I85PREP
⌘ K
BAO Objective Exam study materials
BAO Objective Exam study resources

BAO Objective Exam practice questions

One question at a time. Build your BAO Objective Exam understanding.

First 50 of 200 questions. Each one lists the choices, the correct answer, and an explanation. The checker at the top of this page saves progress in this browser when it is available.

Continue in the practice tool above to load more questions, 50 at a time.

Question 1Regulatory Framework and Governance

Which body is the primary rule-making authority for the Basel Committee on Banking Supervision's capital standards?

  1. The Basel Committee publishes standards, but they only become binding when a jurisdiction adopts them into national law. Correct answer.
  2. The Financial Stability Board votes on behalf of member countries to ratify Basel standards.
  3. The International Monetary Fund converts Basel standards into treaty obligations for members.
  4. The Basel Committee issues directly enforceable regulations that override national banking statutes.

Explanation

The Basel Committee on Banking Supervision is a standard-setting body that produces frameworks and guidance. Its texts have no direct legal force; binding effect arises only when national or regional authorities transpose them into their own rules. This is why implementation timelines and details vary across jurisdictions.

Question 2Regulatory Framework and Governance

Under the Basel framework, which category of capital is designed to absorb losses while a bank remains a going concern?

  1. Common Equity Tier 1 Correct answer.
  2. Tier 2 capital
  3. Total loss-absorbing capacity held as debt
  4. Tier 1 additional instruments redeemable on demand

Explanation

Common Equity Tier 1 is the highest-quality capital and is intended to absorb losses on a going-concern basis, before the bank fails. Tier 2 instruments are designed to absorb losses in resolution or liquidation, a gone-concern basis. This distinction underpins the minimum ratios and buffers in the capital framework.

Question 3Regulatory Framework and Governance

A supervisor wants to require a bank to hold capital above the Pillar 1 minimum because of risks specific to that bank's portfolio. Which Basel pillar provides the mechanism?

  1. Pillar 3
  2. The leverage ratio framework
  3. Pillar 2 Correct answer.
  4. Pillar 1

Explanation

Pillar 2 covers the supervisory review process, under which supervisors assess risks not fully captured by Pillar 1 and may impose additional capital requirements. Pillar 1 sets minimum requirements for credit, market and operational risk. Pillar 3 governs disclosure.

Question 4Regulatory Framework and Governance

Which document issued by the Basel Committee sets out the core principles for effective banking supervision?

  1. The Core Principles for Effective Banking Supervision Correct answer.
  2. The Principles for the Management of Credit Risk
  3. The Standardised Approach for operational risk
  4. The Basel III leverage ratio framework

Explanation

The Core Principles for Effective Banking Supervision define the responsibilities of supervisors and the attributes of an effective supervisory system. They cover licensing, prudential regulation, ongoing supervision and cross-border cooperation. The other documents address specific capital or risk-management requirements.

Question 5Regulatory Framework and Governance

What is the main purpose of the Basel liquidity coverage ratio?

  1. To cap the ratio of a bank's trading assets to its total assets
  2. To limit the share of short-term wholesale funding in a bank's balance sheet
  3. To require banks to hold sufficient high-quality liquid assets to survive a 30-day stress period Correct answer.
  4. To set a minimum return on equity for retail deposit franchises

Explanation

The liquidity coverage ratio requires banks to hold unencumbered high-quality liquid assets at least equal to projected net cash outflows over a 30-calendar-day stress scenario. It targets short-term liquidity resilience. The net stable funding ratio addresses structural funding over a one-year horizon.

Question 6Regulatory Framework and Governance

Which element is a core component of a bank's corporate governance under supervisory guidance?

  1. An independent board that provides objective oversight of senior management Correct answer.
  2. A board composed entirely of executive directors to ensure alignment
  3. Elimination of board committees to speed up decision-making
  4. Delegation of all risk oversight to the external auditor

Explanation

Supervisory guidance emphasises that boards should include a sufficient number of independent directors able to exercise objective judgement. Independence supports effective challenge of management and reduces conflicts of interest. Board committees for audit and risk are commonly expected, not eliminated.

Question 7Regulatory Framework and Governance

A bank's internal audit function reports primarily to which body to preserve its independence?

