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CPA FAR practice questions

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Question 1Financial Reporting

Which of the following is a fundamental qualitative characteristic that makes financial information useful to users?

  1. Comparability
  2. Timeliness
  3. Verifiability
  4. Faithful representation Correct answer.

Explanation

The conceptual framework identifies relevance and faithful representation as the two fundamental qualitative characteristics. Comparability, verifiability, timeliness, and understandability are enhancing characteristics that increase usefulness but are not fundamental.

Question 2Financial Reporting

Under accrual-basis accounting, revenue is recognized when:

  1. The customer has been billed for the goods
  2. The performance obligation is satisfied Correct answer.
  3. The contract has been signed by both parties
  4. Cash is collected from the customer

Explanation

Revenue is recognized when (or as) a performance obligation is satisfied by transferring promised goods or services to the customer. Collectibility, contract signing, and billing are not the events that trigger recognition.

Question 3Financial Reporting

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

  1. Gain on the sale of equipment
  2. Unrealized gain on trading debt securities
  3. Dividend revenue from an equity investment
  4. Foreign currency translation adjustment Correct answer.

Explanation

Other comprehensive income includes items excluded from net income under U.S. GAAP, such as foreign currency translation adjustments, certain pension adjustments, and unrealized gains and losses on available-for-sale debt securities. Trading securities are measured at fair value through net income.

Question 4Financial Reporting

Under U.S. GAAP, research and development costs are generally:

  1. Expensed as incurred Correct answer.
  2. Capitalized once technological feasibility is reached
  3. Deferred until the related product generates revenue
  4. Capitalized and amortized over the useful life

Explanation

R&D costs are charged to expense as incurred because their future economic benefits are uncertain. Materials and equipment with alternative future uses are capitalized, and certain software development costs are capitalized after technological feasibility is established.

Question 5Financial Reporting

Which assumption underlies preparing financial statements on the basis that the entity will continue in existence long enough to realize assets and settle liabilities in the normal course of business?

  1. Monetary unit
  2. Periodicity
  3. Historical cost
  4. Going concern Correct answer.

Explanation

The going concern assumption supports presenting assets and liabilities on a nonliquidation basis. When substantial doubt exists, additional disclosure and, in some cases, alternative presentation may be required.

Question 6Financial Reporting

Under U.S. GAAP, cash paid for interest is reported in the statement of cash flows as:

  1. A financing activity
  2. An operating activity Correct answer.
  3. A noncash investing activity
  4. An investing activity

Explanation

U.S. GAAP classifies interest paid as an operating cash outflow because it enters into the determination of net income. IFRS permits interest paid to be classified as operating or financing, but that choice is not available under U.S. GAAP.

Question 7Financial Reporting

Which of the following must be disclosed about related party transactions?

  1. The names of the related parties and their ownership percentages
  2. Only transactions exceeding 10% of total assets
  3. Nothing, if the transactions were made at arm's length
  4. The nature of the relationship and the amounts involved Correct answer.

Explanation

Disclosure must include the nature of the relationship, a description of the transactions, the dollar amounts, and amounts due to or from related parties. There is no quantitative materiality screen that eliminates the disclosure requirement.

Question 8Financial Reporting

A change in the estimated useful life of a depreciable asset is accounted for:

  1. Retrospectively, with restatement of prior periods
  2. By a cumulative catch-up adjustment to retained earnings
  3. As a prior period adjustment to opening balances
  4. Prospectively over the remaining useful life Correct answer.

Explanation

A change in estimate is accounted for prospectively, affecting the current and future periods only. Retrospective restatement is reserved for changes in accounting principle and corrections of errors.

Question 9Financial Reporting

A customer with a receivable outstanding at December 31 files for bankruptcy in February, before the statements are issued; the customer's deteriorating financial condition existed at year end. The company should:

  1. Disclose the bankruptcy only, with no adjustment
  2. Ignore it, because the filing occurred after year end
  3. Recognize the loss in the following year's statements
  4. Adjust the December 31 statements for the loss Correct answer.

Explanation

A subsequent event that provides additional evidence about conditions existing at the balance sheet date is a recognized subsequent event. The receivable was already impaired at year end, so the loss is recorded in the December 31 financial statements.

