orally agreed to sell Northco, Inc. a computer for $20,000. Northco sent a
signed purchase order to Webstar confirming the agreement. Webstar received the
purchase order and did not respond. Webstar refused to deliver the computer to Northco,
claiming that the purchase order did not satisfy the UCC Statute of Frauds because it was
not signed by Webstar. Northco sells computers to the general public and Webstar is a
computer wholesaler. Under the UCC Sales Article, Webstar's position is
_________________

A) incorrect because it failed to object to Northco's purchase order.
B) incorrect because only the buyer in a sale-of-goods transaction must sign the contract.
C) correct because it was the party against whom enforcement of the contract is being sought.
D) correct because the purchase price of the computer exceeded $500.
Correct Answer: A
Explanation: A writing is not required to enforce a contract of more than $500 if a merchant
fails to object within ten days to a confirming letter sent by another merchant. Since Webstar and
Northco are both merchants and Webstar failed to object to the purchase order sent by Northco, a
writing signed by Webstar was not required under the Statute of Frauds. UCC Sales does not
require that only the buyer sign. Usually only one party need sign (whether buyer or seller), but it
can only be enforced against the one who signed. The failure of a merchant to object to a written
confirmation is an exception to the rule that it can only be enforced against the one who signed.
In a period of rising general price levels, Pollard Corp. discloses income on a current cost
basis in accordance with FASB Statement No. 89, Financial Reporting and Changing
Prices.
Compared to historical cost income from continuing operations, which of the following
conditions increases Pollard's current cost income from continuing operations?

A) Current cost of equipment is greater than historical cost.
B) Current cost of land is greater than historical cost.
C) Current cost of cost of goods sold is less than historical cost.
D) Ending net monetary assets are less than beginning net monetary assets.
Correct Answer: C
Explanation: Holding gains for equipment and land are not part of income from continuing
operations. The reduction in cost of goods sold is reflected in income from continuing operations
and is not applicable for current cost measurement.
Hill, CPA, is auditing the financial statements of Helping Hand, a not-for-profit

organization that receives financial assistance from governmental agencies. To detect
misstatements in Helping Hand's financial statements resulting from violations of laws and
regulations, Hill should focus on violations that:

A) Could result in criminal prosecution against the organization.
Involve reportable conditions to be communicated to the organization's trustees and the
B)
funding agencies.
C) Have a direct and material effect on the amounts in the organization's financial statements.
Demonstrate the existence of material weaknesses in the organization's internal control
D)
structure.
Correct Answer: C
Explanation: The auditor should design the audit to provide reasonable assurance that the
financial statements are free of material misstatements resulting from violations of laws and
regulations that have a direct and material effect on the determination of financial statement
amounts. This responsibility exists for all audits conducted in accordance with generally
accepted auditing standards. The auditor undertakes the same responsibility in an audit, in
accordance with Government Auditing Standards, of financial statements of a not-for-profit
organization that accepts financial assistance from a governmental entity.
Actual sales values at split-off point for joint products Y and Z are not known. For
purposes of allocating joint costs to products Y and Z, the relative sales value at split-off
method is used. An increase in the costs beyond split-off occurs for product Z, while those
of product Y remain constant. If the selling prices of finished products Y and Z remain
constant, how would the percentage of the total joint costs allocated to Product Y and
Product Z be affected?

A) The percentage would decrease for Product Y and increase for Product Z.
B) The percentage would decrease for Product Y and Product Z.
C) The percentage would increase for Product Y and decrease for Product Z.
D) The percentage would increase for Product Y and Product Z.
Correct Answer: C
Explanation: When the actual sales value at the split-off point is not known, the final sales value
is reduced by costs subsequent to the split-off point to determine the relative value at split-off.
Therefore, if subsequent costs for product Z increase while those of Y remain constant, Z's
relative value would decrease resulting in less joint costs being allocated to Z and more being
allocated to Y.
When does a general purchasing power loss occur, and when is it recognized?

It occurs when holding net monetary assets during inflation and is recognized in constant
A)
dollar financial statements.
It occurs when holding net monetary liabilities during inflation and is recognized in
B)
constant dollar financial statements.
It occurs when holding net monetary assets during inflation and is recognized in nominal
C)
dollar financial statements and in constant dollar financial statements.
D) It occurs when holding net monetary liabilities during inflation and is recognized in
nominal dollar financial statements and in constant dollar financial statements.
Correct Answer: A
Explanation: General purchasing power losses occur when net monetary assets are held during a
period of inflation. This is because the monetary assets are fixed in terms of dollars and the value
of the dollar is decreasing. Conversely, a gain occurs if net monetary liabilities are held during
inflation. General purchasing power gains and losses are recognized only in constant dollar
(units-of-general-purchasing-power) financial statements.
Greed Co. telephoned Stieb Co. and ordered 30 tables at $100 each. Greed agreed to pay
15% immediately and the balance within thirty days after receipt of the entire shipment.
Greed forwarded a check for $450 and Stieb shipped 15 tables the next day, intending to
ship the balance by the end of the week. Greed decided that the contract was a bad bargain
and repudiated it, asserting the statute of frauds. Stieb sued Greed. Which of the following
will allow Stieb to enforce the contract in its entirety despite the statute of frauds?

A) Stieb shipped 15 tables.
B) Greed paid 15% down.
C) The contract is not within the requirements of the statute of frauds.
D) Greed admitted in court that it made the contract in question.
Correct Answer: D
Explanation: A writing is not required to enforce a contract for more than $500 if the party to be
charged admits in court that they made the contract. Part receipt and part payment only allow the
contract to be enforced for the amount received or the amount paid for and the question required
the contract to be enforced in its entirety. This contract was for more than $500 and the Statute of
Frauds applies.
For purposes of allocating joint costs to joint products, the sales price at point of sale,
reduced by cost to complete after split-off, is assumed to be equal to the

A) Joint costs.
B) Total costs.
C) Net sales value at split-off.
D) Sales price less a normal profit margin at point of sale.
Correct Answer: C
Explanation: The relative sales value of joint products may be unknown at the point of split-off
or because of extensive subsequent processing required to make the product salable, may be
difficult to determine. In such cases, it is recommended that the subsequent costs be applied as a
reduction in revenue on a dollar-for-dollar basis and the remaining revenue used as the sales
value at split-off for assignment of joint cost.
When reporting on an entity's internal control structure under Government Auditing

Standards, an auditor should issue a written report that includes a:

Statement of negative assurance that nothing came to the auditor's attention that caused the
A)
auditor to believe reportable conditions were present.
Statement of positive assurance that the results of tests indicate that the internal control
B)
structure either can, or cannot, be relied on to reduce control risk to an acceptable level.
Description of the weaknesses considered to be reportable conditions and the strengths that
C)
the auditor can rely on in reducing the extent of substantive testing.
Description of the scope of the auditor's work in obtaining an understanding of the internal
D)
control structure and in assessing control risk.
Correct Answer: D
Explanation: Government Auditing Standards requires a written report on the internal control

structure in all audits. Those standards also require description of any reportable conditions
noted, identification of the categories of the internal control structure, description of the scope of
the auditor's work in obtaining an understanding of the internal control structure and in assessing
control risk, and description of deficiencies in the internal control structure not considered
significant enough to be reportable conditions.
If the auditor notes no reportable conditions during an audit he may so state, rather than give
negative assurance.
Grum Corp., a publicly-owned corporation, is subject to the requirements for segment

reporting. In its income statement for the year ended December 31, 2008, Grum reported
consolidated revenues of $50,000,000, operating expenses of $47,000,000, and net income of
$3,000,000. Operating expenses include payroll costs of $15,000,000. Grum's combined
identifiable assets of all industry segments at December 31, 2008, were $40,000,000. In its
2008 financial statements, Grum should disclose major customer data if sales to any single
customer amount to at least

A) $300,000
B) $1,500,000
C) $4,000,000
D) $5,000,000
Correct Answer: D
Explanation: FASB #131 requires disclosure of major customer data if sales to any major
customer is 10% or more of consolidated revenues. Since consolidated revenues amount to
$50,000,000, disclosure of major customer data would be required if sales to any single customer
amount to $5,000,000. In addition the amount of revenue from each major customer must be
disclosed plus the name of the segment making the sale.
One of a CPA firm's basic objectives is to provide professional services that conform with
professional standards. Reasonable assurance of achieving this basic objective is provided
through:

A) A system of quality control
B) A system of peer review
C) Continuing professional education
D) Compliance with generally accepted reporting standards
Correct Answer: A
Explanation: A system of quality control for a CPA firm, which usually encompasses quality
control policies and procedures, assignment of responsibilities, communication, and monitoring,
can provide a CPA firm with reasonable assurance of conforming with professional standards.
• Peer review which, as an external study of a firm's quality controls, can help evaluate a firm's
professional practice but is not done on a regular, ongoing basis.
• Continuing professional education is one example of an element of quality control.
• Compliance with generally accepted reporting standards could be considered an example of a
professional standard with which a firm should conform.
In a traditional job order cost system, the issue of indirect materials to a production
department increases which of the following?

