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CPA REVIEW QUESTIONS

Regulation

Ajax is eager to sell its former headquarters, a commercial building valued at


$1,650,000. Ajax has received an offer from Johns in the amount of $1,800,000. The
offer stated, among other things, “all fixtures and furnishings now in the building shall
remain and be conveyed with the sale.” The furniture was of inconsequential value, but,
for sentimental reasons the president of Ajax did not want to convey an old “Ajax
Corporation” sign which still hung in the lobby. Which of the following is correct?

a. The board of directors of Ajax must authorize the sale for any contract to be valid.
b. An acceptance by Ajax which does not convey the “Ajax Corporation” sign will
cancel the offer from Johns.
c. The offer from Johns must be notarized since the contract involves real estate.
d. Ajax’s advertisement to sell its building, since it specified the price, is a valid offer.

Auditing

An investor is looking at audit reports for two different companies and finds the same
sentence in both: “Our responsibility is to express an opinion on these financial
statements based on our audit.” In the first case, that sentence is at the end of the first
paragraph. In the second case, that sentence is at the beginning of the third
paragraph. Which of the following is most likely?
a. The first report is for a public entity and the second report is for a nonpublic entity.
b. The first report is for a nonpublic entity and the second report is for a public entity.
c. The first case is correct but the second case is not.
d. The second case is correct but the first case is not.

BEC

An investor recently bought a large amount of gold as an investment after selling a


portfolio of corporate bonds. Which of the following is the most likely reason for those
actions?

a. Inflation rates are expected to remain the same over the near future.
b. Interest rates are expected to fall in the near future.
c. Corporate dividend levels are expected to rise in the near future.
d. Inflation rates are expected to rise in the near future.

Answers

FAR
CPA REVIEW QUESTIONS

Answer is A

For a contingent loss, balances are recognized when they are probable. Bad would
recognize a probable loss of $200,000 in Year One but would then reduce that to
$170,000 because of the settlement. The reduction creates a $30,000 recovery (gain).
Contingent gains are not recognized until finalized because accounting is
conservative. The entire $170,000 is recognized by Good in Year Two.

Regulation

Answer is B

Any “acceptance” which varies from the terms of an offer constitutes a counter-offer
which cancels the original offer.

Auditing

Answer is A

The Public Company Accounting Oversight Board sets the standards for public
companies and has maintained the traditional audit report where the auditor’s
responsibility is stated at the end of the first paragraph. The Auditing Standards Board
sets standards for nonpublic companies and has created a new standard report where
the auditor’s responsibilities are spelled out at the beginning of the third paragraph.

BEC

Answer is D

Since the investor is switching from bonds to gold, corporate dividend levels are not
relevant. A rise in dividend rates would be a reason for switching to equity investments
but not into gold. Because the portfolio of bond investments has already been bought,
their interest rates will not be impacted by a drop in interest rates but their values will
climb because high interest rates have been locked in. If inflation rates do not change,
they have no real impact on the future value of either the bonds or the gold. However,
if inflation rates are expected to rise, the set bond interest rate will not be able to rise
with inflation and the value of the bonds will drop. But the value of gold will rise in
recognition of the reduced value of the dollar (caused by the increase in the rate of
inflation).

STOCKHOLDERS’ EQUITY
CPA REVIEW QUESTIONS

The stockholders’ equity section of a balance sheet is equal to the reported assets
minus liabilities (i.e., net assets). Basically, it shows the source of an entity’s net
assets. Stockholders’ equity consists of two major categories: contributed capital (the
amount of the net assets that were put into the business by owners) and retained
earnings (the amount of the net assets generated by operations – all net income since
operations began minus all dividends).

Businesses also report accumulated other comprehensive income to record gains and
losses that are not reported on the entity’s income statement (such as gains and losses
in the value of investments in available-for-sale securities). A fourth section within
stockholders’ equity (treasury stock) is a negative to indicate that net assets have been
used to repurchase shares of the business but those shares have not, as of yet, been
retired.

Most companies report a statement of changes in stockholders’ equity within their


financial statements which reports the change in each element of stockholders’ equity.

Common Stock

In the incorporation process, a business indicates the number of authorized ownership


shares (the total number of shares that it wants to have the right to issue—this is often a
huge number so that limitations are unlikely to be encountered in the future). The
"shares issued" are the shares that have been provided to outside parties. The "shares
outstanding" are the shares that are currently held by outside parties. The difference in
issued shares and outstanding shares occurs because of treasury stock—issued shares
that have been bought back by the business but not retired.

Ownership shares can be common stock or preferred stock. All companies have
common stock while a few also issue preferred stock. The holders of common stock
gain the rights specified by the state of incorporation. Those rights normally allow the
owners to vote for the members of the board of directors that oversees the running of
the company. Those rights also provide that each owner gets to share proportionally in
any dividends that are distributed.

In most states, a corporation is required to indicate the par value of its common stock
and preferred stock. With common stock, the legal purpose of par value has faded
over the years. It basically means that anyone who buys the stock directly from the
corporation for less than par value might eventually be held liable for this discount if the
company ever goes bankrupt. Today, most corporations set the par value of their
common stock at such a low amount (often a penny or a nickel) that no one ever buys
the stock from the company for less than that amount.

Assume, for example, that a company issues one share of $1 par value common stock
for $35 in cash. The journal entry is as follows. Note that the common stock is
recorded at the par value (a traditional approach in accounting) with the excess shown
CPA REVIEW QUESTIONS

in an account such as “additional paid-in capital” or “contributed capital in excess of


par.” Together, these equity accounts indicate the total amount of contributed capital—
the amount paid in by owners directly to the company.

Cash 35
Common stock 1
Additional paid-in capital
—common stock 34

If stock is issued to pay for an asset or expense, the recording is based on the fair value
of the stock. Only if the value of the stock is not known is the value of the asset or
expense used. However, assets should never be recorded at a figure that is above its
own fair value.

Assume that $1 par value common stock is selling for $35 per share and 1,000 shares
are issued for land that has a fair value of $36,000. The recording entry is as follows
based on the $35,000 value of the shares issued.

Land 35,000
Common stock
($1 par value X 1,000 shares) 1,000
Additional paid-in capital
—common stock 34,000

In a few states, no-par stock is allowed. All of the proceeds from the issuance of no-par
stock is credited to “common stock.”

Costs of registering and issuing common stock are generally netted against the
proceeds so that a smaller amount is reported in the Additional Paid-in Capital account.

Preferred Stock

The holders of preferred stock have only the rights specified in the stock certificate. In
effect, the common shareholders are giving up a preference to these specified rights in
exchange for the cash or other assets being put into the business. Most commonly, the
holders of preferred stock are given the right to receive a set amount of dividends. The
amount of the dividend payout is specified as a dollar amount or as a set percentage of
the par value of the preferred stock.

Additional possible features stated in a preferred stock certificate:

1. Participating—preferred stockholders share with common stockholders in any


dividend distributions that occur after both preferred and common stockholders receive
a specified level of the dividend payment. Thus, preferred stockholders benefit by any
exceptional large dividend payments.
CPA REVIEW QUESTIONS

2. Cumulative—preferred dividends not paid in a prior year (known as “dividends in


arrears”) that must be paid before any distributions can be made to common
stockholders. Dividends in arrears are not reported as a liability until declared by the
board of directors. However, they should be disclosed.

3. Convertible—preferred stockholders have an option of exchanging their stock for


common stock at a specified ratio

4. Callable—the corporation has the option to repurchase the preferred stock at a


specified price. In stock transactions, no gain or loss is ever recognized on the income
statement. Instead, gains are recorded as increases in additional paid-in capital (or an
account with a similar title). Losses are a bit more of a reporting problem. If a
comparable additional paid-in capital balance exists, it can be reduced to record any
loss from a stock transaction. As an alternative, or if no additional paid-in capital
balance exists, retained earnings is reduced. Thus, under certain circumstances,
retained earnings can be reduced by a stock transaction but can never be increased.

Mandatorily redeemable preferred stock is classified as a liability on the balance sheet


(rather than as stockholders’ equity) because payment must be made in the future.
More on Treasury Stock Transactions, Retirement of Stock, Dividends, Stock Splits,
Share Based Payments, Quasi Reorganization, and Ratios…

PRACTICE QUESTIONS

ONE – On January 1, Year One, the VanHuss Corporation issues 1,000 shares of its
preferred stock for its par value of $100 per share. The stock pays a 6 percent ($6)
cumulative cash dividend every December 31. Both the company and the investor
stipulate in the stock contract that these shares will be reacquired by VanHuss in
exactly 8 years for par value plus any dividends that are unpaid at that time. On
December 31, Year One, the first dividend payment is properly made. When the
company then produces a balance sheet, how is this stock reported?

