20 Financial Accounting & Reporting (FAR) Practice Questions & Answers

1. 1. Under the FASB Conceptual Framework, which pair represents the two FUNDAMENTAL qualitative characteristics of useful financial information?

   • A.Relevance and faithful representation✓ Answer
   • B.Comparability and verifiability
   • C.Materiality and consistency
   • D.Timeliness and understandability

   Concepts Statement No. 8, Chapter 3 designates relevance and faithful representation as the fundamental characteristics because information must first matter to a decision and then depict what it purports to depict. Comparability, verifiability, timeliness and understandability are only ENHANCING characteristics that increase usefulness of already relevant and faithfully represented information, and materiality is an entity-specific aspect of relevance rather than a separate characteristic.

   Source: FASB Concepts Statement No. 8, Chapter 3 (Qualitative Characteristics of Useful Financial Information)Report a problem with this question

2. 2. A company reports net income of $200,000. Depreciation expense was $30,000; it recorded a $12,000 gain on the sale of equipment; accounts receivable increased $18,000; inventory decreased $9,000; and accounts payable decreased $7,000. Using the INDIRECT method, what is net cash provided by operating activities?

   • A.$214,000
   • B.$202,000✓ Answer
   • C.$226,000
   • D.$184,000

   The indirect method starts with net income and removes noncash items and items whose cash effect belongs to another category, then adjusts for working-capital changes: $200,000 + $30,000 depreciation − $12,000 gain (its full proceeds are an investing inflow, so the gain must be backed out of operations) − $18,000 receivable increase + $9,000 inventory decrease − $7,000 payable decrease = $202,000. An increase in an operating asset uses cash while a decrease in an operating liability uses cash, which is why those two items are subtracted.

   Source: FASB ASC 230-10-45-28 (indirect method reconciliation of net income to net operating cash flow)Report a problem with this question

3. 3. A U.S. GAAP reporting entity pays cash dividends to its common shareholders and pays cash interest on its outstanding bonds. How are these two payments classified in the statement of cash flows?

   • A.Both dividends paid and interest paid are operating
   • B.Dividends paid are operating; interest paid is financing
   • C.Both dividends paid and interest paid are financing
   • D.Dividends paid are financing; interest paid is operating✓ Answer

   Under U.S. GAAP the classification follows whether the payment enters the determination of net income: interest expense is a component of net income, so interest paid is an operating outflow, while dividends are a return of capital to owners and therefore a financing outflow. The same logic makes interest and dividends RECEIVED operating inflows, because they too flow through net income.

   Source: FASB ASC 230-10-45-15 through 45-17 (classification of operating and financing cash flows)Report a problem with this question

4. 4. A nongovernmental not-for-profit organization receives a $100,000 cash gift that the donor restricts to the purchase of laboratory equipment. During the same year the organization spends $60,000 of that gift on qualifying equipment. How should these events be reported in the statement of activities?

   • A.$40,000 of contribution revenue with donor restrictions and $60,000 of contribution revenue without donor restrictions
   • B.$100,000 of contribution revenue with donor restrictions, and $60,000 shown as net assets released from restrictions — a reclassification between the two net asset classes, not additional revenue✓ Answer
   • C.$100,000 of contribution revenue without donor restrictions, with no reclassification because the equipment was purchased in the same year
   • D.$60,000 of contribution revenue in the current year and $40,000 recorded as deferred revenue until spent

   A donor-restricted contribution is recognized as revenue in full, in the net assets WITH donor restrictions class, in the period the unconditional gift is received; satisfying the restriction later does not create new revenue. When the restriction is met, the amount is reported as 'net assets released from restrictions,' a reclassification that simultaneously decreases net assets with donor restrictions and increases net assets without donor restrictions, so total net assets are unchanged by the release.

   Source: FASB ASC 958-205 and ASC 958-605 (two net asset classes; net assets released from restrictions)Report a problem with this question

5. 5. A city prepares both fund financial statements and government-wide financial statements. Which combination of measurement focus and basis of accounting is correct?