A) Stores control.
B) Work in process control.
C) Factory overhead control.
D) Factory overhead applied.
Correct Answer: C
Explanation: When indirect materials were initially purchased, they would be charged to the
stores control. However, when they are issued to a production department, they would be
charged (increased) to the factory overhead control account.
To satisfy the UCC Statute of Frauds regarding the sale of goods, which of the following
must generally be in writing?

A) Designation of the parties as buyer and seller
B) Delivery terms
C) Quantity of the goods
D) Warranties to be made
Correct Answer: C
Explanation: The Statute of Frauds generally requires that the writing contain a quantity. It does
not require the designation of buyer and seller, the delivery terms or the warranties to be made.
Under the Sales Article of the UCC, which of the following events will release the buyer
from all its obligations under a sales contract?

A) Destruction of the goods after risk of loss passed to the buyer.
B) Impracticability of delivery under the terms of the contract.
C) Anticipatory repudiation by the buyer that is retracted before the seller cancels the contract.
Refusal of the seller to give written assurance of performance when reasonably demanded
D)
by the buyer.
Correct Answer: D
Explanation: A buyer is released from liability if the seller refuses to give written assurance of
performance when reasonably demanded.
• If risk of loss is with the buyer, the buyer is liable for all damage and would not be released.
• The seller may substitute a different means of delivery if the specified means becomes
impractical.
• An anticipatory breach can be retracted as long as the injured party has not canceled the
contract or materially changed position.
Book Co. uses the activity-based costing approach for cost allocation and product costing
purposes. Printing, cutting, and binding functions make up the manufacturing process.
Machinery and equipment are arranged in operating cells that produce a complete
product starting with raw materials. Which of the following are characteristics of Book's
activity-based costing approach?
I. Cost drivers are used as a basis for cost allocation.

II. Costs are accumulated by department or function for purposes of product costing.
III. Activities that do not add value to the product are identified and reduced to the extent
possible.

A) I only.
B) I and II.
C) I and III.
D) II and III.
Correct Answer: A
Explanation: Activity based costing assigns costs to products based upon the product's use of
activities (cost drivers) which caused the costs to be incurred. Costs are accumulated
(homogeneous cost pools) by activities (cost drivers) rather than by department or function as in
more traditional costing systems. Nonvalue-added activities (cost drivers), such as movement of
product, storage, set up, and inspection are minimized or eliminated without adversely affecting
the product or service.
The following information pertains to Aria Corp. and its divisions for the year ended
December 31, 2010:
Sales to unaffiliated customers $2,000,000

Intersegment sales of products similar to those sold to unaffiliated customers 600,000
Interest earned on loans to other industry segments 40,000
Aria and all of its divisions are engaged solely in manufacturing operations. Aria has a
reportable segment if that segment's revenue exceeds:

A) $264,000
B) $260,000
C) $204,000
D) $200,000
Correct Answer: B
Explanation: The test is 10% of all sales including intersegment sales. Therefore, any segment
with revenues of $260,000 or more qualifies as a reporting segment.
When an accountant examines a financial forecast that fails to disclose several significant
assumptions used to prepare the forecast, the accountant should describe the assumptions
in the accountant's report and issue a(an):

A) "Except for" qualified opinion
B) "Subject to" qualified opinion
C) Unqualified opinion with a separate explanatory paragraph
D) Adverse opinion
Correct Answer: D
Explanation: An accountant should not examine a presentation that omits all disclosures of
assumptions. If the presentation fails to disclose assumptions that appear to be significant, the
accountant should describe the assumptions in his report and issue an adverse opinion. "Except
for" qualified opinion. Would be appropriate if, in the accountant's opinion, the prospective
financial statements depart from AICPA presentation guidelines, other than a failure to disclose
significant assumptions.
The incorrect answer choices are not examples of modified accountant's reports involving a
financial forecast examination.
An examination of a financial forecast is a professional service that involves:

A) Compiling or assembling a financial forecast that is based on management's assumptions
Limiting the distribution of the accountant's report to management and the board of
B)
directors
Assuming responsibility to update management on key events for one year after the report's
C)
date
Evaluating the preparation of a financial forecast and the support underlying management's
D)
assumptions
Correct Answer: D
Explanation: An accountant may be engaged to examine, compile, or apply agreed-upon

procedures to financial forecasts or other prospective financial statements. An examination of a
financial forecast involves evaluating the preparation of the forecasted statements, evaluating the
support underlying the assumptions used in preparing the statements, evaluating the presentation
of the statements for conformity with AICPA guidelines, and issuing an examination report.
• Compilation is not an examination.

• The accountant's report on the examination of a financial forecast can be distributed to parties
outside of the reporting entity.
• The accountant's report specifically states that the accountant assumes no responsibility to
update the report for events and circumstances occurring after the date of the report.
Stable Corp. offered in a signed writing to sell Mix an office building for $350,000. The
offer, which was sent by Stable on April 1, indicated that it would remain open until July
9. On July 5, Mix mailed a letter rejecting Stable's offer. On July 6, Mix sent a telegram to
Stable accepting the original offer. The letter of rejection was received by Stable on July 8
and the telegram of acceptance was received by Stable on July 7. Which of the following is
correct?

A) Mix's telegram resulted in the formation of a valid contract.
B) Mix's letter of July 5 terminated Stable's offer when mailed.
C) Stable was not entitled to withdraw its offer until after July 9.
D) Although Stable's offer on April 1 was a firm offer under the UCC, it will only remain
open for three months.
Correct Answer: A
Explanation: The offer was accepted by telegram before the offer was terminated.
• Rejections are only effective when received, not when they are mailed.
• An offer can be revoked anytime before acceptance, even if it says it will be held open.
• Firm offers only apply to sale of goods, not real estate.
Dunn, Inc., had 200,000 shares of $20 par common stock and 20,000 shares of $100 par,
6%, cumulative, convertible preferred stock outstanding for the entire year ended
December 31, 2009. Each share is convertible into five shares of common stock. Dunn's net
income for 2009 was $840,000. For the year ended December 31, 2009, the diluted earnings
per share is:

A) $2.40
B) $2.80
C) $3.60
D) $4.20
Correct Answer: B
Explanation: Diluted EPS is the lesser of $840,000 ÷ 300,000 = $2.80 (assumes conversion) or

$840,000 - $120,000 = $720,000 ÷ 200,000 = $3.60 (basic earnings per share); therefore,
assuming conversion is dilutive.
In its April 2005 production, Hern Corp., which does not use a standard cost system,
incurred total production costs of $900,000, of which Hern attributed $60,000 to normal
spoilage and $30,000 to abnormal spoilage. Hern should account for this spoilage as

A) Period cost of $90,000
B) Inventoriable cost of $90,000
C) Period cost of $60,000 and inventoriable cost of $30,000
D) Inventoriable cost of $60,000 and period cost of $30,000
Correct Answer: D
Explanation: The cost of normal spoilage ($60,000) is a product cost which should be absorbed
by the good units produced and included in the recorded cost of both work-in-process and
finished goods inventories. The cost of abnormal spoilage ($30,000) is a period cost and should
be expensed in the current period.
Grant, Inc. acquired 30% of South Co.'s voting stock for $200,000 on January 2, Year 2.
Grant's 30% interest in South gave Grant the ability to exercise significant influence over
South's operating and financial policies. During Year 2, South earned $80,000 and paid
dividends of $50,000. South reported earnings of $100,000 for the six months ended June
30, Year 3, and $200,000 for the year ended December 31, Year 3. On July 1, Year 3,
Grant sold half of its stock in South for $150,000 cash. South paid dividends of $60,000 on
October 1, Year 3.
Before income taxes, what amount should Grant include in its Year 2 income statement as
a result of the investment?

