Kenneth W. Boyd

Article / Updated 03-26-2016

You can think of the regulation (REG) test as having two parts. One part covers business law issues, including rules on selecting a business structure. The second part of the test goes over taxation. This test is technically the most difficult. It requires you to know and apply many rules, facts and figures. You may find that the REG questions require more focus than other types of questions. Here are some tips for understanding the info on this test: Considering your business law courses: A good portion of the REG test involves topics covered in a business law class. This includes agency and contract law as well as sales law. If you’ve had a business law class, you may have a leg up in learning this material. Some of the law topics may be familiar to you. Pulling out tax forms: Some students see the taxation portion of the REG test as a long list of rules, with very little connection between the rules. These students can’t visualize how all the facts fit together. One great way to connect tax information is to print and review the tax forms themselves. To study for personal taxation, take a look at where the information is posted on Form 1040, the individual tax return.

Article / Updated 03-26-2016

The auditing and attestation test (AUD test) requires you to understand the entire process of auditing a company. An audit requires the CPA to provide an opinion. That opinion states whether or not the financial statements are materially correct. This work requires you to assess all of the accounts in both the balance sheet and the income statement. The test covers planning the audit, understanding the client’s business, and evaluating the firm’s internal controls: Unqualified versus qualified audit opinions: A large portion of the AUD test covers audit opinions (or audit reports). The differences between these opinions can be tricky. An unqualified audit opinion means that the financial statements are materially correct. Review and memorize the exact language for an unqualified opinion. An auditor writes a qualified opinion when he or she finds issues in the audit. For example, if an auditor can’t gather sufficient audit evidence on the inventory account balance, the auditor has a scope limitation, which means that the auditor’s audit work isn’t sufficient for an unqualified opinion on the financial statements. An auditor writes a qualified report for a scope limitation. The qualified report language requires making changes and additions to the unqualified report language. If you memorize the unqualified report language, you have a starting point for writing a qualified report. Segregation of duties: A heavily tested area on the AUD test is segregation of duties. To prevent theft and fraud, a company should segregate three types of duties among three employees: Custody of assets refers to having physical access to the company checkbook or keys to the warehouse. Authorization to move assets means an individual can sign a check or approve a purchase. Recordkeeping refers to posting accounting entries. If these duties are kept separate, a firm has a better chance of preventing fraud and theft in the business.

Article / Updated 03-26-2016

The financial accounting and reporting (FAR) test requires the most number-crunching. This test covers what you’ll spend most of your time on when you start your accounting career. The test requires you to use many types of formulas, and to understand the process of accounting. It covers types of accounts, accounting transactions, and accounting principles: Using formulas: This test covers many of the day-to-day tasks you’ll encounter as a CPA, such as posting accounting transactions. You’ll need to memorize a list of formulas. A common question on the FAR test requires you to use the formula for ending inventory, which is Beginning inventory + Purchases – Cost of goods sold = Ending inventory. The test question may provide three of the numbers in the formula and ask you to solve for the missing number. Understanding accounts: The FAR test requires you to understand a company’s chart of accounts, which is the list of accounts a firm uses to post accounting transactions. You need to understand how accounts are classified on the balance sheet, income statement, and other financial statements. Cash basis versus accrual basis accounting: These two concepts appear on every FAR test. With cash basis, you post revenue when you deposit customer funds. Expenses are recorded when you write checks. The accrual basis, on the other hand, posts revenue when it’s earned. Typically, you earn revenue when you deliver a product or perform a service for a client. Expenses are posted when incurred. Accrual accounting is not driven by cash inflows and outflows.

Article / Updated 03-26-2016

The BEC test includes many topics that concern business management as well as economic concepts and the use of technology. This test covers the tools needed to succeed as a business manager. You’ll find that these concepts are similar to what you learn in a general study of business. Understanding business concepts: The topics on the BEC test are similar to what students learn in general business school classes. For example, this test covers several economic concepts, such as inflation and currency exchange rates. Making decisions: One purpose of the BEC test is to prepare the CPA to make informed business decisions. Some of these topics require you to think strategically as a business owner, not simply as an accountant. The BEC test, for example, may ask questions about pricing a product to cover all your costs and generate a profit. Working with information technology: The use of technology is a growing issue for CPAs. The BEC test covers several areas related to information technology (IT). CPA candidates see questions on how an IT department can generate useful financial reports. The test also includes questions on why IT can create a risk for fraud and theft.

