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HCAFA practice questions

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Question 1Financial Accounting and Reporting

Which financial statement reports a company's assets, liabilities, and equity at a specific point in time?

  1. Income statement
  2. Statement of retained earnings
  3. Balance sheet Correct answer.
  4. Statement of cash flows

Explanation

The balance sheet presents the accounting equation (assets = liabilities + equity) as of a single date. The income statement and cash flow statement cover a period of time rather than a point in time.

Question 2Financial Accounting and Reporting

Under the accrual basis of accounting, revenue is recognized when:

  1. Cash is received from the customer
  2. The invoice is mailed to the customer
  3. The fiscal year ends
  4. The performance obligation is satisfied Correct answer.

Explanation

Accrual accounting recognizes revenue when the performance obligation is satisfied, regardless of the timing of cash collection. Cash receipt timing is relevant to the cash basis, not the accrual basis.

Question 3Financial Accounting and Reporting

A company purchased equipment for $50,000 with an estimated residual value of $5,000 and a useful life of 5 years. Using straight-line depreciation, what is the annual depreciation expense?

  1. $10,000
  2. $5,000
  3. $9,000 Correct answer.
  4. $11,000

Explanation

Straight-line depreciation equals (cost minus residual value) divided by useful life, or ($50,000 − $5,000) / 5 = $9,000 per year. Residual value is excluded from the depreciable base.

Question 4Financial Accounting and Reporting

Which of the following is classified as a current liability?

  1. Bonds payable due in 10 years
  2. Land held for future use
  3. Accounts payable Correct answer.
  4. Prepaid insurance

Explanation

Current liabilities are obligations expected to be settled within one year or the operating cycle. Accounts payable is normally settled in the short term, while long-term bonds, land, and prepaid insurance are not current liabilities.

Question 5Financial Accounting and Reporting

A company records $10,000 of revenue earned but not yet billed to the customer. Which entry correctly records this accrual?

  1. Debit Accounts Receivable $10,000; credit Revenue $10,000 Correct answer.
  2. Debit Unearned Revenue $10,000; credit Revenue $10,000
  3. Debit Revenue $10,000; credit Accounts Receivable $10,000
  4. Debit Cash $10,000; credit Revenue $10,000

Explanation

When revenue is earned before billing or collection, the company debits Accounts Receivable and credits Revenue. This records the right to receive payment and the earned income simultaneously.

Question 6Financial Accounting and Reporting

Which inventory cost flow method generally produces the highest ending inventory balance during a period of rising prices?

  1. Weighted average
  2. First-in, first-out (FIFO) Correct answer.
  3. Specific identification
  4. Last-in, first-out (LIFO)

Explanation

Under FIFO, the oldest, lowest-cost units are assumed sold, leaving the more recent, higher-cost units in ending inventory. This produces the highest ending inventory value when prices are rising.

Question 7Financial Accounting and Reporting

The accounting equation can be stated as:

  1. Assets = Liabilities − Equity
  2. Equity = Assets + Liabilities
  3. Assets + Equity = Liabilities
  4. Assets = Liabilities + Equity Correct answer.

Explanation

The fundamental accounting equation is Assets = Liabilities + Equity, reflecting that resources are financed by creditors and owners. Every transaction preserves this equality.

Question 8Financial Accounting and Reporting

A company issues a $100,000 face value bond at 97. How much cash does the company receive at issuance?

  1. $103,000
  2. $3,000
  3. $100,000
  4. $97,000 Correct answer.

Explanation

A bond issued at 97 is priced at 97% of face value, so cash received equals $100,000 × 0.97 = $97,000. The $3,000 discount is amortized over the bond's life.

Question 9Financial Accounting and Reporting

A company has current assets of $300,000 and current liabilities of $150,000. What is its current ratio?

  1. 1.5
  2. 4.5
  3. 2.0 Correct answer.
  4. 0.5

Explanation

The current ratio equals current assets divided by current liabilities, or $300,000 / $150,000 = 2.0. It measures short-term liquidity.