Question 10Financial Reporting

Under U.S. GAAP, an operating segment is separately reportable when its revenue, including intersegment sales, is at least:

  1. 50% of the combined revenue of all segments
  2. 25% of the combined revenue of all segments
  3. 5% of the combined revenue of all segments
  4. 10% of the combined revenue of all segments Correct answer.

Explanation

An operating segment is reportable if its revenue is 10% or more of the combined revenue of all operating segments, or if its profit or loss or its assets meet the same 10% threshold. Segments are also added until reportable segments cover at least 75% of external revenue.

Question 11Financial Reporting

A U.S. parent's foreign subsidiary operates in a self-contained local economy, generates and spends cash locally, and sets prices based on local competition. The subsidiary's functional currency is:

  1. The local currency Correct answer.
  2. The currency of its largest customer
  3. The parent's presentation currency
  4. The U.S. dollar

Explanation

The functional currency is the currency of the primary economic environment in which the entity operates. A self-contained subsidiary whose cash flows and pricing are local has the local currency as its functional currency, and its statements are translated using the current rate method.

Question 12Financial Reporting

The results of operations of a component that qualifies as a discontinued operation are presented:

  1. Net of tax, below income from continuing operations Correct answer.
  2. As a direct charge to retained earnings, net of tax
  3. Within income from continuing operations, net of tax
  4. Within other comprehensive income, net of tax

Explanation

A discontinued operation is reported separately, net of tax, after income from continuing operations so that users can distinguish continuing performance. Any gain or loss on disposal is presented in the same section.

Question 13Financial Reporting

Net income is $500,000, preferred dividends declared are $50,000, and weighted-average common shares outstanding are 100,000. Basic earnings per share is:

  1. $5.00
  2. $5.50
  3. $4.50 Correct answer.
  4. $4.00

Explanation

Basic EPS equals income available to common shareholders divided by weighted-average common shares. Income available to common shareholders is $500,000 less the $50,000 preferred dividend, or $450,000, divided by 100,000 shares, yielding $4.50.

Question 14Financial Reporting

For an operating lease, the lessee recognizes the total lease cost:

  1. Only as payments are made to the lessor
  2. As separate interest and amortization amounts
  3. Using the lessor's depreciation of the leased asset
  4. On a straight-line basis over the lease term Correct answer.

Explanation

A lessee records a single lease cost for operating leases, allocated on a straight-line basis over the lease term unless another systematic basis is more representative. The separate interest and amortization pattern applies to finance leases.

Question 15Financial Reporting

A long-lived asset group held for use is tested for impairment by comparing its carrying amount with:

  1. The discounted expected future cash flows
  2. The fair value of the asset group less costs to sell
  3. The undiscounted expected future cash flows Correct answer.
  4. The asset group's historical cost

Explanation

Recoverability is assessed by comparing the carrying amount with the sum of undiscounted expected future cash flows. Only if the carrying amount is not recoverable is an impairment measured as the excess of carrying amount over fair value.

Question 16Financial Reporting

Accelerated depreciation for tax purposes and straight-line depreciation for book purposes create a taxable temporary difference that results in:

  1. A permanent difference
  2. A deferred tax asset
  3. A deferred tax liability Correct answer.
  4. No deferred tax amount

Explanation

The difference reverses in future periods when book depreciation exceeds tax depreciation, producing taxable amounts. A taxable temporary difference gives rise to a deferred tax liability measured at enacted future tax rates.

Question 17Financial Reporting

Compensation cost for nonvested stock options is measured at:

  1. The fair value on the grant date Correct answer.
  2. The fair value on the vesting date
  3. The intrinsic value on the grant date
  4. The exercise price on the grant date

Explanation

The grant-date fair value of the award, determined using an option-pricing model, is the measurement basis and is recognized as compensation cost over the requisite service period. Subsequent changes in fair value do not change the amount recognized for equity-classified awards.