Article / Updated 03-26-2016

The CPA exam requires hundreds of hours of preparation and study. To pass the exam, it’s important to have a plan of attack. That plan includes registering with your state board, as well as deciding on a study plan for each of the four tests. Here are some points to consider: State boards of accountancy: Each state has a state board of accountancy. The board in your state is responsible for gathering all your registration information so you can take the exam. Check your state board’s website for their CPA requirements. All CPA candidates must register with their state board. The four tests: The CPA exam consists for four separate tests: Business environment and concepts (BEC), financial accounting and reporting (FAR), auditing and attestation (AUD), and regulation (REG). You must pass each of these four tests to obtain your CPA designation. As you review each area of these tests, make some decisions about those topics that will require the most study time. Managing the amount of exam information: The CPA can require 400 hours (or more) of total study time. Some students find the sheer amount of test information overwhelming. One way to address that concern is to create a detailed study plan. Consider which test you will take first and how many hours of study time that test will require. Use your personal calendar to plan study time each week. If you take the exam preparation just one week at a time, you’ll be able to manage the large amount of study material. Pull out a blank calendar and start to create your plan to pass each test of the exam.

Article / Updated 03-26-2016

A variance is defined as the difference between budgeted and actual amounts in an account balance. Keep in mind, however, that the CPA exam uses the terms budgeted and planned to mean the same thing. Business managers analyze variances to make decisions about company costs and sales. You can think of a variance as a red flag to a manager. A variance is a warning that something in your business isn't going as planned. The variance process starts with planning. All businesses should have a budgeting or planning meeting to forecast sales, production, and costs for the next year. Part of the budgeting process involves setting standard amounts. A standard is management's forecast of a cost, production amount or sales level. Say, for example, that you make denim blue jeans. In planning, you determine that your material cost for denim will be $5 per yard. So $5 per yard is your standard cost. In addition to the cost of denim, your firm plans a standard level of denim usage per pair of jeans. Your firm decides that each pair of jeans will require 3 yards of denim. You now have a standard cost and a standard usage amount. Suppose that after the first quarter, you decide to compare your actual results to the standard amounts you set in planning. Your actual cost per yard for denim is only $4.50 per yard. You have a favorable variance of $5 standard cost – $4.50 actual cost = $.50 variance. The variance is favorable because you spent less than you planned. Your actual cost is less than budgeted. If you generate more revenue than planned, you also have a favorable variance. The first quarter results also indicate that you actually used 4 yards of denim for each pair of pants, compared with your budgeted amount of 3 yards. In this case, you have an unfavorable variance of 4 yards actual usage – 3 yards budgeted usage = 1 yard variance. The variance is unfavorable because you used more than planned. If you generate less revenue than planned, you also have an unfavorable variance. As you review variances, consider analyzing the largest variances first. Take a look the variances that are the largest as a percentage of your budgeted amount. For the denim standard cost, the variance is $0.50 ÷ $5 = 10%. You can also define the largest variances as total dollar amount rather than as a percentage. In either case, these are the variances you should investigate first. Hopefully, your analysis will allow you to make changes that will improve your profitability.