A – As a part of stockholders’ equity


B – As a liability
C – As a footnote disclosure
D – Between the liability section and the stockholders’ equity section.

TWO – The Hough Company issues 100,000 shares of $10 par value common stock for
$12 per share. Two years later, the company reacquires 10,000 of these shares for
$13 per share. The company is going to report this treasury stock by the cost method.
However, at the last minute, company officials decide to report these shares by use of
CPA REVIEW QUESTIONS

the par value method. How does that decision affect the total stockholders’ equity
reported by Hough?

A. Total stockholders’ equity will be $10,000 lower because of the decision to use the
par value method.
B. Total stockholders’ equity will be $20,000 lower because of the decision to use the
par value method.
C. Total stockholders’ equity will be $30,000 lower because of the decision to use the
par value method.
D. Total stockholders’ equity will not be impacted because of the decision to use the
par value method.

THREE – The Lawson Company has 100,000 shares of common stock outstanding with
a par value of $10 per share. The stock was originally issued for $14 per share.
Currently, the stock has a fair value of $17 per share. The company issues 22,000 new
shares of this common stock to its stockholders as a stock dividend. Retained earnings
should be reduced because of this dividend by which of the following amounts?

A. $220,000 (22,000 shares at $10 per share)


B. $308,000 (22,000 shares at $14 per share)
C. $374,000 (22,000 shares at $17 per share)
D. The company can reduce retained earnings by either $220,000 or $374,000

FOUR – On January 1, Year One, the Smith Company issues 1,000 stock options to its
president. The president must work for four years and then has three additional years
in which to buy the stock at a price of $30 per share. The price of the stock on that day
is $28 per share but it goes up in price by $3 per year thereafter. The conveyance
qualifies as a compensatory stock option plan. According to a computer pricing model
(Black-Scholes), one of these options is worth $5 on January 1, Year One but $8 on
December 31, Year One, and $10 on December 31, Year Two. How much expense
should this company recognize in Year Two?

A. No expense is recognized in Year Two.


B. $1,250
C. $2,000
D. $3,000

FAR

The McAdoo Corporation spent $2 million this year on research costs in hopes of developing a new patent and then
another $1 million on development. The company produces a set of financial statements according to US GAAP and
then creates a second set based on IFRS. Based on the normal handling of research and development costs, which
of the following is mostly likely to be true for the current year?
a. The US GAAP statements will report a lower expense total than the IFRS statements.
b. The IFRS statements will report a lower asset total than the US GAAP statements.
CPA REVIEW QUESTIONS

c. The IFRS statements will report a higher net income that the US GAAP statements.
d. The US GAAP statements will report a higher retained earnings total than the IFRS statements.

FAR (Number Two) In my last email lesson, I wrote a problem that contained an obvious typing error. Although the
error was easy to spot, I wanted to provide a correct version of that question.

On January 1, Year One, the Hogan Company issues a four year $100,000 term bond that pays an annual 6 percent
cash interest. Interest is paid every 12/31 with the face value to be paid four years from the issuance date. The
bond is issued to earn an actual annual rate of 10 percent. The present value of an ordinary annuity of $1 for four
time periods at a 10 percent rate is 3.16. The present value of a single amount of $1 in four time periods at a 10
percent rate is .68. What interest expense should Hogan report on its Year Two income statement?

a. $6,000
b. $6,800
c. $8,966
d. $10,000

Auditing

A company starts Year Four with inventory of $200,000. During the year, purchases of $700,000 are made and the
ending inventory is $300,000. During Year Five another $700,000 in inventory is bought and the ending inventory is
$500,000. Based on calculating the inventory turnover, which of the following is most likely to be true for Year Five?

a. Inventory on hand is more likely to be older and therefore subject to age problems
b. The profit margin has decreased during the year.
c. The profit margin has increased during the year.
d. Inventory on hand is more likely to be younger and therefore less likely to be damaged.

Regulation

Which of the following is not a deduction that an individual taxpayer can take in arriving at adjusted gross income in
filing a federal income tax return?

a. Student loan interest


b. Alimony paid
c. Union dues
d. Penalty for early withdrawal of money from a savings account

BEC

June Wysocki was recently appointed as an outside member of the board of directors of the Kantalone Company.
Which of the following is the best identification of an outside director?

a. One who is not directly related to the chief executive officer either personally or financially.
b. One who has sold all of his or her stock in the company to avoid the possibility of a conflict of interest.
c. One who used to work for the company but has since quit or retired.
d. One who is not otherwise employed by the company and does not represent any particular group of
stakeholders.

Answers

FAR
CPA REVIEW QUESTIONS

Answer is C

Under US GAAP, both research and development costs are expensed as incurred. Thus, expenses are high
causing net income to be low. Because the costs are expensed and not capitalized, total assets are low. Because
the costs are expensed, retained earnings is low. Under IFRS, research costs are expensed but most development
costs are capitalized. Expenses are lower and net income is higher. That causes a high retained earnings as well
as a higher balance for total assets. Net income is higher under IFRS than under US GAAP.

2nd FAR Question


Answer is C

The future cash flows are $6,000 per year ($100,000 times 6 percent) for four years and then $100,000. The present
value of those cash flows is $6,000 times 3.16 or $18,960 plus $100,000 times .68 or $68,000. The price of the bond
is the total present value of $86,960 ($18,960 plus $68,000). Interest for Year One is that $86,960 times 10 percent
or $8,696. Because only $6,000 is paid, the other $2,696 is compounded. The bond was sold at a discount so the
compounding is added to bring the principal up to $89,656 ($86,960 + $2,696) at the end of Year One. In Year Two,
this new $89,656 balance is multiplied by 10 percent to get interest of $8,966, the answer for this question.

Auditing

Answer is A

Inventory turnover can be computed in a couple of ways but is most likely to be cost of goods sold divided by the
average inventory. In Year Four, cost of goods sold is $200,000 + $700,000 - $300,000 or $600,000. Average
inventory is ($200,000 + $300,000)/2 or $250,000. Inventory turnover is $600,000/$250,000 or 2.4 times during the
year. That is a measure of how quickly inventory is sold. In Year Five, cost of goods sold is $300,000 + $700,000 -
$500,000 or $500,000. Average inventory is ($300,000 + $500,000)/2 or $400,000. Inventory turnover is
$500,000/$400,000 or 1.25 times during the year. Inventory is selling at a much slower pace in Year Five which
indicates to the auditor that problems might be caused by the age of the inventory on hand. It is more likely to be
broken or unsalable. None of the information given here talks about sales so profit margin cannot be determined.

Regulation

Answer is C

According to current tax laws, student loan interest, alimony payments, and any penalty charged for the early
withdrawal of money from a savings account are deductions that can be taken (in whole or part) in arriving at
adjusted gross income. Union dues, on the other hand, are job expenses that can only be taken as an itemized
deduction.

BEC

Answer is D

Wikipedia provides the following definition of an outside director. “An outside director is
a member of the board who is not otherwise employed by or engaged with the
organization, and does not represent any of its stakeholders. A typical example is a
director who is president of a firm in a different industry. Outside directors bring outside
experience and perspective to the board. They keep a watchful eye on the inside
directors and on the way the organization is run.”
CPA REVIEW QUESTIONS

FAR

On January 1, Year One, the Hogan Company issues a four year $100,000 term bond
that pays an annual 6 percent cash interest. Interest is paid every 12/31 with the face
value to be paid four years from the issuance date. The bond is issued to earn an
actual annual rate of 10 percent. The present value of an ordinary annuity of $1 for
four time periods at a 10 percent rate is 3.16. The present value of a single amount of
$1 in four time periods at a 10 percent rate is .68. What interest expense should
Hogan report on its Year Two income statement?

a. $6,000
b. $6,800
c. $7,070
d. $10,000

Auditing

The CPA firm of Hay and Worth is auditing the financial statements of LaBrend
Corporation. LaBrend has used a special purpose financial reporting framework.
Which of the following statements is true?

a. The cash basis qualifies as a special purpose financial reporting framework but the
tax basis does not.
b. The report should have an emphasis-of-a-matter paragraph to indicate that the
basis being used was not consistent with US GAAP.
c. The tax basis qualifies as a special purpose financial reporting framework but the
cash basis does not.
d. A balance sheet and income statement must be included in the financial statements.