  1. The head of the lending division
  2. The board audit committee Correct answer.
  3. The chief financial officer
  4. The external supervisor

Explanation

Internal audit should report functionally to the board or its audit committee so that it can assess management without management controlling it. This reporting line protects independence and ensures findings reach those charged with oversight. Reporting to an executive it must review would compromise objectivity.

Question 8Regulatory Framework and Governance

What is the primary objective of the Basel Committee's Pillar 3 disclosure requirements?

  1. To replace supervisory reporting with public filings
  2. To promote market discipline by giving market participants consistent information on a bank's risks and capital Correct answer.
  3. To set the minimum capital ratio applicable to internationally active banks
  4. To harmonise accounting standards across jurisdictions

Explanation

Pillar 3 complements minimum capital requirements and supervisory review by requiring public disclosure of risk and capital information. Consistent disclosures allow market participants to assess a bank and exert discipline. It does not replace confidential supervisory reporting or set accounting standards.

Question 9Regulatory Framework and Governance

A jurisdiction adopts the Basel framework but applies a longer phase-in period for a new capital deduction. What does this illustrate about the Basel process?

  1. A requirement that all banks apply the deduction immediately
  2. National discretion in implementation timing, which can produce cross-border differences Correct answer.
  3. Direct enforcement of the standard by the Basel Committee
  4. Automatic invalidity of the standard for all member jurisdictions

Explanation

Basel standards are implemented through national rulemaking, and jurisdictions may use available transitional arrangements and discretions. As a result, identical standards can take effect on different timelines in different countries. Supervisors monitor implementation to limit harmful inconsistency.

Question 10Regulatory Framework and Governance

A bank's common equity tier 1 ratio is 9.0 percent, and the applicable combined buffer requirement is 2.5 percent on top of a 4.5 percent minimum. What does this imply about the bank's position?

  1. It meets the minimum and the combined buffer with capital to spare Correct answer.
  2. It breaches both the minimum and the buffer
  3. It breaches the minimum but meets the buffer
  4. It meets the minimum but falls short of the combined buffer

Explanation

The minimum CET1 requirement is 4.5 percent, and adding the 2.5 percent combined buffer gives 7.0 percent. A ratio of 9.0 percent exceeds both thresholds, leaving headroom. Buffer breaches restrict distributions rather than triggering the same consequences as a minimum breach.

Question 11Regulatory Framework and Governance

A supervisor identifies a concentration risk in a bank's commercial real estate book that the Pillar 1 standardised approach does not fully capture. What is the appropriate supervisory response under the Basel framework?

  1. Require the bank to reclassify the exposures as sovereign
  2. Impose a Pillar 2 capital add-on reflecting the identified concentration risk Correct answer.
  3. Reduce the bank's Pillar 3 disclosure obligations
  4. Waive the Pillar 1 requirement for that portfolio

Explanation

Pillar 2 exists to capture risks that Pillar 1 does not adequately address, including concentration risk. Supervisors may require additional capital or other mitigating actions. Waiving Pillar 1 or reducing disclosure would weaken rather than strengthen the framework.

Question 12Regulatory Framework and Governance

A bank wants to count an instrument as additional tier 1 capital. Which feature would disqualify it?

  1. Full discretion to cancel distributions on the instrument
  2. Subordination to depositors and general creditors
  3. No maturity date and no incentive to redeem
  4. A holder right to redeem the instrument at par on demand Correct answer.

Explanation

Additional tier 1 instruments must be perpetual, fully paid and free of any incentive to redeem. A holder right to redeem on demand creates an incentive and undermines loss absorption, so the instrument would fail the criteria. Discretionary coupons and subordination are expected features.

Question 13Regulatory Framework and Governance

A cross-border bank has a subsidiary in a host country whose supervisor requires local capitalisation of the subsidiary. Which principle guides the home and host supervisors?

  1. Cooperation and information exchange so that each can fulfil its supervisory responsibilities Correct answer.
  2. Host supervisor authority to set the group's global capital ratio
  3. Home supervisor authority to override all host-country requirements
  4. Complete separation with no sharing of supervisory information

Explanation

The Core Principles and Basel cross-border cooperation guidance call for home and host supervisors to exchange information and coordinate. Neither supervisor unilaterally overrides the other's legitimate requirements. Effective consolidated and local supervision depends on this cooperation.