Article / Updated 03-26-2016

Here are some important formulas that often appear on the CPA exam. Understanding these formulas will help you boost your test score. These formulas are used on nearly every CPA exam, so it's an easy way to get some correct answers under your belt. Also, knowing these formulas helps you understand other accounting concepts that are frequently tested. Unearned revenue: adjusting entry Here is the journal entry to record a $1,000 customer deposit. A deposit is a payment you receive before a product or service is delivered. Debit (increase) cash $1,000, credit (increase) unearned revenue $1,000 Unearned revenue is a liability account. The customer deposit must be returned to the client if the product or service is not delivered. As a result, unearned revenue is a type of liability. When the product or service is delivered, you make this entry to recognize revenue: Debit (reduce) unearned revenue $1,000, credit (increase) revenue $1,000 Ending inventory formula For many businesses, inventory is the largest asset category on the balance sheet. CPAs need to know how inventory costs flow through a business. This formula for ending inventory should be on every exam: Ending inventory = Beginning inventory + Purchases – Cost of sales Retained earnings formula The balance in retained earnings represents all the profit that a company has generated — and not distributed to owners — since inception. Exam candidates often misunderstand the activity in this account, so knowing this formula is important: Retained earnings = Beginning retained earnings + Net income – Dividends A net loss reduces retained earnings. Several other transactions may affect retained earnings, but this basic formula is the one that's tested most often. Profit on sale of inventory item: FIFO method The first-in-first-out (FIFO) method of inventory valuation assumes that the oldest items are sold first. Because prices generally rise over time, the oldest items in inventory tend to be the cheapest. Suppose that an item has a sale price of $10,000 per unit. Here are the three items in inventory as of March 1. Each item includes the purchase date and the item's cost: January 15 $7,800 purchase, February 1 $8,200 item, February 15 $8,800 item Say that one item is sold on March 15. Using the FIFO method, the company assumes that the oldest item (January 15) is sold. The profit on the sale is $10,000 sale price – $7,800 cost = $2,200 profit. Profit on sale of inventory item: LIFO method The last-in-first-out (LIFO) method of inventory valuation assumes that the newest items are sold first. Because prices generally rise over time, the newest items in inventory tend to be the most expensive. Suppose the sale price is still $10,000 per unit, and the same three items are in inventory as of March 1: January 15 $7,800 purchase, February 1 $8,200 item, February 15 $8,800 item Say that one item is sold on March 15. Using the LIFO method, the company assumes that the newest item (February 15) is sold. The profit on the sale is $10,000 sale price – $8,800 cost = $1,200 profit. Checking out stock option gains Stock options are a very common way to reward employees for helping a company succeed over the long term. Because stock options are used frequently, the details are tested on the CPA exam. A stock option enables the holder to buy common stock as a set price (called the strike price or exercise price) for a specific period of time. Stock options are often granted to key employees as a reward for staying at a company and helping to increase profitability. Here's a basic formula: Stock option profit per share = Market price of stock per share – Exercise price of stock (buyer's cost) per share In many cases, the employee's ownership of the stock options becomes vested, or earned over time. Suppose a manager must stay at the firm for two years to become fully vested. He or she will be vested for half of the stock options after one year and vested for all the options after two years. Suppose that Sally is vested in stock options that allow her to buy 100 shares at a price of $20 per share. Sally holds the options until the market price of the stock is $40 per share. Sally decides to exercise the options, which means that Sally buys the stock shares at the strike price of $20 and sells them at the current market price of $40. Sally's gain is $40 – $20 = $20 × 100 shares = $2,000. Going over contribution margin Contribution margin reveals the amount of revenue remaining to pay for fixed costs: Contribution margin = Sales – Variable costs Contribution margin is a useful tool for managers. After paying for fixed costs, any balance left is your profit. Keep in mind that contribution margin is not net income. Contribution margin, however, does give you some idea of your profitability. Say, for example, that you manufacture baseball gloves. You sell the gloves for $80 each, and your variable costs to make a glove total $50 per unit. Variable costs typically include direct material costs (leather, in this case) and direct labor. Your contribution margin per unit is $80 – $50 = $30. For each glove, you have $30 left to cover fixed costs. Any amount left after paying your fixed costs will be profit. Using sum of the year's digits depreciation Sum of the year's digit's depreciation (SYD) is an accelerated method of depreciation. Accelerated depreciation methods recognize more depreciation in the early years and less in later years. Keep in mind, however, that the total amount of be depreciated is the same, regardless of the depreciation method you choose. If, for example, you buy a truck for $36,000 with $6,000 in salvage value, you'll recognize $30,000 in depreciation. If you recognize more depreciation in the early years, you'll recognize less depreciation in later years. Suppose that you're going to depreciate that truck with a $36,000 cost and a salvage value of $6,000. Salvage value is the amount you can sell truck for at the end of its useful life. Your depreciable base is Depreciable base = Cost – Salvage value In this example, the depreciable base is $36,000 cost – $6,000 salvage value = $30,000. The useful life of the truck is 5 years. You calculate SYD depreciation using a fraction. The denominator of the fraction is the sum of each year of depreciation, and the numerator of the formula is the number of years of useful life remaining at the beginning of a particular year. You find a particular year's depreciation by multiplying this fraction by the depreciable base: In this case, the denominator is 1 + 2 + 3 + 4 + 5 = 15. At the beginning of the first year, 5 years of useful life remain. The fraction for Year 1 depreciation is 5 ÷ 15, or one-third. Depreciation in Year 1 is $30,000 depreciable base × (5 ÷ 15) = $10,000 depreciation. The fractional part of the Year 2 depreciation formula is 4 ÷ 15.