A) $15,000
B) $24,000
C) $50,000
D) $80,000
Correct Answer: B
Explanation: $24,000 Investment income. As Grant's investment gives it the ability to exercise

significant influence over South's operating and financial policies, the equity method would be
used to account for the investment. Grant's equity in South's income is $24,000 (30% x $80,000
income).
An accountant's standard report on a compilation of a projection should not include:

A) A separate paragraph that describes the limitations on the presentation's usefulness
B) A statement that a compilation of a projection is limited in scope
A disclaimer of responsibility to update the report for events occurring after the report's
C)
date
D) A statement that the accountant expresses only limited assurance that the results may be
achieved
Correct Answer: D
Explanation: The accountant's standard report on a compilation of prospective financial

statements should include an identification of the financial statements, a statement that the
accountant compiled the statements in accordance with AICPA standards, a statement that a
compilation is limited in scope and does not enable the accountant to express an opinion or any
other form of assurance, a caveat that the results may not be achieved, a statement that the
accountant assumes no responsibility to update the report for events and circumstances occurring
after the date of the report. When the presentation is a projection, the report should include a
separate paragraph that describes the limitations on the usefulness of the presentation.
On September 27, Summers sent Fox a letter offering to sell Fox a vacation home for
$150,000. On October 2, Fox replied by mail agreeing to buy the home for $145,000.
Summers did not reply to Fox. Do Fox and Summers have a binding contract?

A) No, because Fox failed to sign and return Summers' letter.
B) No, because Fox's letter was a counteroffer.
C) Yes, because Summers' offer was validly accepted.
D) Yes, because Summers' silence is an implied acceptance of Fox's letter.
Correct Answer: B
Explanation: Since Fox changed the terms of the offer, the letter was a counteroffer and not a
valid acceptance. The remaining answer choices are incorrect because no contract was formed
and Fox doesn't have to sign and return an offer to accept.
Nile Co.'s cost allocation and product costing procedures follow activity-based costing
principles. Activities have been identified and classified as being either value-adding or
nonvalue-adding as to each product. Which of the following activities, used in Nile
production process, is nonvalue-adding?

A) Design engineering activity
B) Heat treatment activity
C) Drill press activity
D) Raw materials storage activity
Correct Answer: D
Explanation: In the production process, storing raw materials until they are needed represents a
non-value added step, whereas engineering, heat treatment or drilling represents improving the
product. In addition, storage requires handling costs, cost of holding inventory, possible breakage
or misappropriation, while inventory simply waits for use at a later time.
Sage, Inc., bought 40% of Adams Corp.'s outstanding common stock on January 2, Year 2,
for $400,000. The carrying amount of Adams' net assets at the purchase date totaled
$900,000. Fair values and carrying amounts were the same for all items except for plant
and inventory, for which fair values exceeded their carrying amounts by $90,000 and
$10,000, respectively. The plant has an 18-year life. All inventory was sold during Year 2.
During Year 2, Adams reported net income of $120,000 and paid a $20,000 cash dividend.
What amount should Sage report in its income statement from its investment in Adams for
the year ended December 31, Year 2?

A) $48,000
B) $42,000
C) $36,000
D) $32,000
Correct Answer: B
Explanation: $42,000 income from investment in Adams. Under the equity method the investor
recognizes in income its share of the investee's net income or loss subsequent to the date of
acquisition. Furthermore, the investor should reflect adjustments which would be made in
consolidation, based on the investor's percentage ownership, if such adjustments (eliminations)
can be recorded between investment income and the investment account.
On February 12, Harris sent Fresno a written offer to purchase Fresno's land. The offer
included the following provision: "Acceptance of this offer must be by registered or
certified mail, received by Harris no later than February 18 by 5:00 p.m. CST." On
February 18, Fresno sent Harris a letter accepting the offer by private overnight delivery
service. Harris received the letter on February 19. Which of the following statements is
correct?

A) A contract was formed on February 19.
B) Fresno's letter constituted a counteroffer.

C) Fresno's use of the overnight delivery service was an effective form of acceptance.
A contract was formed on February 18 regardless of when Harris actually received Fresno's
D)
letter.
Correct Answer: B
Explanation: Acceptances must be unconditional, complying with all of the offeror's terms. This
was a counteroffer because it was not sent by registered or certified mail and it was not received
by February 18. The remaining answer choices are incorrect because no contract was formed and
overnight delivery service was not registered or certified as required.
In an activity-based costing system, what should be used to assign a department's

manufacturing overhead costs to products produced in varying lot sizes?

A) A single cause and effect relationship.
B) Multiple cause and effect relationships.
C) Relative net sales values of the products.
D) A product's ability to bear cost allocations.
Correct Answer: B
Explanation: Activity based costing identifies the activities or transactions that cause costs to be
incurred (cost drivers). Costs are then assigned to products based upon the product's use of these
activities in its production. Multiple cost drivers are usually employed in costing a single product
as multiple activities are used in its production.
Which of the following bodies promulgates standards for audits of federal financial
assistance recipients?

A) Governmental Accounting Standards Board
B) Financial Accounting Standards Board
C) General Accounting Office
D) Governmental Auditing Standards Board
Correct Answer: C
Explanation: The General Accounting Office performs the audit function for Congress and has
published Standards for Audits of Governmental Organizations, Programs, Activities, and
Functions. The Governmental Accounting Standards Board (GASB) and the Financial
Accounting Standards Board (FASB) establish accounting standards, not auditing standards.
"Governmental Auditing Standards Board." does not exist.
On September 10, Harris, Inc., a new car dealer, placed a newspaper advertisement stating
that Harris would sell 10 cars at its showroom for a special discount only on September 12,
13, and 14. On September 12, King called Harris and expressed an interest in buying one
of the advertised cars. King was told that five of the cars had been sold and to come to the
showroom as soon as possible. On September 13, Harris made a televised announcement
that the sale would end at 10:00 p.m. that night. King went to Harris' showroom on
September 14 and demanded the right to buy a car at the special discount. Harris had sold
the 10 cars and refused King's demand. King sued Harris for breach of contract. Harris's
best defense to King's suit would be that Harris' _________________

A) offer was unenforceable.
B) advertisement was not an offer.
C) television announcement revoked the offer.
D) offer had not been accepted.
Correct Answer: B
Explanation: Advertisements and price quotes are not usually offers, they are invitations to deal.
The remaining answer choices are incorrect because no offer was made.
Which of the following audit procedures would most likely assist an auditor in identifying
conditions and events that may indicate there could be substantial doubt about an entity's
ability to continue as a going concern?

*
Review compliance with the terms of debt agreements
A)
B) Confirmation of accounts receivable from principal customers
C) Reconciliation of interest expense with debt outstanding
D) Confirmation of bank balances
Correct Answer: D
Explanation: Review of compliance with terms of debt and loan agreements is an audit

procedure that may identify conditions and events that indicate there could be substantial doubt
about an entity's ability to continue as a going concern for a reasonable period of time. Default
on such agreements may indicate possible financial difficulty.
The audit procedures listed in the incorrect answer choices would be less likely to identify
information about an entity's ability to continue as a going concern.
On July 1, Year 3, Denver Corp. purchased 3,000 shares of Eagle Co.'s 10,000 outstanding
shares of common stock for $20 per share. On December 15, Year 3, Eagle paid $40,000 in
dividends to its common stockholders. Eagle's net income for the year ended December 31,
Year 3, was $120,000, earned evenly throughout the year. In its Year 3 income statement,
what amount of income from this investment should Denver report?

A) $36,000
B) $18,000
C) $12,000
D) $6,000
Correct Answer: B
Explanation: Denver Corp. acquired 30% of Eagle Company's outstanding common stock. With
no evidence to the contrary, an investment of 20% or more is assumed to give significant
influence, and would be accounted for using the equity method. Under the equity method the
investor recognizes in income its share of the investee's net income or loss subsequent to the date
of acquisition. Investment income = $120,000 x 30% x 1/2 year = $18,000.
In order to prevent, detect, and correct errors and unauthorized tampering, a payroll
system should have adequate controls. The best set of controls for a payroll system
includes

Batch and hash totals, record counts of each run, proper separation of duties, passwords
A)
and user codes, and backup copies of activity and master files.
B) Employee supervision, batch totals, record counts of each run, and payments by check.
Passwords and user codes, batch totals, employee supervision, and record counts of each
C)
run.
D) Sign test, limit tests, passwords and user codes, online edit checks and payments by check.
Correct Answer: A
Explanation: This is a good combination of controls. Batch and hash totals and record counts
will detect input errors or skipped records. Proper separation of duties will prevent unauthorized
tampering and could help detect errors. Passwords and user codes can prevent unauthorized
tampering. And backup copies can help correct errors when files are damaged.
The retail inventory method includes which of the following in the calculation of both cost
and retail amounts of goods available for sale?