Question 10Financial Accounting and Reporting

Under the equity method, an investor records its share of an investee's dividends received as:

  1. Dividend income on the income statement
  2. An increase to the investment account
  3. A direct charge to retained earnings
  4. A reduction of the investment account Correct answer.

Explanation

Under the equity method, the investor recognizes its share of investee earnings as income with a corresponding increase in the investment, and dividends received reduce the carrying amount of the investment. Dividends are treated as a return of investment, not income.

Question 11Financial Accounting and Reporting

A company's beginning inventory is $40,000, purchases are $150,000, and ending inventory is $30,000. What is cost of goods sold?

  1. $180,000
  2. $140,000
  3. $150,000
  4. $160,000 Correct answer.

Explanation

Cost of goods sold equals beginning inventory plus purchases minus ending inventory: $40,000 + $150,000 − $30,000 = $160,000.

Question 12Financial Accounting and Reporting

Which item is reported in other comprehensive income rather than net income?

  1. Gain on sale of equipment
  2. Unrealized gain on available-for-sale debt securities Correct answer.
  3. Cost of goods sold
  4. Interest expense

Explanation

Unrealized gains and losses on available-for-sale debt securities are recognized in other comprehensive income until realized. Realized gains, interest expense, and cost of goods sold flow through net income.

Question 13Financial Accounting and Reporting

A company uses the allowance method and estimates that 2% of $500,000 of credit sales will be uncollectible. If the allowance account currently has a $2,000 credit balance, what is the bad debt expense for the period?

  1. $12,000
  2. $8,000
  3. $2,000
  4. $10,000 Correct answer.

Explanation

Under the percentage-of-sales approach, bad debt expense equals the estimate applied to credit sales, or $500,000 × 2% = $10,000. The existing allowance balance is not netted against this income statement estimate.

Question 14Financial Accounting and Reporting

Under IFRS, which cost formula is prohibited for inventory measurement?

  1. Last-in, first-out Correct answer.
  2. Weighted average cost
  3. Specific identification
  4. First-in, first-out

Explanation

IFRS prohibits the LIFO method for inventory costing, while US GAAP permits it. FIFO, weighted average, and specific identification are all acceptable under IFRS.

Question 15Financial Accounting and Reporting

A company sells goods with a 2-year warranty and estimates warranty costs of $6,000 in the year of sale. Which treatment is correct under accrual accounting?

  1. Recognize the expense only when claims are paid
  2. Recognize the $6,000 as warranty expense in the year of sale Correct answer.
  3. Record the estimate as a reduction of revenue
  4. Disclose the estimate only in the notes

Explanation

A warranty obligation arises from the sale, so the estimated cost is accrued as warranty expense and a warranty liability in the same period as the related revenue. This matches the expense to the period the sale is recognized.

Question 16Financial Accounting and Reporting

Which of the following increases a company's return on equity, all else equal?

  1. A decrease in average shareholders' equity Correct answer.
  2. An increase in average shareholders' equity
  3. A decrease in net income
  4. An increase in operating expenses

Explanation

Return on equity equals net income divided by average shareholders' equity, so a smaller denominator raises the ratio when net income is unchanged. Lower net income or higher expenses reduce the numerator and the ratio.

Question 17Financial Accounting and Reporting

A company leases equipment for 5 years with a present value of lease payments equal to 90% of the asset's fair value. Under US GAAP (ASC 842), the lease is classified as:

  1. A sale-leaseback
  2. A finance lease Correct answer.
  3. A short-term lease
  4. An operating lease

Explanation

A lease is classified as a finance lease when the present value of lease payments equals or exceeds substantially all (generally 90%) of the fair value of the underlying asset. Meeting that threshold requires finance lease treatment.