Question 14Regulatory Framework and Governance

Which action best demonstrates a board fulfilling its risk governance responsibilities?

  1. Delegating risk appetite setting entirely to the front office
  2. Reviewing risk only after an annual external audit
  3. Relying solely on the chief risk officer to set limits without board approval
  4. Approving the risk appetite framework and reviewing risk reports regularly Correct answer.

Explanation

The board is responsible for approving the risk appetite and overseeing that management operates within it. Regular review of risk reports supports effective challenge. Delegating these decisions to business lines or a single executive erodes accountability.

Question 15Regulatory Framework and Governance

A bank's remuneration policy allows a trader's bonus to be paid fully in cash immediately after a profitable year. Which supervisory concern does this raise?

  1. Excessive disclosure of remuneration to the public
  2. Incentives that reward short-term risk-taking without deferral or malus Correct answer.
  3. Insufficient alignment of pay with accounting profit
  4. Overuse of non-financial performance metrics

Explanation

Remuneration guidance aims to align pay with prudent risk-taking over time, typically through deferral, clawback and malus provisions. Immediate full cash payment rewards short-term gains even if risks materialise later. Alignment with profit is not itself the problem; the time horizon is.

Question 16Regulatory Framework and Governance

What distinguishes the net stable funding ratio from the liquidity coverage ratio?

  1. The NSFR promotes stable funding over a one-year horizon, while the LCR addresses a 30-day stress Correct answer.
  2. The NSFR applies only to trading books, while the LCR applies to the whole bank
  3. The NSFR is a capital measure, while the LCR is a leverage measure
  4. The NSFR sets a minimum return on assets, while the LCR sets a maximum loan-to-deposit ratio

Explanation

The two liquidity standards operate at different horizons. The LCR tests whether a bank can survive a 30-day stress with liquid assets, while the NSFR encourages reliance on stable funding sources over one year. Together they address short-term and structural liquidity risk.

Question 17Regulatory Framework and Governance

A supervisor is assessing whether a bank's board has sufficient independent oversight. Which fact is most relevant?

  1. The proportion of non-executive directors who have no material relationship with the bank Correct answer.
  2. The number of board meetings held each year
  3. The size of the bank's loan portfolio
  4. The bank's market share in retail deposits

Explanation

Independence concerns whether directors can exercise objective judgement free of material relationships with the bank or its management. The share of genuinely independent non-executive directors is therefore the key indicator. Meeting frequency and business metrics do not establish independence.

Question 18Regulatory Framework and Governance

Under the Basel operational risk framework, what is the principal purpose of the standardised approach's business indicator?

  1. To measure a bank's market risk from trading positions
  2. To determine the liquidity value of high-quality assets
  3. To serve as a proxy for the scale of a bank's operations and thus its operational risk exposure Correct answer.
  4. To set the minimum leverage ratio for the bank

Explanation

The standardised approach uses the business indicator as a proxy for operational risk exposure, scaling the capital requirement with business volume. It does not measure market risk, leverage or liquidity. The indicator is composed of items such as interest, services and financial components.

Question 19Regulatory Framework and Governance

Which arrangement best supports the independence of a bank's chief risk officer?

  1. Reporting solely to the head of the largest business unit
  2. Rotation of the role every six months among trading desk managers
  3. Combining the role with that of the chief financial officer
  4. A reporting line to the board risk committee with removal subject to board approval Correct answer.

Explanation

The chief risk officer should have sufficient stature and independence, typically reporting to the board or its risk committee. Board involvement in appointment and removal protects the role from business-line pressure. Combining the role with CFO duties creates a conflict between risk control and financial reporting.

Question 20Regulatory Framework and Governance

A supervisor discovers that a bank's published Pillar 3 disclosures omit material information on its securitisation exposures. What is the most appropriate supervisory action?

  1. Treat the omission as automatically satisfying disclosure requirements
  2. Refer the matter to the bank's external auditor without further action
  3. Waive the disclosure requirement because securitisation is complex
  4. Require the bank to remediate its disclosures and publish the missing information Correct answer.