   • A.Governmental funds use the economic resources focus and full accrual basis; government-wide statements use the current financial resources focus and modified accrual basis
   • B.All funds and the government-wide statements use the current financial resources focus and modified accrual basis
   • C.Governmental and proprietary funds both use modified accrual, while only fiduciary funds use full accrual
   • D.Governmental funds use the current financial resources focus and modified accrual basis; government-wide statements use the economic resources focus and full accrual basis✓ Answer

   Governmental funds are stewardship-oriented and therefore report only near-term inflows and outflows of spendable resources, so revenues are recognized when measurable and AVAILABLE and expenditures when the fund liability is incurred. Proprietary funds, fiduciary funds and both government-wide statements measure economic resources on the full accrual basis, which is why capital assets and long-term debt appear there but not in a governmental fund balance sheet.

   Source: GASB Codification Section 1600 (Basis of Accounting) and Section 2200 (government-wide reporting); GASB Statement No. 34Report a problem with this question

6. 6. A city levies a special property tax whose proceeds are legally restricted by statute to the ongoing maintenance and operation of city parks. In which fund should the city account for this restricted revenue and the related park maintenance spending?

   • A.Special revenue fund✓ Answer
   • B.Capital projects fund
   • C.Permanent fund
   • D.General fund

   A special revenue fund is used to account for the proceeds of specific revenue sources that are restricted or committed to expenditure for a specified purpose other than debt service or capital projects, which is exactly the case for a park-maintenance-restricted tax levy. A capital projects fund would be used only for acquisition or construction of major capital facilities, and a permanent fund only when the PRINCIPAL must be preserved and only earnings may be spent.

   Source: GASB Codification Section 1300.107 (fund type definitions); GASB Statement No. 54Report a problem with this question

7. 7. A corporation reports net income of $950,000 for the year. It had 20,000 shares of 10%, $100 par CUMULATIVE preferred stock outstanding all year, and no preferred dividends were declared. The weighted-average number of common shares outstanding was 300,000. What is basic earnings per share?

   • A.$2.34
   • B.$3.17
   • C.$2.83
   • D.$2.50✓ Answer

   Basic EPS is (net income − preferred dividends) ÷ weighted-average COMMON shares, and for CUMULATIVE preferred the current year's dividend entitlement is subtracted whether or not it is declared because it accumulates as a claim against income available to common shareholders. Preferred dividends = 20,000 × $100 × 10% = $200,000, so basic EPS = ($950,000 − $200,000) ÷ 300,000 = $2.50; the preferred shares themselves are never included in the denominator.

   Source: FASB ASC 260-10-45-11 (basic EPS; cumulative preferred dividends deducted whether or not declared)Report a problem with this question

8. 8. At December 31 a company's records show: checking account $85,000; a money market fund with an original maturity of 60 days $40,000; petty cash $500; a U.S. Treasury bill purchased with a 90-day original maturity $30,000; a certificate of deposit maturing in 9 months $25,000; a customer check dated two months after year end $3,000; and a customer check returned NSF $2,000. What amount should be reported as cash and cash equivalents?

   • A.$158,500
   • B.$180,500
   • C.$155,500✓ Answer
   • D.$125,500

   Cash equivalents are only those highly liquid investments with an ORIGINAL maturity of three months or less from the date of purchase, so the checking account $85,000, money market fund $40,000, petty cash $500 and the 90-day Treasury bill $30,000 total $155,500. The 9-month CD fails the original-maturity test, and the postdated check and the NSF check are not cash at all — both must be reclassified back to accounts receivable because they do not represent funds currently available for disbursement.

   Source: FASB ASC 305-10-20 and ASC 230-10-20 (definition of cash equivalents — original maturity of three months or less)Report a problem with this question

9. 9. While preparing the December bank reconciliation, an accountant identifies four reconciling items. Which one requires an adjusting journal entry on the COMPANY'S books?