Question 18Financial Reporting

A company exchanges a machine with a carrying amount of $60,000 and a fair value of $75,000 for a dissimilar machine. The exchange has commercial substance. The company should recognize:

  1. A gain of $75,000
  2. A gain of $15,000 Correct answer.
  3. No gain
  4. A deferred gain of $15,000

Explanation

When an exchange has commercial substance, the acquired asset is recorded at the fair value of the asset given up and the full gain of $15,000 is recognized immediately. Gain deferral applies only when the transaction lacks commercial substance.

Question 19Financial Reporting

Level 2 inputs in the fair value hierarchy are:

  1. Quoted prices for identical items in active markets
  2. Observable inputs other than quoted prices for identical assets Correct answer.
  3. Historical cost adjusted for inflation
  4. Unobservable inputs reflecting the entity's own assumptions and models

Explanation

Level 2 inputs are observable, directly or indirectly, but are not quoted prices in active markets for identical assets or liabilities. Examples include quoted prices for similar assets in active markets and observable yield curves.

Question 20Financial Reporting

Under the treasury stock method, assumed option proceeds are used to repurchase shares at the:

  1. Market price on the last day of the period
  2. Average market price during the period Correct answer.
  3. Market price on the grant date
  4. Exercise price stated in the option

Explanation

The treasury stock method assumes proceeds are used to buy back shares at the average market price for the period. Options are dilutive only when that average price exceeds the exercise price.

Question 21Financial Reporting

A company using LIFO liquidates older, lower-cost inventory layers during a period of rising prices. The liquidation results in:

  1. An increase in gross profit and taxable income Correct answer.
  2. A decrease in gross profit and taxable income
  3. No effect on gross profit or taxable income
  4. An increase in the cost of the ending inventory

Explanation

Liquidating older, cheaper layers matches lower historical costs against current-period revenue, which increases gross profit and taxable income. The effect is a LIFO liquidation, and it must be disclosed if material.

Question 22Financial Reporting

Under current U.S. GAAP, a goodwill impairment loss is measured as the excess of:

  1. Implied fair value of goodwill over its carrying value
  2. Fair value of net assets over their carrying value
  3. A reporting unit's carrying value over its fair value Correct answer.
  4. Undiscounted cash flows over the carrying value

Explanation

Goodwill impairment is measured as the excess of a reporting unit's carrying amount over its fair value, limited to the goodwill recognized for that reporting unit. The older two-step implied fair value approach was eliminated by ASU 2017-04.

Question 23Financial Reporting

Amortization of prior service cost is reported as a component of:

  1. Deferred compensation expense
  2. Retained earnings directly
  3. Other comprehensive income
  4. Net periodic pension cost Correct answer.

Explanation

Prior service cost is initially recognized in other comprehensive income and then amortized into net periodic pension cost over the remaining service period. The amortization component therefore affects net income rather than OCI.

Question 24Financial Reporting

Under U.S. GAAP, interim period income tax expense is generally measured using:

  1. A rate selected by management each quarter
  2. The prior year's annual effective rate
  3. The statutory federal income tax rate
  4. The estimated annual effective tax rate Correct answer.

Explanation

Each interim period applies the estimated annual effective tax rate to year-to-date ordinary income, so that the tax provision reflects permanent differences and expected credits for the full year. Discrete items are recognized in the period they occur.

Question 25Financial Reporting

A company discovers that it failed to record depreciation in prior years. The correction is reported as:

  1. A component of current year income from continuing operations
  2. A change in accounting estimate applied prospectively
  3. A prior period adjustment to beginning retained earnings Correct answer.
  4. An item of other comprehensive income

Explanation

A material error in previously issued statements is corrected through a prior period adjustment, with restatement of the prior periods presented. It is not treated as a current-year income item or as a change in estimate.

Question 26Financial Reporting

According to the FASB conceptual framework, which qualitative characteristic requires that financial information be capable of making a difference in a user's decision?

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

Explanation

Relevance is a fundamental qualitative characteristic; information is relevant if it has predictive value, confirmatory value, or both, including materiality. Comparability, verifiability, timeliness, and understandability are enhancing characteristics that improve useful information but do not by themselves make information decision-different.

Question 27Financial Reporting

Under accrual accounting, revenue is recognized when:

  1. An invoice is issued to the customer.
  2. The performance obligation is satisfied. Correct answer.
  3. Cash is received from the customer.
  4. The contract is signed by both parties.