A) Purchase returns
B) Sales returns
C) Net markups
D) Freight in
Correct Answer: A
Explanation: Beginning inventory, purchases, and purchase returns are included in the

calculation of both cost and retail amounts of goods available for sale in the retail inventory
method.
Sales returns is an adjustment of sales, and neither are used in the computation of goods
available for sale.
Net markups affect only the retail value.
Freight-in affects only the cost value of goods available for sale.
A limitation on the scope of an auditor's examination sufficient to preclude an unqualified

opinion will usually result when management:

Presents financial statements that are prepared in accordance with the cash receipts and
A)
disbursements basis of accounting.
States that the financial statements are not intended to be presented in conformity with
B)
generally accepted accounting principles.
C) Does not make the minutes of the Board of Directors' meetings available to the auditor.
Asks the auditor to report on the balance sheet and not on the other basic financial
D)
statements.
Correct Answer: C
Explanation: The auditor will typically want the client to make all minutes of meetings of
stockholders, directors and committees of directors available. If management does not make
these minutes available to the auditor, this would be considered a scope restriction which could
result in the auditor qualifying his opinion or disclaiming an opinion.
• It refers to financial statements prepared in conformity with a basis of accounting other than
GAAP. The auditor can express an unqualified opinion on whether these financial statements are
presented fairly in conformity with the cash basis. The auditor's report on these cash-basis
financial statements would include a statement that they were prepared using a basis of
accounting other than GAAP and would refer the reader to a note in the financial statements
where management states that the financial statements are not intended to be presented in
accordance with GAAP.
• It involves a situation which has limited reporting objectives; the auditor can issue an
unqualified opinion on one basic financial statement and not on the others.
All of the following are examples of a decision support system (DSS) EXCEPT for a

A) Financial modeling application
B) Transaction processing system.
C) Database query application.
D) Sensitivity analysis application
Correct Answer: B
Explanation: A transaction processing system is not a DSS. A transaction processing system

processes (usually accounting) transactions at the basic level of an organization, providing
outputs usually on scheduled reports. A DSS, on the other hand, provides support for
unstructured or semi-structured decisions and suggests possible choices, accessing a database or
a decision-making model. A financial modeling application is an example of a DSS. These
systems provide support for unstructured or semi-structured decisions and suggest possible
choices, accessing a database or a decision making model. A database query application is an
example of a DSS. These systems provide support for unstructured or semi-structured decisions
and suggest possible choices, accessing a database or a decision-making model. A sensitivity
analysis application is an example of a DSS. Sensitivity analysis involves making changes to

some parameters or inputs and observing the impact of such changes on the result. DSSs,
likewise, provide support for unstructured or semi-structured decisions and suggest possible
choices, accessing a database or a decision-making model.
In general, which of the following statements is correct with respect to a limited

partnership?

A limited partner has the right to obtain from the general partner(s) financial information
A)
and tax returns of the limited partnership.
B) A limited partnership can be formed with limited liability for all partners.
C) A limited partner may not also be a general partner at the same time.
D) A limited partner may hire employees on behalf of the partnership.
Correct Answer: A
Explanation: The law gives to all investors the right to inspect books and records at reasonable
times. Stockholders, general partners and limited partners all have this right. Thus, a limited
partner may obtain financial information to include tax returns. A limited partnership must have
at least one general partner and general partners are personally liable for all partnership debts. A
limited partner may also be a general partner in the same partnership at the same time. A limited
partner may not take part in the control of the partnership.
Which one of the following tasks is LEAST likely to be undertaken in the implementation
phase of an accounting software application?

A) Obtain and install hardware
B) Enter and verify test data
C) Identify inputs and outputs
D) Document user procedures
Correct Answer: C
Explanation: The identification of inputs and outputs must occur well before implementation.
Inputs and outputs of the current system are identified during systems analysis, while inputs and
outputs of the new system are developed during the design phase. Hardware installation often
takes place during the implementation phase of an application. Testing the system is usually part
of the implementation phase. Completing the documentation usually takes place during the
implementation phase.
Young Corp. hired Wilson as a sales representative for six months at a salary of $5,000 per
month plus 6% of sales. Which of the following statements is correct?

Young does not have the power to dismiss Wilson during the six-month period without
A)
cause.
Wilson is obligated to act solely in Young's interest in matters concerning Young's
B)
business.
The agreement between Young and Wilson is not enforceable unless it is in writing and
C)
signed by Wilson.
D) The agreement between Young and Wilson formed an agency coupled with an interest.
Correct Answer: B
Explanation: Because an agent owes a fiduciary duty of loyalty to their principal, they must act
solely in the principal's best interests in matters concerning their business.
• Most agencies are terminable at will and therefore Young does have the power to dismiss
Wilson without cause.
• Only an agency to buy land or one impossible to perform in one year would require a writing
under the statute of frauds (GRIPE + marriage).
• With an agency coupled with an interest the principal makes a party their agent solely to pay
off a debt that the principal owes the agent. There is no indication that Wilson was hired by
Young solely to pay off a debt that Wilson owed Young.
Restrictions imposed by a client prohibit the observation of physical inventories, which

account for 35% of all assets. Alternative audit procedures cannot be applied, although the
auditor was able to examine satisfactory evidence for all other items in the financial
statements. The auditor should issue a(an):

A) "Except for" qualified opinion
B) Disclaimer of opinion
C) Unqualified opinion with a separate explanatory paragraph

D) Unqualified opinion with an explanation in the scope paragraph
Correct Answer: B
Explanation: Restrictions on the scope of an audit such as the timing of the work, inability to
obtain sufficient competent evidential matter, or an inadequacy in the accounting records, may
require an auditor to qualify his opinion or disclaim an opinion. When restrictions that
significantly limit the scope of the audit are imposed by the client, ordinarily the auditor should
disclaim an opinion on the financial statements.
During periods of rising prices, when the FIFO inventory method is used, a perpetual
inventory system results in an ending inventory cost that is:

A) The same as in a periodic inventory system
B) Higher than in a periodic inventory system
C) Lower than in a periodic inventory system
Higher or lower than in a periodic inventory system, depending on whether physical
D)
quantities have increased or decreased
Correct Answer: A
Explanation: Under the FIFO method, the cost of the oldest purchases are charged to cost of
goods sold and the costs of the most current purchases are assigned to ending inventory.
Therefore, the costs assigned to ending inventory and cost of goods sold are the same when a
periodic or perpetual inventory system is used with the FIFO cost flow assumption.
Noll gives Carr a written power of attorney. Which of the following statements is correct
regarding this power of attorney?

A) It must be signed by both Noll and Carr.
B) It must be for a definite period of time.
C) It may continue in existence after Noll's death.
D) It may limit Carr's authority to specific transactions.
Correct Answer: D
Explanation: A power of attorney usually limits an agent's authority to specific transactions.
• A power of attorney need only be signed by the principal, not the principal and the agent.
• A power of attorney may be for an indefinite period of time.
• Death of the principal terminates most agencies, to specifically include a power of attorney.
When using the periodic-inventory method, which of the following generally would not be
separately accounted for in the computation of cost of goods sold?

A) Trade discounts applicable to purchases during the period
B) Cash (purchase) discounts taken during the period
C) Purchase returns and allowances of merchandise during the period
D) Cost of transportation-in for merchandise purchased during the period
Correct Answer: A
Explanation: Cash discounts, purchase returns and allowances, and cost of transportation-in all
occur after the actual purchase and would be accounted for separately in cost of goods sold.
Trade discounts are deducted from a list price in arriving at the price charged the buyer and
recorded on the purchase invoice and would not be recorded separately.
When there is a significant change in accounting principle, an auditor's report should refer
to the lack of consistency in:

A) The scope paragraph
B) An explanatory paragraph between the second paragraph and the opinion paragraph
C) The opinion paragraph
D) An explanatory paragraph following the opinion paragraph
Correct Answer: D
Explanation: When there has been a change in accounting principles or in the method of their
application, the auditor should refer to the change in an explanatory paragraph (following the
opinion paragraph) which identifies the nature of the change and refers the reader to the note in
the financial statements that discusses the change. The other paragraphs in the auditor's report are
not affected.
In a computer system environment, the procedures that include the equipment

configuration, program, and data files to be used as well as description of conditions that
may require interruption of a program execution are known as

A) Operating documentation.
B) Application controls.
C) Administrative documentation.
D) Systems documentation.
Correct Answer: A
Explanation: Operating documentation is prepared for the computer operator so that he or she

can run the program. It includes the equipment configuration, instructions for entering data on
the console, and descriptions of conditions which cause the program to halt. Application controls
are controls built into a specific computer application. Administrative documentation includes
overall standards, policies, and procedures for the computer facility. Systems documentation is a
complete description of all aspects of each application, including flowcharts and program
listings.
A retained earnings appropriation can be used to:

A) Absorb a fire loss when a company is self-insured.
B) Provide for a contingent loss that is probable and reasonable.
C) Smooth periodic income.
D) Restrict earnings available for dividends.
Correct Answer: D
Explanation: An appropriation of retained earnings (a reserve) is used to inform financial

statement users of a restriction on the availability of retained earnings for dividends. The entry to
record an appropriation charges Retained Earnings and credits Appropriated Retained Earnings.
When the appropriation is no longer needed, the only proper entry is to reverse the entry that
established the appropriation.
A principal auditor decides not to refer to the audit of another CPA who audited a
subsidiary of the principal auditor's client. After making inquiries about the other CPA's
professional reputation and independence, the principal auditor most likely would:

Add an explanatory paragraph to the auditor's report indicating that the subsidiary's
A)
financial statements are not material to the consolidated financial statements.
Document in the engagement letter that the principal auditor assumes no responsibility for
B)
the other CPA's work and opinion.
Obtain written permission from the other CPA to omit the reference in the principal
C)
auditor's report.
Contact the other CPA and review the audit programs and working papers pertaining to the
D)
subsidiary.
Correct Answer: D
Explanation: If an auditor decides that he or she is the principal auditor and that he or she can
use the other auditor's report, because the other auditor is reputable and independent, the
principal auditor must decide whether or not to make reference to the other auditor. If the
principal auditor decides not to refer to the other auditor, he or she should visit the other auditor,
discuss the procedures followed, and review the audit program and working papers of the other
auditor.
• If the principal auditor decides not to refer to the other auditor, no references of any kind would
be made in the report.
• Assuming no responsibility for the other CPA's work and opinion would not fulfill the principal
auditor's reporting responsibilities.
• Permission would only be necessary if the principal auditor decides to refer to and name the
other auditor.
Ryan Company has an accounting information system that operates in a client/server

environment. Which one of the following situations is LEAST likely to provide Ryan with
an appropriate security environment?

A) Use of application passwords.
B) Power-on passwords for personal computers.
C) Installation of anti-virus programs.

D) Placing complete systems application controls under one individual.
Correct Answer: D
Explanation: If one individual has complete authority over systems applications controls, he or
she could too easily bypass those controls. Application passwords are helpful in prohibiting
access to software to only those authorized to use it. Power-on passwords are helpful in
prohibiting access to the system to only those authorized to have access. Anti-virus programs are
helpful in scanning disks and files introduced into the system for destructive virus software.
Work Corp. has decided to expand the scope of its business. In this connection, it
contemplates engaging several agents. Which of the following agency relationships is
within the statute of frauds and thus should be contained in a signed writing?

A sales agency where the agent normally will sell goods which have a value in excess of
A)
$500
B) An irrevocable agency
C) An agency which is of indefinite duration but which is terminable upon one month's notice
An agency for the forthcoming calendar year which is entered into in mid-December of the
D)
prior year
Correct Answer: D
Explanation: The statute of frauds only requires a writing for contracts for sale of goods of $500
or more, real estate, contracts impossible to perform in one year, a promise to answer the debt of
another, an executor's promise to be personally liable for the debt of an estate and contracts
where marriage is the consideration (GRIPE + marriage). An agency entered into in mid-
December and to last for the entire next year would be impossible to perform in one year and
would require a writing.
• Although the sales contracts of $500 or more would need a writing, the agency would not need
to be in writing.
• An irrevocable agency does not require a writing under the statute of frauds.
• An agency which is terminable upon one month's notice is not impossible to perform in one
year.
As a company becomes more conservative in its working capital policy, it would tend to
have a(n)

A) Decrease in its acid-test ratio.
B) Increase in the ratio of current liabilities to noncurrent liabilities.
C) Increase in the ratio of current assets to units of output.
Increase in funds invested in common stock and a decrease in funds invested in marketable
D)
securities.
Correct Answer: C
Explanation: A conservative working capital policy results in an increase in working capital.

Therefore, current assets increase. Working capital = current assets minus current liabilities. A
conservative working capital policy reduces the liquidity risk. A decrease in acid test ratio means
that quick assets such as cash, receivables and marketable securities are decreasing in proportion
to current liabilities and this results in lower working capital. Increases in the ratio of current
liabilities to noncurrent liabilities increases liquidity risk, and represents a less conservative
working capital policy. As a company becomes more conservative in its working capital policy,
it will not increase the funds invested in common stock (long term) and decrease funds invested
in marketable securities (short term).
In which of the following situations would a CPA's independence be considered to be

impaired?
I. The CPA maintains a checking account that is fully insured by a government deposit
insurance agency at an audit-client financial institution.
II. The CPA has a direct financial interest in an audit client, but the interest is maintained
in a blind trust.
III. The CPA owns a commercial building and leases it to an audit client. The rental
income is material to the CPA.

A) I and II
B) II and III
C) I and III
D) I, II, and III
Correct Answer: B
Explanation: Under Rule 101 of the Rules of Conduct as interpreted, independence is impaired

if there is a direct financial interest in an audit client regardless of materiality. Thus any direct
financial interest in an audit client impairs independence. Independence is specifically impaired
if the auditor owns a building and leases space to the client. Independence is not impaired if the
CPA maintains a checking account at a financial institution audit client and the account is fully
insured by a government agency. II and III impair independence, but I does not.
Ray Corp. declared a 5% stock dividend on its 10,000 issued and outstanding shares of $2
par value common stock, which had a fair value of $5 per share before the stock dividend
was declared. This stock dividend was distributed 60 days after the declaration date. By
what amount did Ray's current liabilities increase as a result of the stock dividend
declaration?

A) $0
B) $500
C) $1,000
D) $2,500
Correct Answer: A
Explanation: $0 current liability.

Declaration of a stock dividend does not affect current liabilities as the dividend will not be
satisfied with the current assets of the corporation. Rather, shares of stock will be issued to
satisfy the dividend. A stock dividend results in a transfer between equity accounts only, the
decrease in retained earnings being offset by an equal increase in the paid-in capital accounts.
King, CPA, was engaged to audit the financial statements of Newton Company after its
fiscal year had ended. King neither observed the inventory count nor confirmed the
receivables by direct communication with debtors, but was satisfied concerning both after
applying alternative procedures. King's auditor's report most likely contained a(an):

A) Qualified opinion
B) Disclaimer of opinion
C) Unqualified opinion
D) Unqualified opinion with an explanatory paragraph
Correct Answer: C
Explanation: Observation of the inventory count and confirmation of receivables is normally

performed during an audit. However, if circumstances do not permit these procedures to be
performed, the auditor may apply alternative audit procedures that may include observation of an
inventory count at a later date and the verification of receivable balances by auditing subsequent
cash receipts. If the auditor is able to employ alternative procedures he considers appropriate in
the circumstances, no modification or qualification of the audit report is necessary.
On December 1, 2009, Line Corp. received a donation of 2,000 shares of its $5 par value
common stock from a stockholder. On that date, the stock's market value was $35 per
share. The stock was originally issued for $25 per share. By what amount would this
donation cause total stockholders' equity to decrease?

A) $70,000
B) $50,000
C) $20,000
D) $0
Correct Answer: D
Explanation: A donation of stock to the corporation causes no reduction of assets and therefore
does not affect total stockholders' equity. Under the cost method, there would be only a
memorandum entry in the treasury stock account. When reissued, the proceeds would be credited
to APIC: Donated Capital. Under the par value method, Treasury Stock would be debited and
APIC: Donated Capital would be credited for the par value. When reissued, proceeds in excess
of par would be credited to APIC: Donated Capital.
A violation of the profession's ethical standards most likely would have occurred when a
CPA _________________

issued an unqualified opinion on the 2009 financial statements when fees for the 2008 audit
A)
were unpaid.
recommended a controller's position description with candidate specifications to an audit
B)
client.
purchased a CPA firm's practice of monthly write-ups for a percentage of fees to be
C)
received over a three-year period.
made arrangements with a financial institution to collect notes issued by a client in

D)
payment of fees due for the current year's audit.
Correct Answer: A
Explanation: Under Rule 101 of the Rules of Conduct as interpreted, independence is impaired

if there is a direct financial interest in an audit client regardless of materiality. Specifically
independence is impaired if audit fees remain unpaid for more than one year prior to the date of
the current year's report. It is considered a loan.
• Independence is not impaired by merely recommending a job position including candidate

specifications. However, independence would be +impaired if the CPA actually did the hiring of
the controller because this would be management.
• There is no prohibition against purchase of a CPA firm's monthly write-ups for a percentage of
fees.
• A CPA may make arrangements with a bank to collect notes issued by a client in payment for a
fee that is due.
In connection with the examination of the consolidated financial statements of Mott

Industries, Frazier, CPA, plans to refer to another CPA's examination of the financial
statements of a subsidiary company. Under these circumstances Frazier's report must
disclose:

A) The name of the other CPA and the type of report issued by the other CPA.
B) The magnitude of the portion of the financial statements examined by the other CPA.
C) The nature of Frazier's review of the other CPA's work.
In a footnote the portions of the financial statements that were covered by the examinations
D)
of both auditors.
Correct Answer: B
Explanation: When referring to another auditor's work, the principal auditor must disclose the
scope of the second auditor's examination in relation to the total consolidated assets of both
companies.
Which one of the following would increase the working capital of a firm?