Explanation

Pillar 3 relies on accurate and complete public disclosure, and supervisors are expected to ensure compliance. Where material information is missing, the appropriate response is to require correction and publication. Waiving requirements or deferring entirely to the auditor would not restore market discipline.

Question 21Regulatory Framework and Governance

Which statement best describes the role of the supervisory review and evaluation process in Pillar 2?

  1. It is a public disclosure regime operated by market participants
  2. It is an accounting standard for valuing financial instruments
  3. It is a forward-looking assessment of a bank's risks, controls and capital adequacy by the supervisor Correct answer.
  4. It is a mechanical recalculation of Pillar 1 minimum requirements

Explanation

The supervisory review and evaluation process involves forward-looking assessment of a bank's risk profile, governance and capital adequacy, including stress testing. It goes beyond recalculating Pillar 1 minimums. Its outputs can include additional capital requirements and qualitative measures.

Question 22Regulatory Framework and Governance

A bank counts a hybrid instrument toward regulatory capital but the instrument includes a dividend stopper that restricts coupons on ordinary shares when hybrid coupons are not paid. How should this feature be assessed?

  1. It may be acceptable if it does not create an incentive to redeem and loss absorption is preserved Correct answer.
  2. It converts the instrument into a Tier 2 item regardless of other features
  3. It has no bearing on capital eligibility because coupons are discretionary
  4. It automatically disqualifies the instrument from all capital categories

Explanation

Features such as dividend stoppers must be assessed for their effect on loss absorption and redemption incentives. A stopper is not automatically disqualifying, but it can create pressure to pay coupons and must not undermine the instrument's ability to absorb losses. Eligibility depends on the full set of criteria.

Question 23Regulatory Framework and Governance

Two jurisdictions implement the same Basel output floor but use different transitional arrangements. What is the most likely consequence for a bank operating in both?

  1. The output floor will be automatically disapplied for the group
  2. The Basel Committee will enforce a single identical floor for the group
  3. The bank must ignore both local implementations and use the Basel text directly
  4. Its group-level capital position may differ depending on which local rules apply to each entity Correct answer.

Explanation

Where jurisdictions adopt different transitional arrangements, the same standard can produce different capital outcomes across entities. Group supervisors must understand these differences when assessing consolidated capital. The Basel Committee does not enforce a single outcome directly on the group.

Question 24Regulatory Framework and Governance

A bank's internal capital adequacy assessment process concludes that its capital is adequate, but the supervisor's stress test shows a shortfall under a severe scenario. How should the supervisor proceed?

  1. Challenge the bank's assumptions and consider a Pillar 2 requirement reflecting the stress result Correct answer.
  2. Accept the bank's conclusion because internal models take precedence
  3. Publish the bank's confidential stress results to the market
  4. Immediately revoke the bank's licence without further review

Explanation

Supervisors are expected to evaluate and challenge a bank's internal capital assessment, including its assumptions and stress testing. Where supervisory stress results reveal vulnerabilities, the supervisor may impose additional capital requirements or other measures. Immediate licence revocation or publication of confidential results would be disproportionate.

Question 25Regulatory Framework and Governance

A bank's board delegates risk appetite setting to its asset-liability committee, which is dominated by trading staff. Which governance weakness is most significant?

  1. The body setting risk limits lacks independence from those who profit from taking risk Correct answer.
  2. The board has retained too much decision-making authority
  3. The committee meets too infrequently to be effective
  4. The committee lacks authority over accounting policy

Explanation

Risk appetite should be set with board involvement and objective challenge, not dominated by the business lines that benefit from risk-taking. A committee dominated by trading staff creates a conflict of interest that undermines the limit-setting process. Independence, not meeting frequency, is the central weakness described.

Question 26Regulatory Framework and Governance

Under the Basel framework, what is the minimum common equity tier 1 (CET1) capital requirement that a bank must meet before any capital buffers are applied?

  1. 2.0 percent of risk-weighted assets
  2. 4.5 percent of risk-weighted assets Correct answer.
  3. 8.0 percent of risk-weighted assets
  4. 6.0 percent of risk-weighted assets

Explanation

The Basel III minimum capital stack requires CET1 of at least 4.5 percent of risk-weighted assets, with tier 1 at 6 percent and total capital at 8 percent. The CET1 minimum is the base layer to which the capital conservation and countercyclical buffers are added. Buffers sit above, not inside, this minimum requirement.