Regulation

The Hyldina Corporation has an account receivable for $10,000 from Prosgko
Corporation that is outstanding at the end of Year One. The debt was incurred as a
result of normal business tranactions. Prosgko is a relatively new customer from a
neighboring town. Hyldina believes that there is an 8 percent chance of collecting this
receivable. Hyldina is an accrual basis taxpayer. What can be deducted by Hyldina
on the company’s Year One income tax return?

a. Zero
b. $800
c. $4,000
d. $10,000

BEC
CPA REVIEW QUESTIONS

At the end of Year One, the Glacken Company has accounts receivable of $435,000.
During that year, the company made credit sales of $2.6 million. At the end of the year,
what is the average age of the reported accounts receivable balance? (rounded)

a. 46 days
b. 53 days
c. 59 days
d. 61 days

FAR

Answer is C

The future cash flows are $6,000 per year ($100,000 times 6 percent) for four years and
then $100,000. The present value of those cash flows is $6,000 times 3.16 or $18,960
plus $100,000 times .68 or $68,000. The price of the bond is the total present value of
$86,960 ($18,960 plus $68,000). Interest for Year One is that $86,960 times 10 percent
or $8,696. Because only $6,000 is paid, the other $2,696 is compounded. The bond
was sold at a discount so the compounding is added to bring the principal up to $70,696
($68,000 + $2,696) at the end of Year One. In Year Two, the new $70,696 balance is
multiplied by 10 percent to get interest of $7,070, the answer for this question.

Auditing

Answer is B

The auditor wants to make certain that any reader of the statements is adequately
warned that US GAAP has not been followed. Thus, an emphasis-of-a-matter
paragraph should be added after the opinion paragraph to explain this distinction. In
addition, the statements are normally given different titles (such as the statement of
assets and liabilities arising from cash transactions rather than balance sheet) to draw
more attention to the difference in the method being used. Special purpose financial
reporting frameworks include the cash basis, the tax basis, the contractual basis, and
that regulatory basis.

Regulation

Answer is A

For tax purposes, accounts receivable must be completely worthless before they can be
deducted as an expense. This receivable is not completely worthless.

BEC

Answer is D
CPA REVIEW QUESTIONS

The company is making credit sales of $7,123 per day ($2,600,000/365). Thus, the
average account receivable balance is 61 days old ($435,000/$7,123).

Under the Sales Article of the UCC, which of the following statements is correct regarding
the warranty of merchantability arising when there has been a sale of goods by a merchant
seller?

A) The warranty must be in writing.


The warranty arises when the buyer relies on the seller's skill in selecting the goods
B)
purchased.
C) The warranty cannot be disclaimed.
D) The warranty arises as a matter of law when the seller ordinarily sells the goods purchased.

Correct Answer: D

Explanation: The warranty of merchantability is implied by law if the seller is a merchant. One
who ordinarily sells the product purchased would be a merchant. Since merchantability is an
implied warranty, no written or oral words are needed for it to arise. The implied warranty of
fitness for a particular purpose arises when the buyer relies on seller to select goods, not the
warranty of merchantability. Merchantability, like all implied warranties, can be disclaimed.

QGibbs Co. uses the allowance method for recognizing uncollectible accounts. Ignoring
deferred taxes, the entry to record the write-off of a specific uncollectible account:

A) Affects neither net income nor working capital


B) Affects neither net income nor accounts receivable
C) Decreases both net income and accounts receivable
D) Decreases both net income and working capital

Correct Answer: A

Explanation: The entry to write off an account is a debit to the allowance account and a credit to
the accounts receivable account. Since the allowance account is a contra account to accounts
receivable and since both are balance sheet accounts, only " Affects neither net income nor
working capital." is correct.

If a group of consumers decide to boycott a particular product, the expected result would
be
CPA REVIEW QUESTIONS

A) An increase in the product price to make up lost revenue.


B) A decrease in the demand for the product.
C) An increase in product supply because of increased availability.
D) That companies in the industry would experience higher economic profits.

Correct Answer: B

Explanation: A boycott would decrease the demand at all price levels and result in a shift in the
demand curve to the left. A lower quantity would be sold at the same price. There would be no
increase in availability. The supply curve would be dictated by the cost of production, not by the
demand curve. The quantity demanded would be lower at every price level with no change in the
cost of production. Thus, profits would decline.

In order to efficiently establish the correctness of the accounts payable cutoff, an auditor
will be most likely to:

A) Coordinate cutoff tests with physical inventory observation


B) Compare cutoff reports with purchase orders
C) Compare vendors' invoices with vendors' statements
D) Coordinate mailing of confirmations with cutoff tests

Correct Answer: A

Explanation: Cutoff tests are used to determine whether items have been recorded in the proper
period. By coordinating cutoff tests with the physical inventory, auditors can determine if the
items are physically present.

Of the following which is the least persuasive type of audit evidence?

A) Documents mailed by outsiders to the auditor


B) Correspondence between auditor and vendors
C) Copies of sales invoices inspected by the auditor
D) Computations made by the auditor

Correct Answer: C

Explanation: The competency (reliability) of evidence depends upon the degree of control
exercised over the evidence by the client. The client does have control over sales invoices and,
thus, it is the least competent.
CPA REVIEW QUESTIONS

On January 1, 2010, Heath Corp. established an employee stock ownership plan (ESOP).
Selected transactions relating to the ESOP during 2010 were as follows:

On April 1, 2010, Heath contributed $45,000 cash and 3,000 shares of its $10 par value
common stock to the ESOP. On this date, the market price of the stock was $18 a share. On
October 1, 2010, the ESOP borrowed $100,000 from Union National Bank and acquired
6,000 shares of Heath's common stock in the open market at $17 a share. The note is for
one year, bears interest at 10%, and is guaranteed by Heath. On December 15, 2010, the
ESOP distributed 8,000 shares of Heath's common stock to employees of Heath in
accordance with the plan formula. On this date, the market price of the stock was $20 a
share.

In its 2010 income statement, what amount should Heath report as compensation expense
relating to the ESOP?

A) $99,000
B) $155,000
C) $199,000
D) $259,000

Correct Answer: A

Explanation: A company records compensation expense based upon cash or stocks (at fair
market value) contributed to the plan during the year. Therefore, the $45,000 cash and $54,000
value of the shares contributed to the plan are reported as compensation expense. The second and
third transactions noted in the question do not result in any expense recognition.

Webstar Corp. orally agreed to sell Northco, Inc. a computer for $20,000. Northco sent a
signed purchase order to Webstar confirming the agreement. Webstar received the
purchase order and did not respond. Webstar refused to deliver the computer to Northco,
claiming that the purchase order did not satisfy the UCC Statute of Frauds because it was
not signed by Webstar. Northco sells computers to the general public and Webstar is a
computer wholesaler. Under the UCC Sales Article, Webstar's position is
_________________

A) incorrect because it failed to object to Northco's purchase order.


B) incorrect because only the buyer in a sale-of-goods transaction must sign the contract.
C) correct because it was the party against whom enforcement of the contract is being sought.
D) correct because the purchase price of the computer exceeded $500.
CPA REVIEW QUESTIONS

Correct Answer: A

Explanation: A writing is not required to enforce a contract of more than $500 if a merchant
fails to object within ten days to a confirming letter sent by another merchant. Since Webstar and
Northco are both merchants and Webstar failed to object to the purchase order sent by Northco, a
writing signed by Webstar was not required under the Statute of Frauds. UCC Sales does not
require that only the buyer sign. Usually only one party need sign (whether buyer or seller), but it
can only be enforced against the one who signed. The failure of a merchant to object to a written
confirmation is an exception to the rule that it can only be enforced against the one who signed.

Which of these statements is true in the long run about equilibrium price in competitive
product markets?

A) It will be a fair price all consumers can afford.


B) It will be set equal to the total costs of production.
C) It will be set equal to the total fixed costs of production.
D) It will be set equal to the marginal costs of production.

Correct Answer: D

Explanation: In a competitive market, the forces of demand and supply will, in the long run,
cause price to equal marginal cost. If price is higher than marginal cost, additional production
will be forthcoming. If price is lower than marginal cost, producers will quit producing. A
competitive market cannot assure a fair price that all consumers can afford.

The disposable income of the consumers dictates whether or not they can afford the product at
the equilibrium price. Some will be able to afford it and some will not. A price set equal to the
total cost of production fails to recognize that the total cost should be divided by the number of
units produced. A price set equal to the total fixed cost of production fails to recognize that the
total fixed cost should be divided by the total number of units produced. Even then, the variable
costs per unit would be ignored.

On January 2, 2010, Morey Corp. granted Dean, its president, 20,000 stock appreciation
rights. On exercise, Dean is entitled to receive cash for the excess of the stock's market
price on the exercise date over the market price on the grant date. The rights are
exercisable beginning on January 2, 2012 and expiring on December 31, 2012. The market
price of Morey's stock was $30 on January 2, 2006 and $45 on December 31, 2010. Morey
CPA REVIEW QUESTIONS

used the Black-Sholes-Merton pricing model and estimated the values of each right at $16
each. As a result of the stock appreciation rights, the company should recognize
compensation expense for 2010 of:

A) $300,000
B) $320,000
C) $150,000
D) $160,000

Correct Answer: D

Explanation: The service period is the period from the grant date, January 2, 2010, to the
exercise date, January 2, 2012, or two years. Therefore, the total compensation of $320,000
(20,000 SARS X the estimated fair value of $16 each) divided by two years equals the
compensation expense of $160,000 each year.