A) Refinancing a short-term note payable with a two year note payable.
B) Purchase of a new plant financed by a 20-year mortgage.
C) Cash collection of accounts receivable.
D) Payment of a 20-year mortgage payable with cash.
Correct Answer: A
Explanation: Refinancing a short-term note payable with a two-year note payable would

increase the working capital of a firm.
Current Assets - Current Liabilities = Working Capital

Assuming CA = $10 and CL = $6, WC = $4. ($10 - $6 = $4)
If a company refinances $2 worth of short-term notes payable with a two year note payable,
working capital would increase. ($10 - $4 = $6).
The purchase of a new plant financed by a 20-year mortgage would not increase the working
capital of a firm. WC would stay the same. A cash collection of accounts receivable would not
increase the working capital of a firm. WC would stay the same. A payment of a 20-year
mortgage payable with cash would not increase the working capital of a firm. WC would
decrease.
Morgan, CPA, is the principal auditor for a multinational corporation. Another CPA has
examined and reported on the financial statements of a significant subsidiary of the
corporation. Morgan is satisfied with the independence and professional reputation of the
other auditor, as well as the quality of the other auditor's examination. With respect to
Morgan's report on the financial statements, taken as a whole, Morgan:

A) Must not refer to the examination of the auditor
B) Must refer to the examination of the other auditor
C) May refer to the examination of the other auditor
May refer to the examination of the other auditor, in which case Morgan must include in
D) the auditor's report on the consolidated financial statements, a qualified opinion with
respect to the examination of the other auditor.
Correct Answer: C
Explanation: The principal auditor may or may not refer to the other auditor's examination. If he
does, he is sharing the responsibility for his opinion. If he accepts full responsibility, no
reference is made to the other auditor.
Eagle and Falk are partners with capital balances of $45,000 and $25,000, respectively.
They agree to admit Robb as a partner. After the assets of the partnership are revalued,
Robb will have a 25% interest in capital and profits, for an investment of $30,000. What
amount should be recorded as goodwill to the original partners?

A) $0
B) $5,000
C) $7,500
D) $20,000
Correct Answer: D
Explanation: Robb's investment of $30,000 for a 25% partnership interest represents an

objective basis for the determination of the fair value of the partnership and for the calculation of
goodwill. If $30,000 is 25% of the fair value of the partnership, then the total fair value is
$120,000 ($30,000 / 25%). The difference between the fair value of the partnership ($120,000)
and the total book value of the three partner's capital of $100,000 ($45,000 + $25,000 + $30,000)
is goodwill of $20,000.
Starrs Company has current assets of $300,000 and current liabilities of $200,000. Which
of the following options could increase Starrs working capital?

A) Prepayment of $50,000 of next year's rent.
B) Refinancing of $50,000 of short-term debt with long-term debt.
C) Acquisition of land valued at $50,000 through the issuance of common stock.
D) Purchase of $50,000 of temporary investments for cash.
Correct Answer: B
Explanation: Working capital is equal to current assets - current liabilities. The refinancing of

$50,000 of short term debt with long term debt decreases current liabilities and increases long
term debt. The decrease in short term debt decreases current liabilities causing working capital to
go up. The prepayment of $50,000 of next year's rent increases and decreases current assets, thus
causing no change in working capital. The acquisition of land through the issuance of common
stock has no effect on current assets or current liabilities, therefore no change in working capital.
The purchase of temporary investments for cash increases and decreases current assets, thereby
not changing working capital.
A CPA's duty of due care to a client most likely will be breached when a CPA
_________________

A) gives a client an oral instead of written report.
B) gives a client incorrect advice based on an honest error of judgment.
C) fails to give tax advice that saves the client money.
D) fails to follow generally accepted auditing standards.
Correct Answer: D
Explanation: Liability for negligence requires proof of four elements: duty of care, breach (lack
of due care), damages and causality. Lack of due care is failure to act like a reasonably prudent
accountant and most often means the accountant failed to follow GAAS or GAAP. Thus the due
care required of an accountant to a client would be most likely breached by a failure to follow
generally accepted auditing standards (GAAS).
• Submission of an oral report instead of a written report does not constitute failure to use due
care.
• An honest error of judgment and a failure to give tax advice may be made by a reasonably
prudent accountant. Lack of due care only occurs when an accountant fails to do what a
reasonably prudent accountant would do.
The result of the economic order quantity formula indicates the

A) Annual quantity of inventory to be carried.
B) Annual usage of materials during the year.
C) Safety stock plus estimated inventory for the year.
D) Quantity of each individual order during the year.
Correct Answer: D
Explanation: The result of the economic order quantity formula indicates the quantity of each
individual order during the year. The result of the economic order quantity formula is not the
annual quantity of inventory carried. The result of the economic order quantity formula is not the
annual usage of materials during the year. The result of the economic order quantity formula is
not the safety stock plus estimated inventory for the year.
When, in the auditor's judgment, the financial statements are not presented fairly in
conformity with generally accepted accounting principles, the auditor will issue a(n):

A) Qualified opinion
B) Special report
C) Disclaimer of opinion
D) Adverse opinion
Correct Answer: D
Explanation: The question states the auditor concludes the statements are not in conformity with
GAAP. In order to make this statement in his report, the auditor must issue an adverse opinion. A
qualification, rather than an adverse opinion, still states the financial statements present fairly,
except for... An adverse opinion states the "financial statements do not present fairly..."
Allen retired from the partnership of Allen, Beck and Chale. Allen's cash settlement from
the partnership was based on new goodwill determined at the date of retirement plus the
carrying amount of the other net assets. As a consequence of the settlement, the capital
accounts of Beck and Chale were decreased. In accounting for Allen's withdrawal, the
partnership could have used which of the following methods?

A) Bonus method No Goodwill method Yes
B) Bonus method No Goodwill method No
C) Bonus method Yes Goodwill method Yes
D) Bonus method Yes Goodwill method No
Correct Answer: D
Explanation: Under the bonus method the capital accounts of the non-retiring partners are
charged (in proportion to their P & L ratios) for the distribution to the retiring partner in excess
of the retiring partner's capital balance (the bonus). Under the goodwill method, the inherent
goodwill (or at least the portion attributable to the retiring partner) is recorded, increasing the
retiring partner's capital balance to an amount equal to the retirement distribution. The capital
balances of the non-retiring partners would not be decreased by the retirement of a partner, but
would be increased if all inherent goodwill were recorded.
Sun Corp. approved a merger plan with Cord Corp. One of the determining factors in
approving the merger was the financial statements of Cord that were audited by Frank &
Co., CPAs. Sun had engaged Frank to audit Cord's financial statements. While performing
the audit, Frank failed to discover certain irregularities that later caused Sun to suffer
substantial losses. For Frank to be liable under common law negligence, Sun at a minimum
must prove that Frank _________________

A) knew of the irregularities.
B) failed to exercise due care.
C) was grossly negligent.
D) acted with scienter.
Correct Answer: B
Explanation: Liability for negligence requires proof of four elements: duty of care, breach (lack
of due care), damages and causality. Thus Sun must prove Frank failed to exercise due care.
• Knowledge is not an element of negligence.

• Gross negligence is constructive fraud. Fraud requires an element of intent and negligence does
not.
• Scienter is the intent element of fraud and negligence does not require proof of intent.
A company issues audited financial statements under circumstances which require the
presentation of a statement of cash flows. If the company refuses to present a statement of
cash flows, the independent auditor should:

A) Disclaim an opinion.
Prepare a statement of cash flows and note in a middle paragraph of the report that this
B)
statement is auditor-prepared.
Prepare a statement of cash flows and disclose in a footnote that this statement is auditor-
C)
prepared.
Qualify his opinion with an "except for" qualification and a description of the omission in a
D)
middle paragraph of the report.
Correct Answer: D
Explanation: The statement of cash flows is required by GAAP and its omission results in a
qualified except for opinion. The statement of cash flows, for reporting purposes, is considered
the omission of a disclosure.
Cor-Eng Partnership was formed on January 2, 2009. Under the partnership agreement,
each partner has an equal initial capital balance accounted for under the goodwill method.
Partnership net income or loss is allocated 60% to Cor and 40% to Eng. To form the
partnership, Cor originally contributed assets costing $30,000 with a fair value of $60,000
on January 2, 2009, while Eng contributed $20,000 in cash. Drawings by the partners
during 2009 totaled $3,000 by Cor and $9,000 by Eng. Cor-Eng's 2009 net income was
$25,000. Eng's initial capital balance in Cor-Eng is?