Explanation

Under accrual accounting, revenue is recognized when the entity satisfies a performance obligation by transferring promised goods or services to the customer. Receipt of cash, signing a contract, or issuing an invoice does not by itself determine recognition.

Question 28Financial Reporting

Under U.S. GAAP, cash dividends paid to shareholders are classified in the statement of cash flows as:

  1. A noncash investing and financing activity
  2. A financing cash outflow Correct answer.
  3. An operating cash outflow
  4. An investing cash outflow

Explanation

Under U.S. GAAP, dividends paid are a financing cash outflow because they are a distribution to providers of capital. Interest paid, by contrast, is classified as an operating cash flow.

Question 29Financial Reporting

A company declares a 2-for-1 stock split after year-end but before issuing its financial statements. For EPS purposes, the split is:

  1. Applied retroactively to all periods presented Correct answer.
  2. Ignored in the current year and applied beginning next year
  3. Applied only prospectively from the split date
  4. Disclosed in the notes with no effect on EPS

Explanation

Stock splits and stock dividends change the number of shares without changing resources, so EPS for all periods presented is restated retroactively to make shares comparable. A split after year-end but before issuance is reflected in the current and prior EPS amounts.

Question 30Financial Reporting

Comprehensive income may be displayed:

  1. Only in a single continuous statement of comprehensive income
  2. Only in the notes to the financial statements
  3. Only in the statement of changes in stockholders' equity
  4. In either a single continuous statement or two separate but consecutive statements Correct answer.

Explanation

ASC 220 permits comprehensive income to be presented either in one continuous statement or in two separate but consecutive statements: an income statement followed by a statement of other comprehensive income. It cannot be presented only in the equity statement or only in the notes.

Question 31Financial Reporting

The fair value measurement framework defines fair value as:

  1. An exit price based on the amount received to sell an asset or paid to transfer a liability Correct answer.
  2. The replacement cost of the asset in the current market
  3. The historical cost of the asset adjusted for depreciation
  4. An entry price based on the amount paid to acquire an asset

Explanation

Fair value is a market-based measurement representing the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is an exit price, not an entry price or cost-based amount.

Question 32Financial Reporting

A lessee may elect not to recognize a right-of-use asset and lease liability for a short-term lease. A short-term lease has a lease term of:

  1. Six months or less, regardless of purchase options
  2. Any lease with monthly payments and no fixed term
  3. Twelve months or less, including leases with a bargain purchase option
  4. Twelve months or less and does not include an option to purchase the asset that the lessee is reasonably certain to exercise Correct answer.

Explanation

A short-term lease is one with a lease term of 12 months or less at commencement and no option to purchase the underlying asset that the lessee is reasonably certain to exercise. The lessee may elect to recognize lease cost on a straight-line basis without recording a right-of-use asset or lease liability.

Question 33Financial Reporting

A loss contingency that is probable and can be reasonably estimated should be:

  1. Recorded as a deferred charge
  2. Disclosed only in the notes
  3. Ignored until the loss is paid
  4. Accrued as a liability Correct answer.

Explanation

A loss contingency is accrued when it is probable that a liability has been incurred and the amount can be reasonably estimated. Disclosure alone is insufficient when both accrual criteria are met.

Question 34Financial Reporting

A contractor estimates variable consideration using the expected value method because it has a large number of similar contracts. Before including the amount in the transaction price, the contractor must:

  1. Include the maximum amount of variable consideration in the transaction price
  2. Exclude all variable consideration from the transaction price
  3. Apply the constraint so that it is probable that a significant reversal of revenue will not occur Correct answer.
  4. Wait until all cash is collected before recognizing any revenue

Explanation

Variable consideration is included in the transaction price only to the extent it is probable that a significant reversal of revenue will not occur when the uncertainty is resolved. The expected value method estimates the amount, but the constraint still must be applied.