The overall attitude and awareness of an entity's board of directors concerning the
importance of the internal control structure usually is reflected in its:

A) Computer-based controls
B) System of segregation of duties
C) Control environment
D) Safeguards over access to assets

Correct Answer: C

Explanation: An entity's internal control structure consists of three elements: the control
environment, the accounting system, and control procedures. The control environment reflects
the overall attitude, awareness, and actions of the board of directors, management, owners, and
others concerning the importance of control and its emphasis in the entity.

The incorrect answer choices are examples of control procedures.

Greed Co. telephoned Stieb Co. and ordered 30 tables at $100 each. Greed agreed to pay
15% immediately and the balance within thirty days after receipt of the entire shipment.
Greed forwarded a check for $450 and Stieb shipped 15 tables the next day, intending to
ship the balance by the end of the week. Greed decided that the contract was a bad bargain
and repudiated it, asserting the statute of frauds. Stieb sued Greed. Which of the following
CPA REVIEW QUESTIONS

will allow Stieb to enforce the contract in its entirety despite the statute of frauds?

A) Stieb shipped 15 tables.


B) Greed paid 15% down.
C) The contract is not within the requirements of the statute of frauds.
D) Greed admitted in court that it made the contract in question.

Correct Answer: D

Explanation: A writing is not required to enforce a contract for more than $500 if the party to be
charged admits in court that they made the contract. Part receipt and part payment only allow the
contract to be enforced for the amount received or the amount paid for and the question required
the contract to be enforced in its entirety. This contract was for more than $500 and the Statute of
Frauds applies.

Which statement is correct where exists a perfectly inelastic supply curve in a competitive
market?

A) It means the equilibrium price must be zero.


B) It says the market supply curve is horizontal.
C) It exists when firms cannot vary input usage.
D) It can only exist in the long run.

Correct Answer: C

Explanation: A perfectly inelastic supply curve is a vertical line; and it implies that a change in
price will not impact the quantity offered in the market. That would be the case where firms
cannot vary input usage. An equilibrium price of zero would mean that it is a free good. A
horizontal supply curve is used to represent a perfectly elastic supply curve, not an inelastic one.
A perfectly inelastic supply curve is more likely to occur in the short run, than in the long run. In
the long run, producers may be able to adjust to lower or higher demand for the product.

As the acceptable level of detection risk decreases, an auditor may:

A) Reduce substantive testing by relying on the assessments of inherent risk and control risk
B) Postpone the planned timing of substantive tests from interim dates to the year end
CPA REVIEW QUESTIONS

C) Eliminate the assessed level of inherent risk from consideration as a planning factor
D) Lower the assessed level of control risk from the maximum level to below the maximum

Correct Answer: B

Explanation: Detection risk is the risk that the auditor will not detect a material misstatement
that exists in an assertion. As the acceptable level of detection risk decreases, the assurance
provided from substantive tests should increase. Since applying substantive tests as of an interim
date rather than as of the year-end potentially increases the risk that misstatements that may exist
will not be detected, if the auditor wants to decrease detection risk, he may decide to perform
substantive tests at year-end rather than at an interim date.

The remaining answer choices are incorrect for the following reasons:

• Substantive tests should be increased when allowable detection risk decreases.


• Inherent risk cannot be ignored.
• Control risk cannot be lowered without additional testing of controls.

When building contractors decide not to build on speculation but only when a contract to
build is executed, it is a signal that wage inflation may be causing a rise in building costs.
One may conclude from this scenario that:

A) The supply curve will remain static as wage inflation increases demand.
The quantity of new homes demanded will decrease, prices will rise, and the supply curve
B)
will shift to the left.
C) The supply curve will shift downward but prices will rise.
D) The quantity of homes built will decrease along with the price of housing.

Correct Answer: B

Explanation: The supply curve will shift to the left, the demand curve will remain unchanged,
prices will increase and the quantity demanded will decline. The supply curve will shift to the
left and speculative homes are no longer built. A downward shift in the supply curve would
suggest an increased supply at all price points (contrary to the removal of speculative homes) and
an increased supply would imply a reduction in price. The supply curve will shift to the left as
speculative homes are no longer constructed. That shift in the supply curve with no change in the
demand curve will result in an increase in price.
CPA REVIEW QUESTIONS

SFAS 123R suggests the use of two types of option pricing models. Which of the following
models are mentioned in the pronouncement?

A) Black-Shoals-Merton Model
B) Lattice Type Model
C) Binomial Model
D) Closed-Exit Model

Correct Answer: B

Explanation: The pronouncement mentions two types of models, the Lattice type model and the
closed-form model. The Black-Sholes-Merton model is an example of the closed-form model
and the binomial model is an example of the Lattice type.

Under the Sales Article of the UCC, which of the following events will release the buyer
from all its obligations under a sales contract?

A) Destruction of the goods after risk of loss passed to the buyer.


B) Impracticability of delivery under the terms of the contract.
C) Anticipatory repudiation by the buyer that is retracted before the seller cancels the contract.
Refusal of the seller to give written assurance of performance when reasonably demanded
D)
by the buyer.

Correct Answer: D

Explanation: A buyer is released from liability if the seller refuses to give written assurance of
performance when reasonably demanded.

The remaining answer choices are incorrect for the following reasons:

• If risk of loss is with the buyer, the buyer is liable for all damage and would not be released.
• The seller may substitute a different means of delivery if the specified means becomes
impractical.
• An anticipatory breach can be retracted as long as the injured party has not canceled the
contract or materially changed position.

The element of the audit planning process most likely to be agreed upon with the client
CPA REVIEW QUESTIONS

before implementation of the audit strategy is the determination of the:

A) Evidence to be gathered to provide a sufficient basis for the auditor's opinion


B) Procedures to be undertaken to discover litigation, claims, and assessments
C) Pending legal matters to be included in the inquiry of the client's attorney
D) Timing of inventory observation procedures to be performed

Correct Answer: D

Explanation: The client is responsible for counting inventory and the auditor is responsible for
observing the client's count. Since the timing of the observation depends on the timing of the
count, there must be agreement between the auditor and client regarding the inventory
observation procedures before the auditor finalizes an audit strategy for inventory.

The incorrect answer choices are evidence-gathering issues that are decided by the auditor
without specific regard to timing and other client concerns. Independently of the client, the
auditor determines the extent of evidence needed in the audit, the nature of procedures to follow
in the audit, and the scope of issues to be addressed in a legal letter.

The installment method of recognizing revenue:

Should be used only in cases where there is no reasonable basis for estimating the
A)
collectibles of receivables
B) Is not a generally accepted accounting principle under any circumstances
C) Should be used for book purposes only if it is used for tax purposes
D) Is an acceptable alternative accounting principle for a firm which makes installment sales

Correct Answer: A

Explanation: According to APB #10 (par. 12), the installment method of accounting is not
acceptable unless "collection of the sale price is not reasonably assured."

To which of the following rights is a stockholder of a public corporation entitled?

A) The right to have annual dividends declared.


B) The right to vote for the election of officers.
CPA REVIEW QUESTIONS

C) The right to a reasonable inspection of corporate records.


D) The right to have the corporation issue a new class of stock.

Correct Answer: C

Explanation: A stockholder has the right to inspect books and records of the corporation at
reasonable times and upon written demand. There is no inherent right to dividends for
stockholders. Stockholders elect directors, not officers. Officers are appointed by the directors.
Stockholders do not generally have the right to participate in management. They have only two
management rights: electing directors and voting on fundamental changes in the corporation.
They do not have the right to have the corporation issue a new class of stock as this is not a
fundamental change in the corporation.

On March 7, 2010, Wax Corp. contracted with Noll Wholesalers to supply Noll with
specific electrical parts. Delivery was called for on June 3, 2010. On May 2, 2010, Wax
notified Noll that it would not perform and that Noll should look elsewhere. Wax had
received a larger and more lucrative contract on April 21, 2010, and its capacity was such
that it could not fulfill both orders. The facts _________________

A) will prevent Wax from retracting its repudiation of the Noll contract.
B) are not sufficient to clearly establish an anticipatory repudiation.
C) will permit Noll to sue only after June 3, 2010, the latest performance date.
will permit Noll to sue immediately after May 2, 2010, even though the performance called
D)
for under the contract was not due until June 3, 2010.

