Financial Accounting and Reporting (FAR) Sample Questions


The following sample questions for the Financial Accounting and Reporting (FAR) of the CPA Exam have been provided by Roger CPA Review.  

View questions for the other sections of the exam.

 

QUESTION: Consistency and feedback relate most closely to which two of the following accounting concepts, respectively?

  1. Predictive value and confirmatory value
  2. Recognition and full disclosure
  3. Conservatism and cost/benefit
  4. Recognition and matching

ANSWER: Answer (a) is correct. Consistency is associated with predictive value since, when items are accounted for consistently from one year to another, users can identify trends and use this information to anticipate what might be expected to occur in the future. Feedback is associated with confirmatory value as feedback, such as actual results, provides information as to the degree to which predictions made in the past were accurate. Recognition relates to when items will appear on financial statements and full disclosure relates to the completeness of information provided. Cost/benefit refers to the fact that an entity should not incur a cost to obtain or provide information which exceeds the benefit of having that information.


QUESTION: Catastrophe Corp. has determined it is not a going concern, and will likely go bankrupt. Which basis of accounting will Catastrophe adopt?

  1. Tax basis
  2. Remain with GAAP
  3. Cash basis
  4. Liquidation basis

ANSWER: Answer (d) is correct. When an entity has determined that it is not a going concern, which means that there is substantial doubt that it will be able to meet its obligations as they become due for at least one year from the date on which they issue their financial statements. Only when liquidation is imminent, which means the entity has adopted a plan of liquidation or one is being imposed on it, will it switch to the liquidation basis of accounting. Whether or not an entity is a going concern is not a factor as to whether or not it will apply the tax or cash basis of accounting.


QUESTION: Under U.S. GAAP, which of the following would be included in accumulated other comprehensive income as a component of stockholders’ equity on the balance sheet? Assume no fair value election for reporting investments.

  1. Unrealized fair value gains or losses on held-to-maturity investments
  2. Foreign currency translation adjustments
  3. Certain gains and losses on derivative financial instruments designated as fair value hedges.
  1. III only.
  2. I and III only.
  3. II only.
  4. I, II, and III.

ANSWER: Answer (c) is correct. Items reported in other comprehensive income and reported in the aggregate in accumulated other comprehensive income, a component of stockholders’ equity, include unrealized gains and losses on available for sale securities, adjustments to a pension asset or liability resulting from the difference between the projected benefit obligation and the fair value of plan assets, translation adjustments resulting from the consolidation of foreign subsidiaries, and changes in the value of derivatives designated as cash flow hedges. Held to maturity securities are reported at amortized cost, not fair value, and unrealized gains and losses are not recognized. Changes in the value of fair value hedges are reported in income, not other comprehensive income.


QUESTION: A company reports the following information as of December 31:


Sales revenue
$350,000
Cost of goods sold
$150,000
Operating expenses
$110,000
Foreign currency translation gain
$ 25,000
Ignoring income taxes, what amount should the company report as comprehensive income as of December 31?
  1. $90,000
  2. $125,000
  3. $150,000
  4. $115,000

ANSWER: Answer (d) is correct. Comprehensive income includes net income plus other comprehensive income (OCI); or all changes in equity during a period except those resulting from investments by owners and distributions to owners. The company’s net income includes sales revenues of $350,000 minus costs of goods sold of $150,000 minus operating expenses of $110,000, for a net amount of $90,000. Other comprehensive income (OCI) includes the foreign currency translation gain of $25,000. Therefore, comprehensive income equals $115,000 ($90,000 + $25,000).


QUESTION: When applying the revenue test to determine if a segment is a reportable segment, the segment’s revenues are compared to the total for the entity. Which of the following revenue items should be included in the revenue calculation?

  1. Sales to unaffiliated customers
  2. Interest earned from loans to other segments
  3. Intersegment sales of products
  1. I, II, and III
  2. I and III only
  3. I and II only
  4. I only

ANSWER: Answer (b) is correct. In evaluating whether or not a business segment is a reportable segment, an entity will compare the segment’s revenues to total revenues of all segments. Revenues include sales to unaffiliated customers and to other segments. It does not, however, include interest earned, which is a form of other income but not revenues.