A) $20,000
B) $25,000
C) $40,000
D) $60,000
Correct Answer: D
Explanation: Under the partnership agreement, each partner has an equal initial capital balance,
and goodwill is to be recognized. Cor's original capital balance will be $60,000, the fair market
value of the net assets contributed as of the date of contribution. Therefore, Eng's original capital
balance will be $60,000, an equal amount, and goodwill of $40,000 will be attributed to Eng
($60,000 capital - $20,000 cash contribution).

Workers' Compensation Acts require an employer to _________________

A) provide coverage for all eligible employees.
B) withhold employee contributions from the wages of eligible employees.
C) pay an employee the difference between disability payments and full salary.
D) contribute to a federal insurance fund.
Correct Answer: A
Explanation: Employees will receive workers' compensation benefits if injured in the scope of

employment. An employer must provide coverage to all eligible employees.
• An employer withholds employee contributions with social security, not workers'

compensation.
• Workers' compensation benefits are based on the injury, not on the employee's pay.
• An employer does not contribute to a federal insurance fund (there is no federal insurance
fund). Employers may purchase private workers' compensation insurance, be self-insured or
make payments to a state insurance plan.
Which group of ratios would be useful in evaluating the effectiveness of working capital
management?

A) Profit margin, acid-test ratio, and return on assets.
B) Acid-test ratio, inventory turnover ratio, and average collection period ratio.
C) Inventory turnover ratio, times interest earned, and debt-to-equity ratio.
D) Acid-test ratio, current ratio, and return on equity.
Correct Answer: B
Explanation: The acid test ratio, inventory turnover ratio, and average collection period ratio are
all ratios that would be useful in evaluating the effectiveness of working capital management
because they each are made up of current assets and current liabilities. Profit margin and return
on assets are not ratios that would be useful in evaluating the effectiveness of working capital
management. Profit margin and return on assets relate to profitability. Times interest earned and
debt to equity ratio are not ratios that would be useful in evaluating the effectiveness of working
capital management because these ratios do not relate to current assets and current liabilities.
Return on equity is not a ratio that would be useful in evaluating the effectiveness of working
capital management because this ratio does not relate to current assets and current liabilities.
Limitation on the scope of the auditor's examination may require the auditor to issue a
qualified opinion or to disclaim an opinion. Which of the following would generally be a
limitation on the scope of the auditor's examination?

A) The unavailability of sufficient competent evidential matter
B) The engagement of the auditor to report on only one basic financial statement
The examination of a subsidiary's financial statements by an auditor other than the one who
C)
examines and reports on the consolidated financial statements
D) The engagement of the auditor after year end
Correct Answer: A
Explanation: Limitations on the scope of the audit can come about by client restrictions,
inability to obtain sufficient competent evidential matter or inadequacy of client accounting
records.
• The auditor can report on only one basic financial statement.

• The use of another auditor is not a scope limitation.
• "The engagement of the auditor after year end." is incorrect because this would not necessarily
result in a scope limitation.
Which of the following provisions is basic to all workers' compensation systems?

A) The injured employee must prove the employer's negligence.
B) The employer may invoke the traditional defense of contributory negligence.
The employer's liability may be ameliorated by a co-employee's negligence under the
C)
fellowservant rule.
D) The injured employee is allowed to recover on strict liability theory.
Correct Answer: D

employment. The employer is strictly liable without regard to fault. The remaining answer
choices are incorrect because negligence will not bar recovery. Negligence is irrelevant. Thus,
the employee does not need to prove the employer negligent, the defense of contributory
negligence by the employee is not available and the liability of the employer is not changed by
the negligence of a co-employee.
What is the purpose of a lock-box system?

A) Accelerates the inflow of funds.
B) Reduces the need for compensating balances.
C) Provides security for late night deposits.
D) Reduces the risk of having checks lost in the mail.
Correct Answer: A
Explanation: A lockbox system accelerates the inflow of funds. A company has numerous
locations throughout their servicing area which will receive payments and are immediately
deposited in the company's bank accounts, thereby speeding the availability of the funds. A
lockbox system does not reduce the need for compensating balances. A lockbox system has
nothing to do with security for late night deposits. A lockbox system does not reduce the risk of
having checks lost in the mail. Checks are still sent in the mail to the various locations within the
servicing area.
On July 1, 2010, a partnership was formed by Johnson and Smith. Johnson contributed
cash. Smith, previously a sole proprietor, contributed property other than cash including
realty subject to a mortgage, which was assumed by the partnership. Smith's capital
account at July 1, 2010, should be recorded at?

A) Smith's book value of the property at July 1, 2010
B) Smith's book value of the property less the mortgage payable at July 1, 2010
C) The fair value of the property less the mortgage payable at July 1, 2010
D) The fair value of the property at July 1, 2010
Correct Answer: C
Explanation: For financial accounting purposes, non-cash contributions are recorded at the fair
market value of the net assets contributed as of the date of contribution.
Which of the following audit procedures is best for identifying unrecorded trade accounts
payable?

Reviewing cash disbursements recorded subsequent to the balance sheet date to determine
A)
whether the related payables apply to the prior period.
Investigating payables recorded just prior to and just subsequent to the balance sheet date
B)
to determine whether they are supported by receiving reports.
Examining unusual relationships between monthly accounts payable balances and recorded
C)
cash payments.
Reconciling vendors' statements to the file of receiving reports to identify items received
D)
just prior to the balance sheet date.
Correct Answer: A
Explanation: The auditor reviews cash disbursements recorded in the period subsequent to the
balance sheet date to determine if they represent payments for goods and/or services received
during the period ending on the balance sheet date. If so, the auditor would then determine
whether or not they have been properly recorded in the period prior to the balance sheet date.
This review of subsequent payments is designed to identify unrecorded trade accounts payable
and other unrecorded liabilities.
• "Investigating payables recorded just prior to and just subsequent to the balance sheet date to
determine whether they are supported by receiving reports." would not detect unrecorded
liabilities because it is testing recorded payables, not potentially unrecorded payables.
• Cash payments are made for many items, not just for accounts payable. Therefore, the
relationship between cash payments and accounts payable balances may fluctuate based on other
activity.
• Reconciling vendor statements to receiving reports would not disclose unrecorded liabilities
unless comparisons were also made with recorded payables and cash payments.
Governmental financial reporting should provide information to assist users in which

situation(s)?
I. Making social and political decisions.

II. Assessing whether current-year citizens received services but shifted part of the
payment burden to future-year citizens.

A) I only
B) II only
C) Both I and II
D) Neither I nor II
Correct Answer: C
Explanation: Governmental financial reporting should provide information to assist users in

making social and political decisions and in assisting users in assessing whether current-year
citizens receive services whose payment is shifted to future years.
Which of following correctly describes the overall cost of capital?

A) Rate of return on assets that covers the costs associated with the funds employed.
B) Average rate of return a firm earns on its assets.
C) Minimum rate a firm must earn on high risk projects.
Cost of the firm's equity capital at which the market value of the firm will remain
D)
unchanged.
Correct Answer: A
Explanation: The overall cost of capital is the rate of return on assets that covers the cost
associated with the funds employed. The overall cost of capital is the weighted average cost of
capital which includes both debt and equity. The overall cost of capital is not the average rate of
return a firm earns on its assets. Hopefully, a firm earns a higher rate of return than the overall
cost of capital. The minimum rate a firm must earn on any project is not related to the overall
cost of capital. The overall cost of capital is not related to the cost of a firm's equity capital at
which the market value of the firm will remain unchanged.
Which of the following provisions is basic to all workers' compensation systems?

A) The injured employee must prove the employer's negligence.
B) The employer may invoke the traditional defense of contributory negligence.
The employer's liability may be ameliorated by a co-employee's negligence under the
C)
fellowservant rule.
D) The injured employee is allowed to recover on strict liability theory.
Correct Answer: D

employment. The employer is strictly liable without regard to fault. The remaining answer
choices are incorrect because negligence will not bar recovery. Negligence is irrelevant. Thus,
the employee does not need to prove the employer negligent, the defense of contributory
negligence by the employee is not available and the liability of the employer is not changed by
the negligence of a co-employee.
Generally, which of the following statements concerning workers' compensation laws is

correct?

A) The amount of damages recoverable is based on comparative negligence.
B) Employers are strictly liable without regard to whether or not they are at fault.
C) Workers' compensation benefits are not available if the employee is negligent.
D) Workers' compensation awards are payable for life.
Correct Answer: B

employment. The employer is strictly liable without regard to fault.
• Negligence by the employee will not bar recovery or change the amount of the award.
• Workers' compensation awards may be in the form of a lump sum and, thus, not be payable for
life.
Star Co. leases a building for its product showroom. The ten-year non-renewable lease will
expire on December 31, 2009. In January 2010, Star redecorated its showroom and made
leasehold improvements of $48,000. The estimated useful life of the improvements is 8
years. What amount of leasehold improvements, net of amortization, should Star report in
its June 30, 2010, balance sheet?