Correct Answer: D

Explanation: An anticipatory repudiation occurs when one side states they will not perform
before the time of performance. The injured party can sue immediately or wait until the time of
performance and then sue. Wax told Noll prior to the time of performance that Wax would not
perform. Thus, Noll can sue immediately and need not wait until June 3. Wax may retract its
repudiation as long as Noll hasn't canceled the contract or materially changed position.

Under which circumstance is the corporate veil most likely to be pierced and the
shareholders held personally liable?

A) The corporation has elected S corporation status under the Internal Revenue Code.
B) The shareholders have commingled their personal funds with those of the corporation.
CPA REVIEW QUESTIONS

C) An ultra vires act has been committed.


D) A partnership incorporates its business solely to limit the liability of its partners.

Correct Answer: B

Explanation: A stockholder may be held personally liable for corporate debts (piercing the
corporate veil). Specifically this may be done by a showing of fraud, undercapitalization of the
corporation and commingling of corporate and personal funds by the stockholder. Thus, the
corporate veil may be pierced if the stockholder commingled their personal funds with those of
the corporation. Choosing S corporation status, commission of an ultra vires act and
incorporation to obtain limited personal liability are all insufficient grounds to pierce the
corporate veil.

Under the Sales Article of the UCC, which of the following statements is correct?

A) The obligations of the parties to the contract must be performed in good faith.
B) Merchants and nonmerchants are treated alike.
C) The contract must involve the sale of goods for a price of more than $500.
D) None of the provisions of the UCC may be disclaimed by agreement.

Correct Answer: A

Explanation: UCC Sales requires all parties to act in good faith.

The remaining answer choices are incorrect for the following reasons:

• Merchants are held to a higher standard in some cases.


• Goods may be sold for less than $500.
• Provisions of the UCC may be disclaimed. For example, implied warranties may be disclaimed
if the disclaimer is conspicuous.

The calculation of the income recognized in the third year of a five-year construction
contract accounted for using the percentage-of-completion method includes the ratio of:

A) Total costs incurred to date to total estimated costs


B) Total costs incurred to date to total billings to date
C) Costs incurred in year 3 to total estimated costs
CPA REVIEW QUESTIONS

D) Costs incurred in year 3 to total billings to date

Correct Answer: A

Explanation: Income recognized in the third year of a five-year construction contract using
percentage-of-completion method would be calculated by multiplying the ratio of the total cost
incurred to date divided by the estimated total cost times the estimated total gross profit on the
contract less the gross profit recognized in years one and two. Note that billings on the contract
do not affect the calculation of income recognized.

Which of the following tests of controls most likely would help assure an auditor that goods
shipped are properly billed?

A) Scan the sales journal for sequential and unusual entries.


B) Examine shipping documents for matching sales invoices.
C) Compare the accounts receivable ledger to daily sales summaries.
D) Inspect unused sales invoices for consecutive prenumbering.

Correct Answer: B

Explanation: The auditor is looking for evidence to prove that goods shipped are properly
billed. To accomplish the completeness of the billing process for all goods shipped, it is
necessary to sample from a population that includes all goods shipped by examining a sample of
shipping documents and tracing them to matching sales invoices.

Upon receipt of customers' checks in the mailroom, a responsible employee should prepare
a remittance listing that is forwarded to the cashier. A copy of the listing should be sent to
the:

A) Internal auditor to investigate the listing for unusual transactions


B) Treasurer to compare the listing with the monthly bank statement
C) Accounts receivable bookkeeper to update the subsidiary accounts receivable records
D) Entity's bank to compare the listing with the cashier's deposit slip

Correct Answer: C

Explanation: A copy of the remittance listing is sent to the accounts receivable clerk and posted
CPA REVIEW QUESTIONS

to the subsidiary records. Accounting for assets is a function that should be separated from the
custody of those assets. The accounts receivable bookkeeper maintains records of the balance
owed by each customer, while the cashier has custody of the cash. The cashier does not have an
opportunity to cover a shortage of cash by using checks received on account because the AR
ledger would indicate a different balance than that owed. There is no need to send copies to the
internal auditor, the treasurer, or the bank, because the goal is to establish accountability for the
asset.

Management can estimate the amount of loss that will occur if a foreign government
expropriates some company assets. If expropriation is reasonably possible, a loss
contingency should be:

A) Disclosed but not accrued as a liability


B) Disclosed and accrued as a liability
C) Accrued as a liability but not disclosed
D) Neither accrued as a liability nor disclosed

Correct Answer: A

Explanation: The key words are "reasonably possible". FASB #5 states that if a loss
contingency is reasonably possible, it should be disclosed but not accrued. A loss contingency is
accrued only if the loss contingency is probable and the amount of the loss can be reasonably
estimated.

Destiny Manufacturing, Inc., is incorporated under the laws of Nevada. Its principal place
of business is in California and it has permanent sales offices in several other states. Under
the circumstances, which of the following is correct?

California may validly demand that Destiny incorporate under the laws of the state of
A)
California.
Destiny must obtain a certificate of authority to transact business in California and the other
B)
states in which it does business.
C) Destiny is a foreign corporation in California, but not in the other states.
California may prevent Destiny from operating as a corporation if the laws of California
D)
differ regarding organization and conduct of the corporation's internal affairs.

Correct Answer: B
CPA REVIEW QUESTIONS

Explanation: A foreign corporation is one doing business in any state other than their state of
incorporation. A foreign corporation must obtain a certificate of authority from each state in
which they do business. Thus, Destiny is a foreign corporation in California because they were
incorporated in Nevada and they were doing business in California. Destiny must obtain a
certificate of authority from California and all other states in which it does business.
Incorporation is not required merely because a corporation is doing business in a state. Destiny is
a foreign corporation in any state in which it does business. Destiny as a Nevada corporation is
only required to comply with Nevada's requirements for incorporation and not California's
requirements.

Stable Corp. offered in a signed writing to sell Mix an office building for $350,000. The
offer, which was sent by Stable on April 1, indicated that it would remain open until July 9.
On July 5, Mix mailed a letter rejecting Stable's offer. On July 6, Mix sent a telegram to
Stable accepting the original offer. The letter of rejection was received by Stable on July 8
and the telegram of acceptance was received by Stable on July 7. Which of the following is
correct?

A) Mix's telegram resulted in the formation of a valid contract.


B) Mix's letter of July 5 terminated Stable's offer when mailed.
C) Stable was not entitled to withdraw its offer until after July 9.
Although Stable's offer on April 1 was a firm offer under the UCC, it will only remain open
D)
for three months.

Correct Answer: A

Explanation: The offer was accepted by telegram before the offer was terminated.

The remaining answer choices are incorrect for the following reasons:

• Rejections are only effective when received, not when they are mailed.
• An offer can be revoked anytime before acceptance, even if it says it will be held open.
• Firm offers only apply to sale of goods, not real estate.

On February 12, Harris sent Fresno a written offer to purchase Fresno's land. The offer
included the following provision: "Acceptance of this offer must be by registered or
certified mail, received by Harris no later than February 18 by 5:00 p.m. CST." On
February 18, Fresno sent Harris a letter accepting the offer by private overnight delivery
service. Harris received the letter on February 19. Which of the following statements is
correct?
CPA REVIEW QUESTIONS

A) A contract was formed on February 19.


B) Fresno's letter constituted a counteroffer.
C) Fresno's use of the overnight delivery service was an effective form of acceptance.
A contract was formed on February 18 regardless of when Harris actually received Fresno's
D)
letter.

Correct Answer: B

Explanation: Acceptances must be unconditional, complying with all of the offeror's terms. This
was a counteroffer because it was not sent by registered or certified mail and it was not received
by February 18. The remaining answer choices are incorrect because no contract was formed and
overnight delivery service was not registered or certified as required.

On December 31, 2009, Largo, Inc. had a $750,000 note payable outstanding, due July 31,
2010. Largo borrowed the money to finance construction of a new plant. Largo planned to
refinance the note by issuing long-term bonds. Because Largo temporarily had excess cash,
it prepaid $250,000 of the note on January 12, 2010. In February 2010, Largo completed a
$1,500,000 bond offering. Largo will use the bond offering proceeds to repay the note
payable at its maturity and to pay construction costs during 2010. On March 3, 2010,
Largo issued its 2009 financial statements. What amount of the note payable should Largo
include in the current liabilities section of its December 31, 2009, balance sheet?

A) $750,000
B) $500,000
C) $250,000
D) $0

Correct Answer: C

Explanation: FASB #6 states that the amount excluded from current liabilities through
refinancing cannot exceed the amount actually refinanced. Therefore, Largo should consider the
$500,000 paid by the refinancing to be a longterm liability and the $250,000 a current liability on
the December 31, 2009 balance sheet. The refinancing was completed before the issuance of the
financial statements and meets both criteria (intent & financial ability) for the classification of
the $500,000 as a long-term liability.