QUESTION: Capsule Corp. reported the following in 2014:


Beginning retained earnings
$260,000
Ending retained earnings
$290,000
Cash dividends declared
$90,000
Beginning accumulated other comprehensive income
$20,000
Ending accumulated other comprehensive income
$15,000
What was Capstone’s comprehensive income for 2014?
  1. $125,000
  2. $55,000
  3. $115,000
  4. $65,000

ANSWER: Answer (c) is correct. Comprehensive income is equal to net income plus other comprehensive income (OCI). Ending retained earnings of $290,000 consists of beginning retained earnings of $260,000 plus net income and minus dividends of $90,000. Beginning retained earnings reduced by dividends gives a balance of $170,000, requiring net income of $120,000 to give an ending balance of $290,000. Ending accumulated other comprehensive (AOCI) of $115,000 equals beginning AOCI of $120,000 plus OCI. As a result, OCI is equal to the reduction in AOCI of $5,000 and comprehensive income is $120,000 - $5,000 or $115,000.


QUESTION: Misk, Inc. received from a customer a one year, $750,000 note bearing annual interest of 9%. After holding the note for six months, Misk discounted the note at National Bank at an effective interest rate of 12%. What amount of cash did Mick receive from the bank?

  1. $700,950
  2. $719,400
  3. $780,713
  4. $768,450

ANSWER: Answer (d) is correct. Misk will first calculate the maturity value of the note, which will be the face value of $750,000 plus one year’s interest at 9% or $67,500. Since the note is being discounted after 6 months, the bank will receive $817,500 after six months. The discount will be $817,500 X 12% X 6/12 or $49,050. As a result, Misk will receive $817,500 - $49,050 or $768,450 from the bank.


QUESTION: When the allowance method of recognizing uncollectible accounts is used, which of the following statements is true regarding the impact a collection of an account previously written off would have on Accounts Receivable and Allowance for Doubtful Accounts balances?

  1. Accounts Receivable would not change and Allowance for Doubtful Accounts would decrease.
  2. Accounts Receivable would not change and Allowance for Doubtful Accounts would increase.
  3. Accounts Receivable would increase and Allowance for Doubtful Accounts would decrease.
  4. Accounts Receivable would increase and Allowance for Doubtful Accounts would not change.

ANSWER: Answer (b) is correct. The recovery of a receivable that was previously written off is recognized by first reversing the entry to write it off with an increase to the allowance account and an increase in Accounts Receivable. The collection is recorded with an increase in Cash and a decrease to Accounts Receivable. The net effect is an increase in the allowance account and an increase in Cash with no change to Accounts Receivable.


QUESTION: Which of the following inventory valuation methods produce(s) the same dollar amount as the balance in ending inventory under both periodic and perpetual inventory systems?


FIFO
LIFO
a.
Yes
Yes
b.
No
Yes
c.
Yes
No
d.
No
No

ANSWER: Answer (c) is correct. Since FIFO assumes that ending inventory consists of the most recent purchases, the FIFO cost flow assumption leads to the same ending inventory balance under both the perpetual and periodic systems. Under the LIFO cost flow assumption, the most recent goods purchased are assumed to be sold while older inventory is assumed to remain on hand. When using the periodic method under LIFO, it is assumed that all sales occur at the end of the period and are taken from the latest purchases. Since goods cannot be sold before they are purchased, the perpetual method will require that early sales be charged against the most recent purchases as of the date of sale and will lead to a different ending inventory balance.


QUESTION: West Co. recorded the following inventory information during the month of February:


Units
Unit Cost
Total Cost
Units on Hand
Balance on 2/1
800
$2
$1,600
800
Purchased on 2/8
1,000
$3
$3,000
1,800
Sold on 2/14
1,500
300
Purchased on 2/17
2,000
$1
$2,000
2,300
Sold on 2/23
1,600
700
Purchased on 2/28
800
$4
$3,200
1,500

West uses the LIFO method to cost inventory. What amount should West report as inventory at the end of February under each of the following methods of recording inventory?