Question 18Financial Accounting and Reporting

A company reports net income of $120,000, including depreciation of $20,000 and a $15,000 increase in accounts receivable. What is cash flow from operating activities using the indirect method?

  1. $155,000
  2. $125,000 Correct answer.
  3. $115,000
  4. $85,000

Explanation

Starting with net income, add back noncash depreciation and subtract the increase in receivables: $120,000 + $20,000 − $15,000 = $125,000. An increase in a current asset uses cash.

Question 19Financial Accounting and Reporting

A company's board declares a 10% stock dividend on 100,000 outstanding shares when the market price is $20 per share. What is the effect on total shareholders' equity?

  1. It decreases by the par value of the new shares
  2. It is unchanged Correct answer.
  3. It decreases by $200,000
  4. It increases by $200,000

Explanation

A stock dividend reclassifies amounts within equity, typically from retained earnings to common stock and paid-in capital, but total shareholders' equity does not change. No assets or liabilities are affected.

Question 20Financial Accounting and Reporting

A company changes from an incorrect inventory method to a correct one. This should be accounted for as:

  1. A change in reporting entity
  2. A prior period error correction Correct answer.
  3. A change in accounting principle applied prospectively
  4. A change in accounting estimate

Explanation

Moving from an incorrect method to a correct one is a correction of an error, which is reported as a prior period adjustment to beginning retained earnings. A change in principle applies only when moving between two acceptable methods.

Question 21Financial Accounting and Reporting

A company factors $200,000 of receivables without recourse and receives $190,000. How should the $10,000 difference be reported?

  1. As interest revenue
  2. As a deferred asset
  3. As a loss on sale of receivables Correct answer.
  4. As a reduction of accounts payable

Explanation

A without-recourse factoring transfers control of the receivables, so the transaction is treated as a sale and the $10,000 difference represents a loss on sale. Retaining the receivables would instead require treating the difference as a financing cost.

Question 22Financial Accounting and Reporting

A company uses the double-declining-balance method for an asset costing $80,000 with a 4-year life and no residual value. What is depreciation expense in year 2?

  1. $30,000
  2. $10,000
  3. $40,000
  4. $20,000 Correct answer.

Explanation

The DDB rate is twice the straight-line rate, or 50%. Year 1 depreciation is $80,000 × 50% = $40,000, leaving a carrying amount of $40,000; year 2 depreciation is $40,000 × 50% = $20,000.

Question 23Financial Accounting and Reporting

A company issues $500,000 of 8% bonds at 104 on January 1. Using straight-line amortization over 10 years, what is interest expense for the first year?

  1. $42,000
  2. $40,000
  3. $38,000 Correct answer.
  4. $52,000

Explanation

Annual cash interest is $500,000 × 8% = $40,000. The premium of $20,000 ($500,000 × 4%) amortized straight-line over 10 years is $2,000 per year, which reduces interest expense to $38,000.

Question 24Financial Accounting and Reporting

A company reports a deferred tax liability arising from depreciation timing differences. This liability is best described as:

  1. An amount payable to tax authorities in the current period
  2. A reduction of the current tax expense
  3. A permanent difference that never reverses
  4. A temporary difference that will reverse in future periods Correct answer.

Explanation

A deferred tax liability arises from a taxable temporary difference, such as accelerated tax depreciation, that will reverse in future periods when book depreciation exceeds tax depreciation. It is not a current-period payable.

Question 25Financial Accounting and Reporting

A company has net income of $90,000, preferred dividends of $10,000, and 20,000 weighted average common shares outstanding. What is basic earnings per share?

  1. $3.50
  2. $4.50
  3. $5.00
  4. $4.00 Correct answer.

Explanation

Basic EPS equals net income less preferred dividends divided by weighted average common shares: ($90,000 − $10,000) / 20,000 = $4.00. Preferred dividends are subtracted because they are not available to common shareholders.

Question 26Financial Accounting and Reporting

A company purchases equipment for $50,000 with an estimated residual value of $5,000 and a useful life of 5 years. Using straight-line depreciation, what is the annual depreciation expense?