Question 27Regulatory Framework and Governance

A supervisor is designing the recovery and resolution planning regime for domestic banks. Which objective is the central purpose of a resolution framework?

  1. Guaranteeing that all creditors receive full repayment
  2. Allowing critical functions to continue without taxpayer bailout Correct answer.
  3. Preserving the franchise value of the failing bank's shareholders
  4. Preventing any bank from ever entering insolvency proceedings

Explanation

Resolution regimes exist so that a failing bank can be wound down or restructured while its critical economic functions, such as deposits and payment services, continue uninterrupted. The key policy aim is to allocate losses to shareholders and creditors rather than taxpayers. Resolution planning therefore focuses on continuity of functions and loss absorption, not on protecting owners.

Question 28Regulatory Framework and Governance

A bank's board wants to establish a risk committee. Which design choice best aligns with supervisory expectations for effective board risk oversight?

  1. Composing the committee mainly of independent non-executive directors with risk expertise Correct answer.
  2. Rotating committee membership annually among all branch managers
  3. Chairing the committee by the chief executive officer
  4. Staffing the committee exclusively with executives from the front office

Explanation

Supervisory guidance expects board risk committees to be composed largely of independent non-executive directors who bring relevant risk expertise and can challenge management. Independence from the executive line, especially from revenue-generating functions, is what gives the committee credible oversight. Executive-dominated membership blurs the challenge function that the committee is meant to provide.

Question 29Regulatory Framework and Governance

A supervisor is reviewing how a bank applies the Basel principles for effective risk data aggregation and reporting. Which outcome indicates the bank is meeting the core expectation of those principles?

  1. Risk reports are produced manually by each business line on separate spreadsheets
  2. The bank can aggregate exposures across legal entities and systems on a timely basis Correct answer.
  3. Data governance is delegated entirely to the information technology vendor
  4. Aggregation accuracy is verified only during the annual external audit

Explanation

The BCBS risk data aggregation principles require a bank to produce accurate, complete and timely risk information, including across legal entities and business lines, and to have strong data architecture and governance. The defining test is the ability to aggregate exposures rapidly and reliably, particularly in stress. Manual, fragmented or vendor-owned processes fail that test.

Question 30Regulatory Framework and Governance

A jurisdiction implements the Basel large exposures framework. A bank's exposure to a single counterparty approaches the limit, and the counterparty is a bank with which it has interbank placements. Which treatment is consistent with the framework's design intent?

  1. Measuring exposures on a gross basis with no recognition of any mitigation
  2. Applying the general large exposure limit to the net exposure after eligible credit risk mitigation Correct answer.
  3. Setting limits only at the level of the banking group's solo entities
  4. Exempting all interbank exposures because they are short term

Explanation

The large exposures framework sets a general limit of 25 percent of tier 1 capital on exposures to a single counterparty or connected group, measured after recognising eligible credit risk mitigation where permitted. Its purpose is to constrain concentration risk and single-name loss potential. Interbank exposures receive only narrow, specifically defined exemptions rather than a blanket carve-out.

Question 31Financial Accounting and Reporting

Under the accrual basis of accounting, when is revenue generally recognized?

  1. When the performance obligation is satisfied Correct answer.
  2. When cash is received from the customer
  3. When the sales order is placed by the customer
  4. When the invoice is mailed to the customer

Explanation

The accrual basis recognizes revenue when the earnings process is complete, which under current standards means the performance obligation has been satisfied by transferring promised goods or services. Collecting cash is a separate event and does not by itself trigger revenue recognition.

Question 32Financial Accounting and Reporting

A company pays 12,000 in advance for twelve months of insurance on October 1 and records it as a prepaid asset. What adjusting entry is needed at December 31 to report the correct amounts?

  1. Debit Insurance Expense 12,000; credit Cash 12,000
  2. Debit Prepaid Insurance 3,000; credit Insurance Expense 3,000
  3. Debit Insurance Expense 9,000; credit Prepaid Insurance 9,000
  4. Debit Insurance Expense 3,000; credit Prepaid Insurance 3,000 Correct answer.