  1. Perpetual: $3,700, Periodic: $4,200
  2. Perpetual: $4,200, Periodic: $3,700
  3. Perpetual: $3,700, Periodic: $3,700
  4. Perpetual: $4,200, Periodic: $4,200

ANSWER: Answer (b) is correct. Under the perpetual method, purchases and sales are recognized as they occur. As a result, the sale of 1,500 units on 2/14 would consist of the 1,000 units purchased on 2/8 and 500 of those in beginning inventory, leaving 300 from beginning inventory. The 1,600 units sold on 2/23 all would have come from the 2,000 purchased on 2/17, leaving 400 of those unites in ending inventory. As a result, ending inventory would consist of 300 from beginning inventory at $2, or $600, 400 from the purchase on 2/17 at $1, or $400, and the 800 purchased on 2/28 at $4, or $3,200 for a total of $4,200. Under the periodic method, it is assumed that all sales occurred at the end of the period. As a result, the total sales of 3,100 units would have included the 800 purchased on 2/28, the 2,000 purchased on 2/17, and 300 of those purchased on 2/8. Ending inventory would consist of the 800 units in beginning inventory at $2 per unit, or $1,600, and the 700 remaining from the purchase on 2/8 at $3 per unit, or $2,100, for a total of $3,700.


QUESTION: Pair Co. sells one product and uses the last-in, first-out (LIFO) method to determine inventory cost. Information for the month of January 2014 follows:


Units
Unit Cost
Beginning inventory, 1/1/14
3,000
$4.70
Purchases, 3/4/14
8,000
$3.90
Sales
7,500
Pair has determined that at January 31, 20X4, the replacement cost of its inventory was $4 per unit and the net realizable value was $4.90 per unit. Pair’s normal profit margin is $1 per unit. Pair applies the lower of cost of or market rule to total inventory and records any resulting loss. At January 31, 20X4, what should be the net carrying amount of Pair’s inventory?
  1. $16,050
  2. $13,650
  3. $14,000
  4. $17,050

ANSWER: Answer (c) is correct. Under LIFO, it is assumed that the 7,500 units sold were all from the purchases on 3/4/14, leaving ending inventory of 3,000 units from beginning inventory, at a cost of $4.70 each or $14,100, and 500 units remaining from the purchase of 3/4 at $3.90 each or $1,950, for a total cost of $16,050. Market is replacement cost of $4 per unit since it is between the ceiling, the net realizable value of $4.90, and the floor, the net realizable value minus a normal profit, or $3.90. At $4 per unit, total market is $14,000, which will be the carrying amount of inventory.


QUESTION: Canterbury Co. issues a discounted, non-interest-bearing note in exchange for borrowed funds. Choose whether the cash received will be higher or lower than the face value of the note, and whether the effective annual interest rate will be higher or lower than the discount rate:


Cash Received vs. Face Value of Note
Effective Rate vs. Discount Rate
a.
Higher
Lower
b.
Lower
Higher
c.
Higher
Lower
d. Lower Higher

 

ANSWER: Answer (b) is correct. When a note is discounted, the issuer will receive the maturity value, which will be the face amount when the note is noninterest bearing, reduced by the discount. As a result, cash received will be lower than the face value of the note. The amount of the discount will be the discount rate multiplied by the maturity value and adjusted for the length of time until the note matures. Upon repayment, the effective rate paid will be higher than the discount rate. A $1,000 noninterest bearing note, for example, maturing in one year that is discounted at 10% will result in cash received of $1,000 - $100 or $900. At maturity, the borrower remits the $1,000 to the lender, which is repayment of the $900 received plus the $100 discount. A cost of $100 to borrow $900 for one year would indicate an effective rate in excess of 11%, higher than the 10% discount rate.


QUESTION: Candy Co. exchanged inventory with Dandy Co. in a transaction that lacks commercial substance. Both Candy’s and Dandy’s inventory had fair values that exceeded their costs by 30%. Since Dandy’s inventory was more valuable, however, Candy paid Dandy cash to compensate for the difference. Who, if anyone, will recognize a gain on the exchange?

  1. Candy only
  2. Dandy only
  3. Both Candy and Dandy
  4. Neither Candy nor Dandy

ANSWER: Answer (b) is correct. In an exchange that lacks commercial substance involving like and unlike assets, such as cash, only the party receiving the unlike assets will recognize a gain. Since Candy paid cash to Dandy to compensate for a difference in the values of the inventory exchanged, only Dandy will recognize a gain on the exchange.


QUESTION: Which of the following statements is correct regarding donated assets?