  1. $11,000
  2. $9,000 Correct answer.
  3. $8,000
  4. $10,000

Explanation

Straight-line depreciation equals depreciable cost divided by useful life. Depreciable cost is $50,000 minus the $5,000 residual value, or $45,000, divided by 5 years.

Question 27Financial Accounting and Reporting

Which financial statement reports the changes in a company's cash receipts and cash payments during a period?

  1. The income statement
  2. The statement of cash flows Correct answer.
  3. The statement of retained earnings
  4. The balance sheet

Explanation

The statement of cash flows classifies cash activity into operating, investing, and financing activities over a period. The other statements report accrual-based performance, financial position, or equity changes.

Question 28Financial Accounting and Reporting

A company collects $10,000 cash from a customer on account. What is the effect on the accounting equation?

  1. Total assets decrease and liabilities decrease
  2. Assets increase and assets decrease by equal amounts, leaving totals unchanged Correct answer.
  3. Total liabilities increase and equity decreases
  4. Total assets increase and equity increases

Explanation

Collecting a receivable increases cash and decreases accounts receivable by the same amount, so total assets are unchanged. Only the composition of assets shifts.

Question 29Financial Accounting and Reporting

Which of the following is classified as a current liability on the balance sheet?

  1. A long-term deferred tax liability
  2. A 10-year mortgage payable
  3. Bonds payable maturing in 8 years
  4. Accounts payable due in 30 days Correct answer.

Explanation

Current liabilities are obligations expected to be settled within one year or the operating cycle. Accounts payable due in 30 days meets that definition, while long-term debt does not.

Question 30Financial Accounting and Reporting

A company's revenue is $200,000 and its gross profit is $80,000. What is its gross profit margin?

  1. 80%
  2. 25%
  3. 40% Correct answer.
  4. 60%

Explanation

Gross profit margin equals gross profit divided by revenue. $80,000 divided by $200,000 equals 40%.

Question 31Financial Accounting and Reporting

Which account is increased with a debit?

  1. Accounts payable
  2. Retained earnings
  3. Equipment Correct answer.
  4. Sales revenue

Explanation

Assets, such as equipment, are increased with debits. Liabilities, equity, and revenue accounts are increased with credits.

Question 32Financial Accounting and Reporting

A company declares and pays a cash dividend of $25,000. What is the effect on the balance sheet?

  1. Liabilities increase and equity increases
  2. Assets decrease and equity decreases Correct answer.
  3. Assets increase and equity increases
  4. Assets decrease and liabilities increase

Explanation

Paying a cash dividend reduces cash (an asset) and reduces retained earnings (equity) by the same amount. The declaration creates a liability, but payment settles it, so the net effect is a reduction in both assets and equity.

Question 33Financial Accounting and Reporting

Which qualitative characteristic of useful financial information means that information is capable of making a difference in a user's decisions?

  1. Relevance Correct answer.
  2. Comparability
  3. Timeliness
  4. Verifiability

Explanation

Relevance means information can influence decisions by having predictive or confirmatory value. Comparability, timeliness, and verifiability are enhancing characteristics rather than the fundamental characteristic described.

Question 34Financial Accounting and Reporting

A company has $600,000 of credit sales and estimates bad debt at 1.5% of credit sales. The allowance account currently has a $2,000 debit balance. What amount is recorded as bad debt expense?

  1. $11,000
  2. $9,000 Correct answer.
  3. $2,000
  4. $7,000

Explanation

Under the percentage-of-sales approach, bad debt expense equals the estimate applied to credit sales regardless of the existing allowance balance. $600,000 times 1.5% equals $9,000.

Question 35Financial Accounting and Reporting

A company reports beginning inventory of $25,000, purchases of $90,000, purchase returns of $5,000, and ending inventory of $20,000. What is cost of goods sold?