Explanation

Three months of coverage (October through December) have expired, so 3,000 of the prepayment has become expense. The adjusting entry reduces the asset and increases expense by that expired portion.

Question 33Financial Accounting and Reporting

Which financial statement reports the changes in a company's retained earnings for a period?

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

Explanation

The statement of retained earnings reconciles the opening and closing balances of retained earnings by adding net income and deducting dividends. It links the income statement to the equity section of the balance sheet.

Question 34Financial Accounting and Reporting

A company purchases equipment for 50,000 cash. How does this transaction affect the accounting equation?

  1. Total assets are unchanged and total equity decreases
  2. Total assets are unchanged and total equity is unchanged Correct answer.
  3. Total assets increase and total liabilities increase
  4. Total assets decrease and total equity decreases

Explanation

The transaction exchanges one asset (cash) for another asset (equipment) of equal value, so total assets do not change. Because no liability or equity account is involved, the equation remains in balance with equity unchanged.

Question 35Financial Accounting and Reporting

Which of the following best describes the going concern assumption?

  1. The entity will continue operating long enough to carry out its objectives Correct answer.
  2. Each entity is separate from its owners
  3. Assets are recorded at their current market value
  4. Revenue is recognized only when cash is collected

Explanation

The going concern assumption presumes the business will continue in operation for the foreseeable future rather than being liquidated. This justifies deferring certain costs and using historical cost rather than liquidation values.

Question 36Financial Accounting and Reporting

A company reports current assets of 80,000 and current liabilities of 40,000. What is its current ratio?

  1. 2.0 Correct answer.
  2. 1.5
  3. 0.5
  4. 3.0

Explanation

The current ratio equals current assets divided by current liabilities, so 80,000 divided by 40,000 equals 2.0. A ratio of 2.0 indicates the company has twice as many current assets as current obligations.

Question 37Financial Accounting and Reporting

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

  1. Specific identification of the newest units
  2. Weighted average
  3. Last-in, first-out
  4. First-in, first-out Correct answer.

Explanation

When prices rise, FIFO assigns the oldest and lowest costs to cost of goods sold, leaving higher costs in ending inventory. Lower cost of goods sold produces higher gross profit and net income compared with other flow methods.

Question 38Financial Accounting and Reporting

Which account normally carries a credit balance?

  1. Cost of goods sold
  2. Accumulated depreciation Correct answer.
  3. Accounts receivable
  4. Prepaid rent

Explanation

Accumulated depreciation is a contra-asset account that is increased by credits and reduces the carrying amount of the related asset. Asset and expense accounts normally carry debit balances.

Question 39Financial Accounting and Reporting

A company issues a 100,000, 6%, five-year bond at a time when the market rate is 7%. At what price will the bond most likely be issued?

  1. At a discount below face value Correct answer.
  2. At a premium above face value
  3. At face value
  4. At a price that cannot be determined from the information given

Explanation

When the stated coupon rate is below the market rate required by investors, the bond must sell for less than face value to provide a competitive yield. The discount raises the effective return to the market rate.

Question 40Financial Accounting and Reporting

A firm uses the allowance method. It writes off a specific uncollectible account of 2,000. What is the effect of the write-off on total assets and net income?

  1. Assets decrease and net income is unchanged
  2. Assets decrease and net income decreases
  3. Assets are unchanged and net income is unchanged Correct answer.
  4. Assets are unchanged and net income decreases

Explanation

Writing off an account debits the allowance and credits accounts receivable, so both the gross receivable and the contra-asset fall by the same amount. Net receivables and net income are therefore unaffected because the expense was recognized when the allowance was estimated.

Question 41Financial Accounting and Reporting

A machine costing 60,000 with a residual value of 6,000 and a useful life of six years is depreciated using the straight-line method. What is depreciation expense for the second year?

  1. 10,000
  2. 12,000
  3. 9,000 Correct answer.
  4. 6,000

Explanation

Straight-line depreciation equals cost minus residual value, divided by useful life: (60,000 - 6,000) / 6 = 9,000. The amount is the same each full year of the asset's life.