Question 35Financial Reporting

An entity has an unconditional right to receive consideration from a customer before transferring goods. The entity should present the right as:

  1. A contract liability
  2. Deferred revenue
  3. A receivable Correct answer.
  4. Inventory

Explanation

An unconditional right to consideration is a receivable because only the passage of time is required before payment is due. A contract asset is a conditional right, while a contract liability is an obligation to transfer goods or services.

Question 36Financial Reporting

At commencement of a finance lease, the lessee's initial measurement of the right-of-use asset includes:

  1. The total undiscounted lease payments over the lease term
  2. Only the present value of the lease payments
  3. The lease liability plus initial direct costs plus prepaid lease payments Correct answer.
  4. The fair value of the leased asset at commencement

Explanation

The lessee initially measures the right-of-use asset at the lease liability amount, adjusted for lease payments made at or before commencement, plus initial direct costs, plus restoration costs, less lease incentives. It is not simply the fair value or the undiscounted payments.

Question 37Financial Reporting

A company has net income of $1,000,000 and 100,000 weighted-average common shares. It also has 10,000 convertible preferred shares, each convertible into 2 common shares, with preferred dividends of $50,000. For diluted EPS, the if-converted method yields:

  1. $9.50
  2. $8.33 Correct answer.
  3. $8.00
  4. $10.00

Explanation

Under the if-converted method, diluted EPS assumes conversion at the beginning of the period, so preferred dividends are added back to the numerator and the additional common shares are added to the denominator. Diluted EPS equals $1,000,000 divided by 120,000 shares, or $8.33.

Question 38Financial Reporting

In the indirect method, a gain on sale of equipment is:

  1. Reported as an investing cash inflow
  2. Ignored in the statement of cash flows
  3. Subtracted from net income in the operating activities section Correct answer.
  4. Added to net income in the operating activities section

Explanation

The gain is included in net income, but the related cash proceeds are investing cash flows, so the gain must be subtracted from net income in operating activities to avoid double counting. Depreciation is added back, while gains on asset sales are subtracted.

Question 39Financial Reporting

For interim reporting, a decline in inventory value that is expected to be recovered by year-end is:

  1. Recognized as a loss in the interim period
  2. Not recognized because it is expected to be recovered by year-end Correct answer.
  3. Recognized only at year-end regardless of recovery
  4. Treated as a change in accounting principle

Explanation

For interim reporting, a decline in inventory value expected to be recovered by year-end is not recognized as a loss in the interim period; it is deferred. If the decline is not expected to be recovered, it is recognized in the interim period.

Question 40Financial Reporting

An indefinite-lived intangible asset is tested for impairment by comparing its fair value with its:

  1. Undiscounted future cash flows
  2. Replacement cost
  3. Carrying amount Correct answer.
  4. Book value plus recorded goodwill

Explanation

Indefinite-lived intangibles are not amortized; they are tested for impairment at least annually by comparing fair value with carrying amount. If fair value is less than carrying amount, an impairment loss is recognized.

Question 41Financial Reporting

A long-lived asset classified as held for sale is measured at:

  1. Fair value
  2. Carrying amount
  3. Higher of carrying amount or fair value less costs to sell
  4. Lower of carrying amount or fair value less costs to sell Correct answer.

Explanation

A long-lived asset held for sale is measured at the lower of carrying amount or fair value less costs to sell, and depreciation ceases. The lower-of test prevents reporting the asset above its expected net realizable value.

Question 42Financial Reporting

A correction of an error from a prior year is reported as:

  1. A component of current-year income from continuing operations
  2. A component of other comprehensive income
  3. An adjustment to beginning retained earnings with restatement of prior period amounts Correct answer.
  4. A change in accounting estimate applied prospectively

Explanation

A correction of a prior-period error is a prior period adjustment reported as an adjustment to beginning retained earnings, with prior period financial statements restated. It is not reported in current income or other comprehensive income.

Question 43Financial Reporting

After the balance sheet date but before issuance, a fire destroys a warehouse that was not damaged at year-end. The entity should:

  1. Ignore the event because it occurred after year-end
  2. Recognize an insurance receivable at year-end
  3. Adjust the year-end financial statements to recognize the loss
  4. Disclose the event in the notes if it is material Correct answer.