A) $45,600
B) $45,000
C) $44,000
D) $43,200
Correct Answer: C
Explanation: Leasehold improvements are capitalized and amortized over the lesser of the
remaining life of the lease (6 years) and the useful life of the improvements (8 years). In this case
the $48,000 is amortized over 6 years resulting in an annual rate of $8,000 per year or $4,000 for
six months.
The problem requires the amount of leasehold improvements net of amortization that should be
reported on the balance sheet six months after the improvements were made. The amount
reported should be $44,000, the original cost ($44,000) less six months amortization ($4,000).
An auditor selected items for test counts while observing a client's physical inventory. The
auditor then traced the test counts to the client's inventory listing. This procedure most
likely obtained evidence concerning management's assertion of:

A) Rights and obligations
* B) Completeness
C) Existence or occurrence
D) Valuation
Correct Answer: B
Explanation: Assertions about completeness deal with whether all accounts and transactions
that should be presented in the financial statements are so included. If an auditor test counts
selected items while observing a client's physical inventory and then traces those counts to the
client's inventory listing, the auditor is obtaining evidence that all inventory items that should be
included in the listing, which becomes the basis for the financial statement amounts, are so
included.
The assertions presented in the incorrect answer choices are not tested by this procedure. If an
inventory item is test counted and on the listing, the client may not have the rights to that item. In
order to test existence, the auditor would compare the listing to the actual items on hand instead
of comparing the test counts to the listing. Valuation of inventory includes tests of lower of cost
and market, not just quantities obtained during test counts.
A preferred stock is sold for $101 per share, has a face value of $100 per share,
underwriting fees of $5 per share, and annual dividends of $10 per share. If the tax rate is
40 percent, the cost of funds (capital) for the preferred stock is

A) 4.2 percent
B) 6.2 percent
C) 10.0 percent
D) 10.4 percent
Correct Answer: D
Explanation: The cost of capital for preferred stock is the dividends per year divided by the net
amount received upon stock issuance. Thus, the cost of capital for the preferred stock is 10.4%
($10 ÷ $96).
According to the FASB Conceptual Framework, earnings:

A) Are the same as comprehensive income
B) Exclude certain gains and losses that are included in comprehensive income
C) Include certain gains and losses that are excluded from comprehensive income
D) Include certain losses that are excluded from comprehensive income
Correct Answer: B
Explanation: Comprehensive income is broader than earnings and includes certain gains and
losses not included in earnings. Examples are holding losses or gains on available-for-sale
marketable equity securities, foreign currency translation adjustments and minimum pension
liability adjustments.
Queen paid Pax & Co. to become the surety on a loan which Queen obtained from Squire.
The loan is due and Pax wishes to compel Queen to pay Squire. Pax has not made any
payments to Squire in its capacity as Queen's surety. Pax will be most successful if it
exercises its right to _________________

A) reimbursement (Indemnification).
B) contribution.
C) exoneration.
D) subrogation.
Correct Answer: C
Explanation: Exoneration is the right of a surety prior to payment to get a court order

demanding that the debtor pay. Exoneration is the only right the surety may use prior to payment.
Reimbursement (the right of a surety to recover from the debtor payments made to the creditor)
only occurs after payment by the surety. Subrogation (the right of the surety to gain the creditor's
rights once the surety makes full payment) only occurs after payment by the surety. Contribution
(the right of a cosuretor to receive a pro rata contribution from other cosuretors for amounts paid
the creditor) only occurs after payment by the cosurety. Since Pax the surety has not made any
payments to the creditor, the only right Pax can successfully assert is the right of exoneration.
When using a flexible budget, a decrease in production levels within a relevant range
would result in which of the following?

A) Decreases variable cost per unit.
B) Decreases total costs.
C) Increases total fixed costs.
D) Increases variable cost per unit.
Correct Answer: B
Explanation: Within the relevant range, total fixed costs do not change and variable cost per
unit does not change (total variable costs change proportionately with activity). Therefore, a
decrease in the production level (within the relevant range) would result in an increase in fixed
costs per unit as the total fixed costs are allocated to fewer units and a decrease in total variable
costs as they change proportionally with activity or production.
Rainbow wants to use unrestricted random sampling without replacement in 2010.

Compared to 2009, the population size of the raw-materials inventory is approximately the
same, and the variability of the items in the inventory is approximately the same. Rainbow
specifies the same precision but desires to change the specified reliability from 90% to
95%. Under these assumptions, the required sample size for 2010 should be:

A) Larger than the 2009 sample size
B) Equal to the 2009 sample size
C) Smaller than the 2009 sample size
D) Of a size that is indeterminate based upon the information given
Correct Answer: A
Explanation: Sampling without replacement was in use for the two years compared and the
finite population correction factor will not have any effect. An increase in the reliability from 90
to 95% will cause an increase in the sample size.

Batch6 CPA REVIEW QUESTIONS

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Batch6 CPA REVIEW QUESTIONS

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CPA QUESTIONS BATCH 6

A CPA should not submit unaudited financial statements of a nonpublic company to a

contribution margin is calculated in two steps:

Explanation: To be negotiable an instrument must be signed by maker or drawer, be

• It is the maker or drawer that must sign, not the payee.

The most likely strategy to reduce the breakeven point would be to

1. Revenue less variable cost of goods sold = Contribution margin: manufacturing

Transaction gains or losses are not extraordinary.

Transaction gains or losses are a part of income from continuing operations.

An auditor who was engaged to perform an examination of the financial statements of a

circumstances the auditor would most likely:

Attachment and perfection will occur simultaneously when _________________

Manhof Co. prepares supplementary reports on income from continuing operations on a

One example of a "special report," as defined by Statements on Auditing Standards, is a

Which of the following conditions is necessary for a practitioner to accept an attest

• The examination may be separate or in conjunction with an audit.

Accepting an engagement to examine an entity's financial projection most likely would be

Explanation: The implied warranty of merchantability arises if the seller is a merchant.

Hill, CPA, is auditing the financial statements of Helping Hand, a not-for-profit

nominal dollar financial statements and in constant dollar financial statements.

When reporting on an entity's internal control structure under Government Auditing

Explanation: Government Auditing Standards requires a written report on the internal control

Grum Corp., a publicly-owned corporation, is subject to the requirements for segment

customer amount to at least

I. Cost drivers are used as a basis for cost allocation.

December 31, 2010:

Sales to unaffiliated customers $2,000,000

An examination of a financial forecast is a professional service that involves:

Explanation: An accountant may be engaged to examine, compile, or apply agreed-upon

• Compilation is not an examination.

open for three months.

Explanation: Diluted EPS is the lesser of $840,000 ÷ 300,000 = $2.80 (assumes conversion) or

Explanation: $24,000 Investment income. As Grant's investment gives it the ability to exercise

An accountant's standard report on a compilation of a projection should not include:

Explanation: The accountant's standard report on a compilation of prospective financial

B) Fresno's letter constituted a counteroffer.

In an activity-based costing system, what should be used to assign a department's

"Governmental Auditing Standards Board." does not exist.

Explanation: Review of compliance with terms of debt and loan agreements is an audit

Explanation: Beginning inventory, purchases, and purchase returns are included in the

Net markups affect only the retail value.

A limitation on the scope of an auditor's examination sufficient to preclude an unqualified

Explanation: A transaction processing system is not a DSS. A transaction processing system

analysis application is an example of a DSS. Sensitivity analysis involves making changes to

In general, which of the following statements is correct with respect to a limited

Restrictions imposed by a client prohibit the observation of physical inventories, which

C) Unqualified opinion with a separate explanatory paragraph

Explanation: A power of attorney usually limits an agent's authority to specific transactions.

In a computer system environment, the procedures that include the equipment

Explanation: Operating documentation is prepared for the computer operator so that he or she

A retained earnings appropriation can be used to:

Explanation: An appropriation of retained earnings (a reserve) is used to inform financial

Ryan Company has an accounting information system that operates in a client/server

C) Installation of anti-virus programs.

Explanation: A conservative working capital policy results in an increase in working capital.

In which of the following situations would a CPA's independence be considered to be

Explanation: Under Rule 101 of the Rules of Conduct as interpreted, independence is impaired

Explanation: $0 current liability.

Explanation: Observation of the inventory count and confirmation of receivables is normally

made arrangements with a financial institution to collect notes issued by a client in

Explanation: Under Rule 101 of the Rules of Conduct as interpreted, independence is impaired

• Independence is not impaired by merely recommending a job position including candidate

In connection with the examination of the consolidated financial statements of Mott