   • A.A monthly bank service charge deducted by the bank but not yet recorded by the company✓ Answer
   • B.Checks written and mailed in December that had not cleared the bank at December 31
   • C.A deposit made on December 31 that the bank recorded on January 2
   • D.A deposit belonging to another customer that the bank erroneously credited to the company's account

   Only BOOK-side reconciling items require a journal entry, because those are amounts the bank already knows about that the company has not yet recorded — service charges, NSF checks, bank collections and company recording errors. Deposits in transit, outstanding checks and bank errors are BANK-side items that the bank will clear or correct on its own, so they adjust the bank balance on the reconciliation but never generate an entry in the company's general ledger.

   Source: FASB ASC 305-10 (cash); standard bank reconciliation methodology — book-side vs. bank-side reconciling itemsReport a problem with this question

10. 10. A company's allowance for credit losses had a beginning credit balance of $40,000. During the year it wrote off $28,000 of specific accounts and recovered $5,000 previously written off. Applying its CECL model, management determines the allowance should be $52,000 at year end. What is credit loss (bad debt) expense for the year?

    • A.$63,000
    • B.$35,000✓ Answer
    • C.$52,000
    • D.$40,000

    Write-offs and recoveries are recorded entirely within the allowance account and never touch expense: the allowance rolls forward $40,000 − $28,000 + $5,000 = $17,000 before adjustment. Expense is the plug needed to bring the allowance to the required balance, so $52,000 − $17,000 = $35,000, which reflects the CECL principle that expense is driven by the estimate of expected lifetime losses rather than by actual write-off activity.

    Source: FASB ASC 326-20 (current expected credit losses; allowance rollforward)Report a problem with this question

11. 11. A company using a PERIODIC inventory system had beginning inventory of 100 units at $10 each, then purchased 200 units at $12 and later 150 units at $14. It sold 300 units during the period. Under FIFO, what is ending inventory?

    • A.$1,833
    • B.$3,400
    • C.$2,100✓ Answer
    • D.$1,600

    FIFO assumes the oldest costs flow to cost of goods sold first, so the 150 units remaining (100 + 200 + 150 − 300) are the most recently purchased units and are valued at the newest cost layer: 150 × $14 = $2,100. The $1,833 answer applies weighted average, $1,600 applies LIFO, and $3,400 is FIFO cost of goods sold rather than ending inventory.

    Source: FASB ASC 330-10-30 (inventory cost determination; first-in, first-out cost flow assumption)Report a problem with this question

12. 12. Which statement correctly describes the SUBSEQUENT measurement rule for inventory under U.S. GAAP?

    • A.All inventory, regardless of costing method, is measured at the lower of cost or market using the ceiling and floor constraints
    • B.All inventory, regardless of costing method, is measured at the lower of cost and net realizable value
    • C.Inventory measured using FIFO or weighted average uses the ceiling-and-floor market test, while LIFO inventory uses net realizable value
    • D.Inventory measured using LIFO or the retail method is carried at the lower of cost or market, where market is replacement cost bounded by a ceiling of NRV and a floor of NRV less a normal profit margin; all other methods use lower of cost and net realizable value✓ Answer

    ASU 2015-11 simplified subsequent measurement to lower of cost and net realizable value, but it deliberately EXCLUDED inventory measured using LIFO or the retail inventory method, which retained the older lower-of-cost-or-market model with the NRV ceiling and NRV-less-normal-profit floor. The costing method therefore determines which rule applies, and under either model a write-down establishes a new cost basis that may not be reversed in a later period.

    Source: FASB ASC 330-10-35-1B and 35-1C (LCNRV) vs. ASC 330-10-35-1 to 35-7 (LCM for LIFO and retail method)Report a problem with this question

13. 13. Equipment held and used has a carrying amount of $900,000. Because of a significant adverse change in its business climate, the company tests it for impairment and determines the sum of expected UNDISCOUNTED future cash flows from the asset is $950,000, while its fair value is $700,000. What impairment loss should be recognized?