Question 42Financial Accounting and Reporting

A company's beginning inventory is 30,000, purchases are 90,000, and ending inventory is 25,000. What is cost of goods sold?

  1. 85,000
  2. 145,000
  3. 90,000
  4. 95,000 Correct answer.

Explanation

Cost of goods sold equals beginning inventory plus purchases minus ending inventory: 30,000 + 90,000 - 25,000 = 95,000. The ending inventory is subtracted because those goods were not sold during the period.

Question 43Financial Accounting and Reporting

Which of the following costs should be capitalized as part of the cost of a newly acquired building?

  1. Real estate commissions paid to acquire the building Correct answer.
  2. Routine monthly cleaning of the building
  3. Annual property insurance after acquisition
  4. Interest on a loan obtained after the building is placed in service

Explanation

Costs necessary to bring an asset to its intended location and condition are capitalized, and acquisition commissions are directly attributable to the purchase. Ongoing operating costs are expensed as incurred.

Question 44Financial Accounting and Reporting

A company declares a cash dividend on its common shares. On the declaration date, what is the effect?

  1. Retained earnings decreases and cash decreases
  2. A liability increases and cash decreases
  3. A liability increases and retained earnings decreases Correct answer.
  4. No entry is recorded until the payment date

Explanation

Declaration creates a legal obligation, so dividends payable is credited and retained earnings is debited. Cash is not affected until the dividend is actually paid.

Question 45Financial Accounting and Reporting

A company receives 5,000 cash for services to be performed next month and records it as unearned revenue. What is the effect on the financial statements at the time of receipt?

  1. Assets decrease by 5,000
  2. Liabilities increase by 5,000 Correct answer.
  3. Equity increases by 5,000
  4. Revenue increases by 5,000

Explanation

Cash received before the service is performed creates a performance obligation, recorded as a liability called unearned revenue. Revenue and equity are not increased until the service is delivered.

Question 46Financial Accounting and Reporting

Which of the following is reported as an operating activity in the statement of cash flows under the indirect method?

  1. Purchase of equipment for cash
  2. Proceeds from issuing ordinary shares
  3. Repayment of long-term borrowings
  4. Depreciation expense added back to net income Correct answer.

Explanation

Under the indirect method, non-cash expenses such as depreciation are added back to net income within operating activities because they reduced income without using cash. Investing and financing cash flows are presented separately.

Question 47Financial Accounting and Reporting

A company has taxable income of 200,000 and a tax rate of 25%, but because of a temporary difference its income tax payable is 40,000. What amount of deferred tax is recognized?

  1. A deferred tax liability of 50,000
  2. A deferred tax liability of 10,000 Correct answer.
  3. No deferred tax is recognized
  4. A deferred tax asset of 10,000

Explanation

Income tax expense based on accounting profit is 50,000, while tax currently payable is 40,000. The 10,000 difference will be paid in future periods, creating a deferred tax liability.

Question 48Financial Accounting and Reporting

Which of the following items is reported in other comprehensive income rather than in net income?

  1. Cost of goods sold
  2. Gain on sale of a delivery vehicle
  3. Foreign currency translation adjustment Correct answer.
  4. Interest expense on a bank loan

Explanation

A foreign currency translation adjustment arises from translating foreign operations and is reported in other comprehensive income until reclassified. Gains on asset sales, interest, and cost of goods sold flow through net income.

Question 49Financial Accounting and Reporting

A company uses the percentage-of-completion method for a long-term contract. Costs incurred to date are 400,000, estimated total costs are 1,000,000, and the contract price is 1,500,000. What revenue is recognized to date?

  1. 400,000
  2. 1,500,000
  3. 500,000
  4. 600,000 Correct answer.

Explanation

Progress toward completion is 400,000 / 1,000,000 = 40%. Revenue recognized to date equals 40% of the 1,500,000 contract price, or 600,000.

Question 50Financial Accounting and Reporting

A company's accounts receivable turnover is 8 times per year. Approximately how many days does it take on average to collect receivables?

  1. 60 days
  2. 8 days
  3. 46 days Correct answer.
  4. 30 days

Explanation

Days sales outstanding equals 365 divided by the receivables turnover, so 365 / 8 is approximately 46 days. This measures the average collection period for credit sales.