Article / Updated 03-26-2016

The regulation (REG) test on the CPA exam requires a student to learn dozens of tax rules. One way to clarify these tax rules is to use a bucket as a learning tool. Consider individual taxation, which is computed on Form 1040. A taxpayer fills up the bucket with taxable income. Taxable income includes wages as well as dividends, interest, and earnings from self-employment. At that bottom on Page 1 of the 1040, you see a list of adjustments to income. These amounts reduce taxable income. For example, self-employed individuals can deduct a portion of their health insurance premiums. Visualize the taxpayer using a small shovel and taking some income out of the bucket. The top of Page 2 of Form 1040 covers the individual and standard deductions as well as exemptions. Both deductions and exemptions reduce income, so the taxpayer's shovel takes more income out of the bucket. After making all the changes to income, you use the taxable income to calculate your tax liability. That taxable amount is reduced by credits and increased by other taxes, such as self-employment tax. After the taxpayer has a final tax amount, imagine cutting a hole in the bottom of the bucket. Some of your income comes out of the bucket to pay taxes. After you pay taxes, you plug the hole of the bottom of the bucket. Form 1040 is a great tool for studying the tax concepts on the REG test. When you need to study tax rules for a given topic, consider where that tax issue is posted on Form 1040. The bucket analogy helps you visualize the process of accumulating income, making adjustments, and paying taxes.

Article / Updated 03-26-2016

One frequently tested topic on the CPA exam is accrual basis accounting. Companies that need to comply with GAAP (generally accepted accounting principles) have to use this method. GAAP represents the preferred rules of the road for the accounting industry. Accrual basis accounting requires companies to recognize revenue when it's earned. The term earned generally means when a product is delivered or a service is completed. Expenses, on the other hand, are recognized when incurred. Incurred refers to when a cost is paid in cash or when a liability is created (accounts payable, for example). The accrual basis recognizes revenue and expense without regard to cash inflows and outflows. Because accrual accounting and cash movements may be different, accountants post accrual entries. These entries are posted to ensure that the revenue or expense is posted in the proper period (month or year). One common prepaid expense is for insurance premiums. Say that Reliable Plumbing pays $2,000 a month in insurance premiums on its trucks. On January 1, Reliable writes a $12,000 check for insurance premiums. The premiums are for the first six months of the year. On January 1, the plumbing company debits (increases) prepaid insurance for $12,000 and credits (reduces) cash by $12,000. On February 1, the firm recognizes one month of insurance expense. The February journal entry is to debit (increase) insurance expense $2,000 and credit (decrease) prepaid insurance $2,000. The result is that the February insurance expense is posted to the proper month. As you can see, the accrual method doesn't record any expense when the insurance premiums are paid on January 1.

Article / Updated 03-26-2016

An audit requires a CPA to collect audit evidence. The evidence must be sufficient for the CPA to provide an audit opinion. An audit opinion states whether the financial statements are free of material misstatement. Analytical procedures are used to gather audit evidence. This topic can be challenging for students taking the CPA exam. Here's why: Analytical procedures require you to relate account balances to each other. You may be asked how one account balance affects a change in another account. You may also be asked to identify a trend in an account balance over several years. The trend may be expressed as a dollar amount of change, as a percentage change, or both. Say, for example, that you're provided with the following balances for sales and accounts receivable for a sporting goods manufacturer: Sales: 2012 $400,000; 2013 $500,000 Accounts receivable: 2012 $50,000; 2013 $75,000 Note that sales have increased 25 percent ($100,000 increase ÷ $400,000 beginning balance). Accounts receivable, on the other hand, increased 50 percent ($25,000 increase ÷ $50,000 beginning balance). The exam may ask you how the two increases are related. Using percentages, accounts receivable increased twice as fast as sales (50 percent versus 25 percent). Percentages allow you to make an apples-to-apples comparison between account balances with different dollar amounts. The sporting goods company is selling more goods to customers who are paying more slowly. As you study for the CPA exam, consider how accounts in the financial statements relate to each other.