  1. Donated assets are not recorded on a company’s balance sheet if the donor requests that the gift remain anonymous.
  2. Donated assets are recorded at historical cost on a company’s balance sheet.
  3. Under GAAP the donation of an asset will result in a credit to either revenue or gain.
  4. Under GAAP no gain can be recorded on a donated asset until and unless it is sold to a third party.

ANSWER: Answer (c) is correct. When assets are received in a nonreciprocal transfer, under which neither equity nor other assets are exchanged, the entity will recognize the assets at their fair values and recognize the total fair value of assets received as a form of nonoperating income.


QUESTION: X Company purchased a patent on January 3, 20X4 from Y Company for $145,000. An attorney drew up the contract between X & Y at a total cost of $15,000, which was split equally by the parties. The patent had a carrying value of $90,000 on Y’s books. X expects to be able to benefit from the patent for 10 years, after which it is expected to be of little to no value.

What will be the carrying value of the patent on X Company’s December 31, 20X5 balance sheet?

  1. $160,000
  2. $152,500
  3. $128,000
  4. $122,000

ANSWER: Answer (d) is correct. X Company will recognize the patent at its cost of $145,000 plus ½ of the attorney’s fee of $15,000, or $7,500, for a total of $152,500. It will be amortized over the expected useful life of 10 years at the rate of $15,250 per year. As of December 31, 20X5, after X held the patent for 2 years, accumulated amortization will be $15,250 x 2 or $30,500 and the carrying value of the patent will be $152,500 - $30,500 or $122,000.


QUESTION: A company reacquired some of its own stock to be held as treasury stock and used for its employee’s 401K plan. In their statement of cash flows how would this cash outflow be reported?

  1. Under operating activities.
  2. Either under operating activities or financing activities.
  3. Under financing activities.
  4. Either under investing activities or financing activities.

ANSWER: Answer (c) is correct. When a company reacquires its own stock it is consider treasury stock and is reported under financing activities on the statement of cash flows.


QUESTION: Very early in 20X3, while developing software for sale to others, after achieving technological feasibility but before the commencement of commercial production, X Company incurred $320,000 to produce product masters and to test the software. X Company estimated that the software will be sold for a total of 10 years. After nearly a full year of selling, X had revenues from software sales of $120,000 in 20X3. Sales in future periods are expected to amount to $680,000. Costs associated with producing and packaging the software approximate 10% of revenues.

What portion, if any, of the $320,000 will be recognized in income in 20X3?

  1. $48,000
  2. $32,000
  3. $0
  4. $320,000

ANSWER: Answer (a) is correct. Costs incurred after reaching technological feasibility but before commercial production, such as the production of product masters, are capitalized and amortized. The amount of amortization will be the greater amount when calculated under both the straight-line method and the volume of output approach. Under straight-line, amortization will be 10% of $320,000 or $32,000. Under the volume of output approach the ratio of current sales, $120,000, to the total of current and estimated future sales, $120,000 + $680,000 or $800,000, is multiplied by the $320,000 carrying value of the amortizable costs to determine amortization of , $120,000/$800,000 x $320,000 = $48,000. Since it is larger, $48,000 will be the amount of amortization in 20X3. In addition, X will determine if the carrying value of the software exceeds its net realizable value from future sales. Future sales are expected to be $680,000. With costs of only 10% or $68,000, the remaining $612,000 exceeds the carrying value of the software indicating no need for further amortization.


QUESTION: At year end, Mayce Co. held investments with the intent of selling them in the near term. The investments consisted of $300,000, 9%, seven-year bonds, purchased for $278,000, and equity securities purchased for $75,000. At year end, the bonds were selling on the open market for $320,000 and the equity securities had a market value of $90,000. What amount should Mayce report as trading securities in its year-end balance sheet?

  1. $410,000
  2. $395,000
  3. $390,000
  4. $373,000

ANSWER: Answer (a) is correct. Investments in trading securities are reported at their fair values as of the balance sheet date. Since Mayce intends to sell both the bonds and the equity securities in the near term, both are trading securities and the amount at which they will be reported on the balance sheet is their fair values of $320,000 and $90,000 for total of $410,000.


QUESTION: OK Co. uses the equity method to account for its January 1, 20X4 purchase of FDL Inc.’s common stock. On January 1, 20X4, the fair values of FDL’s FIFO inventory and plant exceeded their carrying amounts. How do these excesses of fair values over carrying amounts affect OK’s reported equity in FDL’s 20X4 earnings?