  1. $85,000
  2. $95,000
  3. $110,000
  4. $90,000 Correct answer.

Explanation

Cost of goods sold equals beginning inventory plus net purchases minus ending inventory. Net purchases are $90,000 minus $5,000, or $85,000; $25,000 plus $85,000 minus $20,000 equals $90,000.

Question 36Financial Accounting and Reporting

A company uses the percentage-of-completion method for a long-term construction contract. In the current year it recognizes revenue of $400,000 and incurs costs of $350,000. Which statement best describes the effect?

  1. The company reports revenue only to the extent cash is collected
  2. The company reports gross profit of $50,000 in the current year Correct answer.
  3. The company reports a contract liability of $50,000
  4. The company defers all revenue until the contract is complete

Explanation

Under percentage-of-completion, revenue and costs are recognized as progress occurs, producing gross profit of $50,000 in the period. Deferral until completion describes the completed-contract approach.

Question 37Financial Accounting and Reporting

A company issues 1,000 shares of $10 par common stock for $45 per share. What amount is credited to additional paid-in capital?

  1. $55,000
  2. $45,000
  3. $35,000 Correct answer.
  4. $10,000

Explanation

Common stock is credited at par ($10,000) and the excess over par is credited to additional paid-in capital. The excess is ($45 minus $10) times 1,000 shares, or $35,000.

Question 38Financial Accounting and Reporting

A company has net sales of $500,000, average accounts receivable of $50,000, and average inventory of $40,000. What is its accounts receivable turnover?

  1. 5.0 times
  2. 8.0 times
  3. 12.5 times
  4. 10.0 times Correct answer.

Explanation

Accounts receivable turnover equals net sales divided by average accounts receivable. $500,000 divided by $50,000 equals 10.0 times.

Question 39Financial Accounting and Reporting

A company records a $12,000 insurance premium paid in advance for a 12-month policy on October 1. If no adjusting entry is made at December 31, what is the effect on the financial statements?

  1. No misstatement occurs because the policy is still in force
  2. Assets are understated and expenses are overstated
  3. Liabilities are overstated and equity is understated
  4. Assets are overstated and expenses are understated Correct answer.

Explanation

Three months of coverage ($3,000) has expired and should be expensed. Without the adjustment, prepaid insurance (an asset) remains too high and insurance expense is too low.

Question 40Financial Accounting and Reporting

A company uses LIFO and experiences a liquidation of an older, lower-cost inventory layer during a period of rising prices. What is the effect on gross profit?

  1. Gross profit increases because lower historical costs flow to cost of goods sold Correct answer.
  2. Gross profit decreases because older costs are higher
  3. Gross profit decreases because ending inventory is higher
  4. Gross profit is unchanged because total units sold are the same

Explanation

A LIFO liquidation matches older, lower costs against current revenue, temporarily reducing cost of goods sold. That inflates gross profit relative to normal LIFO costing.

Question 41Financial Accounting and Reporting

A company's defined benefit pension plan has a projected benefit obligation of $800,000 and plan assets at fair value of $750,000. How is the $50,000 difference reported?

  1. As a net pension liability Correct answer.
  2. As a deferred revenue liability
  3. As a pension asset
  4. As a reduction of retained earnings

Explanation

When the projected benefit obligation exceeds plan assets, the underfunded status is reported as a net pension liability. The liability reflects the net of the obligation and plan assets.

Question 42Financial Accounting and Reporting

A company has 10,000 outstanding shares and declares a 2-for-1 stock split. What is the effect on total stockholders' equity?

  1. Total equity doubles
  2. Total equity is unchanged Correct answer.
  3. Total equity increases by the par value of new shares
  4. Total equity decreases by half

Explanation

A stock split changes the number of shares and the per-share par value but does not change total equity. It merely reallocates the same equity among more shares.

Question 43Financial Accounting and Reporting

A company uses the effective interest method for a bond issued at a discount. How does interest expense compare with the cash interest paid each period?

