Financial Accounting and Reporting Practice Questions for the CPA Exam - dummies

Financial Accounting and Reporting Practice Questions for the CPA Exam

By Kenneth W. Boyd

The financial accounting and reporting (FAR) test of the CPA exam covers the nuts and bolts of working as an accountant. One focus of this test is the typical transactions that an accountant posts each month and year. The FAR test also goes over accounting principles.

  1. Sun Co. is a wholly owned subsidiary of Star Co. Both companies have separate general ledgers and prepare separate financial statements. Sun requires standalone financial statements. Which of the following statements is correct?

    A. Consolidated financial statements should be prepared for both Star and Sun.

    B. Consolidated financial statements should be prepared only by Star and not by Sun.

    C. After consolidation, the accounts of both Star and Sun should be changed to reflect the consolidated totals for future ease in reporting.

    D. After consolidation, the accounts of both Star and Sun should be combined into one general-ledger accounting system for future ease in reporting.

Answer: B. Star owns Sun; therefore, consolidated financial statements should be prepared for Star but not Sun.

  1. The premium on a 3-year insurance policy expiring on December 31, Year 3, was paid in total on January 1, Year 1.

    Assuming that the original payment was initially debited to an expense account and that appropriate adjusting entries have been recorded on December 31, Year 1 and Year 2, the balance in the prepaid asset account on December 31, Year 2, would be

    A. Zero.

    B. Lower than the balance on December 31, Year 3.

    C. The same as the original payment.

    D. The same as it would have been if the original payment had been initially debited to a prepaid asset account.

Answer: D. This answer is correct because under either method, the balance in the prepaid asset account on December 31, Year 2 (12/31/Y2), should be the unexpired portion of the policy. On 12/31/Y1, an adjusting entry would be made by debiting “Prepaid insurance” and crediting “Insurance expense” for two-thirds of the original payment (the unexpired portion of the policy).

This would result in one-third of the payment being expensed. This entry would then be reversed on 1/1/Y2. At the end of Year 2, an adjusting entry would again be made by debiting “Prepaid insurance” and crediting “Insurance expense” for one-third of the original payment (the unexpired portion of the policy).

Because the reversing entry will not be made until 1/1/Y3, the prepaid asset account balance would be the same on 12/31/Y2 for this method as it would have been had the payment originally been debited to “Prepaid insurance” on 1/1/Y1.

  1. On January 2, Year 4, Raft Corp. discovered that it had incorrectly expensed a $210,000 machine purchased on January 2, Year 1.

    Raft estimated the machine’s original useful life to be 10 years and its salvage value to be $10,000. Raft uses the straight-line method of depreciation and is subject to a 30% tax rate. In its December 31, Year 4, financial statements, what amount should Raft report as a prior period adjustment?

    A. $102,900

    B. $105,000

    C. $165,900

    D. $168,000

Answer: B. The requirement is to determine the amount of the prior period adjustment. ASC Topic 250 provides that an error in the financial statements requires restatement of the financial statements with an adjusting entry to retained earnings for the earliest period presented.

When Raft incorrectly expensed the machine in Year 1, earnings before tax were understated by $210,000. Had Raft properly capitalized this asset, it would have recorded $20,000 depreciation expense per year in Year 1, Year 2, and Year 3. Depreciation expense is calculated on a straight-line basis as $20,000 per year:

($210,000 – $10,00) / 10 years

Over the three years, Raft would have recorded a total of $60,000 of depreciation expense. Therefore, as of January 2, Year 4, expenses have been overstated by $150,000, ($210,000 – $60,000), and the tax effect of the adjustment is 30% x $150,000, or $45,000. Therefore, the prior period adjustment to retained earnings net of taxes is $105,000, ($150,000 – $45,000).

  1. Madden Company owns a tract of land, which it purchased in Year 1 for $100,000. The land is held as a future plant site and has a fair market value of $140,000 on July 1, Year 4.

    Hall Company also owns a tract of land held as a future plant site. Hall paid $180,000 for the land in Year 3, and the land has a fair market value of $200,000 on July 1, Year 4. On this date, Madden exchanged its land and paid $50,000 cash for the land owned by Hall.

    It is expected that the cash flows from the two tracts of land will not be significantly different. At what amount should Madden record the land acquired in the exchange?

    A. $150,000

    B. $160,000

    C. $190,000

    D. $200,000

Answer: A. Per ASC Topic 845, if the cash flows of the two assets are not significantly different, the transaction lacks commercial substance and is recorded at book value. Therefore, the land acquired is recorded as total of the cash paid ($50,000) plus the book value of the land surrendered ($100,000), or $150,000. The economic gain of $40,000 ($140,000 market value less $100,000 book value) is not recognized. The journal entry is

Land (new) $150,000
Land (old) $100,000
Cash $50,000
  1. Wolf Co.’s grant of 30,000 stock appreciation rights enables key employees to receive cash equal to the difference between $20 and the market price of the stock on the date each right is exercised.

    The service period is Year 1 through Year 3, and the rights are exercisable in Year 4 and Year 5. The market prices of the stock were $25 and $28 at December 31, Year 1 and Year 2, respectively. What amount should Wolf report as the liability under the stock appreciation rights plan in its December 31, Year 2, balance sheet?

    A. $0

    B. $130,000

    C. $160,000

    D. $240,000

Answer: C. The 30,000 stock appreciation rights (SARs) entitle the holders to receive cash equal to the excess of the stock’s market price on the exercise date over $20. On 12/31/Y2, the estimate of total SARs compensation expense is $240,000:

30,000 x ($28 –$20)

Because the required service period is 3 years, this total expense will be allocated over a 3-year period. By the end of Year 2, the second year, two-thirds of the total estimated compensation expense should be accrued, resulting in a SARs liability of $160,000:

(2/3 x $240,000)