Absent a specific provision in its articles of incorporation, a corporation's board of


CPA REVIEW QUESTIONS

directors has the power to do all of the following, except

A) Repeal the bylaws


B) Declare dividends
C) Fix compensation of directors
D) Amend the articles of incorporation

Correct Answer: D

Explanation: Stockholders get to vote on fundamental changes in the corporation. This


specifically includes the right to vote on mergers and consolidations, dissolution and amending
the articles of incorporation. Thus, the board of directors would not have the power to amend the
articles of incorporation because it would require stockholder approval. Directors do have the
power to repeal the bylaws, declare dividends and fix their own compensation.

Which of the following is a step in an auditor's decision to assess control risk at below the
maximum?

Apply analytical procedures to both financial data and nonfinancial information to detect
A)
conditions that may indicate weak controls.
Perform tests of details of transactions and account balances to identify potential errors and
B)
irregularities.
Identify specific internal control policies and procedures that are likely to detect or prevent
C)
material misstatements.
Document that the additional audit effort to perform tests of controls exceeds the potential
D)
reduction in substantive testing.

Correct Answer: C

Explanation: AU 319 states that the auditor may make a preliminary assessment of control risk
at less than a high level only when the auditor:

• Is able to identify policies and procedures of the accounting and internal control systems
relevant to specific assertions which are likely to prevent or detect material misstatements in the
financial statement.
• Plans to perform tests of control to support the assessment.

Analytical procedures or tests of reasonableness test amounts of financial data.

Tests of details are performed as a substantive test to determine material mistakes in the financial
CPA REVIEW QUESTIONS

statements.

If the audit effort of performing tests of controls exceeds the potential reduction in substantive
testing, tests of controls will not be performed because doing so would reduce audit efficiency.

Which of the following circumstances most likely would cause an auditor to consider
whether material misstatements exist in an entity's financial statements?

A) Management places little emphasis on meeting earnings projections.


B) The board of directors makes all major financing decisions.
C) Reportable conditions previously communicated to management are not corrected.
D) Transactions selected for testing are not supported by proper documentation.

Correct Answer: D

Explanation: AU 316 states that if a condition or circumstance differs adversely from the
auditor's expectation, the auditor needs to consider the reason for such a difference. For example:

• Analytical procedures disclose significant differences from expectations.


• Significant unreconciled differences between reconciliations of a control account and
subsidiary records.
• Confirmation requests disclose significant differences or yield fewer responses than expected.
• transactions selected for testing are not supported by proper documentation.
• Supporting records or files that should be readily available are not promptly produced when
requested.
• audit tests detect errors that apparently were known to client personnel, but were not
voluntarily disclosed.

When such conditions exist, the planned scope of audit procedures should be reconsidered. As
the differences from expectations increase, the auditor should consider whether the assessment of
the risk of material misstatement of the financial statements made in the planning stage of the
engagement is still appropriate.

"Management places little emphasis on meeting earnings projections." and "The board of
directors makes all major financing decisions." are encouraging factors that management is not
willing to circumvent the rules just to meet earnings projections and that the board of directors
makes all financial decisions. Uncorrected conditions do not necessarily mean that material
misstatements exist.
CPA REVIEW QUESTIONS

On September 10, Harris, Inc., a new car dealer, placed a newspaper advertisement stating
that Harris would sell 10 cars at its showroom for a special discount only on September 12,
13, and 14. On September 12, King called Harris and expressed an interest in buying one of
the advertised cars. King was told that five of the cars had been sold and to come to the
showroom as soon as possible. On September 13, Harris made a televised announcement
that the sale would end at 10:00 p.m. that night. King went to Harris' showroom on
September 14 and demanded the right to buy a car at the special discount. Harris had sold
the 10 cars and refused King's demand. King sued Harris for breach of contract. Harris's
best defense to King's suit would be that Harris' _________________

A) offer was unenforceable.


B) advertisement was not an offer.
C) television announcement revoked the offer.
D) offer had not been accepted.

Correct Answer: B

Explanation: Advertisements and price quotes are not usually offers, they are invitations to deal.
The remaining answer choices are incorrect because no offer was made.

On March 1, 2009, Evan Corp. issued $500,000 of 10% nonconvertible bonds at 103, due
on February 28, 2019. Each $1,000 bond was issued with 30 detachable stock warrants,
each of which entitled the holder to purchase, for $50, one share of Evan's $25 par common
stock. On March 1, 2009, the market price of each warrant was $4. By what amount should
the bond issue proceeds increase stockholders' equity?

A) $0
B) $15,000
C) $45,000
D) $60,000

Correct Answer: D

Explanation: Since no market value is given for the bonds, the amount attributable to the
warrants (stockholders' equity) is $4 each x 30 warrants per bond = $120 x 500 bonds = $60,000.

Long, Pine, and Rice originally contributed $100,000, $60,000, and $20,000, respectively, to
CPA REVIEW QUESTIONS

form the LPR Partnership. Profits and losses of LPR are to be distributed 1/2 to Long, 1/3
to Pine, and 1/6 to Rice. After operating for one year, LPR's total assets on its books are
$244,000, total liabilities to outside creditors are $160,000 and total capital is $84,000. The
partners made no withdrawals. LPR has decided to liquidate. If all of the partners are
solvent and the assets of LPR are sold for $172,000

A) Rice will personally have to contribute an additional $8,000.


B) Pine will personally have to contribute an additional $4,000.
Long, Pine, and Rice will receive $6,000, $4,000, and $2,000, respectively, as a return of
C)
capital.
Long and Pine will receive $28,000 and $4,000, respectively, and Rice will have to
D)
contribute an additional $20,000.

Correct Answer: A

Explanation: Upon dissolution of a general partnership the following order of distribution


occurs: first creditors are paid, second partners are repaid for any loans or advances made to the
partnership, third capital contributions are paid and lastly profits are split.

Creditors are owed $160,000, there are no loans made by partners and a total of $180,000 is due
for capital contributions (Long - $100,000, Pine - $60,000 and Rice- $20,000). Thus, $340,000 is
needed to pay creditors and capital contributions ($180,000 + $160,000). Of the $340,000
needed, only $172,000 is available from the sale of assets. This leaves a shortfall of $168,000
($340,000 minus $172,000 = $168,000). Long's share of the shortfall is 1/2 of $168,000 or
$84,000. Thus, Long will receive his capital contribution ($100,000) minus his share of the
shortfall ($84,000), or $16,000. Pine's share of the shortfall is 1/3 of $168,000 or $56,000. Thus
Pine will receive his capital contribution ($60,000) minus his share of the shortfall ($56,000), or
$4,000. Rice's share of the shortfall is 1/6 of $168,000 or $28,000. Rice will receive his capital
contribution ($20,000) minus his share of the shortfall ($28,000) leaving a negative balance of
$8,000. Thus, Rice will have to contribute an additional $8,000.

In open market transactions, Oak Corp. simultaneously sold its long-term investment in
Maple Corp. bonds and purchased its own outstanding bonds. The broker remitted the net
cash from the two transactions. Oak's gain on the purchase of its own bonds exceeded its
loss on the sale of Maple's bonds. Oak should report the:

A) Net effect of the two transactions as an extraordinary gain


B) Net effect of the two transactions in income before extraordinary items
Effect of its own bond transaction gain in income before extraordinary items, and report the
C)
Maple bond transaction as an extraordinary loss
Effect of its own bond transaction as an ordinary gain, and report the Maple bond
D)
transaction loss in income before extraordinary items
CPA REVIEW QUESTIONS

Correct Answer: D

Explanation: Each transaction must be reported separately since the gain on early
extinguishment of the company's debt is reported as an ordinary item and the loss on the sale of
the investment is an ordinary loss.

In order for an offer to confer the power to form a contract by acceptance, it must have all
of the following elements except?

Be communicated to the offeree and the communication must be made or authorized by the
A)
offeror.
B) Be sufficiently definite and certain.
C) Be communicated by words to the offeree by the offeror.
D) Manifest an intent to enter into a contract.

Correct Answer: C

Explanation: Communication by words is not required as the communication can also be done
by actions. Equally, the communication need not be directly made by the offeror to the offeree,
as it could be communicated through a third party. An offer must be seriously intended,
communicated, and definite in its terms.

In planning an audit of a new client, an auditor most likely would consider the methods
used to process accounting information because such methods:

A) Influence the design of internal control.


B) Affect the auditor's preliminary judgment about materiality levels.
C) Assist in evaluating the planned audit objectives.
D) Determine the auditor's acceptable level of audit risk.