  1. Interest expense equals the cash interest paid
  2. Interest expense is less than the cash interest paid
  3. Interest expense is recognized only at maturity
  4. Interest expense is greater than the cash interest paid Correct answer.

Explanation

For a discount bond, the carrying amount grows toward face value, so the effective interest rate applied to a rising carrying amount exceeds the stated coupon payment. The difference amortizes the discount.

Question 44Financial Accounting and Reporting

A company reports operating cash flow of $150,000, capital expenditures of $60,000, and dividends paid of $20,000. What is its free cash flow?

  1. $90,000
  2. $130,000
  3. $70,000 Correct answer.
  4. $150,000

Explanation

Free cash flow is typically calculated as operating cash flow minus capital expenditures, giving $90,000, and then minus dividends of $20,000, giving $70,000. This measures cash available after maintaining and rewarding capital providers.

Question 45Financial Accounting and Reporting

A company has a deferred tax asset of $40,000 and concludes that it is more likely than not that only 70% will be realized. What is the required accounting treatment?

  1. Derecognize the entire deferred tax asset
  2. Recognize the full asset with no adjustment
  3. Record a valuation allowance of $28,000
  4. Record a valuation allowance of $12,000 Correct answer.

Explanation

A valuation allowance reduces a deferred tax asset to the amount more likely than not to be realized. The allowance is 30% of $40,000, or $12,000.

Question 46Financial Accounting and Reporting

A company reports a gross profit of $300,000 and operating expenses of $220,000. It also has a $40,000 gain from discontinued operations, net of tax. What is income from continuing operations?

  1. $80,000 Correct answer.
  2. $120,000
  3. $40,000
  4. $260,000

Explanation

Income from continuing operations includes gross profit less operating expenses but excludes discontinued operations. $300,000 minus $220,000 equals $80,000.

Question 47Financial Accounting and Reporting

A company enters into a lease that transfers ownership of the asset to the lessee at the end of the lease term. How should the lessee classify the lease under both IFRS and US GAAP?

  1. As a sale-leaseback
  2. As an operating lease
  3. As a short-term lease
  4. As a finance lease Correct answer.

Explanation

A lease that transfers ownership to the lessee is a finance lease under both frameworks. Ownership transfer is a classic indicator that the risks and rewards of ownership have passed.

Question 48Financial Accounting and Reporting

A company's inventory has a cost of $100,000 and a net realizable value of $92,000. Under IFRS, which measurement applies, and can the write-down be reversed in a later period?

  1. Measured at $92,000; reversal is permitted only to original cost Correct answer.
  2. Measured at $100,000; no write-down is recognized
  3. Measured at $92,000; reversal is permitted if NRV recovers
  4. Measured at $92,000; reversal is prohibited

Explanation

IFRS requires inventory to be measured at the lower of cost and net realizable value, so a $92,000 carrying amount applies. IFRS permits reversal of a prior write-down, but only up to the original cost.

Question 49Financial Accounting and Reporting

An investor holds 25% of an investee and applies the equity method. The investee reports net income of $200,000 and pays dividends of $80,000. What is the net effect on the investor's investment account?

  1. An increase of $20,000
  2. An increase of $30,000 Correct answer.
  3. A decrease of $20,000
  4. An increase of $50,000

Explanation

The investor records 25% of net income ($50,000) as an increase and 25% of dividends ($20,000) as a decrease. The net increase is $30,000.

Question 50Financial Accounting and Reporting

A company reports net income of $500,000, including a $100,000 loss on discontinued operations and a $60,000 unrealized gain on available-for-sale debt securities. What is comprehensive income?

  1. $560,000 Correct answer.
  2. $440,000
  3. $660,000
  4. $500,000

Explanation

Comprehensive income equals net income plus other comprehensive income. The unrealized gain on available-for-sale securities is OCI, so comprehensive income is $500,000 plus $60,000, or $560,000.