    • A.$50,000
    • B.$200,000
    • C.$0✓ Answer
    • D.$250,000

    Impairment of a long-lived asset held and used is a TWO-STEP test: step one compares carrying amount to the sum of expected UNDISCOUNTED future cash flows, and only if the carrying amount exceeds that undiscounted total is the asset deemed not recoverable. Here $950,000 exceeds the $900,000 carrying amount, so the asset is recoverable and no loss is recorded — the $700,000 fair value is simply never reached because step two is never performed.

    Source: FASB ASC 360-10-35-17 (recoverability test using undiscounted cash flows) and 35-17 measurement at fair valueReport a problem with this question

14. 14. On January 2, an investor acquired 30% of the voting common stock of an investee for $500,000, obtaining significant influence; the price equaled 30% of the investee's book value, with no basis differences. For the year the investee reported net income of $200,000 and paid total cash dividends of $80,000. What is the carrying amount of the investment at December 31?

    • A.$536,000✓ Answer
    • B.$584,000
    • C.$560,000
    • D.$500,000

    Under the equity method the investment account is increased by the investor's share of investee earnings and DECREASED by dividends received, because a dividend is a return of part of the investment rather than income: $500,000 + (30% × $200,000) − (30% × $80,000) = $500,000 + $60,000 − $24,000 = $536,000. Treating the $24,000 of dividends as revenue (giving $560,000 or $584,000) is the classic error, and $500,000 would only result under a fair value or cost approach that significant influence prohibits.

    Source: FASB ASC 323-10-35-4 (equity method: share of earnings increases, dividends reduce the investment)Report a problem with this question

15. 15. An entity enters a single contract to deliver a machine and provide two years of maintenance service for a total price of $100,000. The observable standalone selling prices are $90,000 for the machine and $30,000 for the maintenance. The machine is delivered and control transfers at contract inception. How much revenue is recognized on delivery of the machine?

    • A.$100,000
    • B.$70,000
    • C.$75,000✓ Answer
    • D.$90,000

    Step 4 of the ASC 606 model allocates the transaction price to each distinct performance obligation in proportion to RELATIVE standalone selling prices, not at the standalone price itself: $100,000 × ($90,000 ÷ $120,000) = $75,000 for the machine and $25,000 for the maintenance. Recognizing $90,000 would ignore the discount inherent in the bundle, and recognizing $100,000 would ignore the unsatisfied maintenance obligation that must be recognized over the two-year service period.

    Source: FASB ASC 606-10-32-31 through 32-33 (allocation based on relative standalone selling prices)Report a problem with this question

16. 16. A lessee classifies a three-year equipment lease as an OPERATING lease under ASC 842. Which statement correctly describes the lessee's accounting?

    • A.A right-of-use asset and lease liability are recognized, and the lessee reports separate interest expense and amortization expense
    • B.A right-of-use asset and lease liability are recognized at commencement, and a single lease cost is recognized on a straight-line basis over the lease term✓ Answer
    • C.No asset or liability is recognized; lease payments are simply expensed as incurred
    • D.The lessee recognizes only a lease liability, with the payments charged directly to retained earnings

    ASC 842 requires a lessee to put virtually every lease on the balance sheet, so an operating lease still produces a right-of-use asset and a lease liability measured at the present value of the lease payments. The classification difference shows up only in the income statement: an operating lease produces ONE straight-line lease cost, while a finance lease produces separate interest on the liability and amortization of the ROU asset, giving a front-loaded expense pattern.

    Source: FASB ASC 842-20-25-6 and 842-20-45 (lessee recognition; single straight-line lease cost for operating leases)Report a problem with this question

17. 17. On January 1, a company issued $500,000 face amount of 5-year bonds paying 6% interest annually. The bonds were issued for $460,000 to yield an effective interest rate of 8%. Using the effective interest method, what is interest expense for the first year?