Correct Answer: A

Explanation: AU 311 states that the auditor should consider the methods the entity uses to
process accounting information because such methods influence the design of the internal control
structure. The extent to which computer processing is used in accounting applications, as well as
the complexity of that processing, may also influence the nature, timing, and extent of audit
CPA REVIEW QUESTIONS

procedures. Materiality, audit objectives, and acceptable level of audit risk are not based on the
methods used to process accounting information.

Dowd, Elgar, Frost, and Grant formed a general partnership. Their written partnership
agreement provided that the profits would be divided so that Dowd would receive 40%;
Elgar, 30%; Frost 20%; and Grant, 10%. There was no provision for allocating losses. At
the end of its first year, the partnership had losses of $200,000. Before allocating losses, the
partners' capital account balances were: Dowd, $120,000; Elgar, $100,000; Frost, $75,000;
and Grant, $11,000. Grant refuses to make any further contributions to the partnership.
Ignore the effects of federal partnership tax law.

What would be Grant's share of the partnership losses?

A) $9,000
B) $20,000
C) $39,000
D) $50,000

Correct Answer: B

Explanation: If a division of profits is specified in a partnership agreement, but not a division of


losses, losses will be divided in the same manner as profits. This partnership agreement specified
that profits were to be split Dowd - 40%, Elgar - 30%, Frost - 20% and Grant - 10%. Therefore
losses must be split the same way. With losses of $200,000 and Grant's share being 10%, Grant's
share of the losses would be $20,000.

On November 1, 2009, Mason Corp. issued $800,000 of its 10-year, 8% term bonds dated
October 1, 2009. The bonds were sold to yield 10%, with total proceeds of $700,000 plus
accrued interest. Interest is paid every April 1 and October 1. What amount should Mason
report for interest payable in its December 31, 2009, balance sheet?

A) $17,500
B) $16,000
C) $11,667
D) $10,667

Correct Answer: B

Explanation: Interest payable is accrued at the stated interest of 8% for the three months since
the last payment date of October 1.
CPA REVIEW QUESTIONS

$800,000 x .08 x 3/12 = $16,000

Which of the following internal control activities most likely would prevent direct labor
hours from being charged to manufacturing overhead?

A) Periodic independent counts of work in process for comparison to recorded amounts


B) Comparison of daily journal entries with approved production orders
C) Use of time tickets to record actual labor worked on production orders
D) Reconciliation of work-in-process inventory with periodic cost budgets

Correct Answer: C

Explanation: Time tickets should be designed to keep track of hours worked, by whom, and on
what production orders. After approval by a production supervisor, time tickets provide the
information on number of hours worked directly on specific production orders. If time tickets are
properly used to record actual hours worked on orders, approval and/or review of these cards
should prevent direct labor hours from being incorrectly charged to manufacturing overhead.

The remaining answer choices are incorrect for the following reasons:

• Counts of work in process will not provide breakdowns between direct and indirect costs and
therefore would not prevent direct labor hours from being incorrectly charged to overhead.
• Errors may be made on the production orders. In order to prevent and/or detect errors regarding
direct labor hours, the production orders would have to be compared to time tickets.
• Work-in-process inventory is a total which combines direct labor and manufacturing overhead.
Even if this total is correct, direct labor could have been incorrectly charged to manufacturing
overhead.

In general, which of the following statements is correct with respect to a limited


partnership?

A limited partner has the right to obtain from the general partner(s) financial information
A)
and tax returns of the limited partnership.
B) A limited partnership can be formed with limited liability for all partners.
C) A limited partner may not also be a general partner at the same time.
D) A limited partner may hire employees on behalf of the partnership.
CPA REVIEW QUESTIONS

Correct Answer: A

Explanation: The law gives to all investors the right to inspect books and records at reasonable
times. Stockholders, general partners and limited partners all have this right. Thus, a limited
partner may obtain financial information to include tax returns. A limited partnership must have
at least one general partner and general partners are personally liable for all partnership debts. A
limited partner may also be a general partner in the same partnership at the same time. A limited
partner may not take part in the control of the partnership.

Cass is a general partner in Omega Company general partnership. Which of the following
unauthorized acts by Cass will bind Omega?

A) Submitting a claim against Omega to arbitration.


B) Confessing a judgment against Omega.
C) Selling Omega's goodwill.
D) Leasing office space for Omega.

Correct Answer: D

Explanation: It takes unanimous consent of all partners to submit a claim to arbitration, to


confess a judgment (admit liability in a law suit) and to sell the partnership's goodwill. Leasing
office space for the partnership by a partner would be within the partner's apparent authority.
Since it would be reasonable to believe that a partner could lease space, the partnership would be
bound.

Noll gives Carr a written power of attorney. Which of the following statements is correct
regarding this power of attorney?

A) It must be signed by both Noll and Carr.


B) It must be for a definite period of time.
C) It may continue in existence after Noll's death.
D) It may limit Carr's authority to specific transactions.

Correct Answer: D

Explanation: A power of attorney usually limits an agent's authority to specific transactions.

The remaining answer choices are incorrect for the following reasons:
CPA REVIEW QUESTIONS

• A power of attorney need only be signed by the principal, not the principal and the agent.
• A power of attorney may be for an indefinite period of time.
• Death of the principal terminates most agencies, to specifically include a power of attorney.

Which of the following is accurate as applies to the apparent authority of a partner to bind
the partnership in dealing with third parties?

It must be derived from the express powers and purposes contained in the partnership
A)
agreement.
It will be effectively limited by a formal resolution of the partners of which third parties are
B)
unaware.
It may allow a partner to bind the partnership to representations made in connection with
C)
the sale of goods.
D) It would permit a partner to submit a claim against the partnership to arbitration.

Correct Answer: C

Explanation: Partners are agents of the partnership and each other. A partner acting with real or
apparent authority can impose contract liability on the partnership and on their fellow partners.
Thus, a partner selling goods with either real or apparent authority would bind the partnership.

Apparent authority depends on how things appear to third parties, not on the express provisions
of the partnership agreement. If a partner's authority was expressly limited by a resolution and
the third party was unaware of the resolution, it may still appear that the partner was authorized.
In such a case, apparent authority would exist. Partnership law requires unanimous consent of all
partners to submit a claim to arbitration.

A bond issued on June 1, 2010, has interest payment dates of April 1 and October 1. Bond
interest expense for the year ended December 31, 2010, is for a period of:

A) Three months
B) Four months
C) Six months
D) Seven months

Correct Answer: D

Explanation: Interest expense begins on June 1, 2010 when the bond is issued and continues for
the seven months ending December 31, 2010.
CPA REVIEW QUESTIONS

In a properly designed internal control system, the same employee most likely would match
vendors' invoices with receiving reports and also:

A) Post the detailed accounts payable records


B) Recompute the calculations on vendors' invoices
C) Reconcile the accounts payable ledger
D) Cancel vendors' invoices after payment

Correct Answer: B

Explanation: The accounts payable, or vouchers payable, department has the responsibility to
prepare vouchers for payment. As part of that process, an employee in that department should
check vendors' invoices for mathematical accuracy by recomputing calculations and extensions,
and should match the vendors' invoices with receiving report sand purchase orders for quantities,
prices, and terms.

Which of the following most likely would not be considered an inherent limitation of the
potential effectiveness of an entity's internal control?

A) Incompatible duties
B) Management override
C) Mistakes in judgment
D) Collusion among employees

Correct Answer: A

Explanation: Segregating incompatible duties is a typical control procedure. Thus, the existence
of incompatible duties is a weakness in control procedures, not an inherent limitation of the
internal control structure. Even if control policies and procedures are placed in operation, the
potential effectiveness of an entity's internal control structure is subject to inherent limitations.
Mistakes in the application of policies and procedures may arise from such causes as mistakes in
judgment as well as personal carelessness, fatigue, and distraction. Also, policies and procedures
that require segregation of duties can be circumvented by management override or collusion
among internal or external parties.
CPA REVIEW QUESTIONS

Work Corp. has decided to expand the scope of its business. In this connection, it
contemplates engaging several agents. Which of the following agency relationships is within
the statute of frauds and thus should be contained in a signed writing?

A sales agency where the agent normally will sell goods which have a value in excess of
A)
$500
B) An irrevocable agency
C) An agency which is of indefinite duration but which is terminable upon one month's notice
An agency for the forthcoming calendar year which is entered into in mid-December of the
D)
prior year

Correct Answer: D

Explanation: The statute of frauds only requires a writing for contracts for sale of goods of $500
or more, real estate, contracts impossible to perform in one year, a promise to answer the debt of
another, an executor's promise to be personally liable for the debt of an estate and contracts
where marriage is the consideration (GRIPE + marriage). An agency entered into in mid-
December and to last for the entire next year would be impossible to perform in one year and
would require a writing.