Inventory excess Plant excess
a. Decrease Decrease
b. Decrease No effect
c. Increase Increase
d. Increase No effect

ANSWER: Answer (a) is correct. Under the equity method, the investor adjusts the portion of the investee’s income recognized to account for differences between the book values of the investee’s assets and liabilities and their fair values. Under FIFO, it is assumed that inventory on hand is sold first and, if the fair value is greater than the carrying value, the difference increases cost of sales, decreasing the investee’s income. Likewise, if the fair value of plant assets is greater than the carrying value, the difference will be allocated over the asset’s depreciable life, increasing depreciation expense and further reducing the investee’s income. The investor will then recognize a proportionate amount of the investee’s adjusted income.


QUESTION: Identify the correct statement(s) regarding stock warrants:

  1. Additional paid-in capital is credited when a company issues warrants to existing shareholders to purchase unissued stock at a given exercise price.
  2. A company’s net income decreases upon the exercise of stock warrants issued to shareholders.
  3. The expiration of stock warrants has no effect on equity accounts.
  1. I and II only.
  2. III only.
  3. I and III only.
  4. I only.

ANSWER: Answer (b) is correct. When stock warrants are issued, such as when bonds are issued with detachable stock purchase warrants, any proceeds allocated to them is recorded in additional paid-in capital. If issued to existing shareholders, however, there are no proceeds and additional paid-in capital is not affected. If the warrants are exercised, the proceeds will be recorded in common stock and additional paid-in capital, with no effect on income. If they expire without being exercised, however, no entry is made.


QUESTION: For the year ended December 31, 2015, Pering Co. reported pretax financial income of $550,000. Its current tax expense was $144,000. Pering reported a difference between pretax financial statement income and taxable income. This difference is due to accelerated depreciation for income tax purposes. Pering’s effective income tax rate is 30% and Pering made estimated tax payments during 2015 of $75,000. What amount did Paring report as taxable income for 2015?

  1. 405,000
  2. 480,000
  3. 475,000
  4. 550,000

ANSWER: Answer (b) is correct. Current tax expense is calculated by multiplying taxable income by the tax rate. Therefore, taxable income is calculated by dividing current tax expense of $144,000 by the tax rate of 30%. Taxable income for 2015 is $480,000.


QUESTION: On December 31, 2016, Blue Co. leased a new machine from Green Co. with the following pertinent information:


Lease term
5 years
Annual rental payable at beginning of each year
$55,000
Useful life of machine
7 years
Blue’s incremental borrowing rate
12%
Implicit interest rate in lease (known by Blue)
10%
Present value of annuity of $1 in advance for 5 periods at
     10% 4.17
     12% 4.04
There is no bargain purchase option but title transfers to Blue Co. at the end of the lease. The cost of the machine on Green’s accounting records is $294,500. At the beginning of the lease term, Blue Co. should record a lease liability of
  1. $294,500
  2. $222,200
  3. $229,350
  4. $0

ANSWER: Answer (c) is correct. Since title will transfer to the lessee at the end of the lease this is a capital lease. A lease obligation will be recognized in an amount equal to the present value of the minimum lease payments using the rate implicit in the lease since it is known to the lessee and lower than the lessee’s incremental borrowing rate. As a result, the lease obligation will be $55,000 x 4.17 or $229,350.


QUESTION: Green Co. had net cash provided by operating activities of $209,000; net cash used by investing activities of $354,000; and cash provided by financing activities of $190,000. Green’s cash balance was $36,500 on January 1. During the year, there was a sale of equipment that resulted in a gain of $7,200 and proceeds of $55,000 were received from the sale. What was Green’s cash balance at the end of the year?

  1. $45,000
  2. $55,000
  3. $81,500
  4. $88,700

ANSWER: Answer (c) is correct. Since cash provided by operating activities is $209,000, cash used by investing activities is $354,000, and cash provided by financing activities is $190,000, the net increase in cash for the period is $209,000 - $354,000 + $190,000 or $45,000. This is added to the beginning cash balance of $36,500 to give an ending cash balance of $81,500. The proceeds from the sale of equipment would already be included in cash flows from investing activities and the gain on sale would have been eliminated in measuring cash flows from operating activities.