    • A.$36,800✓ Answer
    • B.$30,000
    • C.$27,600
    • D.$40,000

    Under the effective interest method, interest expense equals the CARRYING amount of the debt multiplied by the market (effective) rate: $460,000 × 8% = $36,800. Cash interest is the face amount times the stated rate ($500,000 × 6% = $30,000), and the $6,800 excess is discount amortization that increases the carrying amount toward face value over the bond's life.

    Source: FASB ASC 835-30-35-2 (interest method: constant effective rate applied to carrying amount)Report a problem with this question

18. 18. Which of the following gives rise to a PERMANENT difference that does NOT create a deferred tax asset or liability?

    • A.An allowance for credit losses deducted for book purposes but deductible for tax only when the account is written off
    • B.Accelerated depreciation used for tax purposes and straight-line depreciation used for book purposes
    • C.Rent collected in advance that is taxable when received but recognized as revenue when earned
    • D.Interest income earned on state and municipal bonds that is exempt from federal income tax✓ Answer

    A permanent difference is an item that enters book income or taxable income but NEVER the other, so it changes the effective tax rate without ever reversing; tax-exempt municipal interest, life insurance proceeds on officers, and fines and penalties are the classic examples. The other three choices are temporary differences that reverse in future periods and therefore must be measured as deferred tax assets or liabilities at the ENACTED rate expected to apply when they reverse.

    Source: FASB ASC 740-10-25 and 740-10-30-8 (temporary vs. permanent differences; enacted tax rates)Report a problem with this question

19. 19. A company is a defendant in a lawsuit. Counsel advises that a loss is PROBABLE and that the loss will fall somewhere between $200,000 and $500,000, with no amount in that range being a better estimate than any other. Under U.S. GAAP, what should the company do?

    • A.Accrue $200,000 and disclose the nature of the contingency and the range of possible loss✓ Answer
    • B.Accrue $500,000, the maximum exposure in the range
    • C.Accrue $350,000, the midpoint of the range
    • D.Accrue nothing and disclose the range, because no single amount within the range is the best estimate

    A loss contingency is accrued when it is both probable that a liability has been incurred and the amount is reasonably estimable; when only a RANGE is estimable and no amount within it is a better estimate than any other, U.S. GAAP requires accruing the LOW end of the range. The range itself must then be disclosed so users understand the additional exposure above the amount accrued.

    Source: FASB ASC 450-20-30-1 (accrue the minimum of the range when no amount is a better estimate)Report a problem with this question

20. 20. At the beginning of the current year, a company changes its method of depreciating manufacturing equipment from double-declining balance to straight-line because the pattern of consumption of the assets' benefits has changed. How should this change be reported?

    • A.As a change in accounting principle, applied retrospectively by restating all prior periods presented
    • B.As a correction of an error, reported as a prior period adjustment to beginning retained earnings
    • C.As a cumulative catch-up adjustment reported in current-period income as a separate line item
    • D.As a change in accounting estimate effected by a change in accounting principle, applied prospectively to the current and future periods with no restatement✓ Answer

    ASC 250 explicitly treats a change in depreciation, amortization or depletion method as a change in accounting ESTIMATE effected by a change in accounting principle, because the new method reflects a revised assessment of how the asset's future benefits will be consumed. Changes in estimate are accounted for PROSPECTIVELY — the remaining carrying amount is depreciated under the new method over the remaining useful life, and prior-period statements are never restated.

    Source: FASB ASC 250-10-45-17 and 250-10-45-18 (change in depreciation method = change in estimate effected by a change in principle; prospective)Report a problem with this question

Concept-focused practice questions based on the AICPA CPA Exam Blueprints. Not affiliated with the AICPA or NASBA, and not accounting, tax, or legal advice. Specific dollar thresholds change yearly — confirm current figures with authoritative sources. About the CPA Exam →