The remaining answer choices are incorrect for the following reasons:

• Although the sales contracts of $500 or more would need a writing, the agency would not need
to be in writing.
• An irrevocable agency does not require a writing under the statute of frauds.
• An agency which is terminable upon one month's notice is not impossible to perform in one
year.

Generally, under the Revised Uniform Partnership Act, a partnership has which of the
following characteristics?

1. Unlimited duration
2. Obligation for payment of federal income tax

A) Unlimited duration
B) Obligation for payment of federal income tax
C) Unlimited duration & obligation for payment of federal income tax
D) Neither unlimited duration nor obligation for payment of federal income tax

Correct Answer: D
CPA REVIEW QUESTIONS

Explanation: A partnership is not usually considered to be a separate legal entity. Specifically, a


partnership does not pay federal income tax. A partnership does not have perpetual existence like
a corporation.

Gil Corp. has current assets of $90,000 and current liabilities of $180,000. Which of the
following transactions would improve Gil's current ratio?

A) Refinancing a $30,000 long-term mortgage with a short-term note


B) Purchasing $50,000 of merchandise inventory with a short-term account payable
C) Paying $20,000 of short-term accounts payable
D) Collecting $10,000 of short-term accounts receivable

Correct Answer: B

Explanation: The current ratio is equal to current assets divided by current liabilities. Any
transaction which will increase current assets proportionately more than current liabilities or
decrease current liabilities proportionately more than current assets will increase the current
ratio.

Purchasing $50,000 of inventory with a short-term account payable will increase both current
assets and current liabilities by $50,000. However, because the current ratio is less than 1 to 1,
the purchase will increase current assets proportionately more than current liabilities, and
increase the current ratio.

"Refinancing a $30,000 long-term mortgage with a short-term note" is incorrect as it will


increase only current liabilities, decreasing the current ratio.

"Paying $20,000 of short-term accounts payable" is incorrect as it will decrease current assets
proportionately more than current liabilities, decreasing the current ratio.

"Collecting $10,000 of short-term accounts receivable" is incorrect as it will not affect either
current assets or current liabilities. Therefore, the current ratio will be unchanged.

On September 1, 2010, Canary Co. sold used equipment for a cash amount equaling its
carrying amount for both book and tax purposes. On September 15, 2010, Canary replaced
the equipment by paying cash and signing a note payable for new equipment. The cash
paid for the new equipment exceeded the cash received for the old equipment. How should
these equipment transactions be reported in Canary's 2010 statement of cash flows?
CPA REVIEW QUESTIONS

A) Cash outflow equal to the cash paid less the cash received
B) Cash outflow equal to the cash paid and note payable less the cash received
Cash inflow equal to the cash received and a cash outflow equal to the cash paid and note
C)
payable
D) Cash inflow equal to the cash received and a cash outflow equal to the cash paid

Correct Answer: D

Explanation: On the statement of cash flows, the amounts reported as investing activities reflect
the actual inflows and outflows of cash. The amount of the note issued is reflected as a non-cash
significant investing and financing activity in a separate notation or schedule.

According to the standards of the profession, which of the following circumstances will
prevent a CPA performing audit engagements from being independent?

A) Obtaining a collateralized automobile loan from a financial institution client.


Litigation with a client relating to billing for consulting services for which the amount is
B)
immaterial.
C) Employment of the CPA's spouse as a client's internal auditor.
D) Acting as an honorary trustee for a not-for-profit organization client.

Correct Answer: C

Explanation: Under Rule 101 of the Rules of Conduct as interpreted, employment of a CPA's
spouse as an audit client's internal auditor would impair independence.

The remaining answer choices are incorrect for the following reasons:

• An auditor may obtain a collateralized automobile loan from a financial institution client
without impairing independence.
• Independence is not impaired by litigation with an audit client if the amount is immaterial and
not related to the audit work.
• An auditor may act as an honorary trustee for a not for profit audit client.

Which of the following steps in the strategic planning process should be completed first?
CPA REVIEW QUESTIONS

A) Translate objectives into goals


B) Determine actions to achieve goals
C) Develop performance measures
D) Create a mission statement

Correct Answer: D

Explanation: The creation of a mission statement is always the first step in the strategic
planning process. The mission statement outlines the essential reasons for its existence.
Translating of objectives into goals, determining actions to achieve goals, and developing
performance measures are steps that follow the mission statement.

When obtaining an understanding of an entity's internal control procedures, an auditor


should concentrate on the substance of the procedures rather than their form because:

A) The procedures may be operating effectively but may not be documented.


B) Management may establish appropriate procedures but not enforce compliance with them.
C) The procedures may be so inappropriate that no reliance is contemplated by the auditor.
D) Management may implement procedures whose costs exceed their benefits.

Correct Answer: B

Explanation: The auditor should concentrate on the substance of management's policies,


procedures, and related actions rather than their form because management may establish
appropriate policies and procedures but not act on them.

The remaining answer choices are incorrect for the following reasons:

• The lack of documentation is a form issue whereas operating effectiveness relates to substance,
which is what interests the auditor.
• If the auditor does not plan to rely, the difference between form and substance is irrelevant.
• "Management may implement procedures whose costs exceed their benefits." is not related to
the question in that it deals with management's cost/benefit evaluation of implementing controls,
not substance v. form.

n a statement of cash flows, which of the following would increase reported cash flows
CPA REVIEW QUESTIONS

from operating activities using the direct method? (Ignore income tax considerations.)

A) Dividends received from investments


B) Gain on sale of equipment
C) Gain on early retirement of bonds
D) Change from straight-line to accelerated depreciation

Correct Answer: A

Explanation: Dividends received from investments. Dividends received from investments are
classified as a cash flow from operating activities. Under the direct method of reporting cash
flows from operating activities, major classes of operating cash receipts and payments are shown
in the operating activities section of the statement of cash flows.

"Gain on sale of equipment" is incorrect because: 1) gains are not cash flows, and 2) proceeds
from the sale of equipment would be classified as investing activities, not operating activities.
"Gain on early retirement of bonds" is incorrect because: 1) gains are not cash flows, and 2) the
cash payment to retire debt would be classified as financing activities, not operating activities.
"Change from straight-line to accelerated depreciation" is incorrect, as a change in accounting
method is not a cash flow item.

Which of the following controls most likely would help ensure that all credit sales transactions of an
entity are recorded?

The billing department supervisor sends copies of approved sales orders to the credit department
A)
for comparison to authorized credit limits and current customer account balances.

The accounting department supervisor independently reconciles the accounts receivable


B)
subsidiary ledger to the accounts receivable control account monthly.

The accounting department supervisor controls the mailing of monthly statements to customers
C)
and investigates any differences reported by customers.

The billing department supervisor matches prenumbered shipping documents with entries in the
D)
sales journal.

Correct Answer: D
CPA REVIEW QUESTIONS

Explanation: A sale typically occurs and should be recorded when goods are shipped. Matching
prenumbered shipping documents with sales journal entries is a good control to ensure that all sales are
recorded. All the shipping documents should be accounted for as either resulting in a journal entry or
having been voided.

In which of the following situations would a CPA's independence be considered to be


impaired?

I. The CPA maintains a checking account that is fully insured by a government deposit
insurance agency at an audit-client financial institution.

II. The CPA has a direct financial interest in an audit client, but the interest is maintained
in a blind trust.

III. The CPA owns a commercial building and leases it to an audit client. The rental
income is material to the CPA.

A) I and II
B) II and III
C) I and III
D) I, II, and III

Correct Answer: B

Explanation: Under Rule 101 of the Rules of Conduct as interpreted, independence is impaired
if there is a direct financial interest in an audit client regardless of materiality. Thus any direct
financial interest in an audit client impairs independence. Independence is specifically impaired
if the auditor owns a building and leases space to the client. Independence is not impaired if the
CPA maintains a checking account at a financial institution audit client and the account is fully
insured by a government agency. II and III impair independence, but I does not.

Under the balanced scorecard concept developed by Kaplan and Norton, employee
satisfaction and retention are measures used under which of the following perspectives?

A) Customer
B) Internal business
CPA REVIEW QUESTIONS

C) Learning and growth


D) Financial

Correct Answer: C

Explanation: The balance scorecard approach is an outgrowth of the old goal congruence
concept. In both ideas, the effort was to look at the tradeoffs associated with each decision. For
example, a company may invest $100,000 in a machine that is more efficient and increases
profits versus investing in R&D. The decision may be the right one but at some point the
scorecard has to be balanced and the company has to invest in R&D. A typical scorecard
includes profitability; customer satisfaction; innovation; learning and growth; and efficiency,
quality and time. Employee satisfaction and retention are a part of learning and growth.