Explanation

A fire after the balance sheet date that did not exist at year-end is a nonrecognized subsequent event. It is disclosed in the notes if material so users can evaluate its effect.

Question 44Financial Reporting

A U.S. company has a payable of 100,000 foreign currency units when the exchange rate is $1.10. At year-end the rate is $1.20. The company should recognize:

  1. A foreign exchange loss of $10,000 Correct answer.
  2. A translation adjustment in other comprehensive income
  3. No adjustment because the payable is not settled
  4. A foreign exchange gain of $10,000

Explanation

The payable is a monetary liability denominated in a foreign currency, so changes in the exchange rate are recognized in income. The rate increase from $1.10 to $1.20 raises the dollar cost by $10,000, creating a loss.

Question 45Financial Reporting

A valuation allowance against deferred tax assets is recognized when it is:

  1. Probable that some deferred tax assets will not be realized
  2. Certain that some deferred tax assets will not be realized
  3. More likely than not that some deferred tax assets will not be realized Correct answer.
  4. Remote that some deferred tax assets will not be realized

Explanation

A valuation allowance is recognized when it is more likely than not, meaning greater than a 50% chance, that some or all deferred tax assets will not be realized. The allowance reduces the deferred tax asset to the amount expected to be realized.

Question 46Financial Reporting

An entity arranges for a third party to provide cleaning services to customers. The entity sets the price, is primarily responsible for the service, and bears inventory risk. The entity should:

  1. Recognize no revenue because a third party performs the service
  2. Recognize revenue net of the third-party fee as an agent
  3. Recognize revenue gross as a principal because it controls the service before transfer Correct answer.
  4. Recognize revenue only after the customer pays

Explanation

An entity is a principal if it controls the specified good or service before it is transferred to the customer; it then recognizes revenue gross. Indicators of control include primary responsibility, inventory risk, and discretion in pricing.

Question 47Financial Reporting

In a sales-type lease, the lessor recognizes selling profit at lease commencement equal to:

  1. The gross investment in the lease minus the unguaranteed residual value
  2. The total lease payments received over the lease term
  3. The interest income recognized at commencement
  4. The excess of the fair value of the leased asset over its carrying amount, subject to lower-of-cost-or-fair-value constraints Correct answer.

Explanation

In a sales-type lease, the lessor derecognizes the underlying asset and recognizes a net investment in the lease plus selling profit. Selling profit is measured as the fair value of the asset, or carrying amount if lower, minus the carrying amount of the asset.

Question 48Financial Reporting

For an uncertain tax position, the amount recognized is the largest amount of tax benefit that is:

  1. Certain to be realized upon ultimate settlement
  2. Probable of being realized upon ultimate settlement
  3. Greater than 50% likely of being realized upon ultimate settlement Correct answer.
  4. The maximum amount of tax benefit claimed on the return

Explanation

For uncertain tax positions, recognition occurs only if the position is more likely than not to be sustained. Measurement is the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with the taxing authority.

Question 49Financial Reporting

A contract modification adds distinct goods at a price that does not reflect their standalone selling price. The modification should be accounted for as:

  1. A cumulative catch-up adjustment to revenue only
  2. No adjustment until the contract is completed
  3. A separate contract with no effect on the existing contract
  4. A termination of the existing contract and creation of a new contract, with the remaining transaction price reallocated Correct answer.

Explanation

If a contract modification is not a separate contract because the price does not reflect standalone selling price and the remaining goods are distinct, the entity accounts for it as a termination of the existing contract and creation of a new contract. The remaining transaction price is reallocated to the remaining performance obligations.

Question 50Financial Reporting

A company failed to record accrued wages of $20,000 at the end of Year 1. In Year 2, the wages are paid and expensed. The error is:

  1. An error that affects only the balance sheet and never self-corrects
  2. A noncounterbalancing error requiring a prior period adjustment in Year 2
  3. A change in accounting estimate reported prospectively
  4. A counterbalancing error that self-corrects by the end of Year 2 Correct answer.

Explanation

The omitted accrual at the end of Year 1 reverses when the wages are paid and expensed in Year 2, so the error is counterbalancing and self-corrects by the end of Year 2. Prior period adjustment is required for noncounterbalancing errors.